Laboratory Service Contracts: The Devil’s in the Details

After all the blood, sweat and tears that have gone into owning your practice, you’re finally ready to sell. You have a prospective buyer who wants to assume ownership and, after many months of negotiating, you’ve settled upon the terms of your agreement. Then comes the fateful day when your attorney asks, “Is your laboratory contract squared away and ready to be assigned to the new owner?”

You examine your contract with your reference lab and discover that you still owe monthly payments for years into the future. You find some wiggle room in the assignment clause, but your practice’s new owner tells you she has contracted with her preferred lab – and it’s not the same as yours.

Upon taking a closer look at your laboratory service contract, you’re appalled to find that any attempt to terminate the agreement early would result in the entire balance being due. To make matters worse, the equipment you were led to believe was provided to you by the company turns out to be provided, sure, but via a loan. As you continue to read your contract, your retirement dream keeps crashing around you.

The scenario described above admittedly presents a gloomy view of an owner coming to terms with his or her laboratory service contract, one that isn’t necessarily typical. Having said that, though, it is common for these agreements to contain terms and conditions within densely worded paragraphs that can leave a practice owner at a disadvantage when it’s time to terminate the contract. That’s why, like with any contract, you should safeguard yourself against any surprises by taking the time to read all clauses and know exactly what is expected of you and of the contract holder.

For veterinary practice owners, there are multiple options and agreements offered by reference labs that will allow you to outsource your diagnostic lab work to their facilities. Here are typical arrangements.

  • At a bare minimum, you can work with a reference laboratory on a “pay-as-you-go” type of relationship, picking and choosing which laboratory to send your samples to on an individual basis. The downside to this style is that labs won’t offer financial incentives to a practice owner who doesn’t enter a contract.
  • The next level up would be a basic contract with a specified reference lab that gives you a discount on fees or a better rate schedule. Because the practice is charged lower fees, you can theoretically offer clients a better rate on lab work, which will likely convince more of them to agree to have lab work run.
  • The most prevalent type of contract involves signing a multi-year deal with the lab of your choice, with the main incentive offered being a large-sum loan or special in-house lab equipment lease provided to the practice.

As long as you know what’s expected of you from these loans, discounts and equipment financing plans, the rewards of adding them to your practice can be very beneficial. In fact, according to a 2016 article found on the dvm360 website1, there are multiple reasons why it makes sense to sign a laboratory contract. The reasons mentioned most frequently by practice management professionals is the development of a strong relationship with the vendor/laboratory, better customer service and quick response to problems, and easier equipment replacement and upgrades. This data was taken from a survey conducted by the VHMA2 that categorized respondents by how many years were on their current reference laboratory contract. The survey showed that, out of the 64% of professionals whose practice had an exclusive contract with a reference lab:

  • 3% were on a one-year contract
  • 12% had a 2- to 3-year contract
  • 40% had a 4- to 5-year contract
  • 11% had 5+ years on their contract
  • 34% had no minimum length required

Because the data shows how most of these agreements (51 percent) had four or more years remaining in their terms, it becomes obvious why practice owners need to take these types of contracts into consideration several years before retiring.

With any list of pros, there usually comes a list of cons and, when it comes to entering into a laboratory service contract, cons mentioned in the 2016 survey included:

  • inability to take advantage of competitive pricing
  • subpar customer service experiences
  • confusing language of the contract.

As with many legal documents, these contracts typically contain an elevated level of vocabulary, which helps to explains why many owners look for the main points included and then sign their names. Tempting as this is, it can be dangerous to rush the process and not be aware of exactly what you’re signing.

So, what’s the bottom line? Are these contacts good to sign – or bad? The answer depends upon how long you plan to own or manage your practice. First-time practice owners may very well negotiate an acceptable rate schedule in a clear arrangement that will allow them to build a foundation for their practice. The diagnostic equipment that is provided as part of the contract can be a great asset to the practice once the loan is paid off.

Practice owners looking to sell sooner rather than later, though, will have some tough decisions to make. How will the procedure work when it’s time to assign the contract to a new owner of the practice? Are the economic terms listed acceptable? Can you decline to auto-renew your participation in the program if it’s within the appropriate time frame? Auto-renewal clauses on this kind of contract have been known to range from 60 days all the way up to one year prior to the end of the current term.

Incentives provided by the reference lab can be very beneficial to your practice, but you need to realize that all incentives will very likely cost you in some manner. Laboratory representatives might offer incentives as a show of good faith or appreciation for your business, but these incentives are likely to be a hook to persuade you to agree to other, less enticing terms of the contract. Any large sum of money provided or discount offered may be presented as a signing bonus, for example, but may more closely resemble a loan.

And, unless explicitly stated otherwise, discounts and other price alterations can disappear at any time. Even more troublesome, many of these loans or financing schedules are not commonly assignable even when you have requested written consent from the company. In other words, the lab contract you assign to your successor will not necessarily take the loan payments off your hands and, in some cases, assigning the contract may accelerate payments to make the full balance immediately due.

