PROVING THE UNLAWFUL CORPORATE STRUCTURE OF A
PROFESSIONAL CORPORATION
INTRODUCTION Between 1992 and 2001, reports of suspected automobile insurance fraud increased
by
275%, the bulk of the increase occurring in no-fault insurance fraud.
Reports of no-fault fraud rose from 489 cases in 1992 to 9,191 in 2000, a rise of more than 1700%. . By one
estimate, the combined effect of no-fault insurance fraud has been an increase of over $100 per year in
annual insurance premium costs for the average New York motorist.
A principal cause of this “concededly rampant abuse” (Medical Society of the State of New York v.
Serio, 100 N.Y.2d 854 [2003]) was the proliferation of layman controlled professional corporations that
flouted the prohibitions against laymen ownership and control of professional corporations found in N.Y.
Business Corporation Law' §§ 1507, 1508 and N.Y. Education Law § 6507(4)(c).[1][2] These entities,
passing facially as legitimately licensed professional corporations, were known derisively as “Doc-in-thebox” operations.
The Article below examines this problem in detail, and blue prints practical approaches for insurers and their
counsel to combat this problem.
Pete Legal and Legislative History …………………………………............ p.3
The Nature of the Layman Scripted Entity ………………………….. p. 7
Telltales ………………………………………………………………… p. 9
Following on Malella. Proving Illegal Corporate Structure …………p. 12
Following on Law Enforcement ……………………………………….p. 12
Leveraging Intelligence ………………………………………………...p. 16
Augmenting Law Enforcement and SIU Intelligence in Litigation …p. 18
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LEGAL AND LEGISLATIVE HISTORY
In 1973, the Legislature enacted the Comprehensive Automobile Insurance Reparations Act (see L.
1973, ch. 13), which supplanted common-law tort actions for most victims of automobile accidents with a
system of no-fault insurance. Under the no-fault system, payments of benefits "shall be made as the loss is
incurred" (Insurance Law § 5106[a] ). The primary aims of this new system were to ensure prompt
compensation for losses incurred by accident victims without regard to fault or negligence, to reduce the
burden on the courts and to provide substantial premium savings to New York motorists (see Governor's
Mem. approving L. 1973, ch. 13, 1973 McKinney's Session Laws of N.Y., at 2335).
In 1977, the Superintendent first adopted regulations establishing time frames in which to submit
forms and notices pertaining to no-fault claims. Those regulations, adopted as Regulation 68 were codified at
11 NYCRR part 65.
Between 1992 and 2001, reports of suspected automobile insurance fraud increased by 275%, the
bulk of the increase occurring in no-fault insurance fraud. Reports of no-fault fraud rose from 489 cases in
1992 to 9,191 in 2000, a rise of more than 1700%. In 1999, the Superintendent established a No-Fault Unit
within the Frauds Bureau to focus specifically on no-fault fraud and abuse. By one estimate, the combined
effect of no-fault insurance fraud has been an increase of over $100 per year in annual insurance premium
costs for the average New York motorist.
A principal cause of this “concededly rampant abuse” (Medical Society of the State of New York v.
Serio, 100 N.Y.2d 854 [2003]) was the proliferation of layman controlled professional corporations that
flouted the prohibitions against laymen ownership and control of professional corporations found in N.Y.
Business Corporation Law' §§ 1507, 1508 and N.Y. Education Law § 6507(4)(c).[1][2]
These entities, passing facially as legitimately licensed professional corporations, were known
derisively as “Doc-in-the-box” operations. The professionals whose names appeared on the corporate
licenses were in truth, at best, nothing more than salaried employees. These schemes enabled unscrupulous
laymen to reap enormous profits from the operation of “Medical Mills” which “treated” patients pursuant to
predetermined scripts, without regard to their medical condition, and which churned out blizzards of bills for
unnecessary treatments, goods and services.
In 1999, in an effort to combat this widespread abuse, the Superintendent proposed an amended
Regulation 68. The Medical Society of the State of New York successfully challenged these regulations for
failure to substantially comply with the State Administrative Procedure Act Matter of Medical Socy. of
State of N.Y. v. Levin, 185 Misc.2d 536, 712 N.Y.S.2d 745 [Sup.Ct., N.Y. County 2000 ], affd. 280 A.D.2d
309, 723 N.Y.S.2d 133 (App. Div. 1st Dept., 2001] [Medical Society I] ). While the appeal was pending, the
Superintendent re-initiated the rulemaking process and promulgated revised Regulation 68 (repealing and
replacing 11 NYCRR part 65).
This second promulgation by the Superintendent in turn gave rise to Medical Society II. (Medical
Society of the State of New York v. Serio, 100 N.Y.2d 854 (2003)) Therein the Court of
Appealsunanimously held that Regulation 68, although manifestly altering the way claims are processed,
was well within the lawful authority of the Superintendent of Insurance to issue and affirmed the retroactive
implementation of these regulations to April of 2002.
These new Regulations, dealing directly with the problem of laymen controlled professional
corporations provided at 11 NYCRR § 65- 3.16(a)(12). that "a provider of health care services is not eligible
for reimbursement under section 5102(a)(1) of the Insurance Law if the provider fails to meet any applicable
New York State or local licensing requirement....", a reference of course to to N.Y. Business Corporation
Law' §§ 1507, 1508 and N.Y. Education Law § 6507(4)(c). [3]
During the course of these events, while the old regulations were still in control, a sweeping claim
by State Farm that numerous entities ostensibly owned by Mallela were in fact fraudulently owned and
operated laymen entities was dismissed by J. Sifton in Federal Court. State Farm Mutual Automobile
Insurance Company v. Mallela, 175 F. Supp2d 401 (EDNY 2001) ). As it proved this case would not rest and
eventually provided the Court of Appeals of the State of New York the platform necessary to put the issue to
rest.
Following the re-promulgation of the new regulations a second Mallela case was commenced,. (State
Farm Mutual Automobile Insurance Company v. Mallela, (Not Reported in F.Supp.2d, 2002 WL 31946762
(E.D.N.Y.) (Mallela II)).
Even though the new regulations now clearly provided at 11 NYCRR § 65- 3.16(a)(12) that "a
provider of health care services is not eligible for reimbursement under section 5102(a)(1) of the Insurance
Law if the provider fails to meet any applicable New York State or local licensing requirement....", Judge
Sifton still declined to alter his previous ruling significantly. He noted "I am reluctant to undermine the
legislative goal of speedy payment in order to permit insurers such as plaintiff to avoid paying licensed
medical service providers for medically necessary services provided to insured individuals by licensed
physicians."
