7 Legal Pitfalls to Avoid when Buying a Dental Practice

The Dental Business Guide Podcast Episode | February 16th
Arun Mehra and Kate Ford

Arun Mehra: Hello there now welcome back to the dental business guide podcast and today I’m joined by Kate Ford from Rudlings Wakelam Solicitors. Hi, Kate, how are you?

Kate Ford: Hi, I’m not too bad yourself?

Arun Mehra: Yeah. Good, good. Thanks. Now, Kate, what’s your background? What’s your experience.

Kate Ford: I’ve been a qualified solicitor for just under two years now. And I am originally from Liverpool but moved down to Norfolk a few years ago. And I’ve been with Rudlings for the past few years, where we’re quite an experienced firm when it comes to dental practices, or other health care transactions such as vets or doctors.

But I think dental is one of our biggest areas. And so we’re kind of fully equipped when it comes to all the various bespoke bits and bobs that arise when it comes to selling and purchasing dental practices.

Arun Mehra: All the nuances that I’ll I’m very well aware of indeed. So today, I’ve got a bunch of questions I want to ask you, for any listeners out there who are potentially buying a practice, whether it’s mixed, NHS or private. So I know one of the most popular questions we get all the time is: what is due diligence and why is it so important?

Due Diligence

Kate Ford: Yeah, so due diligence is just simply a term which is used to describe the gathering of information for a prospective buyer. It is basically one of the most important stages really, so that the buyer can decide if they most definitely do want to progress with the sale.

Due diligence is an aspect which requires a lot of patience and scrutiny. But essentially the better the due diligence stage is, the better equipped the buyer is. Without an investigation, the buyer would only be able to judge the practice on its face value, but also not be able to identify any potential issues or concerns which they hadn’t previously been aware of.

I always compared it to if you are buying a residential home, you wouldn’t proceed without looking into the title documents or the property searches. And it’s basically the same when you’re buying a practice. Due diligence is an exercise which allows the buyer to address issues or misconceptions or any worries that you may have.

Because a seller and the agents, they can paint quite a deceiving picture about a practice. Whereas, there could actually be some major elements both practically or from a legal point of view, which the buyer is essentially going to take on the responsibility for.

Arun Mehra: Totally, I kind of concur with that. I’ve been dealing with practice sales for many years. And as you mentioned, houses and house due diligence is relatively straightforward. But when you’re looking at business there’s so many aspects – it’s staffing, its contracts that you’ve signed up to, it’s legal, it’s so many things that can be there.

So you cannot not do a good thorough job. If you don’t do the due diligence, you really need to get the due diligence right and have the right solicitors and the right team to help you do this.

Kate Ford: Exactly. And as you said, there’s so many different aspects. Particularly when you’re purchasing, say, a large practice or a group of practices, you’ll usually have multiple legal departments involved. So you’ll have your employment solicitors, you’ll have your property solicitors, you’ll have the commercial solicitors because there’s just so much that forms a business that it’s hard to overlook it. It can be quite an error if a buyer doesn’t, because they’re essentially taking on the financial implications and they’re taking all the risks on it.

Transferring an NHS Contract

Arun Mehra: Okay, so now, I’m a buyer, I have the due diligence done, and I’m buying an NHS practice. What are the most important things to consider when transferring the NHS contract over to me?

Kate Ford: Well, so the first thing to look at is whether the NHS contract is a GDS or a PDS contract, because that can seriously affect the time scale of the transaction.

So GDS contracts, you always hope to find because they’re usually a lot simpler and straightforward. Usually, the LAT requires three months to transfer a PDS contract. And if you haven’t taken that into account when you’re working out your timeline for the transaction, if you get to a point of completion and you haven’t notified the LAT that you’re transferring a PDS contract, then there’s an extra three months that you’ve got to add on to everything.

Whereas with GDS, it’s a lot more shorter and more straightforward. However, when you’re transferring a GDS contracts, there are some elements which buyers would probably not be aware of, in that there’s a specific route which you’ll take which is called ‘the partnership route’.

So the NHS aren’t informed that a seller is actually physically selling their practice. But instead, the seller and the buyer enter into a partnership. And so on completion, the seller and the buyer, they execute a partnership agreement. And then usually after a period of time, which is around a few months, the seller then retires from the partnership. And then the contract is transferred essentially into the sole name or the sole names of the buyer or buyers.

