OCTOBER 2010
MEMBER BRIEFING
BUSINESS LAW AND GOVERNANCE
PRACTICE GROUP
Healthcare and Franchising—Compatible or Contraindicated?
Joel R. Buckberg, Esquire*
Claire Cowart Haltom, Esquire
Baker Donelson Bearman Caldwell & Berkowitz PC
Nashville, TN
Anna Long
University of Tennessee College of Law
Knoxville, TN
Introduction
Consumers familiar with franchises conjure up without prompting images of quick
service restaurants, frozen dessert stores, automotive aftermarket service
centers, and disaster recovery services. But one of the emerging trends in
franchising is toward health-focused franchises. These go beyond the historic
genres of weight-loss clinics, vitamin stores, and health clubs, and extend into
travel medicine clinics (Passport Health), lab test centers (Any Lab Test Now),
and urgent care clinics (Doctors Express). The business models of the current
crop of healthcare franchises seem to have solved the conundrum that plagued
the nascent medi-spa business just a short time ago: Can a healthcare franchise
business model withstand the challenges of corporate practice of medicine and
other regulatory restrictions? Healthcare providers looking for alternative revenue
opportunities to leverage licenses into non-traditional practice areas or deploy
entrepreneurial physician’s assistants and nurse practitioners into higher-return
business opportunities may be considering franchise options. Finally, healthcare
“brand name” institutions may be considering how to leverage their brand names
into new ventures to increase outreach and referral sources while producing
additional cash flow.
Roots in Trademark Law
What makes a franchised business so attractive to consumers, and compliant
with the federal trademark law known as the Lanham Act, 1 is the consistency and
uniformity of the goods or services delivered under the branding of the trademark
or service mark to identify the goods or services. A particular menu item offers
the same appearance, taste, and aroma, and is prepared and packaged the
same way in Boston, San Diego, and everywhere else the item is offered. The
branding distinguishes the item from its competitors and imitators, allowing
franchisees to leverage name recognition in their favor. Consistency creates
brands and allows them to flourish, expand, and gain consumer confidence.
Federal trademark law established the original construct for related companies to
utilize the same brand or service mark. The Lanham Act's scheme of a “related
company” is defined in Section 45:
Related company. The term “related company” means any person whose
use of a mark is controlled by the owner of the mark with respect to the
nature and quality of the goods or services on or in connection with which
the mark is used. 2
The Second Circuit addressed the need for control to avoid confusion over the
origin and quality of goods and services of trademarks in 1959, when it held that
the only effective way to protect the public where a trademark is used by
licensees is to place on the licensor the affirmative duty of policing in a
reasonable manner the activities of his licensees. 3 More recently, the Ninth
Circuit reiterated that the law "is well established that when the owner of a
trademark licenses the mark to others, he retains a ‘duty to exercise control and
supervision over the licensee's use of the mark.’” 4 This duty to exercise control
has led to the franchise models used in the market today.
1
15 U.S.C. § 1050 et seq. Under Section 5 of the Lanham Act, use by a party controlled by the
owner of mark through contract or ownership, called a "related company" under the Act, inures to
the benefit of the mark owner and does not affect the validity of the registration.
2
15 U.S.C. § 1127.
3
Dawn Donut Co., Inc. v. Hart's Food Stores, Inc., 267 F.2d 358, 367 (2d Cir. 1959).
4
Miller v. Glenn Miller Prods., 454 F.3d 975 (9th Cir. 2006).
2
The Conventional Franchise Model
Franchises generally fall into one of two business model categories, with a hybrid
between the two as a third business model. A product distribution franchise, like
a car dealer, sells a branded product manufactured elsewhere under the
branding associated with the product. A business format franchise, like a quick
service restaurant, licenses from the franchisor a complete system and method
of doing business under the brand name, with the product or service produced
locally to the standards prescribed by the franchisor. The hybrid model takes a
branded product from a prescribed source and finishes production locally, like a
coffee shop. Franchisees pay an initial franchise fee at the relationship’s
inception, then ongoing fees during the term of the franchise. Some of these fees
are embedded in the wholesale prices of sourced product, like gallonage fees
charged on ice cream tubs or yogurt mix. Most often, the franchise fees are
based on a percentage of gross revenues of the business, or another auditable
metric of the business such as customer headcount or service calls. Franchise
systems exhibit considerable creativity on fee structures, which usually have no
floor and no ceiling. The franchisor drives top-line revenue instead of net profits
or other performance measures. Franchisees also pay an advertising or
marketing fee, and there are many “a la carte” user fees for specialized and
additional services, extra consulting, and the like. Franchisors that supply
technology usually charge a license fee and an annual maintenance fee similar
to other technology providers. Finally, location-sensitive retail franchises are
sometimes owned or master-leased by the franchisor or an affiliate, and then
ground-leased or subleased to the franchisee. Franchisors also earn revenue
from supply chain activities, such as purchasing administration fees, supplier
rebates, or group-buying commissions. In a model pioneered and pushed
through by the Coca-Cola and McDonald's organizations, suppliers deposit
purchasing rebates into the marketing/advertising fund of the brand. 5
5
See, e.g., Martino v. McDonald’s Sys., Inc., Bus. Franchise Guide (CCH) ¶8477 (N.D. Ill. 1985).
