In this episode, hosts Brad and Michael dive into the story of a successful plastic surgeon who used estate planning strategies to transfer wealth and ownership to his family. What was originally intended to protect his assets ultimately backfired when a personal scandal gave his family the power to remove him from his role as CEO. Tune in to learn the importance of proper business governance, corporate formalities, and the fiduciary duty in protecting your practice.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1.
Brad: Welcome back to another episode of the Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, my co-host Michael Byrd.
Michael: As a business and health care law firm, we meet a lot of interesting people and learn their amazing stories. This season’s theme is Unintended Consequences. We sometimes find ourselves in a situation that can be traced back to a seemingly inconsequential or unrelated decision.
Brad: Well, Michael, before we jump in today’s major show, I wanted to discuss a new lawsuit out of California that was filed, and I figured because our podcast is on legal stuff, it’d be good for us to kind of discuss it.
Michael: Does this involve famous people, Brad? What’s the lawsuit?
Brad: I mean, they’re probably famous. They’re moms and dads, but not anyone…
Michael: Kind of Brad famous.
Brad: [00:01:00] Yeah, exactly. But no more than, oh, the lawsuit is dealing with a law that says nail technicians need to be employees, not independent contractor. I mean, it sounds pretty simple, right? But it’s causing more ripple effects than a spilled bottle of nail polish on a salon floor.
Michael: Okay. Brad, your imagery is vivid. I’ll give you that, but it’s also equally cringey, as my teenage daughter, Ellex would say.
Brad: So cringe is not good?
Michael: No, when she calls me cringey, I don’t feel good. And I don’t want you to feel good.
Brad: I didn’t know if I was supposed to feel good. I mean, grunge was a kind of thing, so I didn’t know cringe and grunge were similar.
Michael: No. That also is cringey.
Brad: Dang it. Well, here’s the scoop. California passed a law called Assembly Bill Five. It was meant to make sure that workers were classified properly. And as we know employee versus independent contractor, that’s a pretty kind of big deal, isn’t it, Michael?
Michael: Yeah. And this was big in the news in California [00:02:00] really going back a few years ago. And AB5, as they say on the streets, sought to crack down on industries in which workers were in their minds, misclassified as independent contractor, and weren’t consequently afforded protections like minimum wage, overtime pay, and workers’ comp and employee would have access to. And I think the big, what may connect people to this AB5 is, I think Uber was a big part of it. And so the ride share world was initially a few years ago fighting this.
Brad: Yeah. Yes. Good job, Michael. Yes. It’s almost like you’ve talked about this before, but as you said, various industries have been targeted for unfairly or creating uneven playing fields with businesses, but instead of just fixing workers right, it’s gotten to the point now we have these salon owners crying [00:03:00] foul because they feel like they’re being unfairly targeted, and it’s targeting their community, specifically the Vietnamese-American salon owners.
Michael: Well, that is a different twist. Now I’m curious – how did that happen?
Brad: Well, 80% of nail technicians in California are Vietnamese women. And the salon owners argue that the lawsuit is telling them that they, they can’t be flexible anymore. They’re suing, claim the law is discriminatory. And it takes into account that they can’t just file their nails in a certain way because they have this bias against their community.
Michael: Okay, what’s the verdict? What happened?
Brad: Well, there’s no verdict. The lawsuit was just recently filed. But they’re claiming an increased cost with these new rules could actually be the death of their business and the manicurists who liked the flexibility to work the way they wanted to, the businesses that filed suits have multiple locations throughout California. There’s one called Blue Nail Bar, happy Nails and Spa, [00:04:00] and Holly and Hudson Nail Lounge.
Michael: Okay. How do the nail salon workers feel about this?