At this point the state of the law in Federal Courts was largely at odds with State Court and
Arbitration decisions. For instance in In the Matter of JRWB Diagnostic against The Travelers Insurance
Company, Arbitrator Mellis determined that JRWB, a large radiological entity, was in fact controlled by a
unlicensed laymen and inelligible to recover No-Fault payments,[4], citing North Bronx Medical, P.C. a/a/o
Paulette Cleckley and Allstate Insurance Company, NF2988 [5].
The Court of Appeals of the State of New York had no such reluctance however when responding
affirmatively to the certified question posited by the Second Circuit, that is "whether 'A medical corporation
that was fraudulently incorporated under N.Y. Business Corporation Law' §§ 1507, 1508 and N.Y. Education
Law § 6507(4)(c) [is] entitled to be reimbursed by insurers, under New York Insurance Law §§ 5101 et seq
and its implementing regulations, for medical services rendered by licensed medical practitioners.'
The Court wrote “We accepted the certification and now answer that such corporations are not
entitled to reimbursement." State Farm Automobile Ins. Co. v. Robert Mallela 4 N.Y.3d 313, 320, 794
N.Y.S.2d 700, 827 N.E.2d 758.
It is important to note at this point that the crucial issue under consideration all along was not merely
whether a professional corporation was facially in compliance with its licensing requirements, but
whether in fact it was truly controlled by a professional.
Thus, the legislature requires professional health service corporations to be owned and
controlled only by those who are licensed to practice medicine, and, in order to obtain the
requisite certificate of authority to practice medicine, a professional service corporation must
certify that each of its directors, officers, and shareholders is licensed to practice
medicine.See N.Y.Bus.Corp.Law §§ 1503, 1507, 1508; Educ.Law § 6507(4)(c). State Farm
Mutual Automobile Insurance Company v. Mallela, 175 F. Supp2d 401 [EDNY 2001] )
As discussed below, with the Malella III decision the Court of Appeals set the stage for the delivery
of justice and reckoning to the countless layman controlled “professional corporations” whose
unscrupulous, greedy and dangerous activities ravaged and permeated the entirety of the New York No-fault
system.
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THE NATURE OF THE LAYMAN SCRIPTED ENTITY
Purported professional corporations that are in fact owned and controlled by laymen for the purpose
of lining their own pockets at the expense of their “patients” wellbeing, are commonly referred to as “Doc
in the Box” operations and “Medical Mills”. The term Layman Scripted Entity is perhaps a more accurate
label, recognizing the eminence of the layman in control of the entity, and the principal money making
scheme by which all patients are subjected to a regimen of expensive treatment determined by a pre-existing
plan or “script” without regard to the patients condition.
A typical “script” that patients are subjected to consists of initial examinations by a physician
followed by extensive and concurrent physical therapy, acupuncture and chiropractic treatment. Overpriced
durable medical equipment is prescribed immediately and may include steep bills for “custom fitted”
orthotics and inflated TENS units. Psychological treatment is arranged, frequently through a fictitious “self
referral” process. The psychological treatment commences billing with an evaluation, coupled with many
hours of specious “testing”, followed by psychotherapy sessions or biofeedback. Dental services are
common with an emphasis on exotic “TMJ” treatments, billing for multiple x-rays and expensive custom
fitted orthotics. Multiple MRIs are prescribed either immediately or after several weeks and usually held on
separate days to maximize billing. In addition electrodiagnostic testing consisting of NCV and needle EMG
procedures generally occur at about the four week mark and are generally the most expensive procedures
billed for.
Other common abuses are “upcoding” wherein a service is billed as if it were much more expensive
procedure, [6] and “unbundling” wherein components of a single procedure are impermissibly broken out
and billed separately. [7] It is additionally common for layman scripted entities to bill for services that were
never rendered and for patients to sign their name to sign-in sheets many times at once resulting in so called
“shadow patients”. [8] It is typical for some $20,000 in billing to be submitted for each patient obtained by a
layman scripted entity.
Indispensable to the revenue streams at the heart of these schemes are payments made to
obtain patients. These payments may be made to the patients themselves, but are most commonly made
to runners or cappers who obtain, present or refer the patients along with a police report (thereby
establishing there is viable insurance coverage) and who themselves may stage or cause accidents. Runners,
cappers and steerer typically receive $1,500 to $2,500 per patient referred. [9]
Rounding out the picture is the synergy between the illegal corporation and the motor vehicle
liability system. Working hand in hand with unscrupulous attorneys, layman controlled entities accept
payments that are ostensibly for patient ‘records’ but which are in fact received for the benefit of referring
patients to the attorneys. The motor vehicle liability system is also, at the end of the day, the principal reason
for the continued participation of patients in the scripted medical treatment. The expectation is that if they
continue to treat they will eventually receive a profitable settlement of their liability case. [10]
The exact manner in which layman scripted entities are configured and the associated schemes
devised vary in nature and scope, limited only by the ingenuity, industry or intelligence of the criminals
involved. All schemes, however, share two common purposes; maximizing the number and size of the
revenue streams flowing into the entity, and sweeping all entity profits to the controlling layman. Indeed it
may be said that the bright line test of whether an entity is illegally operated in contravention of Business
Corporation Law § 1507, § 1508 is whether the professional benefits from the profits of the corporation.
The prototypical layman scripted entity is the stand-alone “multi-disciplined provider” operating on
the license of a single physician and in co-habitation with physical therapy, chiropractic and acupuncture
practices. A small billing company handling all the bills may be owned by the laymen in true control of the
operation, or it may be that the chiropractor himself is in fact the one pulling the strings. At the end of the
day the revenue from all of the operations under the common roof are pocketed by the layman in charge.
An entity of this sort will typically employ the services of various medical service vendors that
ostensibly provide dental, radiological, psychological and nerve testing services. These vendors themselves
are typically laymen controlled entities and may be quite small, or in the case of the radiological entities
enormous.
