Legal 123s with ByrdAdatto (Biting Off More Than You Can Chew )
For the entrepreneurial dentist, it seems like there are always new ways to expand a practice. In this episode Michael and Brad share the story of a dentist client who purchased three dental practices, only to later discover these practices’ values had been built on artificial patients and misleading revenue numbers. Tune in as we address the major issues this client had, and what you can do to uncover potential liabilities within an opportunity and better protect yourself. Unfortunately for the client, there were no happy endings in this dumpster fire!
Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at email@example.com.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences. Creating simplicity in three, two, one.
Brad: Welcome back to another episode of Legal 123s with ByrdAdatto. I’m your host, Brad Adatto with my cohost Michael Byrd.
Michael: Thanks, Brad. As a business and healthcare firm a lot of interesting business opportunities come across our desk that have been presented to our clients, particularly our dental clients. For the entrepreneurial dentist, it seems like they’re always looking for new ways to expand their practice. In today’s episode, we’re going to talk about one of those horror stories where a dental venture worth millions of dollars became a big dumpster fire overnight. And for those not familiar with the term dumpster fire, it basically means a completely mismanaged situation which results in a disaster.
Brad: Before we talk about the dumpster fire, Michael, [00:01:00] as you know, on our previous episode, I finally opened up to the audience and shared a personal story about me. And as we learned, it was a dumpster fire. I think it’s your turn to share your personal dumpster fire story
Michael: First, I don’t think you just started opening up to your audience. You’re an open book. It could be because you test off the chart as an extrovert too. I struggled with my personal dumpster fire story because I have plenty to choose from. I settled on the time I almost threw my law license into a dumpster fire two weeks after I received my law license. So you may not know this, Brad, I once was a bankruptcy attorney.
Brad: That sounds scary.
Michael: Yeah, I was for one day
Brad: But that’s okay. Now it’s making sense.
Michael: Yes. So, 1995, if they still had lawyers back then—
Brad: Did you ride a dinosaur on the way to work?
Michael: I did. I did. [00:02:00] So I just got my law license. This is November of ’95 and literally two weeks into it one partner at this big firm in Downtown Dallas comes in, she’s the partner of our bankruptcy section, and says she has a hearing for me. So this is a big deal, none of my other fellow law school classmates probably would go to court in their whole first year of practice, if not first, two years of practice. And here I was two weeks into starting, to get to not just go to court, but to go to federal court.
Brad: Ooh. You’re the big dog.
Michael: Yeah. Federal court is straight out of the movies. Very formal. It’s the real deal.
Brad: Yeah. Oh, yeah.
Michael: And so I met with this partner. She told me, hey, this is a really straightforward case, its low stakes, we’re accreditor in this [00:03:00] bankruptcy. And the person filing for bankruptcy was asking for relief from the court for $10,000.
Brad: And relief means what, Michael.
Michael: All of her assets were frozen. And so she wanted the court to release $10,000 out of the bankruptcy for use. And we’ll get to that in a minute, but she tells me it’s low stakes, and the law’s on our side. And so as a very green lawyer, I start looking into it and realize, wow, everything is lining up for us. The law is crystal clear that our client’s going to win. And it’s low stakes. So, our client’s not going to fire us if something went wrong because of my performance. And then the [00:04:00] cherry on top is I found out that this person was not even represented by a lawyer.
Brad: Oh no.
Michael: Yeah. So I was like, I got this. I mean, I may be green, but I am a lawyer.
Brad: Oh yeah.
Michael: Two weeks in, I’m officially a lawyer. So I show up and it is a packed courtroom. The whole row of every seat, on every row, was taken. And it was all bankruptcy lawyers, and it was docket day. They weren’t, as much as I hoped they were there just to watch me perform, it was just docket day, but it did raise the intensity of the moment. I’m nervous, as you can imagine, even with all this momentum behind me, and then to have this audience just added to it. And the person on the other side, who’s representing herself, walks out and she’s 90 years old. And she goes first [00:05:00] and proceeds to say that she wants $10,000 so that she can bury her husband. And I see all the eyes on me and I’m thinking, wow this is awkward and I’m really nervous, but I got the law on my side.
Brad: Oh yeah, that’s good.