Brad: Yeah, you would think because the law was supposed to be protecting them that they would be happy they would be against the law. But the Los Angeles Times to actually quote one employee from a salon, her name was Emily, who was among several different employees who spoke in support of the salon owners lawsuit at this news conference. And Emily said that no one forced me to be here today, that she chose to be there because she wanted to express the side of her story, but being an independent contractor meant that she could work for herself, that she could be her own boss, create her own brand on her own business hours, and she could choose what clients to work with. And so the law that was meant to protect workers – to these employees, doesn’t feel like it’s helping them.
Michael: Yeah. I mean, couple things there. So it you’ve got the actual employees who are now have to be called employees [00:05:00] that are not happy and would prefer to be independent contractor. And just that I think we could do a whole season on unattended consequences of laws that are passed and have an overreach.
Brad: I totally agree with that statement. You know, sometimes laws are intended to fix one thing, as you say, and can leave businesses and workers stuck in a really sticky situation. Or as my daughter might say, a botch manicure, because I feel like the number of times I’ve never got one, Michael, I don’t know about you, but I feel like I paid for several where it didn’t work, and then she had to go to a different salon to get it fixed.
Michael: Yeah. No, not had a manicure, so I cannot relate to the botch manicure other than like you in the pocketbook. I think we’ve reached a conclusion that we can move to our story today.
Brad: We can. So this is the actual story. Today we’re driving into a real-life situation where unintended consequences of running a family business on this one’s [00:06:00] coming from the medical world, as you can imagine, and think of it you have a physician who’s running a few clinics, and it becomes kind of a rollercoaster story of success, family drama, legal lessons. So Michael and everyone else, I guess buckle up here.
Michael: So are we about to hear a story that ends with a family feud, Brad?
Brad: Yes. And it’s not the kind that a family feud that you typically have when the monopoly game goes bad, right? Instead, we’re actually dealing with real money, not monopoly money. So in this case, we have legal issues with structures, governance, and real assets. The story starts off – we’ll meet Dr. Hudson, a superstar plastic surgeon who turned his medical practice empire into a real estate empire, a med spa empire, surgical centers and more. And we’ll call his medical companies altogether, we’ll call it Happy Blues Center, or as they say, HBC.
Michael: Okay. So I see you pulling your salon game [00:07:00] into our names for today, HBC. Got it. And we’ve spoken on many episodes with similar concepts of a physician or in this case, a plastic surgeon, that has kind of this Doctorpreneur concept of building around their surgical practice with these kind of ancillary investments.
Brad: Yeah. So let’s just start from the beginning of time. So, Dr. Hudson started his journey with a surgical practice. Now, this was his core entity. Just think of from that perspective where he performed all his procedures and really built his reputation, but then he started expanding into different entities. He built an ambulatory surgery center, an ASC, where all his outpatient surgeries were happening, which also allowed other physicians to operate it besides him. He also then had the med spa for the non-invasive or cosmetic services. And then on top of that, every spot that he started [00:08:00] opening, he had a real estate company that would then own the site that the practices were being put on. He also started an equipment company and surgical supplies and device company.
Michael: Couple of notes that won’t be new to those listeners who’ve listened to prior episodes. You used the word Ambulatory surgery center, and we’ve spoken about that there is a difference between that and kind of the office-based OR. And so an ASC typically has its own certification from the state, and to your point, other doctors can more easily go in as truly as a separate business with separate licensing and oftentimes separate ownership. And you mentioned med spa too, as a separate entity. And so, a lot of our clients may have their “medical spa” or the non-invasive services wrapped in their practice, others [00:09:00] that created as a separate entity, oftentimes we’re doing so strategically, so they may have a different business plan for the med spa. Maybe it’s multiple locations, maybe it’s multiple locations and multiple owners. But it does truly start to look like a pretty sophisticated model when you build these separate businesses that are ancillary, but also have the ability to grow on their own independent of the surgical practice.
Michael: So Dr. Hudson, did he just have one location? Did I hear that?
Brad: Yes. At first HBC just had one location, but as his practice grew, so did the number of locations. He started opening up practices all over kind of Southern California with over five HBC locations when we first met him.
Michael: Okay. Well, when did we meet him?
