Limiting Successor Liability Under Assigned Medicare Provider Agreements

Recent years have seen an uptick in distressed health-care mergers and acquisitions as providers and systems struggle to adjust to a changing economic climate. Significant changes have taken place in health care service delivery as a result of the enactment of the Patient Protection & Affordable Care Act (“Obamacare”) in 2010. Expenditures have increased due to the cost to implement reforms, including capital investments in information technology systems and new patient care and integration models. At the same time, revenues have decreased due to the availability of fewer government funds and the government's efforts to reduce Medicare-related costs. As a result, more and more health care providers have turned to reorganization and consolidation as a means of remaining viable. This article aims to inform readers of the risks associated with accepting assignment of a distressed health care provider's Medicare provider agreement, as well as providing suggestions for managing those risks.

Medicare Provider Agreements and the Prospective Payment System

One source of a health care provider's value is its Medicare provider agreement. This agreement between a health care provider and the Secretary of the United States Department of Health and Human Services enables the provider to receive payment from the federal government for services provided to Medicare beneficiaries pursuant to Title XVIII of the Social Security Act, also known as the “Medicare Statute.” Pursuant to the Medicare provider agreement, the health care provider agrees to provide services and comply with the Medicare Statute, and the government agrees to reimburse the provider for Medicare-eligible expenses. In connection with entry into the Medicare provider agreement, each health care provider is issued a provider billing number under which it may submit claims for reimbursement of covered goods and services.

Medicare functions as an interim prospective payment system in which the health care provider receives periodic payments from the government that are estimates of the actual amount of reimbursements owed to it. Each year, the provider files a cost report that is audited to determine whether the provider's claimed reimbursement costs were proper. If the provider was overpaid, the government is empowered to adjust future payments to the provider “on account of previously made under payments or overpayments ' .” See 42 U.S.C. ' 1395g(a). The Centers for Medicare and Medicaid Services (CMS), which is the federal governmental entity that administers the Medicare program, typically recovers prior overpayments through off set, recoupment, or suspension of future Medicare reimbursements.

Costs and Benefits Associated with Accepting Assignment of a Medicare Provider Agreement

Purchasers of distressed health care companies are often faced with competing considerations when it comes to the question of whether to seek assignment of the seller's Medicare provider agreement. On one hand, if the purchaser assumes the Medicare provider agreement, it may continue providing services under that agreement and will continue receiving prospective reimbursement payments. It may not be practical for a buyer to wait for its own provider number to be issued in a situation where Medicare payments constitute a significant source of income. Assumption of an existing agreement eliminates any gap in reimbursement that would occur while the buyer applied and waited for a new provider billing number to be issued. This concern about lost revenue during the gap period is heightened in light of the fact that CMS, in an apparent effort to encourage assignment of Medicare provider agreements, recently promulgated regulations that make it more difficult and time consuming for purchasers to obtain new provider agreements and billing numbers.

On the other hand, purchasers should be wary of the pitfalls associated with accepting assignment of a provider agreement. A purchaser who takes assignment of a Medicare provider agreement may be subject to liability for prior overpayments made to the seller. Medicare may recoup or off set the prior overpayments against future amounts due to the purchaser, or withhold payment entirely until the prior overpayment is recovered. In addition, the purchaser could potentially be subject to liability under fraud and abuse laws as they apply to health care entities, including under the Federal Anti-Kickback Statute, Stark, the Civil False Claims Act, the Civil Monetary Penalties Law, and similar state fraud and abuse laws, for pre-closing violations by the seller. See, e.g., Deerbrook Pavilion v. Shalala , 235 F.3d 1100 (8th Cir. 2000) (holding that civil monetary penalties assessed against a seller-health care entity could be collected from the buyer of its Medicare provider agreement).

Treatment of Medicare Provider Agreements in a Change of Ownership Situation

Outside of bankruptcy, a health care provider may assign its Medicare provider agreement as part of a change in ownership. In fact, a new owner of a health care provider is deemed to automatically receive assignment of the provider agreement unless the purchaser declines to accept such assignment. Reimbursement payments pursuant to an assigned provider agreement remain subject to adjustment on account of prior overpayments. United States v. Vernon Home Health, Inc., 21 F.3d 693, 696 (5th Cir. 1994).