Michael: So I proceeded to perform, and I did okay. I mean, I was as nervous, as you can imagine. I had a fear of public speaking at the time, so that compounded it. But I got through it, I made my points, finished, and was relieved. And I didn’t know the importance of this, at the time, but I did later as I became a more seasoned attorney: the judge ruled on the spot. Usually they want to sit on it, and they’ll get back to you. And the judge didn’t just rule, the judge started ripping me, the partner, and our [00:06:00] client, a new one for what we are trying to do to this poor lady. She told me at the end of her ruling, when she granted full relief to this 90 year old lady, that if the partner in our firm and the client wanted to appeal this, that she would be more than happy to have a conversation with the partner anytime, because she sees her all the time, and we’ll be seeing her all the time for years to come.
And so I am shaking as I go back, and I have to sit down, I can’t just leave at the moment, and I can hear the crowd kind of snickering at what they had just witnessed— probably glad that it wasn’t them
Brad: Oh yeah.
Michael: And finally one person reaches over and he just said you got sent to the wolves, that’s why your partner didn’t come to this hearing. [00:07:00] I could walk to my office from the courthouse and I really was thinking, I just want to take my license and throw it in the dumpster that was on the way back to the office.
Brad: Well, Sarah is laughing throughout the whole thing. Hopefully that was okay, because it was pretty funny to me.
Michael: Too soon, Brad, it’s only been 25 years. So Brad, we’ve been working together since 2006 and I don’t think we will ever forget the story that we’re going to talk about today. For context, and our loyal listeners will know I love context, you and I were approached by a dental consultant to assist with a review of some post-closing agreements. Normally this is handled by the attorney that papered the deal, but in this case, the dental consultant had reached out and asked if we could [00:08:00] assist his client. They were uncertain as to whether they wanted to actually work with the closing attorney.
Brad: When we got involved, it was a little unusual already that the paperwork that we’re being asked to develop was not even done. A lot of times you’ll see like a dental support agreement would have been completed. So I remember we agreed that we’ll go meet with the dentists who we will call our doctor cavity.
Michael: Why Dr. Cavity?
Brad: Well, as you know, the term cavity means an empty space within a solid object. And as we continue, the audience will soon understand why we gave her this name.
Michael: Motion granted.
Brad: Excellent, something you did not get last time.
Michael: Too soon Brad.
Brad: So back to our story, as we mentioned, we went to go meet with Dr. Cavity. She was a very successful dentist, running a private practice, and had our traditional commercial insurance and cash paying patients. But Dr. Cavity didn’t take [00:09:00] any pediatric Medicaid patients.
Michael: Let’s pause for a moment. It’s important to understand for that, for the audience, that Medicaid patients is ultimately federal funds. Typically, Medicaid is from the state, but it falls because of the federal backing under the federal sword, federal money and federal laws regulate it. And for dental pediatric care, Medicaid actually pays pretty well.
Brad: Sure did. So Dr. Cavity was looking to expand her dental practice by adding these pediatric Medicaid patients, and in doing so, she found another dentist that had a successful Medicaid pediatric practice. And for a cool 3 million plus, she bought these three locations from the other dentist with the hope of generating additional income so that she could speed up her potential retirement.
Michael: So Brad, this season’s all about dumpster fires. Something [00:10:00] bad must have happened.
Brad: Unfortunately it did. When we were meeting with Dr. Cavity, she started discussing the common post-closing agreements that we were going to put together. But one thing she mentioned near the end of the meeting was how the Medicaid patient volume had kind of dried up shortly after closing. Now the seller had agreed to continue to market Dr. Cavity’s practice for a fee, but it didn’t seem to have the same impact. Like there weren’t patients coming through the front door. And so we had the striving pediatric practice one day before the sale. And now post-closing just wasn’t the same
Michael: But the wheels came off at the end of the meeting. Brad, you practice long enough and you see a lot of weird things. I know for both of us, this is one of those moments that neither of us will ever forget. We were getting ready to leave. We’d been there for almost two hours. And Dr. Cavity said, do you think the drop-off in [00:11:00] sales has anything to do with this box I found, and she opens up a closet. When they were cleaning out one of the old locations they had, they had found this box that had copies of gift cards to Target, Walmart, and other establishments with certain dollar amounts. There were also was a ledger in there that had the name of the patient, parents and marketer who gave the card to the parents. Basically, as clearly as possibly could have been recorded, they were paying off the parents to bring the kids in to the prior dentist, the seller.
Brad: And as Dr. Cavity kept pulling paper after paper out of the box, I remember very clearly, I refused to even touch the box or the paper. It was like staring at an act, [00:12:00] the actual smoking gun, that this incredible fraud has been committed on the federal government, the state government. And of course it was clear, at that moment, that these former owners of this dental practice were buying patients. We’re not talking kind of bad, Michael that’s criminal violation, goes straight to jail where you’re in an orange jumpsuit and all.
