SB 351 Proposes To Strengthen California CPOM and CPOD Doctrines

TO WHOM WOULD SB 351 APPLY?

SB 351 would apply to two groups: hedge funds and private equity groups.

The term “hedge fund” includes pools of funds managed by investors for the purpose of earning a return on those funds. SB 351 specifically excludes from the “hedge fund” definition any natural person or entity that contributes to, but does not manage, such fund, along with entities that solely provide or manage debt financing secured by assets of a healthcare facility.

SB 351 defines “private equity group” to include investors that primarily engage in raising or returning capital, and that invest, develop, or dispose of specified assets. Therefore, this definition also appears to include venture capital funds and certain family offices and could potentially include the venture arms of larger organizations, including innovation investment funds of hospitals and health systems.

The definitions of both hedge fund and private equity group specifically exclude passive investors in such funds.

WHAT ACTIONS WOULD SB 351 PROHIBIT?

SB 351 would expressly prohibit private equity groups or hedge funds involved in any manner with a physician or dental practice, including as an investor in the practice or as owner of the assets of the practice, from taking any actions that would interfere with the professional judgment of physicians or dentists in making healthcare decisions, or that would amount to the exercise of control over:

• Owning patient records
• Hiring and firing decisions for clinical staff based, in whole or in part, on clinical competency or proficiency
• Setting the parameters under which a physician, dentist, or practice may enter contractual relationships with third-party payers or other providers
• Making decisions related to coding or billing procedures
• Approving the selection of medical equipment and medical supplies.

Most of the bullet points above are drawn directly from the Medical Board of California’s existing guidance on CPOM. SB 351 would expand on the Medical Board of California’s guidance regarding the need for physicians to make decisions regarding the hiring and firing of physicians by explicitly prohibiting a private equity group or hedge fund from exercising control over contractual relationships with other providers. Interestingly, SB 351 references private equity groups or hedge funds as potential “investors in [a] physician or dental practice.” California’s existing codified CPOM and CPOD prohibitions already prevent nonlicensed professionals from directly investing in physician or dental practices. SB 351’s application to both dentistry practices and physician practices also represents an expansion of the Medical Board of California’s guidance, which has never been formally adopted by the Dental Board of California (although is generally viewed as persuasive authority).

SB 351 would prohibit a private equity group or hedge fund, or an entity directly controlled by a private equity or hedge fund, from entering an agreement or arrangement that would enable interference with the professional clinical judgment of physicians or dentists. This provision serves to prevent subsidiaries or portfolio companies that do not directly meet the definitions of “hedge fund” or “private equity group” from engaging in any of the actions set forth above. This provision is similar to language that has appeared in past California legislation, including last year’s Assembly Bill 3129. While unclear, this language may call into question certain structures in California that would enable a private equity group or hedge fund to replace a friendly physician upon the occurrence of one or more events.

Finally, SB 351 would continue the trend in California and elsewhere against the use of restrictive covenants. Under SB 351, any contract involving the management of a physician or dental practice by a private equity group or hedge fund, or the sale of real estate or other assets owned by a physician or dental practice to a private equity group or hedge fund, may not explicitly or implicitly include a noncompetition or nondisparagement clause for a provider in such practice. As currently drafted, the provision purports to allow noncompetition provisions arising from the sale of a business.

TAKEAWAYS

California has long had some of the strongest CPOM and CPOD prohibitions in the United States, supplemented by the Medical Board of California’s CPOM guidance. SB 351 reiterates the Medical Board of California’s guidance as it relates directly to private equity groups and hedge funds, and supplements that guidance to reflect growing concern about the influence of private equity and hedge fund investments in healthcare. While the Medical Board of California’s guidance has long been considered a helpful source to understand the state’s CPOM prohibition, SB 351’s codification of this guidance would provide the attorney general with mandatory, rather than persuasive, authority to enforce both the CPOM and CPOD prohibitions as they relate to private equity groups and hedge funds.

Private equity groups and hedge funds should review existing management services arrangements with physician and dental practices to ensure that they do not provide for greater control of the physician practice than SB 351 would permit. They also might consider adding layers of protection into these agreements to make clear that such contracts do not implicitly or explicitly take clinical decision-making responsibilities away from licensed professionals. Additionally, private equity groups and hedge funds should review agreements related to friendly physician arrangements to evaluate the feasibility of existing noncompetition provisions. Even if SB 351 is not signed into law, such entities should be wary of the strong persuasive authority of the existing Medical Board of California guidance.

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Reach out to one of the authors of this On the Subject or your regular McDermott lawyer(s) to discuss the potential legal implications of SB 351 for your business.