Anyone who has spent time reviewing claim forms and bills submitted by medical providers has probably encountered at least some of the more typical fraud schemes: overbilling, false claims, or maybe even kickbacks and bribery. Sophisticated technology, investigative techniques, and data analytics let us zoom in – and out – to identify these traditional forms of fraud at the individual claim level and on a system-wide scale.

But a recent opinion by the New York Court of Appeals, the state’s highest court, should serve as a reminder to look out for a different sort of fraud that might not be so immediately obvious. This article will examine Carothers v. Progressive Ins. Co., 2019 NY Slip Op. 66482, the “fraudulent incorporation” defense that resulted in a big win for the insurers on the case, and how to investigate and uncover fraudulently incorporated providers.

Background Facts

The factual background is important to understanding this case and how it applies in practice. Plaintiff Andrew Carothers, M.D., P.C., was a professional service corporation formed by radiologist Andrew Carothers in 2004 to perform MRI scans in New York City. The plaintiff was incorporated after Carothers was introduced to Hillel Sher, a non-physician whose companies held long-term leases on several fully equipped MRI facilities in New York City. The two were introduced by an MRI equipment repair technician who knew Carothers was in financial distress and that Sher was “looking for a doctor.”

The rental fees charged to the plaintiff for various MRI and office equipment were exorbitant. The newly formed corporation subleased Sher’s facilities and equipment for an eye-watering $600,000 per month. To put this figure in perspective, $600,000 would have bought enough used equipment to replace all the MRI equipment in the leases. Similarly, the plaintiff leased nine used fax machines for $60,000 per year, which would have purchased scores of new machines.

Bank accounts opened by Carothers for the plaintiff showed outbound transfers totaling some $12,200,000 to domestic and offshore accounts belonging to Hillel Sher and Irina Vayman, another non-physician who had been hired as the plaintiff’s executive secretary. Funds transferred to Vayman’s personal bank account were used to cover lease payments on her car and water bills for a house in Las Vegas owned by Sher. Vayman’s salary of $120,000 per year was significantly more than the $133,000 Carothers received from January 2005 through 2006. Tellingly, Sher introduced Carothers to Vayman.

Carothers never wrote a check from the plaintiff’s bank account; Vayman would write the checks. Carothers also never sought out referring physicians; that was also done by Vayman. Carothers reviewed at most 79 of some 38,000 reports, and was not involved in evaluating or disciplining employees. When called to testify at trial, Carothers was not able to account for the numerous payments to Vayman and Sher’s personal accounts.

Trial experts testified that there was no quality control and no supervision of the MRI operation, which produced “abysmal” MRIs. Most of the MRI scans were of patients allegedly injured in motor vehicle accidents. Patients would assign their rights to receive first-party no-fault insurance benefits to the plaintiff, which would then bill insurance companies to recover payment on the assigned claims. Insurers, including the defendant Progressive, stopped paying in 2006.

Legal Background

When insurers stopped paying, the plaintiff filed collection actions seeking to recover the unpaid claims. The insurers, including defendant Progressive, contended that plaintiff was not entitled to reimbursement, citing a New York regulation that allows insurers to withhold payments to providers that are not in compliance with New York licensing rules. 11 NYCRR 65-3.16(a)(12) (stating that “[a] provider of health care services is not eligible for reimbursement . . . if the provider fails to meet any applicable New York State or local licensing requirement necessary to perform such service in New York”).

Since the plaintiff was controlled by unlicensed non-physicians, the insurers argued, it was not in compliance with the applicable licensing rules and the insurers therefore had no obligation to pay (See Business Corporation Law §§ 1507 and 1508 [requiring, generally, that shareholders, officers, and directors of a professional service corporation be licensed members of the profession]). The insurers also argued that the plaintiff was not entitled to payment because Carothers, the shareholder with a medical license, did not actually engage in the practice of medicine through the professional corporation.

The plaintiff argued that the court should give the jury instructions on the traditional elements of fraud, including fraudulent intent, based on the theory that an earlier case, Mallela, allows insurers to withhold payments only in situations where there is conduct tantamount to fraud. See State Farm Mut. Auto. Ins. Co. v. Mallela, 4 N.Y.3d 313, 322 (2005). New York’s Court of Appeals had ruled in that case that an insurer may withhold payment for medical services when there is “willful and material failure to abide by” licensing and incorporation statutes. Id at 321. This is the fraudulent incorporation defense in a nutshell.

