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Medical liability coverage
for Texas physicians

Practice set up and liability

by Flauren Bender, JD and Linda Stimmel, JD

Editor's note: physicians should not consider formation of or affiliation with any of the entities described in this article without obtaining specific legal advice about the entity and the laws that apply in the particular situation. Failure to consult with a health care attorney regarding physician practice set up and the drafting of practice-related agreements can result in increased exposure and liability. Readers are also advised that the laws and rules concerning these entities are subject to change.

Physicians have several options to consider when setting up a medical practice in Texas. It is important for physicians to understand these options because how a practice is structured can affect the liability of the group, the physicians, and the staff. This article offers an overview of the options available for medical practice set up in Texas and discusses the legal implications of each practice type.

Entity types

In Texas, there are three primary entity types for the practice of medicine: a 1) Professional Association (PA); 2) Professional Limited Liability Company (PLLC) and 3) Limited Liability Partnership (LLP). The rules and regulations governing these professional entities and their formation can be found in the Texas Business Organizations Code

The three entity types each offer distinct advantages and disadvantages to physicians. (Please see the table comparing practice entity types for a summary.) Three key factors to consider when choosing an entity type for your practice include:

  1. Management and membership — how the entity will be managed and who will comprise the membership of the entity;
  2. Liability — the extent to which the entity will shield its members from personal liability; and
  3. Taxation — whether and how the entity and its members will be taxed.

Texas Professional Associations

A PA is an association, distinct from a corporation or partnership, that is governed as a professional entity and formed for the purpose of providing the professional service rendered by a medical doctor, doctor of osteopathy, doctor of podiatry, dentist, chiropractor, optometrist, therapeutic optometrist, veterinarian, or licensed mental health professional. (1-3)

A PA is created by filing a Certificate of Formation with the Texas Secretary of State and paying the associated $750 fee. Texas Secretary of State Form #204 is a PA Certificate of Formation form that meets Texas' statutory requirements. (4-5)

PAs are owned by members and a PA is required to have at least one member. Every member of a PA must be a professional individual licensed to provide the same service rendered by the PA. (6) However, PAs can employ nurses or other individuals who do not ordinarily provide a professional service, including clerks, secretaries, bookkeepers, technicians, or assistants. The code contains a few exceptions. The exceptions allow doctors of medicine and doctors of osteopathy to own a PA with licensed podiatrists; professionals other than physicians engaged in related mental health fields such as psychology and clinical social work can form a PA to provide services within their scope of practice; doctors of medicine and doctors of osteopathy can jointly form a PA with licensed optometrists or therapeutic optometrists. (7)

PAs are governed and managed by either a board of directors or an executive committee, at the election of the members of the PA. Only members of the PA are eligible to serve as officers or governing persons (i.e. on the executive committee or board of directors) of a PA. Only a governing person of the PA may serve as the PA's president. (8-9)

Generally, PAs are treated as for-profit corporations under Texas law. Unless there is a particular provision specific to PAs, the rules that apply to Texas corporations are applicable to PAs. (10) PA members should draft bylaws setting forth the specifics of how they wish to manage their Association, including capitalization and distribution of profits.

In order for the entity to be respected by Texas courts and to maintain liability protection, PA members should observe certain corporate formalities, including: 1) maintaining minutes for all annual and special meetings; 2) maintaining the PA's financial records separately from those of each member; 3) complying with the PA's bylaws; and 4) ensuring that the PA is adequately capitalized and insured. (11)

A PA is responsible for both the debts and obligations of the PA itself and those of its members, managerial officers, agents, and employees while such persons are providing professional services for the PA or during the course of such persons' employment. (12) A PA does not offer limited liability for the professional malpractice of its members; however, each member has limited liability for claims arising from sources other than his or her own malpractice. (13) If a patient sues a PA for the wrongful act or omission of one of its physician-members, the PA along with the physician-member alleged to have committed the wrong are responsible for any legal ramifications of the wrongful act or omission. A plaintiff can sue the PA and the physician-member whose conduct is at issue but the other physician-members of the association are completely isolated from personal liability.