There are four common financial inducements for using these vendors. There may be a direct cash
kickback or the vendor may pay “rent” for a room at the layman scripted entity to conduct its services. In
certain instances the vendor may strike an arrangement which permits an entity professional to bill for the
technical component the vendor services. Finally there may in fact be an ownership interest in the vendor by
the layman scripted entity and its controller.[11]
A larger scaled layman scripted entity may control both the multi-disciplined provider and the
associated vendor services[12], and there have been instances of jumbo enterprises where scores of
professional corporations managed by dozen of billing companies fed into a single entity at the
pinnacle. [13]
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TELLTALES
There are common telltales of the laymen scripted entity are found in the medical records, the
documents describing with the relationship between the professional corporation and management or billing
companies, and the associated financial records.
Treatment Scripts
Whether a treatment script is being used by an entity, and if so its precise nature, will invariably be
quickly revealed by an examination of several claimant files. The nature of the treatment provided, the
timing of the diagnostic tests prescribed, the template and boilerplate reports, diagnosis, prognosis and
symptomology will be unique from provider to provider, but nearly identical from patient to patient within a
given provider. Examinations Under Oath of a number of claimants from the same provider will often yield
similar results, but can be inexact for these purposes given the variations in the witnesses ability to recall and
relate what occurred to them.
The identification of such a script is a near conclusory indication of a laymen scripted entity since it
demonstrates the complete lack of any meaningful medical analysis or decision making occurring in
connection with patient care at the facility.
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Contractual Agreements
As part of the process of insuring that the laymen is in complete control of the professional
corporation, elaborate and exorbitant management and leasing agreements typically exist between the
professional corporation and the management or billing company. These may be wildly disproportionate to
fair market values and contain clauses, like liquidated damages clauses that handcuff the professional and
grant unfettered control, especially over financial matters, to the layman. Certain crucial terms of the
contract, including the purported compensation to be paid to the “management company” may be left blank.
If the terms are provided for, upon discovery of the entity finances, it is typically found that what is in fact
occurring at the entity is inconsistent with what the agreements ostensibly called for.
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Financial Necessities
Sharp variances between what contracts may calls for and what is actually happening will
necessarily occur because of the true nature of the core financial scheme. Since the entities exist for the
express purpose of sweeping all profits to the controlling layman, the professional involved is in fact nothing
more than a salaried employee receiving a monthly stipend, or an independent contractor paid a perprocedure fee. When the entity thrives the stipend or fee to the professional will not increase, but
increasingly large amounts of money will be pocketed by the laymen. If the tax returns of the professional
corporation are inspected, or credible testimony of a principal is obtained, it should be expected that these
will show all of the businesses profit being swept away to the management company, and amounts claimed
to have been paid as management and leasing fees increasing or decreasing in direct proportion to the gross
revenues of the professional corporation.
This pegging of the management fees to the gross revenues of the professional corporation is of
course of primary importance to the laymen controlling the professional corporation. As the professional
corporation thrives, so he expects to thrive. Such a direct linkage to gross revenues, however, is the very
definition of fee splitting. [14]Accordingly demonstrating this point is often at the heart of any successful
effort to prove the illegal nature of the professional corporation.
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Other telltales
The professional corporation will change “owners” repeatedly, but since the professional figurehead
of the professional corporation has no financial interest in the entity, the transfer of ownership will occur for
no consideration.
The physician will exert little practical control over the professional corporation, he will not hire or
fire employees, the accountants who prepared “his” corporations tax returns and the attorneys who collect
“his” bills will be retained without any input from him whatsoever.
The professional will typically have no knowledge of how much money the corporation is grossing
or netting, and have no involvement in the financial process other than collect his check and possible
endorse checks out of the professional corporation account into the management company account.
The use of name stamps will typically be rampant and unfettered, the physician may not know how
many exist, who possesses them, what purposes they are put to use for or how they came into existence.
In an effort to disrupt facially obvious fee splitting, the laymen will seek to divert revenues before
they reach the professional corporation checking accounts. An inspection of cancelled checks returned to the
insurer may show that they have been cashed at casinos and check cashing stores.
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FOLLOWING ON MALLELA: PROVING ILLEGAL CORPORATE STRUCTURE.
The decision of Mallela III sets the stage for insurers to prove the illegality of laymen scripted
entities in an unprecedented fashion. Several cases have been decided in insurer’s favor on the heels of
Mallela, and an examination of these cases demonstrates the different methods by which a favorable Mallela
decision may be obtained.
Briefly, and as outlined in more detail below, an insurer may expect to prove the illegality of a
Professional Corporation by leveraging SIU intelligence, by following up on law enforcement activities and
by using their own attorneys discovery and subpoena powers in conjunction with declaratory judgment
actions.
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FOLLOWING ON LAW ENFORCEMENT
As evident from the number of press releases annotated in the foot notes of this document, law
enforcement arrests and prosecutions of fraudulent no-fault providers occur at a steady clip. Prosecutions are
routinely brought by the State Attorney Generals Office, the United States Attorney’s Office and local
District Attorneys offices in conjunction with local, state and federal police forces.
In case where the prosecution ends in a plea or conviction, the fact of the conviction, in conjunction
with the allocutions of the defendants, may provide irrefutable proof of the fraudulent scheme of
the professional corporation sufficient to resolve the issue in associated civil cases.
A leading example of a case where litigation along these lines currently is currently being contested
is Metroscan Imaging PC v. Geico Ins. Co. 2005 WL 1384369 (N.Y.City Civ.Ct.), 2005 N.Y. Slip Op.
25228. In Metroscan the insurer consolidated 60 pending actions and sought to follow on the plea allocutions
of a layman in control of this large radiological entity. Noting that the insurer had “articulated a "founded
belief" that the health providers, all incorporated by [the same Doctor] and all subject to a management
agreement with non-licensed professionals, have violated both New York's business corporation and
education laws” the court consolidated the cases for purposes of hearing to determine whether in fact the
professional corporations were in violation of the New York Business Corporation and Education Laws.
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Evidentiary Considerations
Several evidentiary considerations attend this approach since it relies on out of court statements from
different actions to establish the desired result in the current litigation. Complications are injected by this
fact, and by the fact that there will necessarily be at least two principal criminal actors, the Doctor and the
true owner. As the state of the law currently stands, the statements of one will not necessarily be admissible
against the other.
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Doctor’s Plea of Guilty
If, in his criminal allocution, the Doctor admits that he was not in control of the enterprise his
statements will be admissible against himself and, by extension, the entity on at least two grounds, and
should be dispositive on the question of the entities standing to recover reimburstment under the No-Fault
law.
