The long-term service contract dilemma

If someone wants you to sign a multiyear contract with automatic renewal clauses for additional periods of time, remember: All that glitters is not gold

Imagine this… After many, many years of practice, you’ve sold your three-doctor clinic, Four Legged Friends Veterinary Hospital, to an associate who had been with you for several years, leaving you and your spouse able to retire to the sunny coast of Florida. One day you go to the mailbox and find an ominous-looking letter sent by an out-of-state law firm. Its contents inform you the firm represents the outside laboratory company your practice used for many years. It also advises you that since Four Legged Friends Veterinary Hospital has not been using their client’s services for the last several months, you are in breach of contract. Not only that, but there are three years remaining on your contract. Since you agreed to the contract and signed it personally, the lab is expecting $60,000 in compensation from you for its loss of business. The letter states the money will go toward repayment of the loan you were given by the lab when you signed the contract. Wait, what? You thought the $60,000 was a signing bonus. The company wants to be paid within 30 days or it will proceed with collection by filing legal action against you for breach of contract.

You don’t own the practice anymore. So what is the problem?

When you signed the contract with the laboratory and received the loan, your first thought was, “What a great opportunity.” You put the money toward upgrading the exercise yards at your hospital’s pet resort, installing artificial turf and new agility equipment instead of buying a new fishing boat, as perhaps a less disciplined veterinary practice owner might do. Your head begins to spin as you try to piece together what this letter has to do with you. After all, you no longer own the practice.

You immediately call your former hospital to speak to the new owner, Dr. Smith. He confirms, that yes indeed, he just signed a new contract with a competing lab, with a huge up-front cash incentive (i.e. a loan). Not only that, but the clinic would be using this service exclusively for the next five years.

Dr. Smith says he understands your predicament, but reminds you there was never an agreement to continue or assume the contract with the lab service company you had been using when he purchased the practice from you. He also tells you that as an associate in another practice, he had received poor service from the lab previously and vowed to never use it again if and when he owned a practice.

Well, you are dumbfounded. You finally sit down and read the contract you had signed, which personally guarantees the use of the lab service exclusively for three more years at a certain volume of lab business per month. It slowly sinks in that you will likely have to pay the lab for the loss of business and the reimbursement of the prepaid discounts it gave you in the form of an incentive (loan). You quickly realize you should have paid better attention to the details of the contract, especially as you had been anticipating your retirement and the sale of your practice to an associate for several years. You also realize the glitter of getting cash up front to make the improvements to the practice came with a high price and now you, as the signatory to the contract, are going to have to pay the lab company back. A fleeting thought crosses your mind—maybe buying a fishing boat with the lab contract money may not have been all that bad of an idea. At least you would still have something you owned to show for it.

The ties that bind

Though this fictitious example centers on a lab service agreement, there are many other long-term contracts or leases that can complicate your life and the sale of your practice. Besides lab companies, garbage pickup/dumpster services, medical waste services, phone or internet contracts, credit card processing agreements, and equipment leases all can have similar agreements that tie up your business for X number of years into the future. They may resort to many forms of up-front inducements, deals, or special discounts over the term of the contract to keep you locked down. This is much like mobile phone companies offering you a deep discount to sign a multiyear contract with the purchase of a new phone. The agreement guarantees them your ongoing business and restricts your ability to shop other service providers without first paying a “hostage fee” to switch to another carrier. Practitioners are usually so busy they may fail to read contracts thoroughly to understand fully their long-term ramifications. It is often best to have your attorney review any contract before you sign it, especially if its term is longer than a year, it has an automatic renewal clause, it requires a specific volume of business by you, and/or it has prepayment penalty clauses. Remember that everything is negotiable. You can delete clauses you find unfavorable up until the point you sign the contract.

Although in our example the discovery of the service contract did not occur until after the transaction had taken place, it is often the case that these issues come up during the due diligence phase of the practice sale and can be negotiated to mutually agreeable terms between the buyer, the seller, and the service provider. Therefore, it is extremely important for both parties to be aware early in the selling process of any service contracts or leases that could affect the seller’s exit from the practice.

Though long-term service agreements can often provide much-needed capital in the form of a loan, new equipment, or various services at discounted prices, these are legally binding contracts. If your practice does not or cannot perform to meet a contract’s terms, either with your volume of business or for the full term, you may want to consider other options such as joining a buying group or cooperative that has already negotiated the best deals and pricing for members. This can help you avoid having to sign a long-term service contract, especially where you are personally guaranteeing the outcome.

Whenever someone wants you to sign a multiyear contract with automatic renewal clauses for additional periods of time, remember: All that glitters is not gold. And even more importantly, caveat emptor, meaning “buyer beware.”

Wilson McManus II, DVM, CVPM, is a practicing veterinarian, practice management consultant, speaker, and veterinary practice broker with Simmons & Associates, MidSouth, located in Huntsville, Ala.

Kris Smith, CVPM, is a certified veterinary practice manager with more than 20 years’ experience and a veterinary practice valuation analyst with Simmons & Associates MidSouth, also located in Huntsville, Ala.

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