Healthcare management services organizations (MSO), also known as a medical management company, have become critical to managing healthcare operations. The structure of the MSO and the MSO ownership, however, carry risk and case law analyzing their legality is just developing. In a matter of first impression in California, a recent appellate court rejected legal challenges brought against MSOs in California Advocates for Nursing Home Reform v. Arágon (Jan. 29, 2021, A158035)) 60 Cal.App.5th 500.

An MSO provides non‑clinical, administrative support services to healthcare providers and physician group practices. The common objective of an MSO is to provide the non-medical business functions in order that healthcare providers can focus on their expertise: providing healthcare services. MSOs have become increasingly common, especially as health care reform continues to complicate the billing and reimbursement process. MSOs can also buy the assets of the licensed operations or a healthcare practice to provide capital, and then offer the practice essentials such as equipment or space. MSOs can also assist healthcare providers navigate Stark and federal anti-kickback laws if structured appropriately.

MSOs are also a means to navigate state “corporate practice of medicine” laws prohibiting non-licensed and/or non-physician-owned business entities from practicing medicine or employing licensed health care providers (“Corporate Practice Bans”). California, along with Texas and New York, impose stringent laws and regulations related to Corporate Practice Bans. In order to avoid regulatory violations, contractual MSO arrangements need to be structured carefully to ensure that the MSO does not exert undue control over the health care practice in contravention of Corporate Practice Bans and complies with licensing regulations.

In Arágon, the plaintiffs, comprised of a nonprofit group called “California Advocates for Nursing Home Reforms” and two individuals, challenged the legality of a management arrangement in the context of a Skilled Nursing Facility (SNF). A striking fact about the lawsuit is that the Plaintiffs sued the Director of the California Department of Public Health (CDPH), two entities licensed to operate a SNF, and a SNF management company. The defendant-SNF obtained the requisite, operational license from the CDPH. (California Health & Safety Code § 1253 requires a SNF to obtain a license to operate.)

The licensed SNF then contracted with an MSO to assist it with managing its operations. The CDPH approved the relationship. Plaintiffs sought declaratory relief from the courts that CDPH’s approval of an unlicensed MSO was illegal, because only licensed healthcare providers are permitted to operate SNFs. The trial court rejected the argument and dismissed the case, holding MSOs are not illegal and do not need to be separately licensed. The plaintiffs appealed.

The Court of Appeal affirmed the dismissal, holding that the CDPH had the authority to approve unlicensed MSOs to assist in the operations of SNFs and the arrangement did not violate the law. The legislature, the court found, had contemplated and approved MSO relationships in the statutory framework. The court noted that California Health and Safety Code § 1267.5 required licensees to disclose if a SNF would be operated by an MSO and imposed different requirements as between the licensed provider, on the one hand, and the unlicensed MSO, on the other hand.

Plaintiff argued that the MSO violated the law because it: (a) impeded the authority of a nursing home administrator and (b) insulated the licensed-SNF from liability. The Court rejected both arguments, finding Health and Safety Code § 1416.68 defined the administrator’s duty as overseeing the day-to-day management of the SNF and permitted the delegation of management. The court relied on CDPH’s regulations that specified the SNF-licensee remained “responsible for compliance with licensing requirements and for the organization, management, operation and control of the licensed facility.” (Cal. Code Regs., tit. 22, § 72501(a).) Because the SNF’s responsibilities and obligations vis-a-vis the State did not change, the fact that the SNF delegated some of the management duties did not change or alter liability. “It is clear that, even if management companies are running the day-to-day operations, the licensee is still ultimately responsible for those operations," the court said. Because the internal delegation and management structure of the SNF did not, and could not, alter the duties and liability of the SNF under the law, the MSO structure did not contravene the law.

MSO arrangements need to be structured carefully to ensure that the MSO does not exert undue control over the health care practice, pursuant to Corporate Practice Bans, AKS and Stark laws. But, assuming that the MSO is properly set up and operated in accordance with healthcare laws and regulations, Arágon provides a greater sense of certainty that courts recognize the MSO-business structure as legally enforceable and valid.