In bankruptcy, section 363 of the Bankruptcy Code provides a means by which a debtor can sell its assets free and clear of liens and other interests. Typically, section 363 is a valuable tool in reducing or eliminating a purchaser's potential successor liability. The issue that often arises when a health care debtor seeks to sell its assets pursuant to section 363 of the Bankruptcy Code is whether its Medicare provider agreement is an “asset” that can be sold free and clear of liens and interests. At least one court has answered this question affirmatively, finding that the debtor's Medicare provider agreement was a non-contractual statutory entitlement, equivalent to property, that could be sold free and clear of prior overpayment liability. In re BDK Health Management Inc., 1998 Bankr. LEXIS 2031 (Bankr. M.D. Fla Nov. 16, 1998).

However, a majority of courts treat Medicare provider agreements as executory contracts rather than as assets that can be freely transferred. See, e.g., In re Univ. Med. Ctr., 973 F.2d 1065, 1076 (3rd Cir. 1992); In re Consumer Health Servs. of Am. Inc., 171 B.R. 917, 920 (Bankr. D.D.C. 1994), rev'd on other grounds, 108 F.3d 390 (D.C. Cir. 1997); In re Heffernan Mem'l Hosp. Dist. , 192 B.R. 228, 231 n.4 (Bankr. S.D. Cal. 1996). Though not defined in the Bankruptcy Cde, the most widely accepted definition of “executory contract” is “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. R. 439, 460 (1973).

In order to transfer an executory contract, section 365 of the Bankruptcy Code requires that a debtor cure any defaults and assume the contract in its entirety. Thus, a purchaser takes the agreement as it is, with all associated benefits and burdens, and may be subject to later claims by the government for recoupment pursuant to that agreement. Unsurprisingly, CMS takes the position that Medicare provider agreements are executory contracts and that its ability to recoup prior overpayments survives assignment.

For these reasons, a purchaser in bankruptcy and one outside of bankruptcy may be similarly situated when it comes to taking over a Medicare provider agreement ' both will have to decide whether to accept assignment and how to mitigate risks associated with such assignment.

Strategies for Mitigating Risks Associated with Accepting Assignment of'a Medicare Provider Agreement

A purchaser that wishes to insulate itself entirely from Medicare-related successor liabilities can opt not to accept assignment of the agreement, either outside of bankruptcy or by allowing the debtor to reject the agreement in bankruptcy. However, this may not be a viable option because Medicare payments tend to represent a significant portion of the payor mix in distressed health care organizations. Therefore, a purchaser may stand to lose substantial revenue during any gap period between rejection of the seller's Medicare provider agreement and the issuance of a new agreement to the purchaser.

A purchaser that is considering accepting assignment of a Medicare provider agreement should first conduct extensive due diligence to attempt to ascertain what liabilities exist in relation to the provider agreement. Ideally the seller should disclose anticipated overpayment or compliance-related liabilities, but it might not be possible for the seller to do so, or to assign a value to any anticipated liabilities. By way of example, in one case where the purchaser sought to take over the debtor-health care provider's Medicare provider agreement, the anticipated liabilities ranged from between $10,000 to $800,000. See In re BDK Health Management Inc., 1998 Bankr. LEXIS 2031. The buyer's due diligence should include, among other things, reviewing the seller's prior Medicare cost reports and auditing, billing, and coding practices, reviewing the seller's history of Medicare overpayments and analyzing any prior CMS inquiries, and reviewing the seller's calculation of periodic interim payments and comparing them against prior years to identify any discrepancies.

On the basis of its due diligence, the buyer might decide that the risks outweigh the benefits of assignment, or might seek to reduce the purchase price. The purchaser can seek indemnification from the seller against any claims for fees, fines, or penalties assessed in relation to the Medicare provider agreement and for recoupment of any overpayments. However, indemnification may be worthless if the seller is distressed or in bankruptcy. Therefore, in connection with its request for indemnification by the seller, the purchaser should also request that a portion of the purchase price be placed in escrow for a period of time to cover the seller's indemnification obligations. The purchaser's due diligence should provide the purchaser with a basis for the amount necessary to be placed in the indemnification escrow.

