Professional Service Corporations’ Shareholder-Physician Compensation Is Recoverable as Lost Profits; Postbreach Earnings May Offset Damages

Introduction

In Radiation Oncology Servs. of Cent. N.Y., P.C. v. Our Lady of Lourdes Mem. Hosp., Inc., 2025 NY Slip Op 06112 (3d Dept Nov. 6, 2025), the Appellate Division, Third Department (Fisher, J.), addressed a question of first impression in New York damages law: when a professional service corporation (PSC) sues for breach of a coverage agreement, must the salary paid by the PSC to its sole shareholder-physician be treated as an “expense” (i.e., an avoided cost) that reduces the corporation’s lost profits? The court also decided a companion issue—whether the breaching hospital may present evidence of the physician’s postbreach earnings to the jury as mitigation affecting the damages award.

The plaintiffs were Radiation Oncology Services of Central New York, P.C. (ROSCNY), a PSC, and its sole shareholder and medical director, Dr. Michael J. Fallon. The defendant was Our Lady of Lourdes Memorial Hospital, Inc. Under a 2001 coverage agreement (amended through 2014), ROSCNY held the exclusive right to provide radiation oncology services at the hospital, with Dr. Fallon serving as medical director. In 2015, after a chart review suggested quality-of-care concerns, the hospital suspended and then reinstated Dr. Fallon with conditions, but terminated the coverage agreement days later. Liability was resolved on plaintiffs’ breach-of-contract claims, leaving damages for jury trial. The parties filed cross-motions in limine on two pivotal questions: (1) whether ROSCNY’s damages for lost profits must deduct Dr. Fallon’s compensation as an expense; and (2) whether evidence of ROSCNY/Dr. Fallon’s mitigation, including his postbreach income, could be presented to the jury.

The Third Department affirmed Supreme Court’s rulings for plaintiffs on the “expense” question and for defendant on the mitigation question, thereby setting a significant precedent for New York’s treatment of lost-profit damages involving professional corporations.

Summary of the Opinion

New rule for PSC lost profits: For a professional service corporation, the compensation paid to a shareholder-physician who is the operative professional under the breached contract is not categorically treated as an avoidable expense to be deducted from lost profits. The court embraced the approach of Bettius & Sanderson, P.C. v National Union Fire Ins. Co. of Pittsburgh, 839 F.2d 1009 (4th Cir 1988), and rejected the contrary formalist treatment exemplified by Anesthesiologists Assocs. of Ogden v St. Benedict’s Hosp., 884 P.2d 1236 (Utah 1994).
Mitigation evidence permitted: The breaching hospital may present to the jury evidence of the shareholder-physician’s postbreach earnings and the plaintiffs’ mitigation efforts. The jury may determine whether those earnings were increased “because of” the breach and, if so, reduce the damages accordingly.
Underlying principles applied: The court grounded its ruling in New York’s fundamental contract-damages principles: make the nonbreaching party whole (but no more), avoid windfalls, and eschew inflexible damages rules; impose a duty to mitigate and measure loss as net profit (lost revenues less saved costs).
Scope of damages period: The court also noted that the damages period was capped by the agreement’s terms, including events like Dr. Fallon’s cessation of service as medical director (see footnote 3).

Detailed Analysis

Precedents and Authorities Cited

The opinion rests on well-established New York damages doctrine and selectively draws on out-of-state case law to address a first-impression question regarding PSCs.

