Medicare and Medicaid Issues in Insolvency Cases

If a provider was overpaid for prior services, CMS reduces subsequent reimbursement payments to recover the amount of any prior overpayments. Courts have held that the Medicare/Medicaid income stream is subject to common law right to setoff and recoupment as any other claim against a debtor. See Slater Health Ctr. v. United States (In re Slater Health Ctr.), 398 F.3d 98, 103-04 (1st Cir. 2005). The setoff rights in Medicare receivables have priority over a secured creditor's security interest under ' 9-318 of the Uniform Commercial Code. See In re Nuclear Imaging Sys. Inc., 260 B.R. 724, 744-45 (Bankr. E.D. Pa. 2000). CMS can also setoff against any penalties owed by providers for outlier claims or under the False Claims Act. Additionally, if Medicare's intermediaries suspect that a provider may file for bankruptcy or be declared insolvent in a state or federal court proceeding, CMS may reduce payments to a provider to a level necessary to insure that no overpayment to the provider is made. The potential impairment of a heath care provider's income stream should be considered prior to the commencement of any bankruptcy filing so that a health care debtor is not caught off-guard by CMS' exercise of a right of recoupment or request to setoff overpayments.

Anti-Assignment Statute

Federal anti-assignment provisions limit a provider's ability to assign its rights to receive payments from Medicare and other government health care programs. Medicare's anti-assignment statute provides:

[n]o payment which may be made to a provider of services ' for any services furnished to an individual shall be made to any other person under assignment or power of attorney; but nothing in this subsection shall be construed (1) to prevent the making of such a payment in accordance with an assignment from the provider if such assignment is made ' pursuant to the order of a court of competent jurisdiction ' .

42 U.S.C. ' 1395g(c).

As a result, CMS is obligated to pay claims only to the Medicare service provider and will not pay amounts due a provider to any other person pursuant to an assignment, power of attorney, or any other direct payment arrangement. Additionally, Medicare may terminate the provider agreement of providers who execute or continue a power of attorney, or enter into or continue any other arrangement that authorizes payment contrary to the anti-assignment provisions.

Courts addressing whether Medicare receivables can serve as collateral for a loan have generally held that the Medicare receivables are valid collateral so long as there is no factoring agreement, the payments are sent directly to the provider's address or bank account, and the payments are in the control of the provider before being turned over to the lender.

Foreclosing on Medicare Receivables

Since payment cannot be made directly to the lender, to protect their interests, lenders typically require that payments on Medicare receivables be made to a lockbox account in the name of the provider, with instructions given by the provider to the lockbox bank to make daily transfers from the lockbox account to the bank account of the lender. This agreement works smoothly as long as the claims are submitted, processed and paid. If the lender is not repaid, in order to foreclose on Medicare receivables the lender must either obtain court approval of the assignment or acquire the provider's Medicare provider agreement, both of which carry drawbacks.

The federal regulations allow for direct payments to an assignee if the assignment is established by, or in accordance with, a court order. This exception, however, requires that both the provider and the “party that receives payments under a court-ordered assignment or reassignment ' are jointly and severally responsible for any Medicare overpayment to the former.” See 42 C.F.R. ' 424.90(c). Additionally, “[a] court-ordered assignment does not preclude the intermediary or carrier from reducing interim payments ' if the provider or assignee is in imminent danger of insolvency or bankruptcy.” See 42 C.F.R. ' 424.90(b).

The case law is not clear whether court approval must be contemporaneous with the assignment. In the case of Credit Recovery Sys., LLC v. Heike, 158 F.Supp.2d 689, 695 (E.D. Va. 2001), the United States District Court for the Eastern District of Virginia held that such a court order must be entered contemporaneously with the assignment and that courts cannot subsequently validate prior assignments. In granting summary judgment in favor of the government, the court held that “[t]he statutes and regulations do not permit the Court to enter an order that merely validates a prior assignment for past due sums” and that the “Court's order must be entered contemporaneously with the assignment of the right to direct payment, not after-the-fact.” Id. at 696. The court stated that in order for an assignment to be effective, “court participation contemporaneous with the establishment of the assignment is required, as per the statutes and regulations, and the Court does not have the authority to enter an order that simply validates a prior assignment.” Id. The court reasoned that validating prior assignments would allow Medicare providers to benefit from the payment of Medicare receivables by selling their Medicare receivables to third parties. The court further explained that the third-party purchaser in that case only had the right to claim through the provider, and that since the provider relinquished all of their rights, the third-party purchaser's rights also ceased.