3
Franchise Laws and Regulations
What Is a Franchise?
The legal definition of a franchise appears in every statute and rule that governs
franchising. There are two broad concepts into which virtually all of the definitions
fall, with slight variations in each application. The “marketing plan” definition used
by the originator of franchise regulation, the California Franchise Investment Law
(1974), 6 the FTC Franchise Rule (1978, amended 2007), 7 and nine other states
includes the following elements: (1) A franchisee is granted the right to engage in
the business of offering, selling, or distributing goods or services under a
marketing plan or system prescribed in substantial part by a franchisor; (2) the
operation of the franchisee's business pursuant to such plan or system is
substantially associated with the franchisor's trademark, service mark, trade
name, logotype, advertising, or other commercial symbol designating the
franchisor or its affiliate; and (3) the franchisee is required to pay, directly or
indirectly, a franchise fee. The franchise fee is defined as any payment of $500
or more made within the first six months of the relationship other than for the
bona fide purchase of reasonable amounts of inventory.
The other definition, called the “community of interest” test, has its roots in
Minnesota law and relies upon a less-precise notion of interdependence that
goes beyond traditional wholesaler-retailer relationships. 8 This definition provides
that a franchise is a marketing plan: (1) by which a franchisee is granted the right
to engage in the business of offering or distributing goods or services using the
franchisor's trade name, trademark, service mark, logotype, advertising, or other
commercial symbol or related characteristics; (2) in which the franchisor and
franchisee have a community of interest in the marketing of goods or services at
wholesale, retail, by lease, agreement, or otherwise; and (3) for which the
franchisee pays, directly or indirectly, a franchise fee. While only Hawaii and
Minnesota use this definition to govern the offer and sale of franchises, seven
states use the definition in their relationship laws, including the most onerous
6
CAL. CORP. CODE § 31000(a)(1) et seq (2009)
16 C.F.R. pt. 436 (2010) (FTC Franchise Rule).
8
See, e.g., MINN. STAT. § 80C.01(4)(a)(1) (2010); WIS. STAT. § 135.02 (2), (3) (2010).
7
4
statutes for franchisors, those in New Jersey and Wisconsin. The breadth of the
definition was vividly illustrated by a recent Seventh Circuit decision that held the
Girl Scouts of America to be subject to the Wisconsin Fair Dealership law,
primarily because Girl Scout cookie distribution gave the nonprofit regional
councils the level of dependence necessary to establish a community of
interest. 9
The Federal Trade Commission (FTC) considered the question of whether the
licensor of a health travel business was a franchise in Passport Health, Inc. 10
Passport's program for hospitals offered licenses to use its business methods
and systems to provide travel immunizations and information about foreign travel
to patients, as well as other travel-related services. The hospitals then offer travel
immunizations under Passport’s program rules and pay Passport initial and
ongoing fees. Passport's methods included the traditional franchisor controls and
systems, standards and specifications, marketing, training, and management
methods and procedures. Passport argued that the controls and assistance
would not be significant in the broader context of the entire hospital operation,
and therefore would not meet the test contemplated by the FTC Franchise Rule,
namely that the control and assistance must pertain to the entire operation of the
business taken as a whole. The FTC disagreed. While the controls in the
Passport franchise program were not significant to the overall functioning of the
hospital taken as whole, the FTC held that within the narrow context of the
Passport business, the controls were significant and a franchise existed.
Since its inception, the FTC Franchise Rule has applied to commercial and not
nonprofit relationships. The original 1978 Rule referred to a “continuing
commercial relationship” as one of the definitional elements. 11 The 2007 Rule
carries this concept forward. 12
9
Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the U.S.A., Inc., 549 F.3d 1079 (7th Cir.
2008).
10
FTC Informal Staff Advisory Opinion 97-7, Aug. 18, 1997, available at
www.ftc.gov/bcp/franchise/advops/advis97-7.shtm.