As a party declarant, the admissibility of the Doctor’s own statements are subject to a well settled
hearsay exception (People v. Collins, 301 A.D.2d 452, 755 N.Y.S.2d 365 [2003] (defendant's statement to a
third party properly admitted under the party admission exception to the hearsay rule as "inconsistent with
defendant's position at trial") People v. Auricchio, 141 A.D.2d 552, 529 N.Y.S.2d 163 [1988] ). Moreover,
the declaration against penal interest exception to the hearsay rule has been accepted in New York since
1970 ( People v. Brown, 26 N.Y.2d 88 [1970], cert. denied 480 U.S. 948]).
If the Doctor has admitted the illegal structure of the corporation, for instance by acknowledging that
medical treatment and services were routinely performed without his knowledge or direction, or that the
profits of the company were going to someone other than himself, the statements will not merely be
admissible but should also be directly dispositive on the question of the entity’s corporate structure on
collaterall estopell grounds. Under this construct; the Doctor will be barred in the civil action from
relitigating an issue he has admitted to in the criminal proceeding. (Fisch on NY Evidence [2 ed] Sec.
803; Ando v. Woodberry, 8 N.Y.2d 165, 167 [203 N.Y.S.2d 74, 168 N.E.2d 520] ). “While defendant may
not relitigate the issue of his guilt, he may offer proof relevant to character of crime committed”. (Matter of
Levy, 37 N.Y.2d 279 [372 N.Y.S.2d 41, 333 N.E.2d 350] ).
If however, the Doctor has merely plead or allocated to crimes which do not directly implicate the
corporate structure of the entity, (perhaps simple larceny or insurance fraud, depending on the circumstances
of his allocution), the situation may be different. His statements, while still admissible, might now prove
irrelevant to the question of the entities corporate structure. In such a circumstance, the attorney should be
prepared to prove the illegal structure by other means.
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Layman’s Guilty Plea
If it is the layman who has plead guilty to criminal activities concerning the entity, a different set of
legal considerations arise. As noted, the declaration against penal interest exception to the hearsay rule has
been accepted in New York since 1970 [See, People v. Brown, 26 N.Y.2d 88 [1970], cert. denied 480 U.S.
948].
In Criminal actions however, the current state of the law generally prohibits out of court statements
by one person being used against another. In Crawford v. Washington 541 U.S. 36, 124 S.Ct. 1354, 158
L.Ed.2d (U.S.Wash.,2004.) the United States Supreme Court, held that out-of-court statements by witnesses
that are “testimonial”, like plea allocutions, are barred, under the Confrontation Clause, unless the witnesses
are unavailable and the party opposing the admissibility of the statements had a prior opportunity to crossexamine witnesses, regardless of whether such statements are deemed reliable by court.[15] This position, at
least as it attends criminal cases, was adopted by the New York Court of Appeals in People v. Hardy 4
N.Y.3d 192, 791 N.Y.S.2d 513 (2005).
In USDNY Indictment 02-Cr-1586/89, a case involving a MRI facilities "manager" who was
convicted of tax evasion and bribery, the government wrote the following instructive paragrah in support of
its application to use the "managers" plea allocution against a co-conspirator.
“[The Defendant's] allocution was given in open court, under oath, with the assistance of
counsel and it subjected [the Defendant] to the risk of a substantial prison term. The portions of the
statements that the Government seeks to introduce are inculpatory of the declarant, and no not
minimize the declarant’s conduct or shift blame to the defendants. (See Williamson v United
States 512 US 594, 605 (1994)(“the very fact that a statement is genuinely self-inculpatory is itself
one of the ‘particularized guarantees of trustworthiness’ that makes a statement admissible under
the confrontation Clause”). In addition, [the Judge], who accepted [the Defendant's] plea, had the
opportunity to question the Defendant and to judge his demeanor and credibility. See, e.g.
Willimas 927 F.2d at 98-99 (noting that district judge, who conducted the allocution had “intimate
knowledge of the allocutions’ trustworthiness and their lack of susceptibility to challenge”).
Accordingly, [the Defendant's statements] are trustworthy and should be admitted as statements
against penal interest.”
If such an argument is being made the attorney seeking the admission of the statement should be prepared to
demonstrate as a threshold matter to establish that 1) the declarant is unavailable as a witness at trial, 2)
when the statement was made the declarant was aware that it was adverse to his penal interest, 3) the
declarant had competent knowledge of the facts underlying the statement, and 4) supporting circumstances
independent of the statement itself are present to attest to its trustworthiness and reliability. Kelleher v.
F.M.E. Auto Leasing Corp. 192 A.D.2d 581, 596 N.Y.S.2d 136 ( App. Div. 2nd Dept 1993 ). Quintanilla v.
Harchack 183 Misc.2d 569, 705 N.Y.S.2d 836, 2000 N.Y. Slip Op. 20111 [16] )
The most straightforward rationale for admissibility of a laymen's statement against a Professional
Corporation is that the laymen, in fact, is the Professional Corporation. Since the purpose of using a
layman's admission is to prove that he unlawfully controlled the corporation, the self same statement should
simultaneously demonstrate that he is the alter-ego of the corporation, making the statement admissible
against the corporation. In other words, the statement is admissable against the Professional Corporation
because the declarant is the Professional Corporation.
The most instructive discussion of this argument is found in In re Adler, Coleman Clearing Corp.
399 F.Supp.2d 486 S.D.N.Y.,2005. Adler specifically addresses a situation case where an indictment and
plea allocution were used to establish alter-ego status of a declarant. The court wrote:
"A reading of the Indictment, the Plea Agreement, the Guilty Plea, the Gurian Deposition
and various other documents on the record before it on the instant motion persuades the Court that
the Trustee has sufficiently demonstrated circumstances satisfying the Babitt standards to establish
Gurian's exercise of domination and control over the Bahamian Entities. "
The New York common law rule concerning alter ego status is similar, and was set out by
the Appellate Division of the Second Department in 1959 in Geletucha v. 222 Delaware Corp. 7 A.D.2d
315, 182 N.Y.S.2d 893.
A statement of the general rule is contained in Fletcher's Cyclopedia Corporations, Vol. 1,
Sec. 43, pp. 157-160, as follows: 'Whether one is a mere agency or instrumentality or they
are identical, is a question of fact to be proved by competent evidence * * *. This question of
fact depends on many circumstances overcoming or failing to overcome the indicia of
separate entities, sameness of members, officers and objects, and the absence of distinct
interests, being indicia of agency or identity, while differences in officers, objects or conduct
are indicia of separate recognizable entities * * *. Operating departmental or branch
corporations, and sales corporations, afford illustrations of corporations disregarded on the
facts.'