Michael: If you’re looking at it visually, you could almost see a dumpster fire, a box with fire coming out of it. And I remember the look on your face was like you had just seen a ghost. It was super clear at that moment that the former owners had pumped up this dental practice with fake numbers. They were pumping up numbers by giving stuff to people to bring their kids into the dentist.
Brad: Yeah, and what happened is Dr. Cavity took over a practice that really had no true good will built up. It was really just an empty space with a solid object, [00:13:00] AKA, a cavity.
Michael: What started out as a simple assist with post-closing documentation opened up into a much bigger and destructive fire. We’ll discuss how to approach this dumpster fire on the other side of the break
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, my cohost Michael Byrd is still here. He’s still a little [00:14:00] burned up though, from that time he got schooled 25 years ago. But when we left for the break, we had just discovered our client had purchased three dental practices, each for a little over $1 million, and the value was built up on buying patients. Michael, what is the first major issue we had to address with this client?
Michael: For starters, paying someone to visit your dental practice is a violation of federal and state laws. This can be found in the federal and state anti-kickback laws, anti-patient solicitation laws, and simple commercial bribery regulations.
Brad: And for today’s episode, I think we’re not going to concentrate on the laws, as our client was actually not violating any of these laws, the other person had done all that, but she had purchased a practice which violated all these rules. And we can address that a little bit at the end of this episode, but Michael, what should she have done before to help protect herself?
Michael: This is a really common mistake. People think when they buy a [00:15:00] practice that they’re just signing over some papers. It’s more than just signing papers to transfer ownership. It’s trying to figure out if what’s being sold is as beautiful as the seller is saying it is, or even as beautiful as the financials say it is. Think of buying a house and going through the process of hiring an inspector to check the house out to make sure that the bones of the house are as good as what it appears to be.
Brad: Yeah, that’s a great point. And so that sometimes means, unfortunately, you have to slow down to see the bigger picture. This is why we always talk about how conducting due diligence is so critical in these types of arrangements. In this case, the bank and the dentist really only examined 12 months of the sellers revenue. If they had looked at the last three years of the sellers revenue, which we learned about as we spent more time with her, they would have noted that all three locations dramatically, overnight, just spiked in a 12 [00:16:00] month period. By ignoring this, they failed to ask an important question here.
Michael: Yeah. They did not explore how the revenues were built. There are a ton of questions they could have asked, and they could have found out what changed? Why did the revenue go from a modest Medicaid dental practice to an overnight boom, in all three locations, at the same time? These are important due diligence questions that should have been asked
Brad: Yeah, this is a great point. Think about it, all three at the same time boomed and what I don’t think many clients realize is conducting this robust due diligence is the first of many steps of identifying the known, and in this case, the unknown liability. This allows the buyer to minimize and target their risk. Once they understand these risks, they can renegotiate certainty, key terms, and conditions. They can modify the representations and warranties, and finally add [00:17:00] identification provisions and escrows of funds.
Michael: Well, that’s a lot to unpack, and I don’t think we’ll have enough time today to address each of those elements, but let’s talk about a few of them. First, most buyers do not realize the representations in warranty section of a purchase agreement must be tailored to the transaction. And this is one of those areas where the buyer, what they’ll put in if they’re drafting the documents, is that it should be comprehensive. They want to make sure that what the seller is saying they’re selling is true. And the seller is, if they’re drafting the documents, they’re wanting to say, you get this as is and you’re taking all the risks. So thinking about what do these terms mean? A representation is a statement of fact that induces a party to enter into the contract. The statement should be related [00:18:00] to what influences such party to enter into the contract. While a warranty is a promise that the representation is true and creates liability if the representation turns out not to be true.
Brad: Yeah. Those are great points. And a lot of people, I think, don’t understand those terms. So definitely understand the difference between representation and warranties.
Michael: Some of the basic representations can be as simple as representing that you have the authority to sell the practice, or it can be as complicated as making representations that you meet certain federal billing and collection guidelines. What’s important is that the purchase agreement is tailored with reps and warranties appropriate for the circumstances. And the circumstances are revealed in the due diligence process.
Brad: Yeah. And I’ve seen this time and time again where the buyer just uses some form document, and it’s extremely important reps and warrants that we would typically want, or a good attorney would typically want, [00:19:00] they’re just completely left out. So let’s pretend in this story that the purchase agreements had great reps and warrants, which unfortunately it didn’t, what benefit does that give the buyer, Michael?