Because they are treated like private corporations, PAs are subject to "double-taxation," meaning that they are taxed once at the corporate level and again at the member level. To avoid double taxation, a PA may be able to file with the Internal Revenue Service to obtain 'S' Corporation status if the PA meets certain requirements, whereby it will gain pass-through status and only the PA's members, not the entity itself, will be taxed. (14) (Please note that it is important to consult a tax attorney or accountant concerning tax issues.) As of January 1, 2008, all PAs are subject to the state franchise tax.

PAs are required to file an annual statement with the Texas Secretary of State regarding licensure that lists the names and addresses of all members, officers, and governing persons of the PA. (15)

Professional Limited Liability Companies

A PLLC is a limited liability company governed as a professional entity and formed for the sole purpose of providing a professional service, meaning any type of service that requires the person providing the service obtain a license, registration, or other legal authorization prior to rendering such service. This includes the personal services rendered by an architect, attorney, certified public accountant, dentist, doctor, veterinarian, nurse, or insurance agent. (16)

A PLLC is created by filing a Certificate of Formation with the Texas Secretary of State and paying the associated $300 fee. Texas Secretary of State Form #206 is a PLLC Certificate of Formation form that meets Texas' statutory requirements. (17)

Only a professional individual who is licensed to practice the same professional service as the PLLC may be a member or a manager of a PLLC. Officers of PLLCs must be professional individuals who are licensed to provide the same service provided by the entity. Membership in a PLLC may not be transferred to a person who is not a professional individual or professional entity. (The same exceptions in the code that allow certain professionals to jointly form and own a PA also apply to PLLCs.) (18-21)

PLLCs may be governed by managers or by its members, and that governance decision must be made on the certificate of formation. (22) A PLLC is required to have at least one member. Physician-members should draft and approve PLLC regulations setting forth the specifics of how they wish to manage their PLLC.

As with PAs, PLLCs are required to follow certain corporate formalities in order to maintain liability protection. However, unlike a PA, if a PLLC is taxed as a disregarded entity or a partnership (as discussed below), the entity is not required to maintain minutes of annual and special meetings. Even though maintaining minutes is not required, it is encouraged as a good business practice. (23)

Like a PA, the members of a PLLC (whether individuals, organizations, or both) have limited liability for the debts and obligations of the entity. In other words, the physician-members are not personally liable for the debts, obligations, or liabilities incurred by the PLLC, except to the extent of their individual contributions to the PLLC. (24) This means that if liability accrues with the PLLC, the members' personal assets will be protected from creditors of the PLLC. However, it is important to remember that while members of a PLLC are shielded from personal liability for the wrongful acts of any one individual member, an individual member cannot avoid liability for his or her own actions simply because he or she is a part of a PLLC. (25)

PLLCs can be taxed in several different ways. If an individual forms a PLLC, the company will be taxed as a sole proprietorship by default; the entity is disregarded for federal tax purposes but the member is still given the benefits of limited liability under Texas law. If two or more individuals or entities form a PLLC, the entity will be taxed as a partnership by default. After formation, a PLLC may elect to be taxed as a corporation; as such it can function as a C corporation and be taxed at the company and member levels, or, if it meets certain requirements, it can elect to be an S corporation and receive pass-through tax status. (26-27) (It is important to consult a tax expert regarding questions concerning entity taxation.) As with PAs, PLLCs are subject to the state franchise tax.

Limited Liability Partnerships

A general or limited partnership can register with the Texas Secretary of State to form a LLP for increased liability protection. Both professionals and laypersons can form LLPs. (28)

An LLP is created by filing a Registration with the Texas Secretary of State and paying a $200 fee per partner. (28) Texas Secretary of State Form #701 is an LLP Registration form. (29) The registration of an LLP is effective for one year. An LLP registration may be renewed by filing a renewal application and paying a $200 fee per partner; a renewal application must be filed yearly before the expiration of the registration. Texas Secretary of State Form #703 is the registration renewal form. (30)

A unique requirement of LLPs is that they are required to carry at least $100,000 of liability insurance. Alternatively, LLPs can instead set aside $100,000 for the satisfaction of judgments against the partnership. (31)