And the NHS, using this route, they only usually require a month’s notice to affect the change to the partnership. But, and typically when you have engaged solicitors, the solicitors are responsible for serving that notice, because we can line it up with the hopeful completion date. Because NHS are usually quite particular, they want the notice within 28 days off the first of the month. So it’s usually important to instruct a solicitor who’s familiar with, not only the notice periods, but the particular days that NHS want notices served.

Arun Mehra: Okay. So, in a nutshell, there is a process that has to be followed. And it’s important in my experience, that you have solicitors that understand the NHS nuances and contracts, because otherwise, it could take significantly longer if you don’t have that experience in your team correct?

Kate Ford: Yeah, definitely. And the NHS they have a kind of standard partnership agreement. Not a template, but they look for certain provisions, in which if you just have a buyer and a seller acting for themselves, and they don’t have a properly drafted partnership agreement, it’ll get rejected, which adds on just even further delay.

So as you say, it’s always very important to instruct a solicitor who is familiar with what the NHS are wanting. But bearing that in mind, if you’re purchasing an incorporated practice, then you don’t need to do any of that. And it’s just the case of purchasing their shares. Because essentially, the corporate body that’s party to the NHS contract, they don’t change at all. It’s just the owners of the corporate body.

And, of course, the NHS will need to know that there’s been a change of control of the limited company, but it’s a lot easier and a lot more straightforward to simply inform the NHS that the shareholders are changing, as opposed to a whole new partnership agreement drafted.

What Happens to the Staff?

Arun Mehra: Okay, cool. So now when I’m buying a practice on a question I always get from so many people is – I’ve got staff that I’m going to be taking on, do they all transfer automatically to me? Or can I move some staff on? What do what happens is this situation?

Kate Ford: Yeah, so I think employees and the employment obligations are often overlooked, because usually a practice will only have a small number of employees and you think, ‘Oh, I can just let them go and bring in my own employees. And it won’t be an issue.’ But there’s actually quite an important regulation which applies to this situation, which is called TUPE. And the TUPE regulations basically apply whenever there’s a transfer of an undertaking. So the sale of a business, therefore, applies under TUPE.

And so whenever a buyer is taking on a practice, all of the employees who are on payroll at the time of completion will transfer to the buyer. And it’s very important that the buyers are aware of the terms of each employee’s contract, if you will. And it’s important that they know that there are limitations to how they can firstly change any of these terms, and whether they can dismiss any of these employees. Because it may be the case that they don’t want to take on so many employees.

But if you dismiss one after completion, you’re making yourself very vulnerable to breaching the TUPE regulations. There’s also obligations on the sellers that they must consult with the employees and they must inform the buyer of all of the various details and all of the various terms concerning all of the employees. And it’s a situation where a lot of buyers get themselves into trouble because they don’t realise that after completion, they can’t change the terms of the under which the employees that have transferred over.

So it is very, very important that where there are employees involved, either solicitors or even HR advisors, they can guide buyers into how to negotiate TUPE regulations. Because annoyingly, they are a bit of a minefield, there are various obligations for various parties. And these obligations change depending on how big the practice is and how many employees there are. So, if there’s over 10 employees, the seller and the buyer have to do one certain thing. If there’s over 20, they have to do a different thing.

So it is definitely important just to, even if you you don’t want the solicitor to act for you for the entire transaction, but just at the outset to assess the employee’s situation, and just to confirm what your obligations will be, both before and after completion of the purchase.

Indemnity and Warranties

Arun Mehra: Okay, fantastic. That’s very useful. So now in terms of when you get the sale and purchase agreement, I’ve seen so many in my time, there are lots of clauses in there and the ones that always stand out, the indemnity and warranties. What are they and why are they so important?

Kate Ford: Well, warranties and indemnities are essentially just a means of reallocating risk between the seller and the buyer. They’re also a really useful way of ascertaining important information and disclosures, which may not have been obvious from the due diligence process.

But warranties are essentially a number of statements about the business which confirm its position. And this can basically include matters like there haven’t been any litigation issues in the last two years, or the seller hasn’t dismissed any employees in the last year. If any statements are untrue, the seller can make disclosures against them, informing the buyer of any breaches of the warranties, and this will be put into a disclosure letter. Should the seller failed to disclose a particular breach of a warranty, then the buyer can issue a claim for this breach if they’ve suffered a loss.

So if there’s a statement, which says that the seller hasn’t dismissed any employees in the last year and they have done, and this particular employee issues a claim for unfair dismissal, after completion, the buyer is essentially responsible for that claim. And so any losses that they suffer, any damages they suffer, they can pursue the seller. Because you can say ‘you didn’t inform me of this properly, and you’ve breached a warranty’.