On the other hand, in the case of Lock Realty Corp. IX v. U.S. Health, LP, 2007 U.S. Dist LEXIS 14578 (N.D. Ind. 2007), the United States District Court for the Northern District of Indiana approved a prior assignment reasoning that only assignments that provide a non-provider with the opportunity to submit a false claim must be made contemporaneous with a court order. The court concluded that a contrary interpretation would severely hamper a health care provider's ability to finance the costs of providing medical care.

Regardless of when court approval must be obtained, assignors attempting to collect Medicare receivables must agree to become jointly and severally responsible for any Medicare overpayment to the provider, which may far outweigh the value of the Medicare receivables. The consequence of a lender becoming jointly and severally liable could be significant for many lenders seeking to foreclose on Medicare or Medicaid receivables. In effect, a lender could be walking into the unknown and become liable for years of overpayments. The risk of joint and several liability may be the sole reason why many lenders will not foreclose on Medicare or Medicaid receivables.

In order to realize on the Medicare receivables, lenders may also attempt to purchase the provider and assume an existing Medicare provider number. Purchasers of providers with a Medicare provider agreement may either elect to assume the existing provider agreement or choose to apply for a new provider agreement. See 42 C.F.R.
' 489.18. Most courts have held that purchasers that elect to operate under the old provider agreement are obligated for any overpayments or penalties owed by the prior owners. In the case of Deerbrook Pavilion, LLC, v. Shalala, 235 F.3d 1100 (8th Cir. 2000), the Eighth Circuit held that successors who assume the provider agreements are liable for civil monetary penalties imposed on their predecessors by the Health Care Financing Administration. The Eighth Circuit reasoned that otherwise nursing home operators would be able to avoid the penalties by engaging in sham transfers. Similarly, the Third Circuit stated in the case of Official Comm. of Unsecured Creditors v. Chase Manhattan Bank (In re Charter Behavioral Health Sys.,), 45 Fed. Appx. 150, 151 n.1 (3d Cir. 2002), in an unpublished and non-precedential opinion, that “[i]f the new owner elects to take an assignment of the existing Medicare Provider Agreement, it receives an uninterrupted stream of Medicare payments but assumes successor liability for overpayment and civil monetary penalties asserted by the Government against the previous owner.” Prospective purchasers must, therefore, aware of the amount of any fines that have been imposed against the provider when considering whether to assume a Medicare provider agreement.

Rejection of the Provider Agreement

Under the Bankruptcy Code, the Medicare provider agreement is treated as an executory contract that the debtor must either assume or reject. If the debtor rejects the provider agreement, the government's claim for overpayments and penalties is treated as an unsecured claim. However, in light of the importance of Medicare revenues to many heath care providers, debtors who choose to reject their Medicare provider agreements may find it difficult to successfully reorganize. Alternatively, if a debtor assumes the provider agreement, the government can withhold post-petition reimbursements in order to recover pre-petition overpayments without violating the automatic stay.

There is a split among the Circuit Courts as to whether the government must seek relief from the automatic stay in order to recover overpayments prior to the debtor's assumption of its provider agreement. In the case of In re University Medical Center, 973 F.2d 1065 (3d Cir. 1992), the Third Circuit held that when a debtor hospital has not yet obtained court authorization to assume the provider agreement, CMS cannot withhold payments for Medicare services rendered post-petition without first obtaining relief from the automatic stay. The Third Circuit reasoned that the withholding by CMS did not effect a recoupment since the prior overpayments were not part of the transaction as the debtor's post-petition claims for payment. Additionally, the Third Circuit reasoned that the government's withholding was not a valid setoff since section 553 prevents pre-petition overpayments from being set off against post-petition claims.