A further argument may be made that where, as is commonly the case, the layman has set himself up
as president of the culpable management company, that an admission made by a party's agent will be
admissible against that party if it is made within the scope of his agent's or servant's authority. Brusca v. El
Al Israel Airlines, 75 A.D.2d 798, 427 N.Y.S.2d 505 (App. Div. 2nd Dept. 1980). Spett v. President Monroe
Building and Manufacturing Corp., 19 N.Y.2d 203, 278 N.Y.S.2d 826 (1967). As the Court of Appeals
noted in Spett , “Where an agent's responsibilities include making statements on his principal's behalf, the
agent's statements within scope of his authority are receivable against the principal”.
Since the management company routinely makes statements on behalf of the professional
corporation (submitting NF-3’s, responding to verification requests, initiating suits) it should be expected
that the statements of its principal will be admissible against the professional corporation pursuant to
the ‘speaking agent’ exception to the hearsay rule. A frequently cited case on this point is Johnson v. Hallam
EnterprisesLtd.208 A.D.2d 1110, 617 N.Y.S.2d 405 (App. Div. 3rd Dept. 1994) where the court wrote,
“As defendant's president, treasurer and the only person apparently vested with complete
managerial responsibility to run defendant's day-to-day operations, Hallam possessed the
requisite authority to speak on behalf of the corporation (see, Spett v President Monro Bldg.
& Mfg. Corp., 19 N.Y.2d 203, 206, 278 N.Y.S.2d 826; Geletucha v. 222 Delaware Corp., 7
A.D.2d 315, 317, 182 N.Y.S.2d 893) and therefore his declaration of liability was properly
received as an admission binding upon it under this State's current "speaking agent"
exception to the hearsay rule (see, Loschiavo v. Port Auth. of N.Y. & N.J., 58 N.Y.2d 1040,
462 N.Y.S.2d 440, 448 N.E.2d 1351; Nordhauser v. New York City Health & Hosps.
Corp., 176 A.D.2d 787, 791, 575 N.Y.S.2d 117).”
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LEVERAGING INTELLIGENCE
In at least two recent instances Courts have made determinations of illegal corporate structures based
upon pre-suit examinations under oath. In Multiquest, PLLC v. Allstate Ins. Co. --- N.Y.S.2d ----, 2005 WL
2085966 (Civ. Ct., Queens Cty.), 2005 N.Y. Slip Op. 25356, Judge Butler credited the EUO testimony of a
psychologist who was listed as a corporate owner in Multiquest’s incorporation papers, but denied at her
EUO ever having consented to participate in the Multiquest venture. Of particular note was the “nonresponse” raised by Plaintiff to these allegations by the defendant.
Plaintiff, in reply to defendant’s cross-motion, merely asserts that defendant’s denials were
untimely. With respect to defendant’s allegations of fraud and misconduct, plaintiff merely
alleges that Ms. Clarke’s testimony is not credible as it was provided pursuant to an
agreement wherein defendant agreed not to commence an action against Ms. Clarke in
exchange for such testimony. Plaintiff, however, fails to submit any documentary proof
rebutting defendant’s assertions of fraud or misconduct. Additionally, plaintiff fails to
submit an affidavit from someone with personal knowledge of the facts disputing such
allegations
by
defendant.
One of the attractive aspects of having competent proof of an entities illegal structure is the anticipation that,
where the proof is true, it will be difficult or impossible to contradict, there being no one to do so. Judge
Butler concluded the following,
Clearly, the Mallela III Court strongly concurs with the findings of the Superintendent of
Insurance that services provided by fraudulently licensed No-Fault “regimes” should not be
reimbursed.
It is well settled that despite an untimely denial, an insurer is not precluded from raising the
issue of coverage such as a breach of a condition precedent of the terms of the insurance
contract. Presbyterian Hosp. in the City of New York v. Maryland Cas. Co., 90 N.Y.2d 274,
660 N.Y.S.2d 536, 683 N.E.2d 1.In addition, the court notes that proper licensing of a
medical provider is a condition precedent to payment. Valley Physical Med. And Rehab. V.
N.Y. Central Mutual Ins., 193 Misc.2d 675, 753 N.Y.S.2d 289 (App.Term 2nd Dept 2002 ).
Similar results were reached by Judge Arlen Bluth in New York Civil Court , Kings County in the
cases of AT Medial P.C. v State Farm Mut. Ins. Co., No. 64692/04 and AT Medical P.C. v State Farm Mut.
Ins. Co., No 64696/04 wherein the Defendant submitted incorporation papers, tax returns, a management
agreement and an examination under oath. Again there was no substantive opposition from plaintiff, and
again the Court granted the defendant summary judgment premised on Malella grounds specifically finding
AT to be a “Doc in the Box”. [17]
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AUGMENTING LAW ENFORCEMENT AND PRE SUIT INTELLIGENCE DURINGLITIGATION
It is likely that in many instances an attorney may be required to combine law enforcement and pre suit
intelligence with court ordered discovery obtained during the course of litigation for the best result. A good
example of a litigation which fit this bill, occurring in the AAA setting, is In the Matter of the Arbitration
between JRWB Diagnostic Imaging PC / Catherine Voley and The Travelers Insurance Company et al, AAA
Assessment 17 991 26640 02
This case followed the Kings County District Attorney “Wellcare” investigation that shut down a number of
inter-related fraudulent entities During the course of the summer of 2003 a number of lower arbitrator
decisions found an associated radiological entitry, JRWB Diagnostices, to be inelligible for
reimbursement premised upon statements to SIU investigators, and a guilty plea to insurance fraud by the
management company owner. Ultimately twelve separate arbitrations were combined and the principal of
JRWB was obligated to testify and to produce banking records and the management agreement for JRWB.
The testimony demonstrated that the Doctor appeared to be fee splitting with the layman owners, receiving a
nominal $50 fee per scan that was read. The banking records and management agreement appeared
to indicate that JRWB served as a conduit to sweep monies received from insurers to the layman controlled
management company. Arbitrator Melis determined that JRWB was inelligible to for reimbursement
underNew York State ’s No-Fault Law.[18] [19]
An examination of the all of the foregoing cases indicates that the template for establishing an entities illegal
corporate structure combines testimony of the principals along with banking, financial and management and
leasing agreements. A discussion of the arguments to obtain those items of discovery, therefore, follows.