Brad: Just hold off, Michael? We’re not there yet.
Michael: I’m so curious.
Brad: All the entities worked together [00:10:00] to serve his patients efficiently in profitability. So he liked it from there, and he had it all tied together, and so he wanted to find something to do with that. So Dr. Hudson created something called a management service organization, whereas that tattoo says on your back, MSO.
Michael: Oh, got it. Did I hear you right. You said he created the MSO to kind of tie it all together?
Brad: Yes.
Michael: And so that sounds like the glue plan that we talk about where the purpose of your MSO is to connect multiple business lines or centralize them through one MSO type entity.
Brad: Yeah. And that’s exactly what he decided to do. So you got that correct. And his vision was that this MSO would just handle all the management functions and administrative side, support staff and billing, and all the things that these clinics and ASC and the med spa needed really to run day to day business-wise, so that they could just focus on best [00:11:00] care for the patients themselves.
Michael: I’m guessing that that also helped Dr. Hudson with liability and maybe even tax strategies.
Brad: Yeah, yeah, absolutely. We’ve talked about this in other episodes, there’s a lot of different reasons to do it that way, but for him, it really, he was focused on streamlining operations and mitigating some risk. But we’ll say, it also can create, you know, when you’re doing something like this, this does create a more complex legal structure, and that can be problematic for some people from a management perspective.
Michael: Well, I want you to follow very carefully, Brad, so you can follow the bouncing ball. Complicated structures can be complicated to run. Do you follow that?
Brad: So far so good.
Michael: And we’ve talked about this in other episodes. And seriously, it’s fun to build, but you really need to be aware of the monster that you’re building.
Brad: That’s a fair assessment there, Michael. And yeah, it can be difficult sometimes as they grow [00:12:00]. And for Dr. Hudson, the MSO was not just for cost saving. He really loved this idea of having potentially non-physician owners in the MSO. As you are aware, and some of our audience – California is a CPOM state.
Michael: CPOM – Corporate practice of medicine. It’s more fun to say CPOM than it is to agree. Yeah, so that is a law that regulates who can own a, a business that practices medicine in certain states. And California has that, and they have these limitations. So the MSO, because it doesn’t practice medicine, we’ve described it, has all these kind of back office functions can be a solution around CPOM. So if he’s starting to think about, to your point about non physician ownership the MSO is the vehicle that he [00:13:00] could use, he wouldn’t be able to bring them in to some of his other entities. Like the real estate company and potentially the ASC would be allowed. But if you want to be a part of the whole, and you’re a non-physician, I could see the MSO would fit naturally around this CPOM issue.
Brad: Yeah. And so, as this practice or enterprise grew, so that his role as the CEO of the HBC empire and via really the MSO, and he started actually bringing on more physician partners in the medical practices – so downstream, and they were slowly buying him out of these actual practices.
Michael: And so as he’s getting bought out, as he getting paid in his role to manage all these practices.
Brad: Yeah, that’s a good question. He made sure that he was disclosing his CEO salary in the MSO. So the other physician owners knew that his role as it grew as a CEO, he was being compensated [00:14:00] more on the MSO side, than he was on the practice side. He wanted to make sure that he couldn’t be accused of self-dealing or violating any other fiduciary duties because of him being on both the practice side and the MSO side.
Michael: Well, fiduciary duty is a fancy word, Brad. What does that mean exactly?
Brad: I was hoping you would answer the question, but I will, I’ll answer it. So for those who aren’t familiar with fiduciary duty, it really means a duty of loyalty or duty of care. And really, it’s a legal obligation that happens if you’re an officer or a director or in certain cases where you have to act in best interest of the organization on behalf of the owners of that organization Yeah. To make sure that they know what’s going on.
Michael: I wanted to jump in too. You were talking about disclosing that his compensation – and we have seen this mistake happen with others with an MSO. If you have this “self-dealing” risk of being [00:15:00] an owner in the MSO and the practice, then disclosing the management fees and other fees that are paid to this entity do become really important to avoid at a minimum just an optic problem, even worse, this fiduciary problem.