Pay close attention to monthly purchase requirements of laboratory goods and services, which may take various forms across the scope of these arrangements. The standard example would be a clause within the contract that requires your practice to order a specified threshold of payments to the laboratory for diagnostics ordered monthly. The amount required might fluctuate depending upon the size and productivity of your practice, but it is very important to make sure that your gross production will, in fact, allow for that much payment to the company. Some companies will allow for as much as 10% of your diagnostics to be submitted to other laboratories without a breach of contract, as well as any diagnostic tests that their laboratory cannot run. You’ll want to be clear on exactly what does and doesn’t fall under these exceptions because a breach of contract typically comes with severe consequences.

Ethical considerations also exist. If your practice has a monthly quota of diagnostics and associated charges that you must meet, you must carefully consider which tests are necessary for your clients’ companion animals and avoid ordering tests simply to reach your laboratory quota. Some members of the public already have the perception that veterinarians order unnecessary tests that do not provide meaningful results; practices that are perceived to recommend superfluous tests will begin to drive away their consumer base at best and sever the veterinarian-client-patient relationship at worst. So, before signing a laboratory service contract, make sure you can afford the level of production that your lab contract requires.

So, what happens if you can’t maintain your production and you fall behind on payments, or you order too many diagnostics from another reference lab and a breach of contract occurs? The consequences can be severe, such a penalty that states that, upon the event of default, all future monetary amounts and payments are due to be paid immediately to the company. Some companies will give you a brief period in which to cure your breach or default, but such time would usually only be beneficial if the amount of money owed was small. Another penalty for breach of contract is a tiered structure of money owed upon default that decreases depending on the amount of years the contract has been held. This may be more favorable for owners and managers who know they can fulfill the terms of the contract for the initial couple of years.

Returning to the initial scenario, here’s another variation. Let’s say you’re ready to sell your practice to an excited new owner but, in this case, the new owner is eager to fill your role in the reference lab contract. This is a much better scenario because most lab companies, when given the proper amount of notice as specified in the contract, are likely to assign the contract to the new owner. In this case, it will be very important to know what your obligations are after the assignment of the contract. As with purchase agreements, the original owner may still be kept on the contract as a guarantor, meaning that his or her assets are still vulnerable if the new owner defaults on the contract or commits a breach.

Contracts are not made up of purely economic terms. Within these agreements there are typically confidentiality clauses that prohibit you from discussing any aspect of the terms of your agreement unless necessary by law. This restricts the negotiating ability of practice owners or managers by disallowing them to consult with colleagues and assess the likelihood of more beneficial terms.

Part of your due diligence prior to signing a contract should be to consider your general impression of a laboratory’s diagnostics and services. Do you agree with their reference values and the sensitivity and specificity of the tests they perform? Have you had positive or negative experiences with their customer service? While you may not obtain much information from colleagues about the terms of their contracts, there doesn’t appear to be any penalty associated with discussing their satisfaction with service they’ve received.

Reference laboratories have pursued injunctive relief against owners and managers that breach their contract, whether such breach was intentional or not. VIN published an article in March of 2012 detailing multiple lawsuits filed by Antech Diagnostics, the laboratory services division of VCA, between 2011 and 2012[3]. These suits were taken against practice owners who had attempted to end their agreement with the company prior to the full term, citing reasons such as the laboratory’s service being “unacceptably poor” or receiving a more attractive offer from competing companies, such as Idexx.

Many of these owners believed they could terminate their contracts by paying the money due for their loans or incentives ahead of the scheduled time, in part because of the lack of language within the agreement about that topic and in part because of information provided verbally by company representatives. However, in events where these attempts were made, Antech responded with lawsuits for the sum of any money currently owed as well as income they were due to receive for diagnostics ordered by the practice through the length of the contract. According to the article, the revenues that Antech was attempting to claim ranged from $234,000 to $798,000! Many times, Antech was successful in pursuit of these funds and, since that time, the wording in relevant clauses of these contracts has become more specific.

The VIN article emphasizes the importance of considering the ethical aspects of having a diagnostic revenue quota set by laboratory contracts and cautions practice owners to carefully read all laboratory contracts to ensure a clear understanding of stipulations before signing. Though these reference laboratories want your business and will offer a friendly gesture in the form of discounts and significant sums of money (as a loan, mind you), there will be no love lost if they feel you aren’t contributing your share or have breached their terms. As long as you know what’s expected of you, though, and can meet those expectations, the sunnier side of offered incentives will shine through, and reference lab relationships can be highly beneficial to you and contribute to the growth of your business.

 

References:

  1. staff, dvm360.com. “Exclusive Veterinary Lab Contracts: Deal or No Deal?” dvm360.com, 12 Sept. 2016, veterinarybusiness.dvm360.com/exclusive-veterinary-lab-contracts-deal-or-no-deal.
  2. Shupe, Christine. “Lab Notes.” Veterinary Hospital Managers Association, 28 June 2016, vhma.site-ym.com/blogpost/1273540/250849/Lab-Notes.
  3. Lau, Edie. “Veterinary Diagnostics Giant Sues Multiple Practitioners.” VIN, Veterinary Information Network, 9 Mar. 2012, news.vin.com/vinnews.aspx?articleId=21802.