11
16 C.F.R. § 436.2(a).
12
16 C.F.R. § 436.2(h).
5
In a number of requests for interpretative opinions, the FTC developed its own
tests for “commercial relationship” when asked whether arrangements between a
nonprofit licensor and a downstream licensee that pays fees to the licensor
constitute franchises. The FTC examines these relationships notwithstanding the
legal labels applied and looks to the economic substance. A typical formulation of
the four-prong test used by the FTC appeared in All Kinds of Minds, Inc.:
[N]otwithstanding any attempt to hide for-profit activities under the cloak of
a nonprofit entity . . . . [i]n determining whether the Commission has
jurisdiction over a purported nonprofit corporation, the Commission may
consider a number of factors including whether the corporation: (1) is
organized as a nonprofit; (2) has been granted tax-exempt status by the
IRS; (3) distributes funds to its members or shareholders; and (4) devotes
realized profits exclusively to charitable purposes. In franchise matters,
the Commission may also consider whether franchisees are required to
purchase goods or services from for-profit entities owned or controlled by
directors or officers of the nonprofit franchisor. 13
Thus, a nonprofit healthcare provider seeking outreach is cautioned to avoid a
profit motive inconsistent with its exempt purpose that results in the receipt of
unrelated business-taxable income lest it create a genuine franchise. Name
recognition has its price.
Franchise Regulation in the United States
Health law practitioners familiar with the patchwork of federal and state regulation
in healthcare will be relieved to know that U.S. franchise regulation is much less
complex, but it remains much less clear than would be ideal and predictable.
When the scandals in franchising swept into the focus of regulators and
legislators in the late 1960s and the 1970s, there was no regulatory apparatus for
franchising. Federal and state securities laws did not apply to franchising. The
shadow of organized and disorganized crime darkened this period as well, with
13
FTC Informal Staff Advisory Opinion 00-4, Apr. 7, 2000, available at
www.ftc.gov/bcp/franchise/advops/advis00-4.shtm; see also HIPPY USA, FTC Informal Staff
Advisory Opinion 95-3, Apr. 4, 1995, available at
www.ftc.gov/bcp/franchise/advops/advis95-3.shtm; Challenger Center for Space Science
Education, FTC Informal Staff Advisory Opinion 99-4, May 13, 1999, available at
www.ftc.gov/bcp/franchise/advops/advis99-4.shtm
6
investors suffering large losses from ill-conceived or executed franchise
investments. Legislators and regulators instead borrowed mandatory pre-sale
disclosure from securities law, but without registration in some jurisdictions,
under the theory that sunshine would be the best disinfectant for the grime that
was afflicting an otherwise-legitimate business distribution method.
In the United States, the offer and sale of franchises is regulated by the FTC
Franchise Rule, under the authority conferred on the FTC in Section 5 of the FTC
Act to combat unfair and deceptive trade practices. A franchisor must create a
franchise disclosure document conforming to federal regulatory requirements
before it commences the offer and sale of any franchise, but there is no federal
registration akin to securities registration with the Securities and Exchange
Commission. The FTC Franchise Rule is self-executing, and there is no federal
private right of action for its violation. The franchise disclosure document must
include twenty-two items of information about the franchise, copies of the
contracts each franchisee must sign, and certain other information, as well as a
receipt to be signed by the prospective franchisee. The document includes a list
and description of all franchise fees, manager background information, litigation
and bankruptcy history, an estimate of pre-opening investment required,
preferred vendor requirements, financing offered by the franchisor, affiliates or
preferred lenders, a description of pre-opening and post-opening services,
training and advertising provided by the franchisor, summaries and references to
agreement terms, territorial protection disclosure, and certain other disclosures
about the franchise program of the franchisor. The form of disclosure document
is prescribed by the Franchise Rule and cannot include additional information.
However, a franchisor may use separate collateral material to provide additional
information. A franchisor cannot provide financial performance information
(including historical, pro forma or projected revenues, profits, net income, or net
sales) about the franchises to prospective franchisees unless the franchisor has
a reasonable basis for such information, retains its substantiating documentation,
and includes the information in its franchise disclosure document.
7
States have different filing requirements. The franchise disclosure document
must be filed and approved for use by franchise regulators in the states of
California, Hawaii, Illinois, Maryland, Minnesota, New York, North Dakota, Rhode
Island, Virginia, and Washington. The disclosure document must be filed with
designated state agencies in Indiana, Michigan, South Dakota, and Wisconsin.
Simple notices must be filed in Connecticut, Florida, Kentucky, Nebraska, Texas,
and Utah before franchise sales begin. In the other U.S. states and territories,
offers and sales may commence as soon as the franchisor completes the
franchise disclosure document as long as the franchisor has the right to license a
registered trademark. Without the trademark registration, filings may be needed
in Georgia, Louisiana, Maine, North Carolina, and South Carolina. The filing fees
associated with this registration process total less than $7,000. The states with
approval requirements may mandate as a condition of approval that an
undercapitalized franchisor defer, escrow, or impound the initial franchise fees to
be paid by franchisees in that state until the franchisor has performed all of its
pre-opening obligations, or the posting of a surety bond, until the franchisor has
seasoned or successfully sold and opened a number of franchises. There is no
regulatory certainty as to which franchises these conditions would be imposed
since the determination is based on the franchisor's balance sheet and
announced growth plans. 14
The FTC Franchise Rule requires a prospective franchisee to receive the
franchise disclosure document at least fourteen calendar days before signing any
contract with the franchisor or an affiliate, or paying any consideration to a
franchisor or an affiliate. The prospective franchisee must also receive a copy of
all franchise agreements and other agreements to be signed as part of the
transaction at least seven calendar days in advance of signing the agreements
and paying the related fees if the definitive agreement varies from the standard
form appearing in the disclosure document. Any substantive changes made by
the franchisor, such as the description of an exclusive territory, trigger the seven
14
For a general explanation and summary of franchise laws, see Bus. Franchise Guide (CCH)
¶100 et seq.