Unlike partners in a general partnership who are liable for all partnership obligations, a partner in an LLP is not personally liable for partnership liabilities unless such liabilities are attributable to the fault of that partner. A partner in an LLP is not personally liable for a debt or obligation of the partnership arising from an error, omission, negligence, incompetence, or malfeasance committed by another partner or representative of the partnership while that partnership is registered as an LLP and in the course of partnership business unless that partner was: 1) supervising the wrongdoing; 2) actively participating in the wrongdoing; or 3) had actual knowledge of the wrongdoing and failed to take reasonable actions to stop the wrongdoing. As with members of PAs and PLLCs who commit a wrongdoing, partners in an LLP are not shielded from personal liability for their own errors, omissions, negligence, incompetence or malfeasance. (32-34)

For federal income tax purposes, LLPs are taxed as partnerships, meaning all of the profits and losses of the LLP pass through the entity to the partners who pay taxes on their share of the profits on their individual federal tax returns. (35) (Again, it is important to consult a tax expert concerning taxation of your entity.) As with PAs and PLLCs, LLPs are subject to the state franchise tax.

Written agreements

How provisions in a practice agreement are phrased can have a tremendous impact on a physician's liability. In addition to selecting the appropriate entity-type, physicians should have a health care attorney draft their practice-related agreements to ensure that physicians are afforded maximum liability protection.

The language in a physician's agreements with employers, employees, and independent contractors must be carefully worded to reflect the physician's intended relationship with the other parties. If a physician enters into an agreement with a health care professional whereby the professional is the physician's employee, the physician will be vicariously liable for the negligence of the health care professional when the professional is acting within the scope of his or her employment. This means that if the health care professional is negligent and harms a patient, the physician can be held responsible for the health care professional's actions even though the physician did not commit the wrong. On the other hand, if a health care professional contracts with a physician to perform services as an independent contractor, the physician will generally not be liable for the professional's negligence because independent contractors have sole control over the means and methods of their work.

For example, if an agreement states in one provision that a health care professional (in this case a physician) is working for a group as an independent contractor, but other language in the agreement provides for supervision and/or other criteria more consistent with an employer-employee relationship, a court could potentially find the group to be vicariously liable for the actions of the professional.

Protection from liability

No matter the practice entity type, the following guidelines may help physicians minimize liability risk.

  • Maintain the integrity of your entity and follow corporate formalities. It is extremely important to comply with the statutory requirements and respect the corporate formalities of your legal entity. If you fail to act like a PA, PLLC, or LLP, Texas courts may disregard your entity and you may lose your liability protection under the law. If you do not maintain the integrity of your business entity, creditors can have them declared "sham entities" which may allow them to reach your personal assets.
  • Maintain current, detailed bylaws and/or regulations. Make sure your entity's bylaws/regulations/agreements lay out in detail how the physician members/partners want to manage the entity (including how profits are distributed, how members/partners are removed from the practice, etc). In the case of a disagreement, the written bylaws will prevail.
  • Follow your written policies. Maintain office policies and procedures for your practice and make sure you continually update the policies to ensure that your "practice follows your policies."
  • File documentation or registration on time. If your entity requires an annual filing (in the case of a PA) or annual registration (in the case of an LLP) make note of the date and ensure that documentation is filed timely. In the case of an LLP, if the registration is not timely renewed, the liability protection ceases, and partners will have personal liability for liabilities incurred after the expiration date.
  • Be aggressive about protecting your assets. At the time you decide which legal entity is best for your physician practice, you might want to consider having some of your personal assets placed in a more defensive position. An asset manager can advise you on how to protect your assets through family limited partnerships, an irrevocable life insurance trust, or an offshore trust. (For more information on asset protection for physicians, please see the article "Asset protection — revisited" in the January-February 2008 issue of the Reporter.)
  • Do not move assets once a lawsuit is filed. It is extremely important not to move your assets into some new type of asset protection after a lawsuit is filed — or even when a lawsuit is anticipated. The court may consider such transfer a "fraudulent conveyance."
  • Consider using A/Rs as collateral for a loan. Consider having the accounts receivable for your physician practice used as collateral for a business loan from a bank. A creditor cannot take an asset that is already encumbered. (For more information on asset protection, please see the article "Asset protection — revisited" in the January-February 2008 issue of the Reporter.)
  • Maintain malpractice coverage for the entity and individual physicians. Remember that when you form a legal entity, plaintiffs' attorneys may sue your legal entity, as well as the individual physician alleged to be at fault, so try to obtain extra coverage in the event the individual physician does not carry enough medical malpractice coverage.
  • Plan ahead to obtain licensure and DEA numbers. Because some states may take months to issue a medical license, do not delay if you need licensure before starting your practice. Once you have applied for a state medical license, you can file for a DEA number. The DEA will issue the number only after it has received verification that the state in which you intend to practice has actually issued your license.
  • Obtain federal and Texas tax IDs. After forming your entity with the Texas Secretary of State, make sure you obtain a federal tax ID number so you can open a bank account for the business, hire employees, and file federal taxes. The entity will be assigned a state tax ID number for franchise tax purposes once the certificate of formation is filed by the secretary of state.
  • Consult a health care attorney and a tax specialist on entity formation. Physicians should consult with a health care attorney and an accountant or tax attorney to assist in entity formation and regarding tax implications for the entity.
  • Consult a health care attorney to help draft your agreements. Once signed, agreements are legally binding documents. Physicians should consult with a health care attorney to draft their employment and independent contractor agreements to ensure they are written to provide maximum liability protection.