Brad: Absolutely. And as Dr. Hudson’s MSO grew in wealth, he continued to slow down his medical services and kept recruiting more doctors to performed surgeries under this management and other individual providers in the med spa. And eventually, he really was no longer practicing medicine himself. He really was enjoying wearing the CEO role more than anything else.
Michael: Yeah. I mean, when you start, we talk about this other times that small business owners end up wearing a lot of hats, especially professionals. And so you have this hat as a physician, you may have a hat as a supervisor and these different business hats, and then [00:16:00] even within the business side, you may be an owner, an officer, a board member. And so, it sounds like really distilling it down to more the business side, business executive type than actually a practicing physician.
Brad: Yeah. So, as Dr. Hudson’s wealth grew, he actually started working with an estate planning attorney who wanted him to start protecting his assets and figure out ways to give some of this wealth the younger generation. So based on an estate plan, he started gifting ownership of the MSO to his wife and kids, and for reference, they weren’t doctors, they weren’t medical providers – actually had nothing to do with the business. This is a pure estate planning strategy.
Michael: From an estate planning perspective, this is a common strategy. You’re transferring wealth over time while that person’s still alive. And there can be – you and [00:17:00] I are not tax attorneys, but we know that that strategy is, is super common in a way to mitigate estate taxes and that could be owed when that person dies.
Brad: I thought you were going to say that we’re not tax attorneys, but you did stay at a Holiday Inn Express last night, so I didn’t know if that’s where we were going. But yeah, your point otherwise was good. So besides adding them as owners of the MSO, they amend the operating agreement and all the other documentations to do that, he started also appointing his family members as board members, and they were given officer titles and certain salaries as that which technically was actually for full disclosure, was coming out of his CEO comp. So he was spreading the wealth, I guess is the best way to kind of describe it.
Michael: Well, this is less common. On these wealth transfer strategies to actually give the family members titles, roles, salaries, [00:18:00] usually it’s an ownership transfer as we talked about. I have seen circumstances where it enhances asset protection strategy to offload some of the decision making. But that’s pretty nuanced and haven’t heard anything that would make me think that’s the situation here. So I guess the logical question is did the wife and kids actually start helping run the business?
Brad: It is a logical question, and the answer is no. It was all paper – but it was so they could get a salary. So basically all form, no substance.
Michael: I think our listeners know at this point that all form no substance is not good. Is that correct, Brad? That’s not good. Very good, Michael. And we’ve said in Texas, that’s called all hat, no cattle.
Brad: Now, to add a little bit of additional flavor to the story. So just when you thought Dr. Hudson had it all wealth, growing empire, [00:19:00] family “involved” – things turned more dramatic.
Michael: Oh, I don’t like the sound of that. Are we talking family drama, Brad?
Brad: Yes, we are. Okay. Well, the family found out that Dr. Hudson may or may not have been having an affair with the colleague at the MSO, the actual COO of the business. We’ll call her Ms. Emily, and surprise, they were not happy.
Michael: Yeah, that’s generally frowned upon and dramatic. If true, you said may or may not. I think you’re being nice to our Dr. Hudson.
Brad: So his wife did find out about the affair. She was not happy, so she filed for divorce. And then of course, the wife and kids were very upset, feeling betrayed and angry, and they decided to take some actions. So they hired a corporate attorney who then started drafting documents, calling for a special meeting of the owners and officers of the board. And [00:20:00] at this meeting, the family kicked Dr. Hudson off the board. They fired him as a CEO and they fired Ms. Emily as the COO.
Michael: Yikes. That’s a lot, man. And you know, probably an additional element here is that they fired Ms. Emily and they’re in California and there’s some serious employment risk that would be pending out there for her getting terminated for having an affair with one of, I guess, her boss.