Conversely, in the case of U.S. v. Consumer Health Services of Am., Inc., 108 F.3d 390, 395 (D.C. Cir. 1997), the Court of Appeals for the District of Columbia Circuit held that the government's withholding could effectuate a recoupment, and therefore did not violate the automatic stay, reasoning that “Congress rather clearly indicated that it wanted a provider's stream of services to be considered one transaction for purposes of any claim the government would have against the provider” as the Medicare statute “requires the Secretary to take into account pre-petition overpayments in order to calculate a post-petition claim.” Healthcare debtors must therefore weigh any offset to future Medicare receivables when deciding whether to assume their provider agreement.

Valuation Issues

Another significant pitfall for parties to consider is how Medicaid and Medicare receivables are valued in a bankruptcy context. The Bankruptcy Code does not require that a particular method be used in valuing collateral, but rather instructs that “such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property.” See 11 U.S.C. ' 506(a). “In the areas of both bankruptcy and tax, courts have consistently held that the face value of an account receivable may not represent its true value.” Boulder Fruit Express v. Mesing, 1998 U.S. Dist. LEXIS 22887 (C.D. Cal. 1998). The First Circuit has noted that “[a]ccounts receivable need not be taken at face value if circumstances case doubt on their collectability” and that
“[t]he prospects of collection of such assets are evaluated in light of the past record of payment of the obligors, the obligors' current solvency, and the presence or absence of any dispute over the validity of the accounts or debts owed.” Constructora Maza, Inc. v. Banco de Ponce, 616 F.2d 573, 577 (1st Cir. 1980).

The valuation of Medicaid and Medicare receivables maybe crucially important in the bankruptcy process, as under ' 506(a) of the Bankruptcy Code, the amount of a secured claim is equal to the “value of such creditor's interest in the estate's interest in such property.” Therefore, regardless of the face amount of the receivables, the lender's claim is only considered secured up to the value of the receivables as determined by the court, and the remainder of the claim will be treated as a general unsecured claim.

A number of factors will affect the court's valuation. First, courts typically value the accounts receivable of liquidating debtors using a liquidation value analysis, which could lower the value of Medicare/Medicaid receivables in the event that a health care provider files a Chapter 7 petition or proposes a liquidating Chapter 11 plan. Second, the court must estimate that a percentage of claims will be rejected by Medicare's intermediaries for either being improperly filed, not medically necessary, or for other reasons. Third, the court must deduct the amount of any prior overpayments or penalties that CMS can recover from the receivables, which may be especially difficult to calculate if CMS has not yet conducted an audit to determine prior overpayments. Fourth, the amount of a provider's liability for outlier claims or under the False Claims Act may change if the government charges the provider with additional penalties, or if the provider settles any penalties for lower amounts.

The many uncertainties associated with Medicare and Medicaid receivables may motivate a debtor or creditors' committee to challenge the value of the lender's secured claim, or to seek to totally invalidate the lender's lien for violating the anti-assignment provisions. Lenders whose loans are collateralized by Medicare or Medicaid receivables must be aware of the risks inherent with Medicare and Medicaid receivables, and must minimize risks by performing due diligence on potential borrowers and instituting proper controls to monitor the borrower's financial condition. As in medicine, an ounce of prevention is worth a pound of cure.

Andrew H. Sherman is Co-Chair of the Sills Cummis & Gross P.C. Creditors' Rights/Bankruptcy Reorganization Practice Group. He has represented clients in a broad range of complex business reorganizations, debt restructurings and insolvency matters throughout the country. Sherman also routinely represents lenders and other parties in financings and acquisitions involving troubled companies. Adam J. Glanzman is an associate in the same group. The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of Sills Cummis & Gross P.C.

Due to the pervasive nature of Medicare and Medicaid in our health care system, almost every health care bankruptcy case involves Medicare or Medicaid payments in some form or fashion. Insolvency professionals should be aware of the many complications of Medicare and Medicaid payments and potential negative consequences in bankruptcy cases.