Given these competing arguments, the trial court was asked to determine whether the facts above gave the insurers a sufficient basis to refuse payment based on the fraudulent incorporation defense, or whether it needed more evidence to establish an intent to defraud or conduct tantamount to fraud. In other words, the primary issue was what elements are necessary to establish the defense of fraudulent incorporation. The trial court declined to issue the requested jury instruction, and the jury ultimately found that the plaintiff was fraudulently incorporated.

The plaintiff appealed, but the fraudulent incorporation verdict was upheld at the appellate level. The plaintiff appealed again to the Court of Appeals, New York’s highest court. Again, the judgment was affirmed on the basis of the verdict finding the plaintiff was fraudulently incorporated. The Court of Appeals clarified that the fraudulent incorporation defense does not require a finding of fraud for an insurer to withhold payments to a medical service corporation improperly controlled by non-physicians. Because this decision clarified what elements are necessary to establish fraudulent incorporation, we turn now to examine those elements.

The Fraudulent Incorporation Defense

In order to demonstrate fraudulent incorporation, it must be shown that unlicensed individuals are either 1) the de facto owners of the corporation or 2) exercise substantial control over the corporation. See Andrew Carothers, M.D., P.C. v. Progressive Ins. Co., 51 N.Y.S.3d 551, 556 (outlining the ownership or control requirements). To show de facto ownership, it must be shown that unlicensed shareholders exercise dominion and control over the plaintiff and its assets, and that the unlicensed shareholders shared risks, expenses, and interests in the profits and losses of the plaintiff. To show control, the unlicensed individual must have a significant role in the guidance, management, and direction of the corporation.

To help the jury in Carothers, the trial court offered a number of factors they should consider in determining who owned or controlled the corporation. But the court was also clear that the jury should also look to the totality of the circumstances. Specific factors to consider included whether dealings were negotiated at arms-length or instead designed to give control and channel profits to the unlicensed shareholder; whether unlicensed shareholders have control of the corporation’s assets; whether and to what extent the corporation’s funds were used for personal rather than corporate purposes; whether unlicensed shareholders are responsible for hiring, firing, and payment of salaries of the corporation’s employees; whether the day-to-day formalities of corporate existence were followed; whether the corporation shared office space with the offices of the unlicensed shareholders; and whether the licensed shareholder played a substantial role in the day-to-day and overall operation and management of the corporation. Carothers, 51 N.Y.S.3d at 556.

At this point it should be mentioned that making this case outside of New York might prove challenging. But there is a policy argument to be made that the defense should be extended to other jurisdictions. Let us take Illinois as an example. Illinois, like New York, prohibits unlicensed individuals from organizing or controlling medical corporations. See, e.g., 805 ILCS 15/13 (requiring medical corporations to be owned or controlled by licensed physicians). From this law we can conclude that there is a policy against control/ownership of medical corporations by unlicensed individuals, and such corporations are effectively illegal/unlawful.

Taking this a step further, the health care lien act creates statutory, judicially enforceable obligations to pay licensed medical professionals/providers, which includes medical corporations. 770 ILCS 23/et seq. But it’s also against public policy to support/enable/further an illegal enterprise like a medical corporation organized/controlled by unlicensed individuals. Therefore, one could argue, insurers should be able to refuse payment when there is a good faith reason to believe the provider is organized/controlled by unlicensed individuals. See, e.g., Mallela, 4 NY3d 313 at 321 (holding that New York law allows an insurer to refuse payment to medical providers when there is willful and material failure to abide by licensing and incorporation statutes).

Progressive was able to confidently refuse payment in Carothers because its investigation of the plaintiff gave it a good faith belief that the plaintiff was not actually owned or controlled by doctors, but rather the non-doctors Sher and Vayman. This is important – the court was very clear to say that insurers could not withhold payment just to investigate licensing issues, or for failure to follow every corporate formality (such as conducting regular board meetings). See Carothers, 51 N.Y.S.3d 551 at 558 (cautioning insurers not to delay payments to pursue investigations unless they had “good cause,” and noting that mere “technical violations,” such as failing to hold an annual meeting or pay corporate filing fees, “will not do”). Having reviewed the elements of fraudulent incorporation, the next section provides recommendations on how to show ownership or control in order to establish the defense.