Another option is for the purchaser to attempt to broker a settlement directly with CMS, which would enable it to limit its liability to an agreed-upon amount under a final cost report. At the least, the purchaser should negotiate with CMS as to the timing of any offsets or recoupments. The seller's bankruptcy filing might encourage negotiations, and CMS may be more likely to settle if the distressed entity is a necessary service provider in its community.

Purchasers might also consider alternative arrangements, such as a management agreement, as a means of reducing or eliminating successor liability. The asset purchase agreement or other transfer documents could provide that if the purchaser has not obtained a new Medicare provider agreement by the closing date, the seller will agree to enter into an interim management agreement that will enable the purchaser to operate the facility under the seller's existing Medicare provider agreement for a period of time until its own provider agreement is issued. In exchange, the purchaser may reasonably be asked to indemnify the seller for any violations of Medicare fraud and abuse laws or recoupment claims relating to operation of the health care entity after the closing date. In other circumstances, the buyer and seller might structure the transaction as a sale with a temporary leaseback, or delay closing until a new provider agreement is issued to the purchaser where it is practical to do so.

Finally, a purchaser should obtain the agreement of the seller to prepare and file cost reports for the time period prior to the transfer, provide information to support claims for reimbursement, and cooperate in the processing of claims. In any case, purchasers will undoubtedly want to seek counsel experienced in dealing with Medicare provider agreement liabilities to help them navigate these challenging issues.

William P. Smith ([email protected]) and James W. Kapp, III ([email protected]) are partners in the Chicago office of McDermott Will & Emery. Smith's practice focuses on resolution of troubled financing transactions, particularly remediation of capital obligations of healthcare obligors and of municipal and tax-exempt finance. Kapp's practice focuses on corporate bankruptcies and reorganizations, distressed financings and workouts, and creditor rights representation. Megan M. Preusker is an associate in the firm's Chicago office.

Recent years have seen an uptick in distressed health-care mergers and acquisitions as providers and systems struggle to adjust to a changing economic climate. Significant changes have taken place in health care service delivery as a result of the enactment of the Patient Protection & Affordable Care Act (“Obamacare”) in 2010. Expenditures have increased due to the cost to implement reforms, including capital investments in information technology systems and new patient care and integration models. At the same time, revenues have decreased due to the availability of fewer government funds and the government's efforts to reduce Medicare-related costs. As a result, more and more health care providers have turned to reorganization and consolidation as a means of remaining viable. This article aims to inform readers of the risks associated with accepting assignment of a distressed health care provider's Medicare provider agreement, as well as providing suggestions for managing those risks.

Medicare Provider Agreements and the Prospective Payment System

One source of a health care provider's value is its Medicare provider agreement. This agreement between a health care provider and the Secretary of the United States Department of Health and Human Services enables the provider to receive payment from the federal government for services provided to Medicare beneficiaries pursuant to Title XVIII of the Social Security Act, also known as the “Medicare Statute.” Pursuant to the Medicare provider agreement, the health care provider agrees to provide services and comply with the Medicare Statute, and the government agrees to reimburse the provider for Medicare-eligible expenses. In connection with entry into the Medicare provider agreement, each health care provider is issued a provider billing number under which it may submit claims for reimbursement of covered goods and services.

Medicare functions as an interim prospective payment system in which the health care provider receives periodic payments from the government that are estimates of the actual amount of reimbursements owed to it. Each year, the provider files a cost report that is audited to determine whether the provider's claimed reimbursement costs were proper. If the provider was overpaid, the government is empowered to adjust future payments to the provider “on account of previously made under payments or overpayments ' .” See 42 U.S.C. ' 1395g(a). The Centers for Medicare and Medicaid Services (CMS), which is the federal governmental entity that administers the Medicare program, typically recovers prior overpayments through off set, recoupment, or suspension of future Medicare reimbursements.

