Courts Revitalize Washington State's Corporate Practice Doctrine

By Lisa Rediger Hayward
[March 2004]

Washington State’s corporate practice doctrine is “alive and kicking,” at least with respect to the practice of dentistry. After nearly 15 years of judicial silence, courts in two recent cases, Ghorbanian v. Fallahzadeh and E. David Engst et al. v. Orthoalliance, Inc., breathed new life into Washington’s corporate practice doctrine. The doctrine generally prohibits a corporation from engaging in the practice of medicine, dentistry or other “learned profession.” In these two cases, Washington courts have refused to enforce relationships involving licensed dentists and a non-licensed entity or individual, finding that the non-licensed entity or individual was engaged illegally in the practice of dentistry.

The effect of these cases on Washington’s corporate practice of medicine doctrine is unclear, since both cases involved dentists and the courts’ interpretation of specific provisions of the dentistry licensing act. Nevertheless, the cases are notable for the courts’ close scrutiny of the “universe of contractual agreements” between parties. In the course of their review, both courts found a de facto relationship in contravention of the doctrine, despite the unlicensed entity’s or individual’s lack of control over the delivery of patient care services. In addition, the cases highlight how licensed professionals are using the corporate practice doctrine to escape the consequences of an otherwise valid contract. Hospitals, practice management companies and other entities may wish to re-examine their relationships with dentists as well as physicians in light of these developments.

Ghorbanian v. Fallahzadeh

The Ghorbanian case involved a lease arrangement between two tenants-in-common, Ghorbanian, D.D.S., P.S., a dental practice, and Akbar Fallahzadeh, an individual. Ghorbanian and Fallahzadeh purchased a building. Dr. Ghorbanian’s practice rented the building for 50 percent of the practice’s net profits. The practice employed Fallahzadeh as the office manager. In that capacity, Fallahzadeh had check-writing authority and handled the practice’s accounts. Fallahzadeh periodically made loans to the practice and routinely transferred funds, including loan repayments, rent and his monthly salary from the practice’s accounts to his personal account. Fallahzadeh was fired as office manager when Dr. Ghorbanian suspected embezzlement.

Fallahzadeh filed an unlawful detainer action against Ghorbanian, and Ghorbanian argued that the lease was illegal and therefore invalid. The trial court found that the lease was legal. The Washington Court of Appeals disagreed, concluding that Fallahzadeh was impermissibly engaged in the practice of dentistry. According to the appeals court, the combination of the lease and the discretionary power retained by Fallahzadeh over the practice’s assets constituted the ownership, operation or maintenance of an office for the practice of dentistry. Under Washington law, only a licensed dentist is permitted to own, operate or maintain an office for the practice of dentistry.

The Ghorbanian case may have limited applicability due its unique facts. First, the court found that Ghorbanian’s rent payments to Fallahzadeh (50 percent of the practice’s net revenues) were significantly higher than market rent. The court concluded that the only reasonable explanation for the above-market rent was to allow Fallahzadeh to realize the benefits of owning the practice. Second, the court noted “unique evidence” that Fallahzadeh had approached another dentist to ask whether the dentist would be interested in buying Fallahzadeh’s share of the practice, suggesting that Fallahzadeh considered himself a co-owner.

The Orthoalliance Case

A potentially more troubling decision is E. David Engst et al. v. Orthoalliance, Inc. In this case, the U.S. District Court for the Western District of Washington also interpreted Washington’s corporate practice doctrine in the context of a series of relationships between an orthodontic practice management company (Orthoalliance) and individual dentists.

The individual dentists and their associated professional services corporations (“PCs”) sold most of the tangible assets, leasehold interests, and goodwill of their respective practices to Orthoalliance. In connection with the sale, the dentists, through their respective PCs, also entered into broad ranging consulting and business services agreement with Orthoalliance. In exchange for such services, the PCs paid Orthoalliance a yearly fee of $194,703 or 17 percent of the PC’s adjusted gross revenue, whichever was greater. The dentists personally guaranteed the payments owed to Orthoalliance under the consulting and business services agreement. Each dentist also entered into an employment agreement with its respective PC for a five-year term. The employment agreements prohibited the plaintiffs from practicing orthodontics at any other facility or for the benefit of any other patients. Orthoalliance was not a party to the employment agreements but was designated a third-party beneficiary that could enforce the terms of each agreement, including the covenant not to compete.

The dentists became unhappy with their arrangements and brought suit against Orthoalliance claiming, among other things, that the relationships between the parties violated Washington dental code. This statute provides that “no corporation shall practice dentistry or shall solicit through itself, or its agent, officers, employees, directors or trustees, dental patronage for any dentists or dental surgeon employed by any corporation[.]” Under Washington law, “[a] person practices dentistry . . . who. . . owns, maintains, or operates an office for the practice of dentistry.” RCW 18.32.020. The case was removed to the U.S. District Court for the Western District of Washington based on diversity jurisdiction.

The district court granted summary judgment in favor of the dentists finding that, although each orthodontic practice was wholly owned by a licensed dentist, and each dentist was employed by its respective PC, Orthoalliance “effectively” owed or operated the dentistry practice through a web of contractual relationships with the dentists and their PCs. In reaching its conclusion, the district court examined Washington case law interpreting the corporate practice ban (including Ghorbanian) and determined that a court is to “closely scrutinize[] the effect and purpose of the contractual agreements between the parties rather than limiting its scrutiny to the four corners of the contracts themselves.” The court focused on two factors: (1) the personal guarantees that rendered each dentist personally liable to Orthoalliance for the amounts due under the consulting and business services agreements; and (2) the fact that Orthoalliance could enforce the terms of the dentists’ covenants not to compete under the employment agreements. The court held that the combination of relationships put Orthoalliance in the role of a “virtual employer” and enabled it to retain a beneficial interest in the profits from the practice of dentistry. The court was not persuaded by Orthoalliance’s argument that it exercised no control over the dentists’ delivery of patient care services. According to the court, an entity may be in contravention of the corporate practice prohibition even if it has absolutely no involvement in the delivery of patient care services. Orthoalliance has filed a notice of appeal with the Ninth Circuit.

Conclusion

Both Ghorbanian and Orthoalliance involved the Washington statutory provisions that prohibit the unlicensed practice of dentistry. It is unclear the extent to which these decisions will apply to physicians. Unlike the corporate practice of dentistry, which is codified in Washington statutes, the corporate practice of medicine doctrine is largely rooted in the common law. Moreover, there is no parallel statutory provision specifying that the ownership, operation or maintenance of an office for the practice of medicine constitutes the practice of medicine. Nonetheless, providers and management companies alike are well advised to follow the developments in the corporate practice ban as Orthoalliance is reviewed on appeal.

FOR FURTHER INFORMATION, PLEASE CONTACT:

Lisa Rediger Hayward, Seattle, (206) 628-7666, lisahayward@dwt.com

This Health Law Advisory is a publication of the Health Law Group of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of developments in health care law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

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