The Virtual Reality of Enterprise Liability

By Armand Leone, Jr.

Enterprise liability in the managed health care industry has become a virtual reality because of recent decisions from the Third Circuit Court of Appeals, the state Supreme Court and the Internal Revenue Service. See Dukes v. U.S. Healthcare, 57 F.3d 350 (3d Cir. 1995); Dunn v. Praiss, 139 N.J. 564 (1995); J. Johnson, "IRS classifies more doctors as employees," American Medical News, Nov. 27, 1995 at 1. See also T. Schaper and T.A. Tamborlane, "A Quick Look at HMOs in New Jersey," N.J.L., No. 173:8 (December 1995).

The managed health care industry resisted legislative attempts to establish enterprise liability when it was suggested as part of President Bill Clinton's Healthcare Reform Act. See, e.g., B. McCormack, "Enterprise Liability Out: AMA Steering Toward Traditional Tort Reform," American Medical News, June 28, 1993 at 1. However, the courts have created enterprise liability for managed care organizations by way of these recent decisions. The acceptance of enterprise liability by MCOs and health maintenance organizations would alleviate much of the delay in the resolution of medical malpractice claims. See A. Leone, "ADR and Enterprise Liability," 135 N.J.L.J. 1008 (Nov. 8, 1993). Since managed care is becoming the health care delivery system of choice and is replacing traditional health care, providers ought to consider establishing enterprise liability in a more formal setting.

Under the enterprise liability theory, responsibility and liability for medical malpractice in the managed care setting shift initially from individual physicians to the HMO. Physicians are not named as individual defendants in a suit alleging malpractice, but assume the limited role of fact witnesses. The HMO becomes legally accountable for the actions of its physicians and for developing quality assurance programs for patient care.

Enterprise liability can alleviate some of the medical malpractice crisis, at least as far as it concerns physicians and patients. The initial benefits to plaintiffs and the courts would be a drastic reduction in multiparty litigation in medical malpractice cases. The initial benefit to managed care physicians is to shield them from being named as individual defendants in a malpractice suit -- initial litigation of malpractice claims would be against the HMO. If liability is established or settlement reached in litigation, subsequent confidential alternate dispute resolution proceedings can be conducted to apportion fault among the physicians. Such a hybrid resolution system would create significant savings in the emotion and transactional costs of resolving malpractice claims, without providing incentives for increased claim filing.

In today's health care delivery system where treatment decisions require input from primary care physicians, specialists and nonphysician utilization reviewers, enterprise liability avoids forcing a plaintiff to name numerous individual defendants who are potentially liable but unlikely to be found at fault. Enterprise liability also avoids the necessity of plaintiffs having to file multiple amendments to pleadings as discovery unfolds -- all of which are common in malpractice cases today. Plaintiffs should be able to bring causes of action for malpractice injuries in a managed care setting against the MCO without having to name the individual physicians. The MCO is liable for all tortfeasors under theories of agency, direct negligence, and contract law.

No Federal Pre-Emption

The Third Circuit held in Dukes v. U.S. Healthcare, 57 F.3d 350, 356 (3d Cir. 1995), that the complete pre-emption exception to the well-pleaded complaint doctrine enunciated in Metropolitan Life Ins. Co. v. Taylor, 481 U.S. 58 (1987), does not permit removal of state claims against HMOs for malpractice liability predicated upon theories of agency and direct negligence. The issue raised by malpractice claims against HMOs concerns the quality of ERISA benefits, rather than a denial of benefits. Complete pre-emption of state law claims under ERISA exists only if state law claims involve ERISA's civil enforcement provisions. State law malpractice claims do not involve those provisions and do not, without more, state a federal question.

The existence of a potential defense under ERISA does not allow removal of these claims either. Federal courts are simply without jurisdiction to remove malpractice claims against an HMO even under an ERISA plan. Dukes v. U.S. Healthcare, 57 F.3d at 355.