Core New York Damages Principles

Brushton-Moira Cent. Sch. Dist. v Fred H. Thomas Assocs., P.C., 91 NY2d 256 (1998); Freund v Washington Square Press Inc., 34 NY2d 379 (1974): Damages should place the injured party in as good a position as if the contract had been performed, at the least cost to the breaching party.
Biotronik A.G. v Conor Medsystems Ireland, Ltd., 22 NY3d 799 (2014); Ashland Mgt. Inc. v Janien, 82 NY2d 395 (1993): Lost profits are recoverable if they are the natural and probable consequence of the breach and proven with reasonable certainty.
St. Lawrence Factory Stores v Ogdensburg Bridge & Port Auth., 121 AD3d 1226 (3d Dept 2014), lv denied 25 NY3d 907 (2015): The injured party cannot recover more than it would have gained by performance.
Rebh v Lake George Ventures Inc., 241 AD2d 801 (3d Dept 1997); Donald Rubin, Inc. v Schwartz, 191 AD2d 171 (1st Dept 1993); Federico v Brancato, 188 AD3d 1158 (2d Dept 2020): Damages must be net of amounts the injured party earned or could have earned with reasonable diligence during the unexpired term—reflecting mitigation.
Wilmot v State of New York, 32 NY2d 164 (1973); Fitzpatrick v Animal Care Hosp., PLLC, 104 AD3d 1078 (3d Dept 2013): Duty to mitigate.
R & I Elecs. v Neuman, 66 AD2d 836 (2d Dept 1978): Generally, salaries paid to corporate shareholders/principals are treated as avoidable expenses deducted from damages—this is the baseline rule for conventional corporations that the court distinguished for PSCs.
E.J. Brooks Co. v Cambridge Security Seals, 31 NY3d 441 (2018); Bibeau v Ward, 228 AD2d 943 (3d Dept 1996): Damages should be fair and just compensation commensurate with actual losses; reject inflated or windfall measures.
Spitz v Lesser, 302 NY 490 (1951); Ehrenworth v Stuhmer & Co., 229 NY 210 (1920): New York disfavors inflexible rules of damages; damages must adapt to the facts.
Cornell v T.V. Dev. Corp., 17 NY2d 69 (1966): The jury may consider whether postbreach opportunities to earn income were increased because of the breach when measuring net loss.
Tendler v Bais Knesses of New Hempstead, Inc., 112 AD3d 911 (2d Dept 2013): Supports jury consideration of whether postbreach income was causally linked to the breach.

Out-of-State Authorities on PSC Damages

Bettius & Sanderson, P.C. v National Union Fire Ins. Co. of Pittsburgh, 839 F.2d 1009 (4th Cir 1988): The court adopted this approach. Treating shareholder-principal compensation in a PSC as a deductible expense would often annihilate the PSC’s ability to prove lost profits, given that PSCs commonly pass earnings through as deductible compensation. Recognizes the distinctive operational reality that professional shareholders generate the corporation’s revenue.
Anesthesiologists Assocs. of Ogden v St. Benedict’s Hosp., 884 P.2d 1236 (Utah 1994), and Southern Bell Tel. & Tel. Co. v Kaminester, 400 So2d 804 (Fla. 3d DCA 1981): The court declined to follow these decisions, which apply the conventional corporate rule to PSCs and emphasize accepting the “disadvantages” of incorporation along with its benefits.
Hoagland ex rel. Midwest Transit, Inc. v Sandberg, Phoenix & von Gontard, P.C., 385 F.3d 737 (7th Cir 2004): Highlights that a PSC’s principal capital is human capital—skills, reputation, and contacts of the professionals—underscoring the inapplicability of rigid corporate-damages rules.
Jurisdictions aligned with Bettius: Atkins v Robbins, Salomon & Patt, Ltd., 97 N.E.3d 210 (Ill. App. Ct. 2018); Stat Imaging, LLC v Med. Specialists, Inc., P.C., 2014 WL 5310256 (N.D. Ill. 2014); Sisters of Providence in Washington v A.A. Pain Clinic, Inc., 81 P.3d 989 (Alaska 2003).

Statutory Context: Professional Corporations

The Business Corporation Law provisions emphasizing the distinctiveness of PSCs include:

BCL §§ 1504, 1505, 1507, 1508: Only licensed professionals may be shareholders, officers, or render professional services; professionals remain personally liable for their own malpractice.
BCL § 1513: Recognizes overlap with business corporations but does not erase the PSC’s defining reliance on licensed human capital.

