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Avoiding Gaps in Your Partnership or Group Practice's Operating Agreement

July 26, 2010
Because of the potential drawbacks and pitfalls of a group practice, dentists considering this form of practice should enter into a well-crafted, comprehensive agreement to govern the affairs of the “partnership.”

by Barry F. Levin, Esquire and Philip M. Bogart, Esquire

Practicing in a partnership or group practice with one or more dentists has several advantages. In many situations, these practices offer dentists the potential of enjoying more personal freedom and producing higher income with lower overhead. Dentists can also take advantage of sharing management responsibilities, marketing duties, and operational costs.

However, because of the potential drawbacks and pitfalls of a group practice, dentists considering this form of practice should enter into a well-crafted, comprehensive agreement to govern the affairs of the “partnership.”

One of the biggest blunders made by dentists is not having a written, thorough, all-inclusive agreement. A handshake is never enough. Even among the best of friends, disputes arise. A well-crafted agreement will help avoid misunderstandings because it is the “road map” for the partnership arrangement. Often, solid agreements avoid disputes that otherwise might cause ill will, the dissolution of the practice and, in some cases, litigation (where there are no winners). The time to negotiate and execute the agreement is at the outset of the relationship, when the dentists’ interests are most aligned. This is not to suggest that it is ever too late to enter into a written agreement if you are currently operating pursuant to a handshake.

Lately, the preferred entity of choice is the limited liability company or, in some states, the professional limited liability company. This article discusses the limited liability company operating agreement (which, in some states, is called a limited liability company agreement). If the practice is a corporation, many of the issues outlined below may be covered in the dentists’ shareholders’ agreement, employment agreements, and bylaws.

While many jointly owned practices purport to have written operating agreements, many such agreements fail to address a broad enough range of circumstances and conditions. Generic “form” agreements can be more damaging than no written agreement at all. That said, even the best of operating agreements often contain gaps. The following is a list of matters/issues which, at a minimum, should be considered and addressed before finalizing an operating agreement:

1. Effective Date — While this may seem elementary, it is surprising how often parties forget to date the agreement or otherwise agree upon an effective date.

2. Signatures — It is astonishing how often dentists procrastinate and never actually sign their operating agreement (or amendments to the same)! It is almost impossible to enforce an unsigned agreement.

3. Term — Does the LLC have a definite term or is it perpetual?

4. Principal Office/Resident Agent/Registered Office — If required by state law, where are these located?

5. Revenue and Expenses — How will the dentists share the revenue of the practice? Many dentists have discovered that sharing profits based upon ownership (e.g., 50/50) does not work, as neither dentist is rewarded for working hard. On the other hand, splitting revenue based upon productivity alone can be counter productive to developing a feeling of teamwork in the practice. It may be optimal for dentists to agree upon a formula that takes into account both productivity and ownership.

6. Draws Does each member receive a fixed salary or a draw (i.e., an advance of his or her compensation)? If the LLC permits draws, how and when are the actual compensation amounts reconciled with the amounts drawn by each dentist?

7. Capital — Initially, how much cash must each member contribute to the LLC? Are members required to contribute additional cash (i.e., a capital call)? What happens if a member fails to contribute the required sum?

8. New Members — How may new members can be admitted to the LLC?

9. Guarantees — If the LLC requires a bank loan, must the other members (and their spouses) personally guarantee the LLC’s debt? Must each member agree to reimburse the other member(s) if anyone satisfies more than his or her share of the LLC’s liability? One item often missed is how a member’s obligation to guarantee a debt will be handled upon that member’s withdrawal.

10. Tax Allocations— An LLC is very versatile, and taxable profits and losses may be allocated among the members in many ways. A tax advisor and each party’s personal accountant should review these relevant sections.

11. Management— The operating agreement should clearly delineate how decisions are to be made. Frequently, one dentist may have the day-to-day authority, while “significant decisions” may require a majority or unanimous vote. If that is the case, the operating agreement should include an exhaustive list of “significant decisions.” The operating agreement should also provide whether the managing member is paid for his or her administrative duties. Often, dentists fail to appreciate the time and energy needed to manage the affairs of a practice, so a management fee may be appropriate.