The result is logically correct, because patients should enjoy the right to be free from medical malpractice in a managed care setting regardless of whether or not their medical care is provided through an ERISA plan. When plaintiffs complain about the low quality of the medical treatment received, they are not contesting a denial of benefits under ERISA. In fact, the ERISA statute says nothing about the quality of benefits that are to be provided, but only speaks to whether or not benefits are provided. The civil enforcement provisions of ERISA simply do not contemplate a remedy for a plan participant who is injured by medical malpractice. See 29 U.S.C. 1132. Thus, unlike the common practice before the Third Circuit's decision in Dukes v. U.S. Healthcare, HMOs cannot remove state law malpractice claims based upon agency or direct negligence theories to federal court. See also Muller v. Maron 1995 U.S. Dist. LEXIS 15048 (E.D. Pa., Oct. 13, 1995); Howard v. Sasson, 1995 U.S. Dist. LEXIS 14373 (E.D. Pa., Oct. 3, 1995).

HMO Liability in N.J.

The New Jersey Supreme Court in Dunn v. Praiss, 130 N.J. 564 (1995), held that an HMO can be liable for negligent acts that contribute to patient injury. See also T. Schaper and T.A. Tamborlane. "A Quick Look at HMOs in New Jersey," N.J.L., No. 173 at 8 (Dec. 1995). The theories recognized by the Court for HMO liability include vicarious liability based upon respondeat superior or ostensible agency; corporate negligence based upon negligent selection and control of the plans physicians; corporate negligence based upon the plans independent actions; breach of contract; and breach of warranty.

In the Dunn case, the specific issues addressed were whether a breach of contract claim against the HMO by a patient could be a basis for contribution on a cross-claim by a plans physician and whether the physicians cross-claim had been timely preserved during the trial. Although the physician had abandoned his cross-claim during the proceedings, thus precluding his claim for contribution from the HMO, the Supreme Court held that the HMO could be liable in contribution for the patient's injuries.

The Dunn Court emphasized that the HMO act does not immunize managed care organizations from medical malpractice liability. See N.J.S.A. 26:2J-1. The Court went out of its way to clarify that, upon a sufficient showing of evidence, claims based upon vicarious liability, corporate negligence is selecting and controlling member physicians, direct corporate negligence and breach of contract or warranty can make an HMO liable for malpractice damages.

This liability can be asserted directly by the plaintiff or by a co-defendant in a cross-claim for contribution. The Court noted that indemnification agreements between HMOs and member physicians may effectively immunize HMOs from making payments based upon vicarious liability through agency or respondeat superior. By expressio unius, exclusio alterius, the Court indicated that the other liability theories have independent bases and leave HMOs responsible for their own share of the damages.

The basis for the breach of contract claim in Dunn was that the HMO failed to provide the coordination of care with and by the primary care physician, a feature which was emphasized in the HMOs promotional literature. Accordingly, plaintiffs who allege injuries as a result of the plan's failure to coordinate care between its member physicians can state a claim for breach of contract and/or breach of warranty that causes injury. This type of claim would exist, for example, when injury is caused by the failure of an abnormal test result or specially consultation to reach the attention of the primary care physician. As a result, the necessary treatment is not given to the patient or is unduly delayed, causing the disease to progress to an advanced stage.

Other claims against HMOs that cannot be passed off to co-defendant physicians through indemnification agreements are claims that the managed care organization was negligent in credentialing its physicians by accepting physicians who lacked specialty certification, who committed repeated acts of negligence or who had prior disciplinary problems. Direct HMO liability can also exist when the plan is negligent in processing the plaintiffs medical care.

The plaintiff in Dunn apparently did not obtain his health care through an ERISA health plan. However, the Supreme Court's reasoning that an HMO is not afforded statutory immunity from malpractice liability indicates that HMOs will be held responsible in New Jersey for negligent harm to plan patients, notwithstanding ERISA. The talisman is fault -- and fault that leads to patient injury, whether through negligence or breach of contract/warranty, is a basis for liability against an HMO.

