Ketamine Due Diligence: What Any Buyer Should Know, Part 2

As noted in Ketamine Due Diligence: What A Buyer Should Know – Part 1, we have worked on several Ketamine clinic acquisitions, and one of the most important aspects of any deal is due diligence. This post will discuss some of the state healthcare regulatory issues a buyer will want to focus on for a ketamine deal.

Corporate Practice of Medicine Doctrine

One of the issues a buyer will need consider is the corporate practice of medicine (“CPOM”) doctrine. This is uniquely a state issue, and each state has a different regulatory regime. For some states, like Arizona, the CPOM doctrine is loosely defined by common law. On the other end of the spectrum, states like California have a strict regulatory and statutory scheme for CPOM issues.

At its core, the CPOM doctrine seeks to prevent non-healthcare professionals from making medical decisions or decisions that impact a provider’s practice. For example, if Buyer is a publicly held corporation, would a provider want Buyer directing the provision of care by the provider? Would a provider be ok if Buyer decided to stop carrying certain products because the margins are not large enough? Aside from the CPOM doctrine, providers have their own ethical and moral obligations that should never be trumped by non-healthcare individuals.

As mentioned above, in Arizona, the CPOM doctrine is defined solely by case law. There are two appellate decisions involving optometrists that serve as the basis for the CPOM doctrine. For example, the first decision was Funk Jewelry Co. v. State ex rel. La Prade, 46 Ariz. 348 (1935). The Arizona Supreme Court framed the issue this way:

The principal question necessary for us to decide is whether the complaint, alleging that the corporation defendant, through a registered optometrist, is employing objective and subjective means and methods, other than the use of drugs, to determine the refractive power of the human eye or any visual or muscular anomalies thereof, and prescribing or adapting lenses or prisms for its correction or relief, states a cause of action for injunction against such practice.

The Supreme Court then found:

Article 11, chapter 58 (sections 2570–2576), Revised Code of 1928, contains legislation defining and regulating the practice of optometry. Therein it is provided that a person desiring to engage in the practice of optometry must be over 21 years of age and of good moral character and possess certain specified educational qualifications, pass an examination before the state board of optometry appointed by the Governor, and obtain from such board a certificate of registration. The qualifications of an optometrist, as thus outlined, of course exclude a corporation from the practice. It cannot qualify and cannot obtain a certificate of registration. It is not of the class of persons the Legislature intended to authorize to practice optometry. It does not possess the necessary moral and intellectual qualities.

Finally, the Supreme Court went on to note:

That a corporation may not engage in the practice of the law, medicine, or dentistry is a settled question in this state. None of those professions which involves a relationship of a personal as well as a professional character, which has to do with personal privacy, can be placed in the same category as druggists, architects, or other vocations where no such relationship exists.

Based upon the foregoing, including the statutory interpretation and authority from other jurisdictions which prohibited the practice of professions in a corporate context, the Arizona Supreme Court held that the defendant’s employment of an optometrist violated the laws regulating the practice of optometry.

At the other end of the spectrum is California, which has an extensive and rigid CPOM doctrine. The California CPOM is derived from the laws for professionals and case law that has developed over many decades. A full discussion of the California CPOM is beyond the scope of this post. However, if you are considering starting or buying a Ketamine clinic in California, we would caution you to seek healthcare regulatory counsel who is fluent in the CPOM doctrine. Deal structures in California are typically more involved than other states because of the CPOM doctrine, and often times requires a variety of companies and relationships to effectuate a compliant operation.

State Licensing Issues

Depending upon which state you live in, there could be state licensing issues you will need to explore. In Arizona, we are aware of at least one Ketamine clinic that is licensed as an Outpatient Treatment Center (“OTC”) by the Arizona Department of Health Services. However, we do not know the exact services that are provided by this clinic, which could impact whether a clinic needs to be licensed by the state.

In Arizona, an OTC is defined as “a class of health care institution without inpatient beds that provides physical health services or behavioral health services for the diagnosis and treatment of patients.” A.A.C. § R9-10-101(156). Seems pretty broad? Yes.

In turn, behavioral health services are defined as:

services that pertain to mental health and substance use disorders and that are either: (a) performed by or under the supervision of a professional who is licensed pursuant to title 32 (e.g., physicians and nurses) and whose scope of practice allows for the provision of these services, or (b) performed on behalf of patients by behavioral health staff as prescribed by rule. A.R.S. 36-401 § (A)(11).

So, imagine that Ketamine is used to treat a substance use disorder. Would that then subject the clinic to licensure by the state? There is certainly a compelling argument to be made in that case. And, this is just one example of how a Ketamine clinic could be a regulated entity in Arizona.

What if the clinic you are buying is already licensed by Arizona or another state? What do you need to do to stay in compliance? The first step is to check your state’s regulatory and statutory schemes for licensing. If your state has “change of ownership” or “change in control” requirements, the buyer may very well need to notify the state and update clinic’s application. Alternatively, if you are not buying the stock of Ketamine clinic, you may need to apply for a license with the new entity that will be running the clinic.

As an aside, and further to Part 1 of this article, if the clinic is licensed as a Medicare provider, you may need to update your Medicare application or you may need a new license altogether if you are not buying the stock of the clinic. Great care must be taken to make sure you are applying under the correct conditions. The Medicare application, which includes sections for amending an application, is the Medicare 855 Form.

Operating Agreements

Arizona passed a new Limited Liability Act (the “New Act”) that became effective on August 31, 2019 but was designed to be implemented in stages. The New Act applies to Arizona LLCs formed, converted or domesticated on or after September 1, 2019, and applied to all other LLCs starting on September 1, 2020. There are various issues under the New Act that should be considered if the selling entity or another entity involved in your deal was organized before the New Act became effect.

Some of the issues under the New Act include:

1. initiation of derivative claims on behalf of a limited liability company and the treatment of foreign protected series limited liability companies;
2. voting rights, information rights and dissociation/dissolution rights of limited liability companies, and
3. fiduciary duties and rights of indemnification of limited liability companies.

These are just a few examples of issues you will need to review and consider. Moreover, you may very well determine that amendments are needed to any such Operating Agreements. Under the New Act, there are many “optional” provisions you could layer into an Operating Agreement.

Before consummating any transaction involving an Arizona LLC, corporate counsel should review such agreements in great detail and advise their clients of the various ways that the agreement can be amended or changed (whether mandatory or permissive under the New Act).

Conclusion

Healthcare is an industry that requires a significant substantive knowledge and incredible attention to detail. State law issues, in addition to Federal issues, can be pervasive for a Ketamine deal (and any other healthcare-related deal). Any buyer or seller in this industry should consult with attorneys who are fluent in healthcare laws. Otherwise, the penalties for violating these laws can be quite severe, including criminal penalties and jail time.

Put another way, this is just like medicine – preventative care can save you a lot of time, money, and headaches. Due diligence and retention of the right counsel is tantamount to preventative care for the legal and business worlds.