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Discovery Generally
Even before the Mallela III Court clearly made the corporate structure of an entity a potentially
dispositive issue in No-Fault litigation, the relevancy of the question had been affirmed by the Appellate
Terms. In Valley Physical Medicine and Rehabilitation P.C. v. New York Cent. 193 Misc.2d 675, 753
N.Y.S.2d 289 (N.Y.Sup.App.Term,2002) the Court wrote that “In light of the Insurance Law's requirement
that insurers enact fraud prevention plans (Insurance Law § 409), and the New York State Department of
Insurance's Opinion Letters urging insurers to be more vigilant about potential fraud, discovery requests
pertaining to Plaintiff's license status and corporate structure, which are related to allegations of fraudulent
billing, are proper discovery subjects”.
Since Mallela III, clearly the inquiry has acquired a heightened status and sense of urgency, and
should subject itself to the normal inquiry of relevancy pursuant to CPLR §3102(a) which provides that
there shall be "full disclosure of all matter material and necessary in the prosecution or defense of an action,
regardless of the burden of proof." It is well settled that the words "material and necessary" should be
interpreted liberally to "require disclosure, upon request, of any facts bearing on the controversy which will
assist preparation for trial by sharpening the issues and reducing delay and prolixity. The test to determine if
the information sought is material and necessary is one of usefulness and reason." Allen v. Crowell-Collier
Publishing Co., 21 N.Y.2d 403, 406-407 (1969); U.S. Ice Cream Corp. v. Carvel Corp., 190 A.D.2d 788, 593
N.Y.S.2d 861 (App. Div. 2d Dep't 1993). "[I]f there is any possibility that the information was sought in
good faith for possible use as evidence-in-chief or in rebuttal or for cross-examination, it should be
considered evidence material ... in the prosecution or defense.” In re Comstock's Will., 21 A.D.2d 843, 844,
250 N.Y.S.2d 753, 755 ( App. Div. 4th Dept 1964 ).[20]
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Depositions and Provider EUOs
The road for the insurer will likely be easiest when it pursues a provider EUO, specifically
authorized by 11 N.Y.C.R.R 65-3 et seq., to verify whether a provider is properly licensed and accordingly
eligible for reimbursement under the No-Fault law. As there has not yet been any denial, the insurer will not
barrel into the frequent crimping of the discovery process imposed by Civil Court Judges who have settled
into the practice of limiting the scope of depositions to the substance of the denial. Examples of these sorts of
rulings are found in Socrates Psychological Services, P.C. v. Progressive Cas. Ins. Co., 7 Misc.3d 642, 791
N.Y.S.2d 394 N.Y.City Civ.Ct.,2005 and All-County Medical & Diagnostic P.C. v. Progressive Cas. Ins.
Co. 8 Misc.3d 616, 795 N.Y.S.2d 434 N.Y.Dist.Ct.,2005. There is already one bad Civil Court decision
which denied a defendant’s application to depose a Doctor in an effort to develop a Mallela defense. The
Court imposed a predicate showing of a factually founded belief of impropriety, noting that defendant herein
does not identify one non-licensed individual who either owns, controls or operates the medical
corporationseven though defendant has been provided with management agreements and income tax
information for certain employees. Statewide Medical Acupuncture Services, PC v. Travelers Ins. Co. Slip
Copy, 2005 WL 2866916 (Table) N.Y.City Civ.Ct.,2005.
The upshot of the reality of the mind set of the Judges in Civil Court is that they will likely require
some predicate showing of fraudulent conduct in order to obtain a deposition of a Doctor on fraudulent
incorporation issues. As noted previously, in the absence of pre-existing SIU, NICB or law enforcement
intelligence, it is likely that such a showing can made by a physicians’ inspection of a number of claimants
files, or a physicians review of the EUO testimony of a number of claimants. When such a review is made, it
will probably, in instances involving layman scripted entities, reveal the treatment script, a clear sign of a
lack of meaningful medical decision making at the entity. Coupling a detailed affidavit from an expert who
did the review, with an affidavit from an SIU or Claim witness who recognizes the significance thereof, will
likely be establish a satisfactory “factual founded belief”. Such an approach is similar in all respects to the
successes that insurers have experienced in the Civil Courts in combating staged accidents. [21]
Another typical telltale in the possession of the insurer are its own cancelled checks. If it can be
shown that they are being diverted out of the revenue stream immediately, for example by being cashed at
Casino’s or Check Cashing stores, that fact is strong proof of fraudulent behavior.
All this is not to say that all Judges will ignore the normal precepts of Allen v. Crowell-Collier
Publishing Co. and Valley Physical Medicine and Rehabilitation P.C. v. New York Cent. (supra). Where a
defense of fraudulent incorporation has been raised in a defendant’s answer, and given the clear import of
Malella, the better proposition is the discovery on all relevant issues consistent with Article 31 of the CPLR
should occur.
Finally the attorney should be mindful that a non-party deposition of the layman in actual control of
the professional corporation may prove extremely fruitful. There is little direct authority on this point,
however an excellent authority is Universal Acupuncture Pain Services, P.C. v. State Farm Mut. Auto. Ins.
Co. Not Reported in F.Supp.2d, 2002 WL 31309232 (S.D.N.Y.) In Universal, J. Sheindlin, dealing directly
with a case alleging illegal corporate structure decided several corporate No-Fault discovery issues. In the
course of his decision J. Sheindlin directed the continuation of deposition of a third-party enity, ordered the
plaintiff and third-party defendant entities to tax documents and a witness who could testify about them, and
ordered a non-party witness to produce federal income tax returns and forms, and check ledgers.