8
calendar day waiting period. The two periods will run concurrently if the
franchisor does nothing more than complete the form agreements included in the
franchise disclosure document with the name and address of the franchisee and
the store location. Changes made to the franchise agreement at the request of
the franchisee do not trigger a new waiting period.
In addition to laws governing franchise offers and sales, laws in twenty-four
states govern some aspects of the franchise relationship and administration of
the franchise agreements between franchisors and the franchisees located in
such states. These laws range from setting minimum time periods for
termination, to requiring litigation between the franchisor and the franchisee to be
conducted in the franchisee’s state, to more-significant regulation of contract
rights and terms. 15
Exemptions and Exclusions
Practitioners can readily observe how non-traditional healthcare relationships
might cross over into franchises. A hospital looking to outreach a particular
specialty into smaller markets or exurbs as a feeder-referral source of more
seriously ill patients may license its branding to a medical group. The hospital
provides practice management standards and guidelines so its quality levels and
image are maintained. The licensee pays a fee for the services it receives and for
the trademark license. Under most federal and state definitions, that is a
franchise.
Recognizing that some relationships are not deserving of the enhanced
protection of franchise disclosure rules, the FTC offers a number of exemptions
and exclusions that can apply to licensing arrangements.
Nonprofits
As described above, the FTC Franchise Rule contemplates a continuing
commercial relationship as a definitional element for a franchise. A nonprofit
“franchise” simply is not one under the FTC Franchise Rule if the arrangement
15
For a general explanation of franchise relationship laws, see id. at ¶800.
9
supports the exempt purpose of the nonprofit licensor and is not run as a forprofit adjunct to the nonprofit organization. 16
Fractional Franchises
When a service provider decides to supplant an existing service with a branded
concept service of the same or similar products (think about the Starbucks®
coffee bar in a hotel) and the revenues from the concept service will not exceed
20% of the enterprise's revenue at the location, this exemption can apply.
Large Investment Exemption
Borrowing slightly from securities registration exemptions for sophisticated
investors, the FTC Franchise Rule exempts transactions from the pre-sale
disclosure requirements where the estimated investment, exclusive of the cost of
land and the costs financed by the franchisor, is at least $1 million. Few of the
states with franchise pre-sale approval requirements have followed this lead,
although some, like California and Maryland, offer exemptions that have similar
qualifications. 17
Health Law Regulation of Commercial Activity
Franchises may provide great benefits to businesses, but the development of
healthcare franchises presents some not-insignificant challenges. Typically, two
benefits to a franchise are that it enables businesses to take advantage of: (1) a
uniform process for product or service delivery developed by the franchisor; and
(2) the referral of leads or customers provided by the franchise's marketing
function, advertising, or referral network. By controlling the product or service
delivery, franchises assure that the customer's experience is as close to uniform
as possible, so that no significant distinction exists between what is delivered in
Seattle and what is delivered in Miami. However, this framework compels
16
But state relationship laws may offer a different view. As previously mentioned, in Girl Scouts of
Manitou Council, Inc, v. Girl Scouts of the U.S.A., Inc., 549 F. 3d 1079 (7th Cir. 2008), the
Seventh Circuit held that the Wisconsin Fair Dealership Law (WIS. STAT. §§ 135.01 et seq.)
applied to the relationship between GSA and a local council because of the Girl Scout Cookie
program.
17
CAL. CORP. CODE § 31109(a)(2) (2009); MD. CODE REGS. 02.02.08.10(E)(1) (2010).
10
franchisors to exert a significant amount of influence over the franchisees
business operations. As most health law practitioners would immediately
recognize, lay influence over medical practitioners can present some serious
corporate practice of medicine concerns.
Similarly, many franchises, such as hotel chains, are evaluated by prospective
franchisees on the basis of the contributions made by their referral services, like
central reservations systems and group event/meeting sales forces. Franchisees
pay for these referrals through a complex fee structure. The point of many
franchise affiliations for businesses that could function independently is indeed
the benefit of referrals. In the healthcare sector, however, this desire to receive
referrals through a franchise network confronts federal and state prohibitions on
referral remuneration. For these reasons, individuals advising healthcare
franchisors should carefully consider the following issue areas when developing
the structure for healthcare franchises.