Setoff and Recoupment Rights

Medicare providers submit applications for payments and receive periodic interim payments, which are estimates of their costs, from Medicare's fiscal intermediaries. The Medicare statute requires that payments to providers be made monthly or at the discretion of Medicare's administrator, the Centers for Medicare and Medicaid Services (“CMS”). The latter then performs yearly audits on the providers to determine whether they have been overpaid or underpaid.

If a provider was overpaid for prior services, CMS reduces subsequent reimbursement payments to recover the amount of any prior overpayments. Courts have held that the Medicare/Medicaid income stream is subject to common law right to setoff and recoupment as any other claim against a debtor. See Slater Health Ctr. v. United States (In re Slater Health Ctr.), 398 F.3d 98, 103-04 (1st Cir. 2005). The setoff rights in Medicare receivables have priority over a secured creditor's security interest under ' 9-318 of the Uniform Commercial Code. See In re Nuclear Imaging Sys. Inc., 260 B.R. 724, 744-45 (Bankr. E.D. Pa. 2000). CMS can also setoff against any penalties owed by providers for outlier claims or under the False Claims Act. Additionally, if Medicare's intermediaries suspect that a provider may file for bankruptcy or be declared insolvent in a state or federal court proceeding, CMS may reduce payments to a provider to a level necessary to insure that no overpayment to the provider is made. The potential impairment of a heath care provider's income stream should be considered prior to the commencement of any bankruptcy filing so that a health care debtor is not caught off-guard by CMS' exercise of a right of recoupment or request to setoff overpayments.

Anti-Assignment Statute

Federal anti-assignment provisions limit a provider's ability to assign its rights to receive payments from Medicare and other government health care programs. Medicare's anti-assignment statute provides:

[n]o payment which may be made to a provider of services ' for any services furnished to an individual shall be made to any other person under assignment or power of attorney; but nothing in this subsection shall be construed (1) to prevent the making of such a payment in accordance with an assignment from the provider if such assignment is made ' pursuant to the order of a court of competent jurisdiction ' .

42 U.S.C. ' 1395g(c).

As a result, CMS is obligated to pay claims only to the Medicare service provider and will not pay amounts due a provider to any other person pursuant to an assignment, power of attorney, or any other direct payment arrangement. Additionally, Medicare may terminate the provider agreement of providers who execute or continue a power of attorney, or enter into or continue any other arrangement that authorizes payment contrary to the anti-assignment provisions.

Courts addressing whether Medicare receivables can serve as collateral for a loan have generally held that the Medicare receivables are valid collateral so long as there is no factoring agreement, the payments are sent directly to the provider's address or bank account, and the payments are in the control of the provider before being turned over to the lender.

Foreclosing on Medicare Receivables

Since payment cannot be made directly to the lender, to protect their interests, lenders typically require that payments on Medicare receivables be made to a lockbox account in the name of the provider, with instructions given by the provider to the lockbox bank to make daily transfers from the lockbox account to the bank account of the lender. This agreement works smoothly as long as the claims are submitted, processed and paid. If the lender is not repaid, in order to foreclose on Medicare receivables the lender must either obtain court approval of the assignment or acquire the provider's Medicare provider agreement, both of which carry drawbacks.

The federal regulations allow for direct payments to an assignee if the assignment is established by, or in accordance with, a court order. This exception, however, requires that both the provider and the “party that receives payments under a court-ordered assignment or reassignment ' are jointly and severally responsible for any Medicare overpayment to the former.” See 42 C.F.R. ' 424.90(c). Additionally, “[a] court-ordered assignment does not preclude the intermediary or carrier from reducing interim payments ' if the provider or assignee is in imminent danger of insolvency or bankruptcy.” See 42 C.F.R. ' 424.90(b).