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Discovery of Tax Records
The disclosure of tax returns is generally disfavored due to their private and confidential
nature.Walter Karl, Inc. v. Wood, 161 A.D.2d 704, 705, 555 N.Y.S.2d 840, 841 (2d Dep't 1990 ). "A party
will not be required to produce income tax returns in a particular action unless the record presents a strong
necessity for such disclosure in order for the party to prove its cause of action or defense." Niagara Falls
Urban Renewal Agency v. Friedman, 55 A.D.2d 830, 830, 390 N.Y.S.2d 310, 311 (4th Dep't 1976 ). Not
only must a showing of necessity be made, but the applicant for such an order must demonstrate that the
information is not available from any other source. Leinoff v. 208 West 29th Street Associates, 243 A.D.2d
418, 419, 662 N.Y.S.2d 554, 556 (1st Dep't 1997), Gordon v. Grossman, 183 A.D.2d 669, 670, 584 N.Y.S.2d
54, 55 (1st Dep't 1992); V-Mart v. Gaetano, 204 A.D.2d 1038, 1039, 614 N.Y.S.2d 92, 92 (4th Dept.1994)
Even if the alternative methods attempted by parties may seem burdensome compared to the release of the
non-moving party's tax returns, no discovery is allowed "absent showing an inability to obtain information
from other sources." Penn York Construction v. State of New York, 92 A.D.2d 1086, 1087, 462 N.Y.S.2d
82, 83 (3d Dep't 1983) Courts have also denied discovery of a plaintiff's tax returns if a party's intent and
"tax motives [can] be obtained through deposition or trial testimony." BRS & W Associates v. W.R. Grace &
Co., 156 A.D.2d 249, 249, 548 N.Y.S.2d 511, 512 (1st Dept.1989).
Courts have frequently recognized, however, that where a claim of fraud is central to a defense or action,
special circumstances exist which may warrant production. Where, for example, an insurance fraud scheme
has been alleged, and circumstances give riste to the inference of insurance fraud, courts have been willing
to order the production of tax returns. Four Aces Jewelry Corp. v. Smith, 256 A.D.2d 42, 680 N.Y.S.2d 539,
540 (1st Dep't 1998 ),. (See also, David Leinoff, Inc. v. 208 W. 29th St. Assocs, 243 A.D.2d 418, 663
N.Y.S.2d 554, 556 (App. Div. 1st Dept. 1997). holding that personal income tax returns of sole shareholder
of insured were discoverable "because they may contain vital information tending to prove or disprove the
existence of an [insurance fraud]); Leon Sylvester, Inc. v. Aetna Cas. & Sur. Co., 189 A.D.2d 730, 592
N.Y.S.2d 741, 742 (1st Dep't 1993) (holding that where plaintiff, a closely held corporation, was suspected
of insurance fraud, disclosure of personal income tax returns of its two principals was warranted).
For the insurer, there is one case which applies these considerations directly to a case involving allegations
of illegal corporate structure. In Universal Acupuncture Pain Services, P.C. v. State Farm Mut. Auto. Ins.
Co. Not Reported in F.Supp.2d, 2002 WL 31309232 (S.D.N.Y.) J. Sheindlin, dealing directly with a case
alleging illegal corporate structure, handled a number of discovery issues relevant to the discussions outlined
heretofore. Specifically on the question of tax returns he wrote; “There is no question that Nandi and
Universal are required to file tax returns. Further, the returns are clearly relevant to State Farm's claim that
Nandi was the true owner of Universal during the relevant time.”
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Discovery of Banking Records
Banking records, generally statements and copies of cancelled checks, tending to show where and in
what amounts money was coming from, and where and in what amounts it was going are frequently obtained
from banks by subpoena.
Counter-intuitively, bank records are not afforded the same protection as tax records. In United States v.
Miller, 425 U.S. 435, 96 S.Ct. 1619, 48 L.E.2d 712 (1976) the Supreme Court ruled that information
contained in bank records, deposit slips, cancelled checks and financial statements is neither confidential or
private. The Court ruled that such documents are “negotiable instruments” used in commercial transactions,
exempt from claims for privacy or confidentiality. Similarly, the Court ruled that deposit slips, canceled
checks and signature cards contain information which is voluntarily conveyed by the customer to the banks
and exposed to the bank’s employees in the ordinary course of business thereby stripping it of confidentiality
or privacy protection.
Indeed it has been held that when a bank customer chooses to open and maintain an account at a financial
institution, he inherently assumes the risk that the information contained in his financial records will be
conveyed to a third party. This proposition has been extended so far so as to say that such records “are the
business records of the banks and appellant can assert neither ownership nor possession." Shapiro v. Chase
Manhattan Bank 53 A.D.2d 542 (1st Dept. 1976 ). [22]
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[1] "[a] professional service corporation may issue shares only to individuals who are authorized by law to
practice in this state a profession which such corporation is authorized to practice" and prohibits shareholders
of professional service corporations from transferring the voting power of their shares to any person who is
not authorized by law to practice the profession that the professional service corporation is authorized to
practice. N.Y.Bus.Corp.Law § 1507.
"[n]o individual may be a director or officer of a professional service corporation unless he is authorized by
law to practice in this state a profession which such corporation is authorized to practice and is either a
shareholder of such corporation or engaged in the practice of his profession in such
corporation."N.Y.Bus.Corp.Law § 1508.
4. The department shall:c. (i) Issue a certificate of authority to a qualified professional service corporation
being organized under section fifteen hundred three of the business corporation law or to a university faculty
practice corporation being organized under section fourteen hundred twelve of the not-for-profit corporation
law on payment of a fee of ninety dollars, (ii) require such corporations to file a certified copy of each
certificate of incorporation and amendment thereto within thirty days after the filing of such certificate or
amendment on payment of a fee of twenty dollars, (iii) require such corporations to file a triennial statement
required by section fifteen hundred fourteen of the business corporation law on payment of a fee of one
hundred five dollars. N.Y. Education Law § 6507(4)(c).[1]
[2] "[p]rofessionals are subject to stricter State supervision and licensing requirements, in order to maintain
standards of responsibility for the protection of the public." (Manganaro v. Tully 88 A.D.2d 206, 209, 453
N.Y.S.2d 889 [3rd Dept 1982] ).
[3] The Superintendent also gave its arbitrators power to pursue this issue in all events, providing that they
may unilaterally issue subpoenas and consider “any issue the arbitrator deems relevant”. 11 NYCRRR 654.4(e).
[4] Arbitrator Mellis’ decision was affirmed by a Master Arbitrator and ultimately affirmed in Supreme
Court New York County in an Article 75 proceeding. In the Matter of JRWB Diagnostic Imaging P.C. a/a/o
Nadian Peterson against American Transit Insurance Company, et al. No. 108679/04 (Sup. Ct. N.Y. Cty., J.
Bransten, December 17th, 2004).