Brad: Yeah. And we won’t get into the labor talk today for this one. We’ll save that for Mr. Ben Hernandez if he ever wants to come on for this. But part of the reason for his firing of the CEO or what the family claimed anyway was that Dr. Hudson had violated, going back to word we used earlier, his fiduciary duty to the business, as he and Ms. Emily were traveling around on the MSOs dime as a part of the affair. Now again, this is what they were [00:21:00] claiming as to that violation.
Michael: Fiduciary duty again. You keep bringing that up. Does this mean that Dr. Hudson had a legal obligation to be loyal to his family or his business?
Brad: Well, I’d say both. But in different meanings. Like as an officer and director especially, as the CEO of the MSO, he does have a fiduciary duty and duty loyalty to the business which means he has to be – he’s legally required to make the best decisions for the company and for the owners, not just for himself. And obviously from a personal perspective, the duty of loyalty to your wife, that’s his vows between your God and yourself, but that would be the different aspect of that.
Michael: Okay. So bam gone just like that. Yeah. He built this empire from the ground up and is on the street.
Brad: Precisely. And this is where the unintended consequences start kicking in. And since he transferred the ownership [00:22:00] interest and of the MSO and his family appointed to officers, and based on the estate and tax planning, they had control and they chose to assert it.
Michael: This sounds like a scene out of the TV show, Succession.
Brad: I’ve never seen it, but you’re probably right. And worst was that his medical license had expired because he was no longer actually really involved in the practice, medical practice anymore because he had really become the full-time CEO.
Michael: Well, that all took a turn. When did we get involved with Dr. Hudson? I hope you didn’t cause any of this.
Brad: No, it was not me. It could have been you. So we received a phone call from the boardroom from his CPA as the wife and kids were voting him off the board and filing for resolutions to fire him as a CEO.
Michael: Okay, man, this is intense. Let’s go to commercial and on the other side, learn more about what happened to Dr. Hudson and the legal [00:23:00] impact of this story.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, still here with my co-host, Michael Byrd. Now Michael, this season, our theme is Unintended Consequences, and we had a great story about a family that’s in love with each other, an entrepreneur, Dr. Hudson, who really loved his kids so much, that he started giving them all this stuff and then bam, they don’t love him anymore. So before we go too far [00:24:00] down the Dr. Hudson trap, let’s kind of take a step back here, Michael, and like focus on some of the things that happened here. So let’s begin with the corporate structure that Dr. Hudson built. He created multiple entities, surgical practice, an ASC, a med spa, a real estate holding company, equipment company, and he wrapped it all up with this MSO. This is common as you talked about earlier – in healthcare, but especially for the more entrepreneurial plastic surgeons, but the key issue here is, is the entity structures and governance.
Michael: Yeah. If the entities are not properly separated and governed, there is a risk of liability crossing over. And the MSO model can provide these operational efficiencies. It also creates complex legal relationships. And so for instance, if the MSOs controlling multiple entities or managing multiple entities, it has to be careful about the contracts, licenses and employment arrangements [00:25:00] to avoid kind of crossing the line from a regulatory perspective and from a corporate formality perspective.
Brad: Corporate formalities, that sounds like a big word, Michael. Are they important?
Michael: Yeah, you’ll also hear another big word called governance. Many have heard that this entity can shield you from personal liability, and so owners can’t be liable for what an entity does. One of the strings attached is that an entity has rules that have to be followed to maintain the integrity of the business and keep them from piercing the corporate veil, and for it to be recognized as truly a separate entity from the individual owners or sometimes from the other businesses. So for an LLC, these rules are found in California in an operating agreement. In Texas, they call it a company agreement. For corporations, they’re found in [00:26:00] what we’ll call the bylaws. But there’s also, every state has statutory laws that create minimum formalities that have to be followed.
Brad: Yeah, exactly. And this ties back to the fiduciary duties that we talked about earlier. So I think this is the fifth time we’ve said this. But Dr. Hudson as the CEO and owner owned the company, but still had that duty of loyalty, duty of care. And when he started talking to the family members who weren’t really involved in the day to day operations and bringing them on and appointing the board and salaries, this obviously probably raised some red flags to you, Michael.