Corporate Practice of Medicine
Perhaps the greatest initial challenge to any healthcare franchising model is the
particular state's corporate practice of medicine doctrine. State corporate practice
of medicine doctrines generally encompass a collection of prohibitions that make
it illegal for a corporation or business to employ physicians in such a way that the
physician’s professional judgment may be influenced. Although the laws vary by
state, certain arrangements, such as lay employment of physicians or contractual
agreements with physicians for the provision of medical services, are suspect or
prohibited in many jurisdictions. This condemnation found its voice in a 1982
Opinion of the California attorney general:
[F]irst, that the presence of a corporate entity is incongruous in the
workings of a professional regulatory licensing scheme which is based on
personal qualification, responsibility and sanction, and second that the
interposition of a lay commercial entity between the professional and
his/her patients would give rise to divided loyalties on the part of the
professional and would destroy the professional relationship into which it
was cast. 18
18
65 Op. Cal. Att'y Gen. 223, 225 (1982).
11
Corporate practice prohibitions raise two questions in the context of franchises:
(1) do the services furnished by the franchise constitute a “professional service”
subject to a corporate practice bar, such as medicine, optometry, etc.; and (2) if
so, can the franchise be structured in a manner to preserve the autonomy of the
professional?
One example of a healthcare franchise straying into the realm of the corporate
practice of medicine may be seen in California Ass'n of Dispensing Opticians v.
Pearle Vision Center. 19 The franchise agreement with Pearle Vision Center
contained controls regarding store location, design and appearance, display of
trademarks, and use of the Pearle system of doing business. In addition, the
franchisor controlled the choice and source of frames, lenses, and the laboratory
for machining the lenses to fit the frames selected. The appellate court noted the
strong public policy against permitting lay persons to practice medicine and
concluded that “[r]eservation of this authority over an optometrist by a nonhealing
arts practitioner is against public policy and clearly illegal.” 20 In addition, the court
found that the franchise fee structure, which gave Pearle an 8.5% royalty on the
store's gross revenues, violated the California fee-splitting statute, 21 which
prohibits profit-sharing and co-ownership arrangements between optometrists
and lay persons. Despite striking down the proposed arrangement, however, the
court's conclusion provided the basis for healthcare franchising, noting the
distinction between the selling of eyewear and the practice of the healing art of
optometry. The court indicated that the business elements are distinct from the
profession of dealing with the health and well-being of the public, insofar as the
state had chosen to control the profession. 22 The Pearle court's dichotomy,
healing arts and business elements, lead to creation of the management services
model for healthcare businesses. This separation of healing arts from the
business of medical practice opened the door ever so slightly to a franchise
19
191 Cal. Rptr. 762 (1983).
Id. at 768.
21
CAL. BUS. & PROF. CODE § 655.
22
191 Cal. Rptr. at 773.
20
12
model for healthcare's non-medical aspects. Management systems and services
that are proven and fully developed are what franchises offer to businesses that
could otherwise operate independently.
While unified by name, the corporate practice of medicine prohibitions vary
considerably among the states in application, enforcement, and source.
Depending upon the state, the prohibitions may be found in the state statutes,
medical practice acts, licensure requirements, or public policy arguments
promoted through common law, or any combination of the above. At the very
least, any contractual agreement between a franchise and a physician should
specify that the physician retains independent medical judgment. However,
because of the varied sources and nature of the doctrine among the states,
attorneys representing a healthcare franchise should investigate the particular
corporate practice of medicine laws in the relevant state carefully when
structuring a healthcare franchise.
Anti-Kickback Issues
The federal Anti-Kickback Statute prohibits the offering, payment, solicitation, or
receipt of any remuneration, including kickbacks, bribes, or rebates, in return for
the referral of patients for the purchasing or leasing of, or for the ordering,
recommending, or arranging of items or services for which payment may be paid
in whole or in part by a federal healthcare program, including Medicare and
Medicaid. 23 Despite its name, the Anti-Kickback Statute applies to more than just
“kickbacks.” Remuneration has been interpreted as a catchall category that
includes any type of cash or in-kind benefit. 24
A violation of the Anti-Kickback Statute is a felony and can result in a $25,000
fine, imprisonment for not more than five years, or both. In addition, a violation
could result in exclusion from participation in any federal healthcare programs.
Further, the Civil Money Penalty Law allows for the administrative imposition of
23
42 U.S.C. § 1320-7b(b).
See, e.g., United States v. Greber, 760 F.2d 68, 71 (3d Cir.), cert. denied, 474 U.S. 988 (1985)
(indicating that remuneration can take many forms including long-term credit arrangements, gifts,
supplies, equipment, or the furnishing of business machines).