[5] Arbitrator Nathan Ritzer in the case of North Bronx Medical, P.C. a/a/o Paulette Cleckley and Allstate
Insurance Company, NF2988, N.Y. No-Fault/Sum Arb. Rep. Vol 26, No. 3, 2000 stated: “Section
65.15(o)(1)(vi) of the No-Fault Regulation…does as a matter of law mandate that No-Fault arbitrators deny
payment to an unlicensed provider-be it corporate or individual…Payment to only duly certified medical
corporations is clearly inferred from the terminology of the entire section…To find otherwise would serve to
condone and reward a practice that the legislature has condemned. It would permit non-professionals to
organize a medical corporation, employ licensed physicians and profit by the sharing of fees. This obligation
would often result in the lowering of the quality of medical care, overcharging, and the rendering of
unnecessary services, which Judge Sifton himself recognized as possibilities in his decision.”
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[6] Subcutaneous Novocain injections billed as if they were epidural procedures is a common example, as is
the practice of providing 1 to 15 minutes of psychotherapy but billing for 50. (See for example the New York
State Attorney General press release at http://www.oag.state.ny.us/press/2003/dec/dec12a_03.html.
[7] By the Worker’s Compensation Fee Schedule ground rules Range of Motion testing is considered a
integral aspect of a comprehensive evaluation but is frequently billed separately.
[8] See for example the New York State Insurance Department press release concerning the Queens District
Attorney Office “Operation Crash Course” indictments. http://www.ins.state.ny.us/p0409221.htm
[9] See for example the Statement by August D'Aureli, Supervising Investigator, Insurance Frauds Bureau,
New York State Insurance Department, before the Senate Standing Committee on
Insurancehttp://www.ins.state.ny.us/spch0209.htm
[10] See for example the Queens District Attorney “Fraud Factory” indictment press release.
http://www.queensda.org/Press%20Releases/2004%20Press%20Releases/04-April/04-15-2004.htm
[11] For a discussion of this prohibition against self referral in any setting, see Stand-Up MRI of
the Bronx v. General Assur. Ins. --- N.Y.S.2d ----, 2005 WL 2779919 (N.Y.Dist.Ct.), 2005 N.Y. Slip Op.
25453
[12] The entities shut down by the Brooklyn DA’s “Wellcare” investigation were styled in this fashion.
Besides the typical multidiscipline provider, the brothers running the scheme also owned the radiological
technical company “Ocean Diagnostics” which was alleged to controlled the professional radiological entity.
[13] NYPD’s Operation Gateway (Operation) was a large scale, long-term investigation that involved a
Brooklyn-based organization known as Parallel Management Group (Parallel). A detailed account of this
investigation is provide by the Statement by August D'Aureli, Supervising Investigator, Insurance Frauds
Bureau, New York State Insurance Department, before the Senate Standing Committee on
Insurancehttp://www.ins.state.ny.us/spch0209.htm
[14] Necula v Glass 231 A.D.2d 457, 647 N.Y.S.2d 501, 1 AD 1996. [C]ontracts petitioner entered into with
management companies, under which the companies were to provide petitioner with facilities, supplies,
equipment and nonphysician staff necessary to operate his radiology practice, and petitioner was to pay the
companies a fixed percentage of his receipts for billing services and fixed dollar amount for each procedure
performed. This was illegal fee splitting under 8 NYCRR 29.1(b)(4) since petitioner’s payments to the
companies were a percentage of or otherwise dependent upon his income or receipts.
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[15] abrogating Ohio v. Roberts, 448 U.S. 56, 100 S.Ct. 2531, 65 L.Ed.2d 597,
[16] See also In re M/B Child, 2005 WL 1388846, *3, 8 Misc.3d 1001(A), 1001(A), 2005 N.Y. Slip Op.
50884(U), 50884(U) (N.Y.Fam.Ct. Apr 13, 2005)
[17] See also, Fortune Medical v Allstate Ins. Co No. 3176/04 (Dist. Ct., Nassau County, April 6,
2005);Caprice Medial P.C. v Allstate Ins. Co. No. 045532/03 (N.Y. City Civ. Ct. May 26, 2005).
[18] Arbitrator Mellis made a strong link between fee splitting and illegal corporate structure,
expressing a bright line rule; “where an unlicensed individual has more of an interest than the professional in
the profitability and success of the medical practice, the arrangement is clearly illegal. In Hartman v.
Bell,137 AD2d 585, 524 NYS2d 477 (2nd Dept., 1988), the Court found that an agreement to pay 40% of the
gross income, or a minimum of $140,000 from the practice of medicine constituted fee-splitting, and denied
recovery on that basis. In Sachs v. Saloshin, 138 AD2d 586, 526 NYS2d 168 (2nd Dept. 1988), the Court
held that a dentist violated the Education Law by remitting 20% of his gross revenues to plaintiff in
consideration for his use and occupancy of a fully-equipped dental facility, and also denied any recovery for
that reason.”
[19] Arbitrator Mellis’ decision was affirmed by a Master Arbitrator and ultimately affirmed in Supreme
Court New York County in an Article 75 proceeding. In the Matter of JRWB Diagnostic Imaging P.C. a/a/o
Nadian Peterson against American Transit Insurance Company, et al. No. 108679/04 (Sup. Ct. N.Y. Cty., J.
Bransten, December 17th, 2004).
[20] The Allen case makes clear that disclosure extends to all relevant information calculated to lead to
relevant evidence, not just information that can be used as evidence in chief. See CPLR 3101, Siegel, Practice
Commentaries McKinney's Cons. Laws of NY, Book 7B, CPLR c3101:7, at 18, citing West v. Aetna Casualty and
Surety Co., 49 Misc.2d 28, 266 N.Y.S.2d 600 (1965) mod'd. 28 A.D.2d 745, 280 N.Y.S.2d 795 ( App. Div. 3d Dept
1967 ).
[21] Ocean Diagnostic vs. Utica 7 Misc.3d 133(A), 2005 WL 948998 (N.Y.Sup.App.Term), 2005 N.Y. Slip
Op. 50611(U), GPM Chiropractice vs. State Farm 7 Misc.3d 138(A), 2005 WL 1356451
(N.Y.Sup.App.Term), 2005 N.Y. Slip Op. 50861(U).
[22] See also Dore v Allstate Indem. Co. 264 A.D.2d 804, 695 N.Y.S.2d 422 (App. Div. 2nd Dept. 1999)
Defendant Insurance companies effort to discover bank records to prove fraud granted.