Michael: Let’s go backward and play out how this could have worked. In due diligence, Dr. Cavity sees a spike in revenue numbers. Dr. Cavity, if she decides to go forward after seeing this spike, and let’s assume she was not able to discover that there was a fraud at this point in time, which would have been hard. She would have had to know where this dumpster fire box was located in a closet. She would tailor the purchase agreement to deal with the spike in numbers and have reps and warranties around billing and collections. When this whole thing was uncovered, this would give her a direct path to relief.
Brad: Right. But this still means they need to go to court to enforce the contract. What else could have Dr. Cavity done to protect herself?
Michael: Based on the due diligence, the buyer [00:20:00] probably would have wanted to escrow, or hold back funds, for six to 12 months so that it financially gives protection if the numbers don’t turn out to be true, there’s a direct financial benefit that would go to the buyer. And so this does allow some protection to Dr. Cavity if, in the event, the overall practice was not above the $3 million, some of the escrow funds could have been actually returned to her.
Brad: Yeah. And when developing these escrow sections it is really critical, is making sure how these funds automatically can be returned to the buyer, or released to the seller, if these sections are not fully developed. Again, we go back to this could lead to litigation down the road. And, Michael, we talked to our clients about modifying these purchase agreements. You know, a lot of times we get some pushback and say, you know what, if the other side doesn’t agree to these changes, what do we tell them?
Michael: [00:21:00] Yeah. And a lot of times they’re so excited about the shiny object that they’re about to buy and they, rightly or wrongly, particularly the ones that haven’t worked with us think the lawyers are only there to mess things up.
Brad: Or slow things down.
Michael: Yes, absolutely. And so the way we kind of disarm that is to keep the power with our clients, and we just talk to them about risk tolerance and choices. I’m doing a deal right now with a very risk tolerant client, and he also trusts the seller. I know I’ll have to be convincing, with any recommendations I have, to bolster the reps and warranties in that deal. But Brad, we promised our audience, tell everybody what happened with Dr. Cavity.
Brad: Well, unfortunately for Dr. Cavity she spent a lot of money on attorneys. She actually even hired a white collar defense attorney, which we’ve had [00:22:00] Sarah on before to make sure that she was protected from the criminal implications. And she had choices of speaking with litigators about going after that former Denis for breach of contracts, again, spending more time and effort on that. But unfortunately, as we kind of alluded to the reps and warrants and the purchase agreement were so weak that, even though there was a fraud committed here, it really wasn’t a solid way in which she could go after. And she already felt like she spent a lot of time and effort building this up. So unfortunately, not only did she not go after that other dentist, but she ended up having to sell all three locations for massive losses. And so what she thought she had, that shiny object of this striving practice to help accelerate her retirement, unfortunately end up being a dumpster fire that massively delayed it.
Michael: I want to circle back to the house analogy, I think everyone can relate to this, if you’ve bought a house before, you see it, [00:23:00] you’re really excited by it. You emotionally are moving in when you make the decision to make an offer to buy it. Yet, once that contract is in place there always is an option period. And during that option period, you hire someone to go inspect the house. You have the house appraised to make sure it’s worth what they say its worth, and that you’re going to be able to get the bank financing. That’s the home buying version of due diligence and really that’s the same concept we strongly encourage our clients when they’re entering into a transaction to acquire a business. And, for our clients you’re going to sell a business that they have to understand that that’s going to be part of the process.
Brad: I agree. And for those you really want to see when things really go bad, it’s dated a little bit, but go rent the movie Money Pit. And you can see when you see a beautiful home that you think is that shiny, great thing that you always [00:24:00] wanted. And it turns out to be, you can keep dumping more and more money into it. And that’s what happened in that movie. But Michael, thanks, always fun being with you on this podcast.
Outro: Please join us for next week when we talk about Coke is Bad For Your Teeth on February 17th. Thanks again for joining us today. And remember, if you liked this episode, please subscribe. Make sure to give us a five-star rating and share with your friends. You can also sign up for the ByrdAdatto newsletter by going to our website www.byrdadatto.com. ByrdAdatto is providing this podcast as a public service. This podcast is for educational purposes. Only this podcast does not constitute legal advice, nor does it establish an attorney, client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own and their appearance on the program does not imply an endorsement of them or any entity they represent. Please consult with an attorney on your legal issue. [00:25:00]