So it’s very important that when drafting the purchase agreement, that from a seller’s perspective, they’ll want as few as warranties as possible. And they’ll want to make sure that they disclose as much information as possible. And the buyer will want to make sure that there are more warranties in there because there are more elements that could be covered.

Now, indemnities are very similar. They, in principle, have the same meaning, but they offer an element of protection for the buyer. Usually warranties are general sweeping statements like ‘there have been no litigation matters in the last two years’, whereas indemnities cover specific issues. So say, for example, we take the employee that was dismissed before completion, they issued a claim, the buyer would want an indemnity to deal with that specific tribunal claim, in which the seller would make sure that the buyer is compensated pound for pound for that specific tribunal matter.

And essentially, we as lawyers, we consider indemnities blank checks. So when you’re acting for a seller, you don’t want any indemnities, you want to avoid them all. Because it could be quite costly for the seller. But for a buyer, if there are any significant, specific issues, you want to make sure that they are all covered in the indemnity to make sure that your client is covered, if they do incur a risk to the most amount as possible.

Defective Work

Arun Mehra: Okay. Very helpful. So now if I’m a buyer, or even a seller, there’s always gonna be work that hasn’t been finished or completed and how is that apportioned? And also what happens in respect of defective work as well? Is there a claim that could be made against those? Or does it come under warranties or indemnities again?

Kate Ford: Yes. So one unusual thing about a dental transaction is that there’s usually quite a substantial section of the purchase agreement which deals with apportionments. And for some reason with other businesses, there isn’t so much of a focus. But with dental work, as you know, dentists will sometimes you have advanced payments, sometimes you’ll have a lot of uncompleted work that will be going on at the time of completion. And there’ll be customers or patients who aren’t happy with treatment that they received before completion, but now the buyer is responsible for them.

And the main way to deal with it will be through the purchase agreement and the negotiation process. So essentially, the buyers and the sellers will have to come to an agreement of how to deal with each matter individually. So for example, advance payments, you’ll have to assess whether all advance payments will stay with the seller, or if they’re going to be to the buyer wholly or if they’re going to be split 50/50. There isn’t a set format, it’s just more kind of who wins the negotiations.

Usually you find that work that’s already been started but hasn’t yet been paid for, if all of the works been completed, and none of the fees have been paid, all of those fees will be apportioned to the seller. And essentially, the buyer pays the seller after completion for those specific bits of work. Whereas, if there’s part of the work has been done, but part hasn’t been done, there’ll be a percentage split once the payments been received.

You also have to think of apportionment of monthly BSA payments. Typically, they’re split on a day rate. So if completion falls on the 15th of the month, then they’ll be split to 15 days and 15 days. You have to think about underperformance of targets. At the moment with COVID, obviously the NHS have changed their targets. But if before completion, your due diligence has shown that there will likely be an underperformance because of the seller, quite often there’s a retention which is included in the purchase agreement.

So the buyer gets to hold on an additional piece of money which the seller pays. And if there is, in fact, an underperformance the buyer can keep that money. But if in fact, the buyers work fairly hard, they only keep a proportion of that money and they pay back the remainder to the seller. So it’s all things which there isn’t a set format for that this is how it will work. But it’s more negotiations. And so it’s good to get an an experienced solicitor, who’s familiar with all of these bespoke things that dental practices incur, and who knows how to properly negotiate them.

Reviewing the Property

Arun Mehra: Okay. All right. And then the last couple of questions here, Kate. Properties are always a large part of the transaction quite often, whether it’s a freehold or whether it’s a leasehold. What are the top tips in terms of reviewing the property carefully?

Kate Ford: Yes, so obviously, when you come to purchase a practice, it’s always good to assess whether you want to purchase the freehold or just take out a leasehold. It may be the case that you don’t have any choice in the matter. But both freehold and leasehold give you pros and cons depending on your personal situation.

Obviously, freehold you have a lot more autonomy in relation to how the property is dealt with. But leasehold, you’re only obligated to hold that property for a fixed period of time. And little things like if there’s an issue with the roof, generally the landlord’s responsible for it. Whereas, if you own it, it’s your responsibility.

And so this is where due diligence again comes back into it. It’s just so important to to know exactly what you’re taking on a property is such a large asset, it’s usually the largest asset of a dental practice. If you own it outright and something goes wrong, that’s a substantial bill that you’re going to have to fit.

