Finally, a Consensus Is Near on Who Should Gain from Medical Malpractice Buyouts

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Finally, a Consensus Is Near on Who Should Gain from Medical Malpractice Buyouts

In 2018, when Berkshire Hathaway bought out the mutual medical malpractice insurer MLMIC for more than $2.5 billion,^[1] all the attention focused on the huge purchase price. Little attention was paid to the question of who was entitled to share in the benefits of the buyout – the doctors who held malpractice policies or the medical practices that had been paying the premiums on those policies. It turned out to be a difficult question to answer, as this was the first demutualization case of its kind in New York State, and the First and Fourth departments of the Appellate Division were of different minds on the matter. Now, however, there are signs that a consensus might be reached, perhaps even by the Court of Appeals. This article examines the legal issues at stake and what the future may hold.

The Demutualization Proceeds

Pursuant to Insurance Law § 7307(e)(3), MLMIC’s Conversion Plan provided that anyone who was an MLMIC policyholder from July 2013 to July 2016 would receive a cash consideration in exchange for the extinguishment of the policyholder’s membership interest. Who were the policyholders? Well, according to the policy documents and the conversion plan approved by the New York State Department of Financial Services, it was the doctors who maintained policies as the named insured parties – or so the Department of Financial Services and MLMIC believed and agreed to in the conversion plan. However, many medical practices had a different idea. After all, according to the practices, they were the ones that had been paying the policy premiums while their employed doctors were receiving huge windfalls. Not surprisingly, litigation ensued.

At first, the practices saw a major win in a case known as Shaffer.^[2] In that case, submitted based on stipulated facts pursuant to CPLR 222(b)(3), the First Department held that the practices were entitled to the payout under an unjust enrichment argument, since the practices had paid the premiums. In the short run, this decision resulted in many doctors, with the advice of counsel, accepting defeat and settling their disputes for pennies on the dollar or even abandoning their actions outright. At that time, some attorneys, including myself, did not believe that Shaffer got it right or was even applicable to the majority of cases, and as such, litigation continued in all four departments.

The practices’ victory in Shaffer was short-lived. It was only a matter of time until the remaining Departments disagreed with the holding in Shaffer and the tide turned in favor of the doctors. First, the Fourth Department, in a unanimous ruling by a five-judge panel, ruled in favor of the doctors in Maple-Gate.^[3]

The Fourth Department cited to the relevant portion of the Insurance Law, pointing out that a plan for conversion of a mutual insurance company to a stock company:

“shall . . . provide that each person who had a policy of insurance in effect at any time during the three year period immediately preceding [a specified date] shall be entitled to receive in exchange for such equitable share, without additional payment, consideration payable in voting common shares of the insurer or other consideration, or both.”[4]

Based on the language of the conversion plan and the cited statutory law, the Fourth Department found that the practices “had no legal or equitable right of ownership to the demutualization payments,” that “the mere fact that the plaintiff [employer] paid the annual premiums on the policies on the defendant [employee]’s behalf does not entitle it to the demutualization payments” and that “the MLMIC plan of conversion, in accordance with that provision of the Insurance Law, provided that cash distributions were required to be made to those policyholders who had coverage during the relevant period prior to demutualization in exchange for the ‘extinguishment of their Policyholder Membership Interests.’”[5]

Then the Third Department followed the Fourth Department’s lead and, in two decisions rendered unanimously by five-judge panels, ruled in favor of the doctors in both Schoch^[6] and Shoback.^[7] Having decided the two cases concurrently, the Third Department provided most of its substantive analysis in the Schoch decision, where it too quoted the same section of the Insurance law, further citing to the following sentences for clarity:

“The equitable share of the policyholder in the mutual insurer shall be determined by the ratio which the net premiums (gross premiums less return premiums and dividend paid) such policyholder has properly and timely paid to the insurer on insurance policies in effect during [those] three years . . . bears to the total net premiums received by the mutual insurer from such eligible policyholders” (Insurance Law § 7307[e][3]). [8]

The Third Department then made a straightforward conclusion of law based on the black letter of the conversion plan and the relevant provision of the Insurance Law, as well as the detailed reasoning of the Maple-Gate decision from the Fourth Department. Without mincing words, Justice Mulvey, writing for the Court, declared:

“The first quoted sentence of this statute [Insurance Law § 7307(e)(3)] explains who is entitled to receive the consideration, whereas the second quoted sentence explains how the consideration for each eligible person is to be calculated. Consideration is owed to anyone who had a policy of insurance in effect during the relevant time period. Under MLMIC’s conversion plan, the consideration is payable to eligible policyholders or their designees. Designee is defined to mean someone who a policyholder specifically designated to receive the proceeds from demutualization; an ordinary designation as policy administrator does not convey the right to receive the cash consideration. The conversion plan defines member of the corporation as a policyholder, which is further defined as the person identified on the policy’s declarations page as the insured. Plaintiff was the named insured on the relevant MLMIC policy. Hence, per the relevant statute and the conversion plan’s definitions, plaintiff was entitled to the cash consideration” (see Maple-Gate Anesthesiologists, P.C. v Nasrin, 182 AD3d 984, 985 [2020]). [9]