12. Signing Authority — Even if there is only one manager, do other members have the authority to sign checks or otherwise bind the LLC?

13. Meetings — How often will the members meet?

14. Financial Data — Will the nonmanaging members have access to the books and records of the LLC? How often will the LLC prepare reports?

15. Employment Issues — Typically, each member would also enter into a member service agreement (similar to an employment agreement) with the LLC to address various employment-related issues. Alternatively, these items can also be included in the operating agreement. Regardless of the placement of these employment terms, the following issues should be addressed:
(a) Compensation (as discussed above);
(b) Benefits (for example, an automobile or mobile telephone allowance, reimbursements for continuing education and dues and/or licenses)
(c) Number of days per week required by each member for both clinical and administrative duties
(d) Marketing responsibilities
(e) Vacation
(f) Does the LLC or each member pay for malpractice insurance (including ‘the tail’ upon the withdrawal of a member)?
(g) Noncompetition and non-solicitation restrictions (where permitted)
(h) Nondisclosure restrictions.

16. Expulsion — Can a member be expelled if he or she fails to meet a specific productivity or profitability threshold? Do other circumstances permit the LLC to remove a member? What happens if a member’s license to practice dentistry is suspended or revoked? If a member is expelled, how much will the LLC pay that member for the interest? What are the payment terms?

17. New Patients — How are new patients split among the doctors? How should the receptionist “divide” new incoming calls?

18. Transfers of Ownership Interests — Can a dentist sell his or her interest to another dentist? Should the remaining dentists have a right of first refusal?

19. Bankruptcy of a Member — The operating agreement should give the LLC the right to purchase a member’s interest if the member becomes bankrupt or insolvent.

20. Deadlocks — What happens if the dentists cannot agree? How will deadlocks be resolved?

21. Death/Disability — There are several considerations here:
(a) What happens if a dentist dies or becomes disabled? Is the LLC (or the remaining members) required to purchase that member’s interest or is there merely an option to purchase?
(b) How is “disability” defined?
(c) How is the purchase price determined? Is it based upon an appraisal or an agreed-upon formula (e.g., a multiple of the annual compensation of the members)?
(d) What are the payment terms? Cash or overtime? If the LLC is the purchaser, must the other member(s) guarantee the obligation? Is the obligation secured (with a lien on the LLC interests or assets)?
(e) How will the purchase price be funded? Life/disability buy-out insurance?

22. Retirement/Withdrawal — Can a member retire and require the LLC (or the remaining members) to purchase the interest? If so, as stated above, the agreement should provide the method for assessing the value of the interest, the payment terms, etc. What happens if more than one member wants to retire at the same time or a few months apart? Furthermore, is a member permitted to otherwise withdraw? If so, can that member require the LLC (or the remaining members) to purchase his or her interest? This issue is especially important if the applicable state limited liability company act provides default rules permitting a member to unilaterally withdraw from the LLC.

23. Dissolution — Under what circumstances can the LLC be dissolved? This issue is particularly important if the applicable law provides default rules permitting one member to unilaterally cause a dissolution.

24. Amendments — How many members are required to agree upon an amendment to the operating agreement?

25. Disputes — If the parties need to litigate a dispute, must they submit their differences to mediation or binding arbitration?

In sum, the goal of the operating agreement is to provide the LLC and the dentists with clarity, certainty, and a “roadmap” on how to operate the practice on a day-to-day basis, as well as how to address matters which must be dealt with from time to time. Working with a trusted legal advisor who understands the business and challenges of a group dental practice can ensure that the operating agreement is as comprehensive as possible. Agreeing upon these issues at the outset is key to launching a strong dental practice with understood and accepted ground rules. In other words, as with brushing your teeth, an ounce of prevention is worth a pound of cure!

Barry F. Levin is a partner and vice chair of Saul Ewing LLP’s business department. Philip M. Bogart is a special counsel in the business department in Saul Ewing LLP’s Baltimore office. They represent dentists and the business entities in which clinicians practice in all aspects of the dental practice structure through and including the structuring, negotiation, documentation, and implementation of associateships or employee arrangements, partnership arrangements, acquisitions, sales, and mergers of mature practices.