Michael: Yeah. A trap that owners can fall into when they bring family members on board is to treat titles and money like a game.
Brad: What title can I have?
Michael: Like playing a game of Monopoly? We’ll call you president.
Brad: Wait, that is my title.
Michael: Sorry. Yeah. Excuse me. We’ll talk about this offline. The mindset is when they do this is that the [00:27:00] money’s all under one roof. It’s just family, and so they’re kind of playing pretend business together. You even said he was carving this out of his CEO salary to hand off to the family. And there may be times that this is part of a tax strategy, but it’s also sometimes done for family ego reasons. You might hear a talk track like, “Well, Junior dropped out of college and he needs a job, but he’s unemployable, so we’ll just make him President.”
Brad: Yes. That’s sounds great – at the country club. And this goes back, these appointments were in paper only. So to an outsider, it sounds like they obviously wouldn’t know the difference, but obviously they were just doing this for estate and tax planning, and you had called it earlier – all hat, no cattle, this is a lot of times a straw or shell [00:28:00] ownership. And if you’re really scrutinizing the family members, are they really truly exercising, oversight or control? And so let’s take a step back in Michael, talk about how family members are able to call a meeting or have the board fire him. Like, how does that happen?
Michael: Well, because we’ve established this was not a board game, and it had these corporate formalities that we’ve been talking about. Power comes from being appointed a director – which they were, or through controlling ownership, which they had, or even from being appointed an officer like Junior, the president or whatever. And so yeah, that’s where they established that power. But Brad, talk about the breach of duty of loyalty and the duty of acting in the best interest of the company.
Brad: I mean, this is a situation which was a double-edged sword, right? He has to be more transparent in maintaining that proper governance protocols that you were talking about, and documenting these decisions so that everyone [00:29:00] can clearly see what he’s up to so that it could avoid certain fallouts. Now, in this particular case, it’s a bad example because the fallout was the affair.
Michael: That was a fallout too.
Brad: Yes. But for example, like proper corporate governance would include formal board meetings, documented minutes, conflict of interest policies, independent oversight if necessary. And this can help shield officers from liability if allegations come up down the road by scorned officers, scorned owners, but more importantly, these safeguards help with the integrity of the enterprise.
Michael: Yeah, yeah. I agree.
Brad: Now, Michael, let’s talk about transferring this ownership to family members who are not involved in the business, especially without proper agreements and oversight, and in this case, or impact in general, excluding what happened in this story. Just kind of talk about in general.
Michael: The basics are understand that an estate planning strategy does not correlate to a sound business strategy. If you’re going to have form and substance [00:30:00] you’re now involving in giving control and leadership to individual family members who may not be qualified. And so if you go this route and you don’t connect business and estate planning strategy together, you create risk to the morale of the employees who have these – Junior, the President showing up as a boss. And so it’s really why the most common strategy when you’re doing the estate planning is to transfer the non-controlling amount of ownership and not messing with titles. So what happened?
Brad: Yeah, we actually ended up working with his family lawyer and the judge actually eventually reinstate him as the CEO after a very long battle with his wife and kids. And the judge agreed that it was all form no substances, so the ownership form. And so, therefore they really didn’t have the power that was in the paperwork.
Michael: Alright. We ran a little over. Do you have any quick final thoughts?
Brad: I was going to ask you the same thing.
Michael: Well, I think my main my final thought is that with you being our president, we need to give you some responsibilities.
Brad: Kennedy, you can cut all of that. All right, audience members, I know we went along today, but we’ll be back next Wednesday, we’ll continue down this journey when we have Jay Reyero join us to discuss the unintended consequences of branding your business. Thanks again for joining us today. And remember, if you like this episode, please subscribe, make sure to give us a five star rating and share with your friends.
Michael: You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com.
Outro: 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 [00:32:00] attorney on your legal issues.