This left the Second Department with conflicting precedents to rely on when it took up the question in Maple Medical.^[10] The Second Department did not consider this a difficult question, unanimously agreeing with the Third and Fourth Departments in holding that “the plain language of Insurance Law § 7307, the plan of conversion, and the DFS decision make clear that the policyholder is entitled to the consideration paid in connection with the MLMIC demutualization,” that “in conformity with the statute, the MLMIC plan of conversion also makes clear that the policyholders are the ones entitled to the cash consideration unless there has been a specific designation to an identified policy administrator” and that “it is undisputed that Scott (as well as the other physicians) did not specifically designate Maple Medical to receive the demutualization payments and that, in the cases of Youkeles and Mutic, Maple Medical was never designated policy administrator at all.”[11]

The Second Department further noted that the First Department did not address the statutory issues in Schaffer and instead only addressed the argument of unjust enrichment based on stipulated facts. Addressing the First Department’s reasoning, the Second Department rejected the unjust enrichment argument, pointing to the fact that the First Department analogized the situation to the federal cases based on the ERISA statute and the Second Department rejected the analogy as inappropriate, given the clear state statutes involved in this controversy.

The Second Department found that “the essence of Maple Medical’s unjust enrichment claim is an effort to use the principles of unjust enrichment to overcome the medical professionals’ entitlement to the proceeds of demutualization, which entitlement derives from this State’s Insurance Law. We therefore conclude that the unjust enrichment claim must be analyzed under New York’s common law principles of unjust enrichment. The federal ERISA authorities are of no assistance in this regard.”[12]

Instead, the Second Department held that to establish a cause of action for unjust enrichment, the plaintiff needs to establish that as a result of a mistake in fact or law, “it conferred a benefit on the other party and that the other party will retain that benefit without adequately compensating the first party therefor.” Applying those principles, the Court held that:

“Maple Medical has not proven, and cannot prove, a cause of action for unjust enrichment. It has not provided the benefits in question to its employee-physicians—those benefits are provided by the plan of conversion and, ultimately, by the acquiring entity. At most, Maple Medical provided malpractice insurance premium payments, surely a benefit, but a benefit of the employment contracts between Maple Medical and its physician-employees for which the physician-employees paid valuable consideration in the form of their labor. Since the physicians provided their services to Maple Medical in exchange for the benefits paid to them, or for them, under the employment agreements, it simply cannot be said that the employees have not already adequately compensated Maple Medical for the benefits paid. The payment of the medical malpractice insurance premiums was not a gratuitous act; it was part of the bargained-for consideration for the employment services that the physicians provided to the medical group. Moreover, the medical group itself benefitted from the payment of premiums for the malpractice policies to the extent that they covered the group’s vicarious liability for the acts of its employees.

“Analyzed somewhat differently, we agree with our colleagues in the Third Department that it cannot be said that any benefit was paid here under a mistake of law or fact. The demutualization proceeds are properly payable to the policyholders (or their written designees) based upon the appropriate construction of the governing statute and the conversion plan. No mistake of fact exists. No party changed its position. There was no fraud or other tortious conduct.

“The thrust of Maple Medical’s argument is that Scott and the other physicians are receiving a windfall as the result of the demutualization of MLMIC. However, as our colleagues in the Third Department have written, the reality is that the consideration would equally be a windfall to Maple Medical if it were to receive it. Neither party bargained for it and neither party can be said to have paid for it.”[13]

At this point, the First Department also realizes that the holding in Shaffer is flawed, or should at least be highly limited. As such, the First Department has agreed to hear a new case, Dworkin,^[14] where it will have the opportunity to overrule or limit Shaffer and we expect that that is precisely what the First Department will do.

The Second Department then quoted to the Third Department in reaching a very simple conclusion:

“Had [the medical group] selected a different company to provide malpractice insurance to cover [the employee], [the medical group] would have met its contractual obligation to provide and pay for that insurance while [the employee] would have received the benefit of such coverage. Under those circumstances, neither party would receive a cash consideration. Thus, the demutualization proceeds were unexpected and will be a windfall to whichever party receives them. The fact that one party will receive these benefits does not mean that such party has unjustly enriched itself at the other’s expense (see Goel v Ramachandran, 111 AD3d [783,] 791), i.e., that it ‘is in possession of money or property that rightly belongs to another’” (Clifford R. Gray, Inc. v. LeChase Constr. Servs., LLC, 31 AD3d at 988).[15]

This decision left the First Department alone in its Schaffer reasoning. Interestingly, the First Department, in an effort to resolve the conflict, just held oral arguments in another appeal, seeking to overturn Schaffer. It was expected by many legal experts that the new action, Dworkin, would result in the First Department overturning or limiting Schaffer and ending the conflict between the departments.

