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When a PPM enters into a long-term management service agreement with the medical entity rather than acquiring the medical entity's stock outright, the PPM first considers whether the Variable Interest Entities subsections of ASC 810, Consolidation, apply. If so, the PPM applies that guidance in evaluating whether it should consolidate the assets and operations of the medical practice. If the VIE guidance does not apply, the PPM assesses the need for consolidation in accordance with the provisions of the Consolidation of Entities Controlled by Contract subsections of ASC 810-10, as discussed in the remainder of this ARM section.
A PPM can establish a "controlling financial interest" in a medical entity solely through contractual arrangements (i.e., the MSAs) if the PPM has both "control" over the medical entity and a "financial interest" in the medical entity, as determined based on the following six requirements (ASC 810-10-15-22):
Contract term
1.
The term of the contractual arrangement between the PPM and the medical practice is for either (i) the remaining legal life of the physician practice entity (if applicable) or (ii) 10 years or more.
2.
The contractual arrangement is not terminable by the physician practice except in cases of gross negligence, fraud, or other illegal acts by the PPM, or upon bankruptcy of the PPM.
Control of the medical entity
3.
The PPM has exclusive authority over all decision-making related to ongoing, major or central operations of the physician practice, except for the dispensing of medical services.
4.
The PPM has exclusive authority over all decision-making related to total practice compensation of the licensed medical professionals, as well as the ability to establish and implement guidelines for the selection, hiring and firing of them.
Financial interest
5.
The PPM must have a significant financial interest in the physician practice that is unilaterally salable or transferable.
6.
The PPM's significant financial interest must provide the PPM with the right to receive income (both as ongoing fees and as proceeds from the sale of its interest in the physician practice) in an amount that fluctuates based upon the performance of the operations of the physician practice and the change in the fair value thereof.
Contract term (ASC 810-10-25-63 through 25-64). The first two criteria focus on the long-term nature of the contractual relationship. The contractual agreement between the PPM and the medical entity must be for a period of ten years or more (or for the remaining legal life of the entity, if shorter) and may not be terminable by the medical entity except in the event of gross negligence, fraud or other illegal activities, or bankruptcy of the PPM. The evaluation of whether the contractual arrangement can be considered long-term should be based on substance as opposed to form. Therefore, both the original stated contract term and any renewal or cancellation provisions must be considered; for example, an agreement having an initial stated term of five years, with one five-year renewal option exercisable solely at the discretion of the PPM, is considered "long-term" because it is collectively a ten-year contract. (Note: ASC 810-10-25-64 indicates that use of a contract period of ten years or more is specific to this particular guidance, and should not be applied in other consolidation situations).
Control of the medical entity (ASC 810-10-25-65 through 25-72). A two-pronged approach is used for evaluating whether control exists, depending on whether or not the contractual arrangement uses the "nominee shareholder" model (which generally is regarded as the most effective way to demonstrate control in such situations). ASC 810-10-25-65 provides the following description of a nominee shareholder arrangement (which again may not be unique to this industry):
"One or more shareholders whose relationship with the PPM (which can be either the PPM itself or its controlled subsidiaries) perpetually has all of the following characteristics:
Time Frame:
  • The PPM can at all times establish or effect a change in the nominee shareholder.
  • The PPM can cause a change in the nominee shareholder an unlimited number of times, that is, changing the nominee shareholder one or more times does not affect the PPM's ability to change the nominee shareholder again and again.
Discretion:
  • The PPM has sole discretion without cause to establish or change the nominee shareholder.
  • The PPM can name anyone as a new nominee shareholder (that is, the PPM's choice of an eligible nominee is not limited).
Impact:
  • The PPM and the nominally owned entity incur no more than a nominal cost to cause a change in the nominee shareholder.
  • Neither the PPM nor the nominally owned entity is subject to any significant adverse impact upon a change in the nominee shareholder.
When the contractual arrangement between the PPM and the medical practice is structured using the nominee shareholder model, and a majority of the outstanding voting equity instruments of the practice are owned by the nominee shareholder, a presumption exists that the PPM has control over the medical entity. The presumption is rebutted if the PPM, either through a management agreement or through its nominee, has granted rights to others such that the PPM does not have "exclusive decision-making authority." However, it cannot be rebutted if the PPM possesses exclusive decision-making authority.
If the nominee shareholder model is not used, the existence of "control" would be determined based on whether the contractual arrangement meets bothof the following requirements:
  • The PPM has exclusive authority over all decision making related to total compensation of the licensed medical professionals, as well as the ability to establish and implement guidelines for their selection, hiring and termination; and
  • The PPM has exclusive authority over all decision making related to ongoing, major, or central operations of the medical entity, other than the dispensing of medical services. This includes decision making authority over scope of services, patient acceptance policy and procedures, pricing of services, negotiation and execution of contracts, and establishment and approval of operating and capital budgets. If debt financing is an ongoing, major or central source of financing for the medical entity, the PPM must also have exclusive decision-making authority over issuance of debt.
It is difficult to meet the criteria for control in other than a nominee-shareholder arrangement.
ASC 810-10-25-68 through 25-72 provides guidance on whether certain common contractual provisions (e.g., binding arbitration, physician co-signing requirements) result in surrender of some or all of a PPM's "exclusive decision-making authority" in critical areas. There also is discussion regarding the relationship of the "exclusive decision-making authority" requirements and state laws that might appear to impair that decision-making authority, such as patient anti-dumping laws.
Financial Interest (ASC 810-10-25-73 through 25-79). This evaluation also uses a two-pronged approach based on whether or not the contractual arrangement is based on the nominee shareholder model. If the nominee shareholder model is used, and the nominee shareholder owns a majority of the outstanding voting equity instruments of the practice and has exclusive decision-making authority, as discussed above, the PPM is presumed to have a financial interest in the medical entity, as long as the PPM has the power to at will and for no or only nominal compensation, reset the terms of its financial interest in the physician practice to a basis that would meet criteria (e) and (f).
If the nominee shareholder model is not used, then the PPM must demonstrate that it has a significant financial interest in the medical entity. The required "significant" level of financial interest of the PPM in the physician practice is intentionally not prescribed. This is meant to convey that what is "significant" must be determined in the context of the facts and circumstances.
A financial interest in a physician practice is the right to share in the change in the fair value of that physician practice. This right must be economically similar to the right a shareholder must possess. For purposes of the financial interest requirements contained in criterion (f), that change in fair value is viewed as consisting of two components: 1) the portion of the change that manifests itself as current operating results and 2) the remainder, which is the portion of the change that manifests itself only upon sale or liquidation of the physician practice. Criterion (f) requires that the PPM have rights to share in both components, and that the amounts collectively derived constitute a significant portion of the total change in fair value. If the PPM's arrangement with the physician practice will end before the physician practice is sold or liquidated, the PPM would need to have the right to share in the change in the fair value of the physician practice that arose during the PPM's relationship with it in order to meet the requirement described in criterion (b).
For purposes of determining compliance with criterion (f), the calculation of ongoing fees and the calculation of proceeds from sale are to be evaluated based on their substance as opposed to their form. Determining whether the requirements of criterion (f) are met will require the use of judgment.
The guidance is written in the context of medical entities involved in the practice of medicine, dentistry, or veterinary science. However, there may be industries other than the health care industry in which one entity manages another entity under similar circumstances, and in those situations this guidance should also be applied.
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