And if it’s a lease holder, however, you won’t be responsible for the major repairs. But if you breach the lease, you could be in breach. And so it’s always just best to, if you’re purchasing a property, double check over the title deeds. Because there may be rights which your neighbor has a right of access over, which you may not be familiar with. And the practice owner may not be familiar with. But there’s this right there. And if you stop a neighbor using that particular right of access, then you could have a serious financial liability on your hands.

Similarly, there may be covenants which the property is bound by. And if you breach that covenant, the person who benefits from that could then again issue you for breach of Covenant, and you’d be faced with a significant financial responsibility.

There are also property searches, which are a really useful way of not only knowing more about your property, but the surrounding area. And there are a lot of searches that we can undertake, where it will show you all the nearby commercial property. So it may be other dentists or GPS, or shops, which may affect how you want to carry out your business.

So it isn’t just whether your property is connected to mains drainage, but also other things like, there’s a development proposed on a couple streets over which may mean more patients, which could really benefit your business. Or it could be that around the corner there’s a very large dental practice, which you may think well actually ‘I don’t want to be competing with them, I’m not going to proceed’. So it may look like a great property on the face of it. Or it may look like a bad property on the face of it. But having these property searches and doing a full review of the title documents can really make or break your business.

Buying the Practice You Work In

Arun Mehra: All right, cool. And then I suppose one of the things that I see all the time is that there are a lot of buyers out there who are actually working in the practice that they intend to end up buying. So do they have to go through this whole process as well? What would you recommend?

Kate Ford: Yep. So as you say, it happens so often that an associate will come into a position where they can either purchase the practice outright, or quite often will be able to buy into a practice. And there’s this misconception that because I work for a practice, either as an employee or self-employed contractor, that because I work for them, I don’t actually need to carry out any reviews, I don’t need to go through this long arduous due diligence process or going through the negotiations with the purchase agreement.

But often, there’ll be elements of a business where the practice owner doesn’t want to disclose it to all of its employees and all of its contractors. For example, litigation matters, as an employee myself, if my employer has a litigation matter, or an employee unemployment matter, often, they’re obligated not to disclose that information to other employees or other contractors, because it doesn’t involve me.

And going back to the property as well, there’ll be property elements, which I myself am not party to, until I do those reviews, or ask the seller to provide me that information. When you’re buying a practice, you want to make sure that you pay the market value for it. And without doing a full review, you won’t actually know if the practice is trading well, or if it’s trading really well.

So doing the due diligence process and doing the negotiations process, you know exactly what you’re buying into, or what you’re purchasing. You know how the business is doing and how it’s trading, so that you can project what your profits are going to be once you own it. And you can also just make sure that you’re entering into this deal on the best terms that you want to be party to. It is just so important.

As we said earlier, there are so many elements that make up a business. It isn’t just a property where you purchase bricks and mortar, you’re buying employment contracts, you’re buying supply and maintenance contracts, you’re buying stock, you may buying vehicles. There are so many elements, which can so easily be overlooked when you’re already part of a business. But there are too many things which, firstly, you legally can’t be aware of. But practically you can’t be aware of every single element as an employee. So it is most definitely just to, even if you do it yourself just to have a thorough review of what you’re buying into.

Always Engage a Legal Professional

Arun Mehra: Okay, well, that’s been really, really helpful, Kate. We’ve gone through seven major kind of pitfalls that people hit sometimes when they’re buying a practice. Any the last comments to people when buying a dental practice, from a legal perspective?

Kate Ford: I think from a legal perspective, you know, obviously legal fees can be quite overwhelming. But even if you don’t want to engage a solicitor for all of the transaction, there are certain parts like the due diligence, or the purchase agreement, where it’s just best to have a legal person look over it for you.

So even if you’re quite confident that you can do a lot of it yourself, I would advise just to get a legal person glance over over the transaction, because there may have been things which you’ve missed or haven’t realised. And so yeah, it is always just worth speaking with a legal professional to make sure that it is as you’re hoping to buy.

Arun Mehra: Okay, fantastic. Well, thank you very much today for your inputs. Okay, and been really helpful. I think the seven legal factors that people should be looking out for when they’re buying a practice are essential. And I think as deals get more complicated, I think these issues are just getting more and more important. So there you go. That’s Kate, from Rudlings Wakelam, and if you’re looking for business tips, check out our next podcast on the dental business guide. Thanks, Kate.