However, before Dworkin could be heard at oral argument, the Court of Appeals agreed to hear an appeal of Schoch, now pending under Docket # APL-2020-00169. Upon being made aware of that, the First Department panel hearing Dworkin appeared to opt to wait until that matter is argued and decided before issuing its own decision on whether to have Dworkin overrule Schaffer. And so, all eyes are now on the Court of Appeals.

However, there are much more curious claims that doctors may have against their practices, which are only coming to light as a result of the MLMIC litigation.

The Dividends: Conversion and Unjust Enrichment by the Practices

Many practices asserted, as part of their arguments for why they should keep the demutualization windfall, that it would be consistent with the dividend payouts, which are also paid to the policyholders but which they (the practices) have been pocketing for years. While that seems to have (correctly) fallen on deaf ears when it comes to being considered a viable legal argument for them keeping the demutualization proceeds, it also (sadly) fell on deaf ears in those situations where the lawyers for the doctors did not immediately spot a claim that their clients have against the practices.

In some cases, like in Schoch, doctors actually “signed a form designating defendant as the policy administrator of the MLMIC policy, thereby appointing defendant as her agent and giving defendant the right to, among other things, make changes to the policy and receive dividends.”[16] However, many others did not. Instead, those doctors relied on the practices to act as their fiduciaries in purchasing insurance on their behalf. At no point did those doctors actually designate the practices as the recipients of dividend payments, which, over many years of practice, add up to rather significant sums.

In effect, it can be argued that since the courts (in at least three of the departments) now clearly hold that the policyholder is the doctor and is entitled to all payouts, by the practice’s own arguments the doctor is also entitled to all of the dividends paid. Normally, the statute of limitations would limit such recovery to at most six years, on a breach of contract claim. So, a doctor who was aware of the practice can only sue to recover the last six years of dividends.

However, where the practice simply pocketed the money and never mentioned to the doctor that a dividend payment even existed, the recovery would be based on a concealed fraud, and the cause of action would be for the entire period of the dividend payments – provided it is commenced within two years of discovery of the fraud.

So, as a result of the MLMIC litigation, the medical practices have not only solidified the position that the doctors are entitled to the proceeds but further exposed themselves to (and often flat out admitted to) claims against themselves for conversion, unjust enrichment and even fraud. In fact, given this new line of argument, even if a doctor were not insured with MLMIC, he or she may now have a cause of action against his or her past or present employer.

Alexander Paykin is managing director and sole owner of the Law Office of Alexander Paykin, Esq. in New York City. He uses his entrepreneurial background to handle a vast array of cases, focusing largely on commercial and residential real estate matters as well as business, litigation, and financial cases. He serves on the Law Practice Management Committee of NYSBA and as an attorney coach for the Ezra Academy High School Mock Trial Team, part of NYSBA’s Youth & Citizenship Initiatives.

[1]. Berkshire Hathaway Inc. 2019 Annual Report, p. K-79, https://www.berkshirehathaway.com/2019ar/2019ar.pdf.

[2]. In re Schaffer, Schonholz & Drossman, LLP v. Title, 171 A.D.3d 465 (1st Dep’t 2019).

[3]. Maple-Gate Anesthesiologists, P.C. v. Nasrin, 182 A.D.3d 984 (4th Dep’t 2020).

[4].Id. at 985.

[5]. Id.

[6]. Schoch v. Lake Champlain OB-GYN, P.C., 184 A.D.3d 338 (3rd Dep’t 2020).

[7]. Shoback v. Broome Obstetrics & Gynecology, P.C., 184 A.D.3d 1000 (3rd Dep’t 2020).

[8]. Schoch at 341-342.

[9]. Schoch, 184 A.D.3d at 342.

[10]. Maple Medical, LLP v. Scott, 2020 N.Y. Slip Op. 07366, 2020 WL 7233649 (2d Dep’t 2020).

[11]. Id. at *25.

[12]. Id. at *36.

[13]. Id. at *37–39

[14]. Mid-Manhattan Physician Services, P.C. v. Dworkin, First Department Docket # 2019-03771, with oral arguments on January 5, 2021 (and available on YouTube).

[15].Schoch, 184 A.D.3d at 346 (cited by Maple-Medical).

[16]. Id. at 340.