Sources

  1. Texas Business Organizations Code Ann. Section 301.001.
  2. Texas Business Organizations Code Ann. Section 301.003.
  3. 7 Tex. Jur. 3d Associations and Clubs. Section 4 (2009).
  4. The Texas Secretary of State. Form 204 (Revised September 2007). Available at: http://www.sos.state.tx.us/corp/forms/204_boc.doc. Accessed June 8, 2009.
  5. 20 Tex. Prac., Business Organizations Section 24.17 (2d ed.).
  6. Texas Business Organizations Code Ann. Section 301.006.
  7. Texas Business Organizations Code Ann. Section 301.012.
  8. Texas Business Organizations Code Ann. Section 302.005.
  9. Texas Business Organizations Code Ann. Section 302.008.
  10. Texas Business Organizations Code Ann. Section 302.001.
  11. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 292, 302.
  12. Texas Business Organizations Code Ann. Section 301.010.
  13. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 305.
  14. Egan BF. Choice of entity decision tree after margin tax and Texas Business Organizations Code. Texas Journal of Business Law. 2007 Volume 42. 71. 118.
  15. Texas Business Organizations Code Ann. Section 302.012.
  16. Texas Business Organizations Code Ann. Section 301.003.
  17. The Texas Secretary of State. Form 206 (Revised January 2006). Available at: http://www.sos.state.tx.us/corp/forms/206_boc.doc. Accessed June 8, 2009.
  18. Texas Business Organizations Code Ann. Section 301.003.
  19. Texas Business Organizations Code Ann. Section 301.007.
  20. Texas Business Organizations Code Ann. Section 301.009.
  21. Texas Business Organizations Code Ann. Section 301.012.
  22. Texas Business Organizations Code Ann. Section 101.251.
  23. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 307.
  24. Texas Business Organizations Code Ann. Section 301.010.
  25. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 306-07.
  26. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 307-08.
  27. Egan BF. Choice of entity decision tree after margin tax and Texas Business Organizations Code. Texas Journal of Business Law. 2007 Volume 42.156.
  28. Texas Business Organizations Code Ann. Section 4.158.
  29. The Texas Secretary of State. Form 701 (Revised November 2007). Available at: http://www.sos.state.tx.us/corp/forms/701_boc.doc. Accessed June 8, 2009.
  30. The Texas Secretary of State. Form 703 (Revised March 2009). Available at: http://www.sos.state.tx.us/corp/forms/703_boc.doc. Accessed June 8, 2009.
  31. Texas Business Organizations Code Ann. Section 152.804.
  32. Texas Business Organizations Code Ann. Section 152.801.
  33. Riddle MC, Butts C, Akiens KK. Choice of Business Entities in Texas. Houston Business and Tax Law Journal. 2004 Volume 4. 299-300.
  34. Egan BF. Choice of entity decision tree after margin tax and Texas Business Organizations Code. Texas Journal of Business Law. 2007 Volume 42. 189.
  35. Egan BF. Choice of entity decision tree after margin tax and Texas Business Organizations Code. Texas Journal of Business Law. 2007 Volume 42. 196.
Flauren Bender, JD is an attorney with Stewart Stimmel LLP in Dallas. She can be reached at flauren@stewartstimmel.com. Linda Stimmel, JD is a partner with Stewart Stimmel LLP in Dallas. She can be reached at linda@stewartstimmel.com.
 


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