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Production Quotas and Compensation Adjustments for Dentists…

When David Mayzel and I gave a presentation a few months ago to a group of dentists at the Toronto Academy of Dentistry’s All Societies Night (which you can watch here), one of the questions that came up was: “Do Dental Consolidators Impose Production Quotas and Compensation Clawbacks on Dentists?”  The answer: some do in certain situations.

“Dental service organizations” or “dental consolidators” (a term we use to describe dentists either acting alone or with non-dentist involvement) don’t typically impose production or EBITDA (earnings before interest, taxes, depreciation and amortization) quotas and compensation clawbacks on purely associate dentists.  They don’t do it because it wouldn’t make much sense: an associate may / may not have the ability to impact EBITA (either from production / cost management).  They also might not have access to the financial reporting of the practice.  And they may not be the only one working there; so their contribution is much smaller.  So they simply sign an associate agreement getting 40% (or whatever percentage) and the dentistry professional corporation takes the other 60%.

Some of the dental service organizations have, however, imposed EBITDA quotas and compensation clawbacks on dentists who sell their practices and continue to associate and / or manage the practice after the sale.

For example, in Dr. David Mady v. The Queen, the Court mentioned how Dr. David Mady had sold his practice and had signed legal paperwork that included an EBITDA quota and clawback mechanism.  Here are the passages from the Federal Tax Court case that are relevant:

[18]       Dr. Mady and [Dental Corporation of Canada Holdings Inc., hereinafter “DCC“] also executed a Professional Services Agreement in conjunction with the [share purchase agreement]. The Professional Services Agreement required Dr. Mady to continue to provide services for 5 years or to arrange for someone else to provide such services. He would be paid a set remuneration. He was required to guarantee a minimum profit level in the form of earnings before interest, tax, depreciation and amortization (“EBITDA”). If the minimum EBITDA was not met, Dr. Mady would face a clawback from his salary. If he exceeded the EBITDA target, he would receive a bonus. [emphasis added]

[61]        Dr. Mady was required to execute a Professional Services Agreement. Under this agreement, Dr. Mady had to guarantee a minimum EBITDA (the “EBITDA Target”) or else face a clawback of his own salary. The clawback was to be effected automatically and according to a formula. There was no opting out. The only way the clawback would not operate was if Dr. Mady died or became disabled.

[62]        The earnings projections that were used to set the EBITDA Target were reviewed by Deloitte in performing the due diligence on behalf of the purchaser.

[63]        While the projected 2012 EBITDA Target was higher than prior year results, Mr. Van Essen described the target as “realistic” in an email to DCC because it was in line with Dr. Mady’s average revenue growth of 15% per year for the previous four years.  The acquisition budget called for total revenue of $2.550 million, which was also the figure used in the Heads of Agreement.  Higher EBITDA would also be achieved through savings in overhead costs, which DCC would be able to achieve after the acquisition.  Mr. Van Essen admitted on cross-examination that he would not have advised Dr. Mady to accept the figure if it were not within the realm of possibility.

Note: this case had more to do with tax ramifications of restructuring than anything else; but it was interesting to see the court mention how Dr. Mady had agreed to a mandatory EBITDA Target and how we would be financially penalized for not achieving it.

A number of questions come from this:

  1. Was Dr. David Mady required to achieve this EBITDA Target in his capacity as a dentist OR as a person managing the practice?  Are the two (2) roles distinguishable?  Would it make a difference?
  2. Shouldn’t all dental practices strive, at some level, to achieve a certain EBITDA through managing production and expenses?
  3. Is an EBITDA Target problematic because it could set an unrealistic goal to achieve?  And who determines the EBITDA Target using what criteria?  Is this something that can be reviewed over time?
  4. Is an EBITDA Target problematic because it incentivizes dentists to focus on financial results – possibly at the expense of patient care through over-treating?
  5. Is an EBITDA Target problematic because it incentivizes dentists to focus on cutting back on expenses in a way that could jeopardize patient care (e.g. switching to grey-market sundries; not investing in capital equipment that would help improve treatment planning; etc.)?
  6. Who determines the financial impact of the clawback or bonus?  Is this something that can be reviewed?
  7. How could an EBITDA Target coupled with a financial clawback or bonus impact a dentist’s independence?  What about avoiding conflicts of interest?
  8. Is the EBITDA Target more focussed on production?  On cost-management?  On both?  Does it make a difference?
  9. What does this say about fee-splitting between a dentist and non-dentist, if anything at all?

I think there are lots of questions that dentists should be asking when faced with a contract that includes a minimum EBITDA that needs to be achieved for them NOT to be financially penalized.

Now imagine this: what if a dentist who signed an agreement with this clause no longer had a good relationship with the dental services organization and decided to leave and compete / solicit patients.  The dental services organization sues the dentist for breaching their agreement; in their defence, the dentist says that the agreement was illegal and contrary to public policy in part because of the EBITDA Target and clawback mechanism.  Now it’s up to a court to decide whether (1) the dentist was sophisticated / resourceful and knew what they were getting into so the contract should be enforced, (2) regulatory issues between the RCDSO and the dentist aren’t probably addressed in a court dealing with the interpretation and enforcement of a private agreement (that’s what happened in Dr. Daniel Pesin v. Smilecorp), or (3) like they often do in the U.S., the contracts should be declared illegal for being contrary to public policy and hence, unenforceable, either in whole or in part.

Things to think about as we head down the path of a greater dental services organization presence in Canada.