Want a higher “Red Book friendly” pathology rent?: How you go about it matters!

This article was first published by the Medical Republic on 20th April 2021.

Editor update: 27th June 2021

In the original article below we highlighted the need for an independent valuation by an industry expert with experience in valuing pathology collection centre rents.

“Given these proceedings, the value of an expert valuation cannot be underestimated.”

The recent Federal Court high pathology rent case

It will be interesting to observe whether the actual dermatology practice will be asked to give evidence.On the 20th June 2021 SDS(pathology collection centre) are in Federal Court as respondents to a claim brought on by the Commonwealth (Medicare). This is an interesting development. It appears the Federal Court has requested an “expert valuation” in relation to an excessive pathology rent paid to a medical practice.

Original article on 20th April 2021

Albert Einstein once quipped

“You don’t have to know everything. You just have to know where to find it.”

Not a day goes by when a general practice owner contacts me about how much they should charge for a pathology rent. For a number of practices, pathology rent represents a significant part of a practices’ sustainability. The real problem is there are no readily available and comparable national pathology rent benchmarks you can easily point to.

Since the 2020 Department of Health announcement of 700 investigations with the threat of criminal prosecutions Damocles sword continues to hang over every owner that has a pathology collection centre lease. With over 13,000 practices in Australia your chances of getting caught may appear to be low, employee, doctor, competitor (including a rival pathology lab) by contacting the Department of Health. (Here is the latest case.)

In order to win new business, we have seen an ex-employee of a winning pathology dibber dob in a big practice for the losing pathology laboratory they now work for. Cartel behaviour is not allowed under the Australian Consumer Competition (ACCC) rules. Serious penalties apply. Everyone needs to be careful.

Examples include bid-rigging for example withdrawing from bidding when either a practice or a pathology laboratory usually would. This could be seen as a form of market sharing. Starting with an open tender process with the same clear terms and conditions offered to all is a useful starting point e.g. no options to renew.

One can only speculate is the Department of Health is looking for a couple of national public hangings.

If you do things properly by the Red Book you should have little to be concerned about.

Many practices know since 2006 I have nationally been negotiating and benchmarking pathology rents for practices. I have had some role in securing legislative awareness for a free market for pathology rents since 2008. These range from a small solo general practice to the really big ones you read about on the Australian Stock Exchange.

Facing million-dollar fines and possible criminal prosecution, I have been approached by numerous practices to provide independent pathology rent valuation. Prior to hiring a uniquely experienced lawyer, it is most likely the smartest move if you are concerned about the valuation.

Depending on your practice there are legitimately safe legal and ethical ways  to justify your rental market value. The rent amount can be higher than the traditional rents charged to the local butcher, baker and candlestick maker. If your local pathology laboratory suggests that you are doing something wrong, it is for a good reason I am sure.

This is about what is the correct commercial market value pathology rent for your practice

There are three key steps to take:

Step 1 Start with qualified and experienced advisers

Starting with useful independent advice is always a good idea. There are very few people who have national expertise in this area. Your local everyday real estate agent, accountant or lawyer is not going to know the latest players in the national pathology rental market that comply with the latest pathology Red Book rules

Step 2 Be clear how you independently verified the new rent or any renewal

Often we see these deals done over dinner. After a few drinks, it accidentally spills out to a competing lab who you are talking to and how much they are paying. This is an absolute no-no. Expect the investigators to ask how you arrived at these numbers. Do not leave yourself in an awkward situation. Most importantly pay for dinner!

Critical to any defence is how did you establish the rent value and the leasing terms and conditions. I would avoid restaurants and pubs altogether. Keep it professional. Do not fall for the nudge wink response from them that “you don’t need an adviser talk”. A rumour I have heard is that if there is a problem the medical practice owners and directors are exposed to a full prosecution, however, the problem is quarantined for the ultimate owners/directors of the laboratory. If it is true it does sound a tad unfair the pathology labs have been able to strike a better deal with the Government. I am happy to stand corrected on this point.

Step 3 Document your lease so it is “Red Book” Compliant

Over the years I have seen many pathology lease agreements over a bottle of wine, look like they have been written on the back of a napkin to save on legal costs. You have to wonder if any lawyers were involved.

We have seen high profile law firms who have missed out on addressing the Red Book concerns in the lease. A good example is allowing the uneconomic clause to remain within the agreement, which permits the early termination of a lease by the pathology labs. Such arrangements explicitly put pressure on in-house referrals. The fear of missing out by the practice seems to be the primary driver of agreeing to the tenant’s terms. Potential problems seem to go beyond just the legal agreement.

How did you document your agreement is critical. You do need an independent and experienced lawyer and accountant to look over it. The business rationale is critical. This is not a good time to cut corners. The process more than pays for itself.

Ignorance of the law is no excuse.

What are pathology rent investigators asking practices?

We have seen the large gamut of questions by the Department of Health investigator put to practices. It starts with a few. Depending on how you answer you get a lot more.

Many questions may unwittingly entrap a practice. It is not uncommon for practice owners and their practice managers not to clearly know and understand their business model and commercial arrangements. The pressure to be perceived as cooperative to the Department’s demands may cause the practice to sometimes hastily respond. This can be used as evidence against the practice. Now is the time to be more careful and considered your responses.

