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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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