Costs and Benefits Associated with Accepting Assignment of a Medicare Provider Agreement

Purchasers of distressed health care companies are often faced with competing considerations when it comes to the question of whether to seek assignment of the seller's Medicare provider agreement. On one hand, if the purchaser assumes the Medicare provider agreement, it may continue providing services under that agreement and will continue receiving prospective reimbursement payments. It may not be practical for a buyer to wait for its own provider number to be issued in a situation where Medicare payments constitute a significant source of income. Assumption of an existing agreement eliminates any gap in reimbursement that would occur while the buyer applied and waited for a new provider billing number to be issued. This concern about lost revenue during the gap period is heightened in light of the fact that CMS, in an apparent effort to encourage assignment of Medicare provider agreements, recently promulgated regulations that make it more difficult and time consuming for purchasers to obtain new provider agreements and billing numbers.

On the other hand, purchasers should be wary of the pitfalls associated with accepting assignment of a provider agreement. A purchaser who takes assignment of a Medicare provider agreement may be subject to liability for prior overpayments made to the seller. Medicare may recoup or off set the prior overpayments against future amounts due to the purchaser, or withhold payment entirely until the prior overpayment is recovered. In addition, the purchaser could potentially be subject to liability under fraud and abuse laws as they apply to health care entities, including under the Federal Anti-Kickback Statute, Stark, the Civil False Claims Act, the Civil Monetary Penalties Law, and similar state fraud and abuse laws, for pre-closing violations by the seller. See, e.g., Deerbrook Pavilion v. Shalala , 235 F.3d 1100 (8th Cir. 2000) (holding that civil monetary penalties assessed against a seller-health care entity could be collected from the buyer of its Medicare provider agreement).

Treatment of Medicare Provider Agreements in a Change of Ownership Situation

Outside of bankruptcy, a health care provider may assign its Medicare provider agreement as part of a change in ownership. In fact, a new owner of a health care provider is deemed to automatically receive assignment of the provider agreement unless the purchaser declines to accept such assignment. Reimbursement payments pursuant to an assigned provider agreement remain subject to adjustment on account of prior overpayments. United States v. Vernon Home Health, Inc. , 21 F.3d 693, 696 (5th Cir. 1994).

In bankruptcy, section 363 of the Bankruptcy Code provides a means by which a debtor can sell its assets free and clear of liens and other interests. Typically, section 363 is a valuable tool in reducing or eliminating a purchaser's potential successor liability. The issue that often arises when a health care debtor seeks to sell its assets pursuant to section 363 of the Bankruptcy Code is whether its Medicare provider agreement is an “asset” that can be sold free and clear of liens and interests. At least one court has answered this question affirmatively, finding that the debtor's Medicare provider agreement was a non-contractual statutory entitlement, equivalent to property, that could be sold free and clear of prior overpayment liability. In re BDK Health Management Inc., 1998 Bankr. LEXIS 2031 (Bankr. M.D. Fla Nov. 16, 1998).

However, a majority of courts treat Medicare provider agreements as executory contracts rather than as assets that can be freely transferred. See, e.g., In re Univ. Med. Ctr., 973 F.2d 1065, 1076 (3rd Cir. 1992); In re Consumer Health Servs. of Am. Inc., 171 B.R. 917, 920 (Bankr. D.D.C. 1994), rev'd on other grounds, 108 F.3d 390 (D.C. Cir. 1997); In re Heffernan Mem'l Hosp. Dist. , 192 B.R. 228, 231 n.4 (Bankr. S.D. Cal. 1996). Though not defined in the Bankruptcy Cde, the most widely accepted definition of “executory contract” is “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. R. 439, 460 (1973).

In order to transfer an executory contract, section 365 of the Bankruptcy Code requires that a debtor cure any defaults and assume the contract in its entirety. Thus, a purchaser takes the agreement as it is, with all associated benefits and burdens, and may be subject to later claims by the government for recoupment pursuant to that agreement. Unsurprisingly, CMS takes the position that Medicare provider agreements are executory contracts and that its ability to recoup prior overpayments survives assignment.