24
13
civil monetary penalties for a violation of the Anti-Kickback Statute. Such civil
monetary penalties could range up to $50,000 plus damages of three times the
total remuneration offered, paid, solicited, or received per violation, without
regard to whether a portion of such remuneration was offered, paid, solicited, or
received for a lawful purpose. 25
The Anti-Kickback Statute prohibits direct remuneration for patient referrals
covered by federally funded programs like Medicare and Medicaid. Whether
federal payors will be providing reimbursement is a key issue in analyzing any
healthcare franchise model. Depending on the type of franchise and the services
offered, the Anti-Kickback Statute may not be applicable.
Fee-Splitting Issues
Fee-splitting arrangements, wherein a medical professional shares a portion of
patient fees with a lay entity, are prohibited by many states. Fee-splitting
prohibitions may take the form of prohibitions against payment for referrals
similar to the federal Anti-Kickback Statute, or the prohibition of sharing
compensation with anyone other than another physician with whom one
practices. Again, the rationale is to prevent the division of loyalty between the
physician's own financial interest and the provision of appropriate patient care.
The type of procedures provided by the franchise will usually determine whether
a state’s healthcare fee-splitting prohibitions are applicable. Some procedures,
such as facials provided at a medical spa, would not fall under many state
healthcare fee-splitting laws. However, in states such as California, any
procedure that requires administration by a licensed health professional is
considered medical, meaning payments for Botox injections or laser hair removal
would be subject to fee-splitting prohibitions.
It should also be noted that some states, such as New York, apply the feesplitting prohibition to a variety of practitioners including, for example, nurses and
chiropractors. 26 As a result, attorneys should identify the types of healthcare
25
26
42 U.S.C. § 1320a-7a(a)(7).
See N.Y. EDUC. LAW §§ 6500, 6509, 6530(19).
14
practitioners that will be providing services in the healthcare franchise and
analyze whether the state applies fee-splitting prohibitions to that particular
group.
Attorneys advising healthcare franchises should carefully consider whether
federal and/or state fee-splitting prohibitions are applicable and structure the
financial relationship between medical practitioners and lay entities accordingly.
Generally speaking, any payments to the lay entity related to medical services
should be clearly identified in the contractual agreements and profits should not
be shared on a per-case or percentage basis. Possible alternative payment
models would include payments based on fair market value, monthly salary, or
flat-fee arrangements not directly connected with the volume of cases performed
or the volume of referrals received.
Stark Laws/Mini-Stark Laws
The federal Stark Law 27 prohibits a physician from owning a financial interest in
an entity to which he or she refers patients. As a result, if the physician owns a
percentage of the healthcare franchise, there is a self-referral issue that needs to
be addressed. The Stark Law only applies to referrals for twelve categories of
service identified in the statute, and only where the services provided pursuant to
those referrals may be reimbursed under Medicare or Medicaid. However,
several states have established “mini” Stark laws restricting self-referral by
healthcare providers. Laws vary by jurisdiction, but in general they fall into three
main categories: (1) laws that are nearly identical to the federal Stark Law that
are applied to state programs; (2) laws that prohibit all self-referrals, regardless
of payor; and (3) laws requiring physicians to disclose their financial interests in
entities to which they refer. 28 In a number of cases, state mini-Stark statutes
simply incorporate the terms of the federal law by reference. 29
State mini-Stark laws may extend to “referrals paid for by payors other than
Medicare and Medicaid, referrals by practitioners other than physicians, and
27
42 U.S.C. § 1395nn and the regulations thereunder.
Rebecca Bethard, Physician Self-Referral: Beyond Stark II, 43 BRANDEIS L.J. 465, 474 (2005).
29
ALICE G. GOSFIELD, MEDICARE AND MEDICAID FRAUD AND ABUSE §3.30 (Thompson/West 2008).
28
15
referrals for services other than those designated by the federal law.” 30 In
contrast, some state laws offer more flexibility than the Stark laws by providing
broader exceptions to prohibitions on referrals. Where state laws ban all selfreferrals (creating standards more stringent than the federal self-referral statute),
physicians are generally banned from any ownership interest in facilities to which
they refer their patients. State statutes requiring only disclosure vary widely, but
most states in this category require disclosure in writing to the patient. 31
Physicians and their counsel should make sure the appropriate disclosures are
being made to patients about the financial interest in the entity that is receiving
the referral.
HIPAA and State Data Privacy Laws
Data mining (the method by which corporate franchise offices distill vast amounts
of data into information that is useful for inventory planning, labor scheduling, and
product preparation planning) offers franchise models a consistent, reliable, and
accurate method of forecasting inventory and product depletion rates over set
periods for business planning purposes. However, in the case of a healthcare
franchise, monitoring customer routines and preferences may implicate various
state and federal privacy laws unless carefully navigated.