The vicarious liability of HMOs for their physicians' acts of malpractice based upon respondeat superior is strengthened by two recent Technical Advice Memoranda released by the Internal Revenue Service that reclassify most hospital-based physicians as employees, rather than as independent contractors. See TAM 9535001 and TAM 9535002. The consequences of these IRS decisions are far-reaching. The IRS now judges a physician's work status on the independence of business operations, rather than on the independence of medical decision-making. Hospital physicians who are supplied with equipped and staffed facilities, who are required to be members of a medical staff and who are required to record medical entries concerning patient care have the characteristics of employees, not independent contractors. Noncompetition agreements further limit the physicians' abilities to offer services to the public and, therefore, establish another element of control by the hospital. These new IRS decisions reclassify almost all hospital-based physicians as employees and lend themselves readily to an analysis of the relationship of managed care physicians to HMOs.

The immediate consequences of the IRS decisions for physicians are the loss of tax benefits in qualified retirement plans and greater restrictions on deductible business expenses; hospitals face liability for payment of back Social Security and federal unemployment taxes on physicians' wages, as well as steep penalties for having failed to comply. Another result is that an HMO's vicarious liability for malpractice injuries is increased.

A Possible Solution

The virtual reality of health care enterprise liability is not all doom and gloom, as some major HMOs would contend. In fact, it is possible to envision a scenario in which it actually improves the litigation of medical malpractice claims in a managed care setting.

Litigation transaction costs for malpractice claims can be significantly reduced with an enterprise liability system. The apportionment of fault among involved health care providers, if any is found, can be more efficiently determined with confidential ADR proceedings after liability for malpractice has been found at trial against the HMO.

The litigation transaction costs for plaintiffs, defendants and the courts can be reduced by having one named institutional defendant who represents the multiple potential tortfeasors. Defense costs would be decreased, because only one defense firm would be appointed initially to represent the HMO in the medical malpractice litigation. Liability and overall damages to the plaintiff would be determined in court. Plaintiff transaction costs would also be decreased, because there would be only one named defendant and no delays caused by multiple amendments to the pleadings to bring in additional defendants as discovery proceeds. The court's transaction costs to resolve the malpractice claim will decrease, since it is not dealing with multiparty litigation.

If there is a favorable settlement or verdict for the plaintiff, then the apportionment of fault among the HMO and its health care providers can be determined through less costly and confidential ADR processes. The potentially liable physicians can fully present their cases to expert mediators and/or arbitrators in a subsequent proceeding. Expert witnesses can defend individual physicians in the confidential ADR proceeding without the fear of destroying a unified defense at trial. Defendant physicians are often discouraged from introducing exculpatory evidence implicating other co-defendants at trial, because once any defendant says, "There was malpractice, but it wasn't me," the trial game is over for all defendants. The mediator or arbitrators can apportion the fault and damages amongst those who properly deserve it. Payment by the physician's insurance carriers and reporting to the National Practitioners Data Bank can be made in accordance with the post-trial ADR findings

The issues as to whether the HMO is only vicariously liable or independently liable vis-a-vis its physicians would be addressed only after liability to the plaintiff has been found. If the ADR process finds the HMO vicariously liable for the acts of its physicians, the indemnification provisions could apply to reimburse the HMO and/or its insurance company. If there are independent bases for the HMOs liability and the physicians liability, the ADR process can make a fair apportionment of the fault between all involved.

The net result of an enterprise liability system would be that the time, transaction costs and emotional stress of resolving medical malpractice claims would be lessened without creating incentives for an increase in claim flings. Frivolous and meritorious claims would be more quickly resolved with less expense to defendants and plaintiffs, respectively. If it becomes necessary to apportion fault through ADR, the involved health care providers can resolve their disputes with less cost and with more candor than if the issues were resolved in the underlying litigation.

The article is reprinted with permission from the April 15, 1996 issue of the New Jersey Law Journal. © 1996 NLP IP Company.