Recommendations

As a preliminary matter, investigators should be familiar with the professional services corporation act and/or medical corporation act for their jurisdiction. Spotting a potentially fraudulent corporation requires knowing what the requirements are, after all. Illinois, for instance, requires all officers, directors, and shareholders of a professional service or medical corporation to be licensed. That means no unlicensed individuals can have any part in the ownership, management, or control of the corporation. New York’s law is substantially similar.

While corporate law is typically fairly uniform throughout the states, it is always a good idea to double (and triple) check or simply ask counsel. And as insurance professionals know, insurance law varies significantly state by state, so what holds true in New York may not work the same way in Illinois or another jurisdiction. Again, be cognizant that there is variation, and reach out to experts if the answer is not clear. And be sure to keep some of the following resources in mind when investigating a potentially fraudulently incorporated entity.

In Carothers, the court stated that insurers may “look beyond the face of licensing documents to identify willful and material failure to abide by state and local law,” such as actual ownership or operation of the practice by an unlicensed individual. Carothers, NY Slip Op. at p. 2 (quoting Mallela, 4 N.Y.3d at 321). Therefore, the first thing investigators should try to obtain are the licensing documents. The challenge with obtaining these records is often in knowing where to look. Many states provide websites where users can search for corporations by name, and these can be a good place to start digging. Once the legal name of the entity is determined, investigators can plug it in to their preferred investigative database (i.e. Lexis).

But there are other ways to find information. For instance, the New York State Office of the Professions offers an online searchable database that allows users to search for licenses for both professional service corporations and the professionals themselves. See http://www.op.nysed.gov/opsearches.htm. Illinois’ Department of Financial and Professional Regulation provides a similar service. See https://www.idfpr.com/profs/pfsrvcp.asp. Some states may not be able to offer the convenience of an online searchable database. In that case, a special trip may be required to inspect and copy records. The state office may be able to copy and mail the requested records to you – a quick phone call can be worthwhile.

All this information will be useful in getting what is really needed, which is evidence of who owns or controls the business, and whether those individuals are licensed professionals. While it may seem obvious, sometimes asking a few simple questions can give the insurer the requisite “good cause” to investigate further or refuse payment. Questions like “who is the office manager” or “did (the doctor shareholder, often the name on the letterhead) look at this” can reveal important information about the structure and day-to-day operation of the entity.

Furthermore, discovery opens up a wealth of investigative opportunities, allowing for the request of information about shareholders and operations of the company that is typically not publicly available. In Carothers¸ account statements, balance sheets, and other financial records were important in establishing that the business was effectively a sham corporation designed to funnel money to unlicensed individuals Sher and Vayman, who effectively owned and controlled the business.

            Throughout your investigation, keep in mind the factors listed above and look for creative ways to obtain information that proves an unlicensed shareholder owns or controls the business. For example, equipment is often leased or purchased on credit by way of a secured transaction. These types of transactions typically leave a paper trail in the form of financing statements filed with local government offices. If an unlicensed individual named in the financing statement is also somehow involved in the business, it may be evidence that the business is somehow funneling money to an unlicensed shareholder.

Conclusion

This article has reviewed the case of Carothers, an important decision recently handed down by New York’s highest court. In this case, insurers were allowed under New York law to deny payment to a medical provider because the insurers were able to show that the plaintiff medical provider, while nominally owned and controlled by a doctor, was actually owned and controlled by unlicensed shareholders in clear violation of New York’s licensing and corporation requirements.

We also reviewed the elements of the fraudulent incorporation defense that won the day. The insurers were able to prove fraudulent incorporation by showing that the unlicensed shareholders, Sher and Vayman, were actually controlling the business and were its true owners. Numerous factors showed that Sher and Vayman were in charge of day-to-day operations, the corporation’s assets, management of employees, and development of the corporation’s business. Equipment leases at exorbitant rates were highly favorable to Sher, and suggested the corporation was designed to channel money to him and Vayman. Detailed records of large, unexplained transfers from the corporation to Sher and Vayman provided further support.

Lastly, we offered a few investigative pointers and useful resources to consider if there are suspicions of fraudulent incorporation. As a final reminder, please remember that the law varies by state. Check with an attorney familiar with your jurisdiction before reaching an ultimate decision on any of the issues or guidance above.

HeplerBroom law clerk Robert G. S Hartzer contributed to this article.