The case law is not clear whether court approval must be contemporaneous with the assignment. In the case of Credit Recovery Sys., LLC v. Heike , 158 F.Supp.2d 689, 695 (E.D. Va. 2001), the United States District Court for the Eastern District of Virginia held that such a court order must be entered contemporaneously with the assignment and that courts cannot subsequently validate prior assignments. In granting summary judgment in favor of the government, the court held that “[t]he statutes and regulations do not permit the Court to enter an order that merely validates a prior assignment for past due sums” and that the “Court's order must be entered contemporaneously with the assignment of the right to direct payment, not after-the-fact.” Id. at 696. The court stated that in order for an assignment to be effective, “court participation contemporaneous with the establishment of the assignment is required, as per the statutes and regulations, and the Court does not have the authority to enter an order that simply validates a prior assignment.” Id. The court reasoned that validating prior assignments would allow Medicare providers to benefit from the payment of Medicare receivables by selling their Medicare receivables to third parties. The court further explained that the third-party purchaser in that case only had the right to claim through the provider, and that since the provider relinquished all of their rights, the third-party purchaser's rights also ceased.

On the other hand, in the case of Lock Realty Corp. IX v. U.S. Health, LP, 2007 U.S. Dist LEXIS 14578 (N.D. Ind. 2007), the United States District Court for the Northern District of Indiana approved a prior assignment reasoning that only assignments that provide a non-provider with the opportunity to submit a false claim must be made contemporaneous with a court order. The court concluded that a contrary interpretation would severely hamper a health care provider's ability to finance the costs of providing medical care.

Regardless of when court approval must be obtained, assignors attempting to collect Medicare receivables must agree to become jointly and severally responsible for any Medicare overpayment to the provider, which may far outweigh the value of the Medicare receivables. The consequence of a lender becoming jointly and severally liable could be significant for many lenders seeking to foreclose on Medicare or Medicaid receivables. In effect, a lender could be walking into the unknown and become liable for years of overpayments. The risk of joint and several liability may be the sole reason why many lenders will not foreclose on Medicare or Medicaid receivables.

In order to realize on the Medicare receivables, lenders may also attempt to purchase the provider and assume an existing Medicare provider number. Purchasers of providers with a Medicare provider agreement may either elect to assume the existing provider agreement or choose to apply for a new provider agreement. See 42 C.F.R.
' 489.18. Most courts have held that purchasers that elect to operate under the old provider agreement are obligated for any overpayments or penalties owed by the prior owners. In the case of Deerbrook Pavilion, LLC, v. Shalala , 235 F.3d 1100 (8th Cir. 2000), the Eighth Circuit held that successors who assume the provider agreements are liable for civil monetary penalties imposed on their predecessors by the Health Care Financing Administration. The Eighth Circuit reasoned that otherwise nursing home operators would be able to avoid the penalties by engaging in sham transfers. Similarly, the Third Circuit stated in the case of Official Comm. of Unsecured Creditors v. Chase Manhattan Bank (In re Charter Behavioral Health Sys.,), 45 Fed. Appx. 150, 151 n.1 (3d Cir. 2002), in an unpublished and non-precedential opinion, that “[i]f the new owner elects to take an assignment of the existing Medicare Provider Agreement, it receives an uninterrupted stream of Medicare payments but assumes successor liability for overpayment and civil monetary penalties asserted by the Government against the previous owner.” Prospective purchasers must, therefore, aware of the amount of any fines that have been imposed against the provider when considering whether to assume a Medicare provider agreement.

Rejection of the Provider Agreement

Under the Bankruptcy Code, the Medicare provider agreement is treated as an executory contract that the debtor must either assume or reject. If the debtor rejects the provider agreement, the government's claim for overpayments and penalties is treated as an unsecured claim. However, in light of the importance of Medicare revenues to many heath care providers, debtors who choose to reject their Medicare provider agreements may find it difficult to successfully reorganize. Alternatively, if a debtor assumes the provider agreement, the government can withhold post-petition reimbursements in order to recover pre-petition overpayments without violating the automatic stay.

There is a split among the Circuit Courts as to whether the government must seek relief from the automatic stay in order to recover overpayments prior to the debtor's assumption of its provider agreement. In the case of In re University Medical Center, 973 F.2d 1065 (3d Cir. 1992), the Third Circuit held that when a debtor hospital has not yet obtained court authorization to assume the provider agreement, CMS cannot withhold payments for Medicare services rendered post-petition without first obtaining relief from the automatic stay. The Third Circuit reasoned that the withholding by CMS did not effect a recoupment since the prior overpayments were not part of the transaction as the debtor's post-petition claims for payment. Additionally, the Third Circuit reasoned that the government's withholding was not a valid setoff since section 553 prevents pre-petition overpayments from being set off against post-petition claims.