For these reasons, a purchaser in bankruptcy and one outside of bankruptcy may be similarly situated when it comes to taking over a Medicare provider agreement ' both will have to decide whether to accept assignment and how to mitigate risks associated with such assignment.

Strategies for Mitigating Risks Associated with Accepting Assignment of'a Medicare Provider Agreement

A purchaser that wishes to insulate itself entirely from Medicare-related successor liabilities can opt not to accept assignment of the agreement, either outside of bankruptcy or by allowing the debtor to reject the agreement in bankruptcy. However, this may not be a viable option because Medicare payments tend to represent a significant portion of the payor mix in distressed health care organizations. Therefore, a purchaser may stand to lose substantial revenue during any gap period between rejection of the seller's Medicare provider agreement and the issuance of a new agreement to the purchaser.

A purchaser that is considering accepting assignment of a Medicare provider agreement should first conduct extensive due diligence to attempt to ascertain what liabilities exist in relation to the provider agreement. Ideally the seller should disclose anticipated overpayment or compliance-related liabilities, but it might not be possible for the seller to do so, or to assign a value to any anticipated liabilities. By way of example, in one case where the purchaser sought to take over the debtor-health care provider's Medicare provider agreement, the anticipated liabilities ranged from between $10,000 to $800,000. See In re BDK Health Management Inc., 1998 Bankr. LEXIS 2031. The buyer's due diligence should include, among other things, reviewing the seller's prior Medicare cost reports and auditing, billing, and coding practices, reviewing the seller's history of Medicare overpayments and analyzing any prior CMS inquiries, and reviewing the seller's calculation of periodic interim payments and comparing them against prior years to identify any discrepancies.

On the basis of its due diligence, the buyer might decide that the risks outweigh the benefits of assignment, or might seek to reduce the purchase price. The purchaser can seek indemnification from the seller against any claims for fees, fines, or penalties assessed in relation to the Medicare provider agreement and for recoupment of any overpayments. However, indemnification may be worthless if the seller is distressed or in bankruptcy. Therefore, in connection with its request for indemnification by the seller, the purchaser should also request that a portion of the purchase price be placed in escrow for a period of time to cover the seller's indemnification obligations. The purchaser's due diligence should provide the purchaser with a basis for the amount necessary to be placed in the indemnification escrow.

Another option is for the purchaser to attempt to broker a settlement directly with CMS, which would enable it to limit its liability to an agreed-upon amount under a final cost report. At the least, the purchaser should negotiate with CMS as to the timing of any offsets or recoupments. The seller's bankruptcy filing might encourage negotiations, and CMS may be more likely to settle if the distressed entity is a necessary service provider in its community.

Purchasers might also consider alternative arrangements, such as a management agreement, as a means of reducing or eliminating successor liability. The asset purchase agreement or other transfer documents could provide that if the purchaser has not obtained a new Medicare provider agreement by the closing date, the seller will agree to enter into an interim management agreement that will enable the purchaser to operate the facility under the seller's existing Medicare provider agreement for a period of time until its own provider agreement is issued. In exchange, the purchaser may reasonably be asked to indemnify the seller for any violations of Medicare fraud and abuse laws or recoupment claims relating to operation of the health care entity after the closing date. In other circumstances, the buyer and seller might structure the transaction as a sale with a temporary leaseback, or delay closing until a new provider agreement is issued to the purchaser where it is practical to do so.

Finally, a purchaser should obtain the agreement of the seller to prepare and file cost reports for the time period prior to the transfer, provide information to support claims for reimbursement, and cooperate in the processing of claims. In any case, purchasers will undoubtedly want to seek counsel experienced in dealing with Medicare provider agreement liabilities to help them navigate these challenging issues.

William P. Smith ([email protected]) and James W. Kapp, III ([email protected]) are partners in the Chicago office of McDermott Will & Emery. Smith's practice focuses on resolution of troubled financing transactions, particularly remediation of capital obligations of healthcare obligors and of municipal and tax-exempt finance. Kapp's practice focuses on corporate bankruptcies and reorganizations, distressed financings and workouts, and creditor rights representation. Megan M. Preusker is an associate in the firm's Chicago office.