Legal Reasoning

1) Why shareholder-physician compensation is not an “expense” for PSC lost-profit damages

The court’s reasoning proceeds from first principles of New York contract damages:

Make-whole without windfall: A rigid rule deducting a PSC’s shareholder-physician compensation as an expense would often reduce the PSC’s lost-profit recovery to zero precisely because PSCs routinely pay out earnings as deductible compensation for tax efficiency. That would insulate contract breachers from liability and undercompensate injured PSCs—contrary to E.J. Brooks and New York’s make-whole framework.
No inflexible rules of damages: Adopting a one-size-fits-all corporate rule would contravene long-standing New York admonitions against inflexible damages regimes (Spitz; Ehrenworth).
PSC operational realities: The shareholder-physician is the operative professional who generates the revenue under the coverage agreement. Unlike conventional corporations where shareholders are typically passive and employee salaries are separate from ownership returns, PSC shareholder compensation is economically indistinct from the corporation’s earnings stream generated by the professional’s licensed services. Treating that compensation as an “expense” erases the very profit the PSC earned under the breached contract.
Fairness and policy: Denying recovery based on a tax- and industry-standard compensation structure would produce an “unrealistic situation” that the PSC earned no profit under a lucrative agreement, an outcome the court rejected as inequitable and inconsistent with New York damages law.

Applying those principles, the court aligned with Bettius, explicitly recognizing that while PSCs share some corporate traits, their “principal capital” is human capital. The opinion emphasized that locum tenens fees (temporary coverage when the primary physician is unavailable) are genuine expenses that reduce profit, but deducting the shareholder-physician’s compensation would mischaracterize the earnings stream itself as an avoidable cost rather than the profit derived from performance of the contract.

2) Mitigation and postbreach earnings

The court also held that the jury may hear evidence of Dr. Fallon’s postbreach income and plaintiffs’ mitigation efforts and determine whether such earnings were increased because the breach freed Dr. Fallon to pursue other remunerative opportunities during the unexpired term.

Consistency with the PSC ruling: Having held that shareholder compensation is not an expense, the court refused to allow plaintiffs to use that principle as both shield and sword. The make-whole framework also requires netting out income reasonably earned due to time freed by the breach to avoid overcompensation.
Functional nexus: Although Dr. Fallon is not a contracting party, he is the sole shareholder/officer and primary revenue generator; his postbreach professional services are the principal means by which ROSCNY could offset damages. The opinion looks through form to function—consistent with New York’s focus on economic realities.
Causation filter: Following Cornell and related cases, the factfinder must decide whether postbreach opportunities and income were increased “because of” the breach—i.e., whether they were enabled by freed capacity or otherwise attributable to the breach—as opposed to income from unrelated, preexisting commitments.
No windfalls for either side: The damages model must avoid both: (a) zeroing out PSC profits by mislabeling shareholder compensation as an expense; and (b) allowing plaintiffs to recover the full contract margin while also pocketing additional income made possible by the breach.

The court also noted that Dr. Fallon entered a new coverage agreement through a different professional corporation during the relevant period; while plaintiffs explained reasons unrelated to maximizing damages, the jury may consider whether those earnings were increased as a direct consequence of being relieved from the Lourdes contract obligations.

Impact and Practical Consequences

For Professional Corporations (Medical, Legal, Dental, Accounting, Architecture, and other licensed professions)

Damages valuation: PSCs may calculate lost profits without automatically subtracting shareholder-principal compensation as a saved expense. This significantly affects damages models in coverage agreements, service line exclusives, and medical director contracts.
Evidentiary proof: Plaintiffs should be prepared to show historical earnings under the contract, the role of the professional(s) in generating revenue, and legitimate expenses (e.g., locum tenens fees, variable costs, overhead actually saved).
Mitigation scrutiny: Defendants will seek discovery of postbreach schedules, new contracts, hours worked, and income streams to argue that earnings increased “because of” the breach. PSCs should document preexisting commitments versus new work enabled by freed capacity.
Corporate structuring: The use of separate entities (e.g., a new PSC for a replacement engagement) will not, by itself, shield postbreach income from mitigation analysis; juries may look to substance over form.
Contract drafting: Parties may consider clauses addressing damages measures, mitigation expectations, and caps tied to contingencies (e.g., disability, cessation of service), which the court recognized as limiting damages duration.