Conversely, in the case of U.S. v. Consumer Health Services of Am., Inc. , 108 F.3d 390, 395 (D.C. Cir. 1997), the Court of Appeals for the District of Columbia Circuit held that the government's withholding could effectuate a recoupment, and therefore did not violate the automatic stay, reasoning that “Congress rather clearly indicated that it wanted a provider's stream of services to be considered one transaction for purposes of any claim the government would have against the provider” as the Medicare statute “requires the Secretary to take into account pre-petition overpayments in order to calculate a post-petition claim.” Healthcare debtors must therefore weigh any offset to future Medicare receivables when deciding whether to assume their provider agreement.

Valuation Issues

Another significant pitfall for parties to consider is how Medicaid and Medicare receivables are valued in a bankruptcy context. The Bankruptcy Code does not require that a particular method be used in valuing collateral, but rather instructs that “such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property.” See 11 U.S.C. ' 506(a). “In the areas of both bankruptcy and tax, courts have consistently held that the face value of an account receivable may not represent its true value.” Boulder Fruit Express v. Mesing, 1998 U.S. Dist. LEXIS 22887 (C.D. Cal. 1998). The First Circuit has noted that “[a]ccounts receivable need not be taken at face value if circumstances case doubt on their collectability” and that
“[t]he prospects of collection of such assets are evaluated in light of the past record of payment of the obligors, the obligors' current solvency, and the presence or absence of any dispute over the validity of the accounts or debts owed.” Constructora Maza, Inc. v. Banco de Ponce , 616 F.2d 573, 577 (1st Cir. 1980).

The valuation of Medicaid and Medicare receivables maybe crucially important in the bankruptcy process, as under ' 506(a) of the Bankruptcy Code, the amount of a secured claim is equal to the “value of such creditor's interest in the estate's interest in such property.” Therefore, regardless of the face amount of the receivables, the lender's claim is only considered secured up to the value of the receivables as determined by the court, and the remainder of the claim will be treated as a general unsecured claim.

A number of factors will affect the court's valuation. First, courts typically value the accounts receivable of liquidating debtors using a liquidation value analysis, which could lower the value of Medicare/Medicaid receivables in the event that a health care provider files a Chapter 7 petition or proposes a liquidating Chapter 11 plan. Second, the court must estimate that a percentage of claims will be rejected by Medicare's intermediaries for either being improperly filed, not medically necessary, or for other reasons. Third, the court must deduct the amount of any prior overpayments or penalties that CMS can recover from the receivables, which may be especially difficult to calculate if CMS has not yet conducted an audit to determine prior overpayments. Fourth, the amount of a provider's liability for outlier claims or under the False Claims Act may change if the government charges the provider with additional penalties, or if the provider settles any penalties for lower amounts.

The many uncertainties associated with Medicare and Medicaid receivables may motivate a debtor or creditors' committee to challenge the value of the lender's secured claim, or to seek to totally invalidate the lender's lien for violating the anti-assignment provisions. Lenders whose loans are collateralized by Medicare or Medicaid receivables must be aware of the risks inherent with Medicare and Medicaid receivables, and must minimize risks by performing due diligence on potential borrowers and instituting proper controls to monitor the borrower's financial condition. As in medicine, an ounce of prevention is worth a pound of cure.

Andrew H. Sherman is Co-Chair of the Sills Cummis & Gross P.C. Creditors' Rights/Bankruptcy Reorganization Practice Group. He has represented clients in a broad range of complex business reorganizations, debt restructurings and insolvency matters throughout the country. Sherman also routinely represents lenders and other parties in financings and acquisitions involving troubled companies. Adam J. Glanzman is an associate in the same group. The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of Sills Cummis & Gross P.C.