When practice business entities go wild

Physicians and veterinarians seem to have a minimalist attitude when it comes to all things legal. They tend to consider time spent working on any project that doesn't involve a quantifiable or qualitative improvement in the life of a patient to be "busy work" and somehow fundamentally meaningless.

At least in some instances, doctors of all stripes can identify some benefit to desk-related undertakings. Insurance forms are annoying, but at least they result in fees being received. Thorough medical records are known to be important to diagnosis and therapy. But more esoteric paperwork related to business and law often is ignored. These just don't seem important—until the consequences of this perpetual procrastination becomes manifest.

Nowhere does this neglect of legal detail work show up more often than in the maintenance (or lack thereof) of a veterinarian's business entity. Here's what usually happens: The veterinary practitioner opens up his or her office and decides whether it will operate as a proprietorship, a general partnership, a corporation or an LLC. After the practice's attorney files the necessary papers, the business entity's documentation is never looked at again.

In the case of a partnership, this would include any partnership agreement or employment contracts. For a corporation, such documents include corporate bylaws and shareholder agreements. An LLC (limited liability company) has an operating agreement that controls business operations and decision-making.

Failing to keep these documents current is a big problem. Business entities are like living things—if they're not tended to and cared for, they can become dangerous. Complete abandonment of a corporation or LLC can actually kill it. The primary symptom of a neglected business entity is an unanticipated and voracious appetite for cash. Other complications can include severe irritation due to letters from the IRS and an embarrassing failure to perform during the act of executing an exit strategy.

Abandoning an LLC

It took the IRS, as well as a number of the more conservative state legislatures, to completely embrace the benefits and flexibility of the LLC business entity. Now, however, these organizational structures are available as an outstanding option for organizing a veterinary practice. Setting one up is simple enough, and once it's done, it offers exceptional liability limitations and pass-through taxation opportunities. Unless an LLC is formed and then subsequently ignored.

Many health professionals organize their professional practices using the LLC framework. Once their state's Secretary of State accepts the formation documents, the professionals often begin working and never look at their LLC or LLP documents again.

Fast forward 20 years when such a practice is sold and the owner(s) prepare to file their final income tax return. The practice purchaser will likely take title to the assets of the company. Then, somewhere along the line, final owner profit distributions and sales taxes on the practice assets will have to be paid. Capital gains and losses on some LLC assets may then need to be determined at the time the LLC is wound up. This is often the point when the owners' abandonment of the LLC or LLP paperwork comes home to roost. Here's an example:

Dr. A contributed operating capital funds to the "Smalltown Animal Hospital LLC" at various times during the early years. Then later, Dr. B came along as an additional owner. He turned over his mobile clinic vehicle to the LLC. When associate Dr. C joined the practice, the LLC loaned him $5,000 for moving expenses but then took his orthopedic surgery equipment in payment for the loan when he, too, was asked to become an owner.

When the members decide to sell the practice to a huge corporate veterinary practice chain (owners of an LLC are called "members"), each one will receive final payment of profit and his share of the value of the LLC assets. But in this instance, nobody can remember how much was contributed by whom and how long ago. This makes tax filing for all members a huge mess, because each member's tax is based on how much capital he individually has contributed to the LLC and how much was taken back out by him in the past (as pay, profit or return of capital).

Neglecting a corporation

Here's our scenario for corporate troubles because of paperwork procrastination:

Multidoctor Veterinary Hospital PC (that's professional corporation) was a veterinary business set up by a pair of boarded internists shortly after they completed their residencies. Their lawyer filed the PC paperwork, and each doctor received a stock certificate for 25 shares.

Over the years, every time a new doctor came into the practice, the PC would issue him or her 10 shares from the supply of blank stock certificates. Eventually, there were 10 shareholders.

Then the newer doctors decided they wanted to make some major decisions about pension plans and purchasing some expensive equipment. They also wanted to consider cutting back compensation for the two practice founders (whom they believed had recently been "slacking.")

The founding two doctors would have none of that! One was "president" and the other was "vice president" of the PC. They said they simply wouldn't allow it.

Too bad nobody ever completed the corporate bylaws or any shareholder agreement indicating how corporate decisions would be made. No paperwork existed telling how PC officers would actually be elected or how long their terms would last.

In fact, legally, Multidoctor PC had no president and no vice president, nor did they have a secretary or treasurer for that matter. The practice just had two aging veterinarians who believed they had the authority to decide stuff. When the founding shareholders called their respective attorneys, each was asked to fax over a copy of the corporate bylaws. There were none—so a meeting of all shareholders was arranged.

As one might imagine, decisions ended up being made that the original two owners did not embrace. When the younger vets pooled their total of 80 shares, much of what the founders wanted to see become policy didn't. They were outvoted on many of the issues over which they thought they had control due to their imaginary "officer" status.

Ignoring a general partnership

General partnerships are generally such a poor way to set up a veterinary practice that I am only going to address one area of their maintenance. In a partnership arrangement, it is critical to remember that a person's life changes over time and each partner's intentions may change as well.

While the liability traps associated with general partnership cannot be avoided regardless of how carefully the partnership paperwork is maintained, another huge set of problems can be sidestepped with good planning and appropriate documentation. These are the issues and disagreements associated with each partner's exit strategy.

Even in the most functional and amicable partnerships, there comes a time when one or more of the partners wants—or needs—to cash out and depart the partnership either to work part time or to move onto retirement or other pursuits. If the partnership agreement that was in force at the outset of the partnership has never been revisited, this can present a fertile area for disagreement between the departing partner and the remaining partners.

For example, consider these questions: To whom may the departing partner sell his interest in the practice? Does he owe the other partners a right of first refusal to purchase that interest? If so, what price would be appropriate?

If the partner who is "easing back" from his day-to-day role in the practice wants to continue to be an owner, is that permitted? Can he continue to have a role in decisions about profit distribution? Will he still have a say in hiring, firing and employee compensation?

Do you want any of that to happen to you? It's natural to duck paperwork, but don't neglect the crucial documents that represent your standing in your veterinary practice.

Dr. Allen is president of the Associates in Veterinary Law P.C., which provides legal and consulting services to veterinarians. Call (607) 754-1510 or email info@veterinarylaw.com.