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7.4 Consolidation of entities controlled by contract
Publication date: 31 Jul 2023
us Consolidation guide
ASC 810-10-25 describes the framework for determining when a controlling financial interest has been established through a contractual management arrangement, thus requiring consolidation by the controlling entity.
While this issue was raised specifically to address contractual arrangements between entities that are in business to practice and dispense medicine (physician practices) and entities that are in business to manage the operations of those physician practices (physician practice management entities, or PPMs), it also applies to similar arrangements in other industries.
This guidance only applies to an entity that is not a VIE. Since an entity that is controlled by contract is almost always a VIE (as the equity holders at risk lack the decision making ability), we believe the application of this guidance may be very limited. Therefore, the entity would likely be subject to the VIE model and not the consolidation by contract guidance.
The following requirements must be met for a PPM (reporting entity) to have a controlling financial interest in a physician practice:
- Term – the term of the contractual arrangement between the PPM and the physician practice is at least 10 years or for the entire remaining legal life of the physician practice, and the arrangement is not terminable except in the cases of gross negligence, fraud, or other illegal acts by the PPM, or bankruptcy of the PPM. The term must be determined based on its substance rather than its form, and thus, both the original term and renewal or cancellation provisions must be considered. As indicated, the reasons for termination are intended to be very specific and narrow in scope.
- Control – the PPM has unilateral decision making over (1) ongoing, major, or central operations of the physician practice, except for the dispensing of medical services, and (2) compensation for the licensed medical professionals as well as the ability to establish and implement guidelines for the selection, hiring, and firing of them. Decision making over ongoing, major, or central operations of the physician practice must include authority over scope of services, patient acceptance policies and procedures, pricing of services, negotiation and execution of contracts, and the establishment and approval of operating and capital budgets. It also includes issuance of debt if debt financing is an ongoing or major source of financing for the physician practice. These significant decisions reflect the minimum level of decision making needed for the PPM to meet the control requirement. The dispensing of medical services is excluded from the PPM’s control only because state law requires licensed medical professionals to dispense medical services and a PPM would generally not satisfy that requirement.
- Financial interest – the PPM has a significant financial interest in the physician practice that both (1) is unilaterally saleable or transferable by the PPM and (2) provides 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 varies based on the operating performance and fair value of the physician practice. If the PPM’s financial interest in the physician practice does not meet both of these criteria, the PPM would not be deemed to have a financial interest in the physician practice.
7.4.1 Nominee shareholder
The consolidation by contract model also introduces the concept of a nominee shareholder(s) into the consolidation model. A nominee shareholder may or may not be used in the PPM/physician practice structure to achieve consolidation. If used, the nominee shareholder is generally the 100% equity shareholder of either a new or the existing physician practice. Simultaneously, the nominee shareholder and the PPM enter into a management agreement that gives control of the physician practice to the PPM. Effectively, the nominee shareholder is an agent of the PPM. The nominee shareholder’s relationship with the PPM perpetually has all the following characteristics:
- Time frame – the PPM can change or replace the nominee shareholder at any time and as many times as it so chooses.
- Discretion – the PPM has the sole discretion to establish or change the nominee shareholder and can name anyone it so chooses as the new nominee shareholder.
- Impact – the PPM and the nominally owned entity incur no more than nominal cost to change the nominee shareholder and there is no significant adverse impact to the physician practice upon a change.
The concept of a nominee shareholder is also very common in many VIE arrangements, including foreign ownership structures, local management agreements, etc.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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