When structuring franchising arrangements, consider the implications of the
federal Health Insurance Portability and Accountability Act of 1996 and
regulations thereunder (collectively, HIPAA) and the numerous state data laws. If
the individual franchise entities and/or the parent corporation are “covered
entities” that are subject to HIPAA (e.g., a health provider that bills an insurance
company or Medicare/Medicaid electronically), then the affected entity should
factor in its HIPAA obligations and should develop a HIPAA compliance plan.
Some structures may instead trigger HIPAA business associate relationships,
also requiring compliance.
30
See generally THOMAS C. FOX, CAROL COLBORN LOEPERE & JOSEPH W. METRO, HEALTH CARE
FINANCIAL TRANSACTIONS MANUAL §§ 9:37 - 9:49 (rev. ed. 2009).
31
Id.
16
HIPAA compliance should be considered at the beginning of the planning phase
because some corporate structures may be able to benefit from the Organized
Healthcare Arrangement, Affiliated Covered Entity, or hybrid entity designations
under HIPAA or certain exceptions to HIPAA. Such designations/exceptions can
help relieve certain administrative obligations and potential liabilities if
appropriately utilized. It is important to remember that, as a fallback option, an
entity can always obtain a patient's HIPAA-compliant authorization to utilize
patient data but cannot condition treatment on the signing of such an
authorization.
Aside from federal law, most states protect the confidentiality of medical and
financial information. These state laws add separate and additional compliance
obligations and should be thoroughly analyzed.
Franchise Business Models
Healthcare franchises vary considerably in the degree of control exercised by the
franchisor and the way in which the arrangements seek to accommodate the
unique considerations of healthcare practice. The following models illustrate two
approaches to healthcare franchising, but are in no way an exhaustive list of
existing or successful healthcare franchise models.
Examples
Doctors Express
Doctors Express is a system for the development and management of urgent
care centers. 32 These centers treat minor injuries and infections on a walk-in
basis and consist of exam rooms, X-ray technology, and an on-site laboratory
and pharmacy. A franchisee is entitled to use the proprietary management and
development system, as well as the name “Doctors Express” and all associated
marks. The franchise system exercises control over numerous aspects of urgent
care practice, including site selection, construction design, and preferred vendors
for the provision of equipment and supplies. The system also establishes
32
Doctors Express Disclosure Document (May 15, 2009), available at
http://134.186.208.228/caleasi/Pub/Exsearch.htm.
17
procedures for monitoring operations, quality, management, training, advertising
and promotions, and business format and standards.
To operate an urgent care center under the Doctors Express name, in addition to
entering into a franchise agreement with the franchisor, the franchisee must enter
into a Management Agreement with a professional corporation (PC) that will act
as the center’s owner and operator. In addition, the PC must be composed
entirely of physicians who are licensed to provide medical services in the state in
which the urgent care center is located. If state law permits, the PC may be the
same entity, or have the same owners, as the franchisee. However, if such an
arrangement is not permitted by state law, the franchisee may only provide the
PC with management and administrative services and the PC maintains sole
discretion regarding all aspects of the provision of medical care and the hiring of
medical staff.
Passport Health
Passport Health is a health travel service that dispenses vaccinations, travel
immunizations and information, skilled nursing services, and travel-related
products and supplies to persons traveling to foreign countries. 33 The system
consists of several controls, including: uniform standards, specifications, and
procedures for dispensing vaccines and immunizations; methods and procedures
for gathering and imparting health, risk, and other related information; inventory
and equipment requirements; and proprietary training, marketing, and
management methods, procedures, and materials. In addition, the franchisor
exercises considerable control over the location of the facility. Most facilities are
operated out of existing outpatient care facilities, but they may also be located in
franchisor-approved, stand-alone locations.
The franchisee may be an individual, corporation, or partnership. Unlike Doctors
Express, there is no requirement that the franchisee be a separate entity from the
owners and operators. In addition, the system does not require that the practice
33
Passport Health, Inc. Franchise Disclosure Document (June 4, 2009), available at
http://134.186.208.228/caleasi/Pub/Exsearch.htm.
18
be owned solely by licensed medical professionals, but does provide that the
staff must include a registered nurse and that a licensed physician be available
for consultation. The franchisor also provides that it will not interfere in any way
with the exercise of the medical staff's professional judgment. As an added legal
protection, within forty-five days of signing the franchise agreement, the
franchisee must obtain a written opinion from an attorney addressing whether the
franchise complies with applicable healthcare law, including the laws regarding
the corporate practice of medicine, fee splitting, and healthcare rules and
regulations.