For Litigators and Experts

Expert methodology: Damages experts should model PSC lost profits by:
- Establishing historical contract revenues and margins;
- Deducting true saved expenses (variable costs, locum tenens, overhead actually avoided);
- Excluding shareholder-principal compensation from “saved expenses” where it reflects the earnings stream generated by the professional’s services;
- Quantifying postbreach incremental earnings causally linked to the breach (e.g., increased hours made available by the breach) for jury consideration as offsets.
Jury instructions/themes: Focus the jury on (a) making the PSC whole without over- or under-compensating; (b) distinguishing preexisting, unrelated income from incremental income attributable to freed capacity; and (c) the economic reality that the professional’s work produced the contract’s profits.
Discovery priorities: Payroll records, general ledgers, tax filings, physician schedules, locum tenens invoices, new engagement agreements, and time allocation evidence will be central. Causation narratives about how the breach changed capacity and income opportunities will be pivotal.

Systemic Effects

Statewide influence: As a Third Department first-impression decision aligning with the majority approach, this ruling is likely to be persuasive across New York and influential in PSC disputes statewide unless and until the Court of Appeals speaks directly to the issue.
Healthcare contracts: Hospitals and physician groups should expect damages exposure calibrated to the economic value of the professional’s services, not minimized by tax-efficient compensation structures. Conversely, mitigation will be a robust, fact-intensive inquiry.

Complex Concepts Simplified

Professional Service Corporation (PSC): A corporation formed by licensed professionals (e.g., physicians). Only licensed professionals may be shareholders/officers and render services on the corporation’s behalf. The PSC’s “capital” is the professionals’ skills and time.
Coverage Agreement: A contract granting exclusive rights to provide certain services (here, radiation oncology) at a facility, often with a named medical director, for compensation over a term.
Lost Profits: The profits the nonbreaching party would have earned had the contract been performed. Typically calculated as expected revenues minus costs saved because performance did not occur.
Avoided Costs (Saved Expenses): Costs the nonbreaching party did not have to incur due to the breach (e.g., variable costs, some overhead). For PSCs, the shareholder-principal’s compensation under the breached contract is not automatically an “avoided cost.”
Mitigation: The duty of the nonbreaching party to make reasonable efforts to reduce damages. Earnings gained because the breach freed time/capacity can offset lost profits.
Postbreach Earnings Causation: The jury must decide whether increased earnings were caused by the breach (e.g., additional hours available) or were independent (e.g., preexisting commitments).
Locum Tenens: Temporary providers who cover for the primary physician. Their fees are ordinary expenses that reduce profit and are deducted in damages calculations.

Key Takeaways

New York now recognizes that for PSCs, shareholder-physician compensation tied to the breached contract is not a per se “expense” to be deducted from lost profits. This aligns New York with the majority approach typified by Bettius.
To prevent windfalls and effectuate the make-whole principle, defendants may present mitigation evidence—including postbreach earnings—to show that income increased because the breach freed capacity; the jury decides causation and the appropriate offset.
The decision rejects inflexible corporate damages rules in favor of a fact-sensitive approach responsive to PSCs’ distinctive reliance on licensed human capital.
Damages periods remain bounded by contractual contingencies (e.g., cessation of the physician’s service) that limit recoverable terms.

Conclusion

The Third Department’s opinion establishes a consequential precedent in New York: professional service corporations may recover lost profits without automatically subtracting shareholder-principal compensation as a saved expense, recognizing the economic reality that those earnings represent the PSC’s profit stream generated by professional services. At the same time, the court preserves balance by allowing juries to consider mitigation through postbreach earnings causally linked to the breach. The result is a nuanced, fact-driven damages framework that avoids both undercompensation of PSCs and overcompensation that would confer a windfall—faithful to New York’s long-standing make-whole doctrine and its rejection of inflexible damages rules.

Procedural note: The orders appealed from were affirmed in all respects. The court also confirmed Supreme Court’s determination that the recoverable damages period was capped by, among other contractually specified events, Dr. Fallon’s cessation of service as medical director.