It is hard to unsay an email or a phone call. This system appears to operate similar to a Medicare investigation except this is a more serious criminal matter. Some lawyers are too quick to volunteer their clients’ responses. This can only breed more avoidable litigation.

Responding to all of the questions (many of which appear to go beyond the scope of enquiry) may accidentally trigger further statutory Fair Work, ATO, Superannuation Guarantee, payroll tax and WorkCover audits with corresponding penalties.

From our experience relating to clients being investigated to date, common areas of evidence (documents) include but are not limited to:

  1. Any past, current or future arrangements, negotiations or leases in writing e.g. email correspondence
  2. Any initial external written bids or rent review rival bids
  3. Any written and verbal communication on how the value was established independent of the landlord and tenant, e.g. using Health and Life bidding, valuation or other independent valuation services
  4. Valuations of the premises
  5. Current arrangements with doctors e.g. employment contracts and contracts for services
  6. Administration and banking arrangements e.g. contractors
  7. Sub leasing arrangements with other parties e.g. co-located leasing arrangements e.g. allied health, specialists and pharmacy or a pizza bar
  8. Details of rental increases
  9. Floor area, parking and signage rights and practice infrastructure and staff support etc
  10. Signed service agreements and provider contracts
  11. Financial statements and tax returns that support the landlord v tenant arrangement or the business structure used to engage the diagnostic service
  12. An explanation of the nature of any contracts with doctors e.g. discounting of service fees
  13. Director and staff statutory compliance declarations
Circuit breaker: Do you have to provide all the information?

We have found an independent valuation may be a useful circuit breaker. This would avoid sending too much information. It may help the practice avoid any further unfair scrutiny or misunderstanding. The Red Book does provide the option of preparing a valuation report to justify the rent charged to the pathology labs. The valuation report would prove essential upon a practice being investigated by the Department. The hard part is finding somebody prepared to put their name to the valuation with the appropriate legal oversight.

For a general practice, specifically, we had recently received this Barristers legal opinion. He states:

‘The valuation should be obtained before the sublease is offered to the sublessee at the higher rent amount in anticipation of a Departmental investigation.

For the avoidance of any doubt, I am of the opinion that it would be extremely difficult (if not impossible) to justify charging the anticipated rent amount without a supporting independent valuation.

In the absence of such a valuation, there would be an irresistible inference that the amount being charged results from an agreement between the parties for the sublessor to request pathology services from the sublessee.’

Find out if you have an excessive pathology rent problem?

Before hiring legal advisers, a useful starting point is to enquire what the average commercial rents are in your local region, which is a relatively straightforward exercise.

For an approximate guess, locate your property on a commercial real estate platform. Compare the total rent per sqm with other commercial businesses located next to your practice with your pathology rent per square metre.

For example, if the local butcher is paying rent totalling $120,000 p.a. exclusive of outgoings plus GST for a 600 sqm premises the rent is $200 (i.e. Rent $120,000/600 sqm) sqm p.a.

You need to do the same calculation for the area you are designating in your practice for a pathology collection centre.

If the pathology rent exceeds the commercial rent you are seeking or your existing lease; then it is time to engage some professional help to tidy things up.

To be clear a verbal telephone call or an email will not cut it.

A written valuation is required.

The valuation report is not the same as the traditional property valuation process, as it should place into context your total business model, structures, agreements and systems amongst other considerations.

Update your current Pathology Lease to be Red Book Compliant

We can also refer you to experienced lawyers. For an obligation-free confidential chat, Health and Life can provide more accurate independent national pathology rental market valuations.

We have been approached by solicitors to provide independent pathology valuations due to our unique 15-year dataset of pathology bids and comparable market rates in Australia. Health and Life has been independently tendering pathology, medical, pharmacy and other allied health services since 2006. Traditional property valuers do not have access to this unique database, and it is not publicly available.

For over a decade, we have successfully argued for our clients’ legally and ethically higher market rates, in excess of traditional local property valuations.

For more information

Source: Red Book available from the Department of Health.

Australian GP Alliance’s comments on this investigation and its implications: New Excessive Pathology Rent Red Book Alert!

For more insights visit our blog.

About me: David Dahm BA (Acc.), CA., FCPA, CTA, FFin, CPM, FAAPM, FAIM, FGLF.

Chartered Accountant, Chartered Tax Adviser, Registered Tax Agent, Former AGPAL Surveyor 10 years of service

David Dahm is CEO and founder of the national medical and healthcare chartered accounting firm Health and Life and global Founder and CEO of the not for profit project the International Healthcare Standards and Ethics Board (www.ihseb.org)

After a serious work related car accident in 1989, and nine operations later I continue to be a patient and provider advocate. I enter my third decade as a national Chartered Accountant for Medical and Healthcare practices in Australia. I am a former 10-year Australian General Practice Accreditation surveyor. I come from a medico family. I have served on the AAPM national Board and was the inaugural national Chair of the Certified Practice Manager CPM post nominal. I continue to provide accounting tax and practice management advice to many practices all over Australia.

You know who you are and I thank you for this real honour and privilege to serve you and your community through you. Note, I am not a lawyer please seek appropriate legal and accounting advice. This information is for general information and discussion only.

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