Franchise Regulatory Reaction
When the med spa business first started to spread its wings, an applicant for
California franchise registration collided with an interdepartmental regulatory
inquiry between the franchise regulators and the Medical Board of California. The
franchise examiner reviewing the application of Solana Medspa Franchise Corp.
sent to the Medical Board the franchise disclosure document, including the
proposed forms of franchise agreement and the affiliation agreement between
the franchisee and the professional medical corporation that would supervise the
spa. The board concluded in a May 17, 2004, letter that the arrangement called
for the corporate practice of medicine, violating California Business and
Professions Code Sections 2400 and 2052. 34
However, the model Solana had submitted was based on the models used by
other medical spa franchises that had already been granted registration and were
actively engaged in the sale of comparable franchises. After a period of review,
the Medical Board wrote to at least one of the competitors advising them of their
corporate practice of medicine in violation of California statutes implicated by
their activity. 35 While the competitor remains in business, the California Medical
34
Information in this Section was obtained by access to the franchisor's files published at the
California Department of Corporations website for disclosure of franchise filings, CAL-EASI:
http://134.186.208.228/caleasi/pub/exsearch.htm.
35
The board's letter to Nu Image Medspa, Inc., dated Jan. 3, 2006, available on CAL-EASI, cites
possible violations of CAL. BUS. & PROF. CODE §§ 2052, 2400, and 2417, as well as CAL. CORP.
CODE §§ 13401, 13401.5, and 13403.
19
Board felt compelled to issue a stern warning in its April 2009 quarterly
newsletter to the effect that medical spa procedures were the practice of
medicine unless licensed cosmetologists performed procedures that were noninvasive and truly cosmetic. Doctors were admonished that franchises or other
models that resulted in unlicensed persons influencing or making medical
decisions remained unlawful. 36 The board's hostility to franchises extended to
management service organizations that are not majority owned (51%) by
physicians.
Franchisors seeking to enter the California market, and any other markets where
the medical licensing authorities demonstrate a heightened scrutiny for corporate
practice of medicine concerns, should expect to demonstrate why their proposed
models do not violate the corporate practice policies of the applicable medical
regulatory body to both that body and the franchise regulatory authority in that
state. At a time when physicians may be seeking to augment income lost from
reduced insurance and governmental reimbursements with private-pay
procedures offered by aesthetics centers, med spas, and other businesses that
do not rely on insurance or governmental payments, healthcare franchise models
may be attractive models for consideration.
Conclusion
Conventional franchising and healthcare regulation have a strong potential for
conflict because of concerns regarding control by a lay entity over a medical
practice and the control exercised by a franchisor over a franchisee's method of
operation in the conventional franchise model. The management services model,
which distinguishes between the commercial aspects of the enterprise and the
exercise of independent medical judgment by healthcare professionals, has
proved attractive to some organizations. To safeguard against treading on the
corporate practice of medicine prohibitions, the healthcare franchise will likely
need to minimize the controls placed on the franchisee, leaving to the healthcare
provider the sole authority to direct all aspects of the medical practice, including
36
Janine Cordray, The Business of Medicine—Medical Spas, 110 Medical Board of California
Newsletters, Apr. 2009.
20
decisions regarding treatment, ethics, documentation, and management of
employees. Because of the limited controls permitted in a healthcare franchise,
the franchisor's ability to ensure that patients obtain uniform quality of treatment
is severely limited. The consumer will not receive or benefit from the uniformity of
service delivery seen in non-medical franchised business, but if the franchised
brand's benefits reduce costs and operational risk to the franchise operator,
perhaps the franchise will justify its fees.
Anyone considering a healthcare franchise model should carefully weigh the
risks associated with entering into the highly regulated realm of health services.
While several healthcare franchise models have navigated the various federal
and state laws necessary for franchising, it was not without significant regulatory
analysis or cost. Ultimately, most healthcare franchisors are likely to discover that
while they may be able to control the patients' experience in the waiting room, a
franchise system operator may have little-to-no control over the actions of the
licensed practitioner who actually provides healthcare services at the franchised
location.
*Mr. Buckberg, a member of the Tennessee, Texas, Georgia, and New Jersey bars, is of
counsel in the Nashville, TN, office of Baker Donelson Bearman Caldwell & Berkowitz
PC. Ms. Haltom, a member of the Tennessee Bar, is a healthcare attorney in the
Nashville office of Baker Donelson. Ms. Long is a law student at the University of
Tennessee College Of Law. The authors would like to thank their colleagues Thomas
Bartrum, Esquire, and Gina Ginn Greenwood, Esquire, for their assistance and insight
with this article.
Healthcare and Franchising—Compatible or Contraindicated? © 2010 is published by the
American Health Lawyers Association. All rights reserved. No part of this publication may be
reproduced in any form except by prior written permission from the publisher. Printed in the
United States of America.
Any views or advice offered in this publication are those of its authors and should not be
construed as the position of the American Health Lawyers Association.
“This publication is designed to provide accurate and authoritative information in regard to the
subject matter covered. It is provided with the understanding that the publisher is not engaged in
rendering legal or other professional services. If legal advice or other expert assistance is
required, the services of a competent professional person should be sought”—from a declaration
of the American Bar Association
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