Healthcare Bankruptcy: Not Garden-Variety

Healthcare provider bankruptcies differ from garden-variety Chapter 11 cases. While providers deal with the usual staple of lenders, vendors and employees in Chapter 11, they also address patients' care, record-keeping and privacy rights, at times with intermediary oversight by a court-appointed patient-care ombudsman. The Bankruptcy Code requires the appointment of a patient-care ombudsman within 30 days after commencement of a “health care business” bankruptcy case, unless the court finds that an ombudsman is not necessary for the protection of the patients under the facts and circumstances of the case.

An ombudsman is required to monitor the quality of patient care, represent the interests of the patients during the bankruptcy case, and protect confidential patient records. If it is determined that the provider will need to shutter its operations for financial or regulatory reasons, or issues arise with insufficient quality of patient care, the provider could be required to transfer its patients to another facility providing substantially similar care within the vicinity, and adhere to related patient notice requirements.

The ombudsman must report to the bankruptcy court and parties-in- interest every 60 days regarding the quality of patient care. If the ombudsman determines that the quality of patient care is declining or otherwise is being materially compromised, he or she must detail that determination in a written report that must be filed with the court. The fees of the ombudsman, which may include the fees of any professionals retained by the ombudsman, are paid by the bankruptcy estate and are entitled to administrative expense priority. The anticipated expense of a patient care ombudsman is something that would need to be included in a cash collateral budget with the applicable secured lender.

Government and Private Insurance Company Payers

Not every healthcare provider Chapter 11 will require the appointment and participation of a patient-care ombudsman, but every provider Chapter 11 will involve participation by payers including the government and/or private insurance companies. The provider versus payer terrain is difficult enough outside of bankruptcy, where federal and state governments have roles as payers and/or regulators, and both government and private insurance company payers simultaneously can be debtors and creditors of a healthcare provider relative to issues of underpayments, zero payments and overpayments. However, in a healthcare provider bankruptcy, these issues are complicated by disputed bankruptcy court jurisdiction over the provider reimbursements and payer claims reconciliation process relative to exhaustion of administrative remedies, the automatic stay, and setoff and recoupment rights, as well as disputing the treatment of provider agreement obligations in free and clear sales and/or assignments of executory contracts under Sections 363(f) and 365 of the Bankruptcy Code.

Many times, these matters affect a provider's ability to successfully reorganize or maximize the value of its assets in a bankruptcy sale, which otherwise would enable the provider or its purchaser to maintain operations, preserve the level of healthcare for patients and address its other constituents.

Pledging Government Receivables As Collateral

Often, receivables owed from a payer are pledged as collateral to a provider's lender, which again raises issues in the government payer context. Exercising remedies on government accounts receivable is complicated because the receivables are subject to related federal and state “Anti-Assignment Rules” affecting Medicare and Medicaid healthcare programs.

These Anti-Assignment Rules require that Medicare and Medicaid payments be made only to a deposit account over which the healthcare provider has sole control. Any attempt by a provider to assign these receivables in violation of the Anti-Assignment Rules may result in the termination of the provider agreement. However, parties have enacted a successful work-around mechanism in which the government receivables and their proceeds are deposited directly into a provider's bank account, and then the government payments are subsequently swept daily into a second deposit account under the lender's control.

Upon a provider bankruptcy filing, however, a lender must stop the automatic sweep of cash from the provider's account due to the Bankruptcy Code's automatic stay. Further, a lender's floating lien on after-acquired property provided in most loan documents is cut off as of the bankruptcy filing date — though the lender retains its lien on accounts receivable generated before the filing date, even if they are collected after the bankruptcy is commenced. As such, it is advisable for Chapter 11 providers and their lender to enter into cash collateral agreements subject to bankruptcy court approval, which typically provide for adequate protection payments and a negotiated budget, and may also include replacement liens on the provider's receivables and cash generated after the bankruptcy filing.

A Fight over Where to Fight with Payers

Outside of bankruptcy, the federal government and its contractors routinely withhold Medicare and Medicaid payments upon determining that a healthcare provider has been overpaid on a prior unrelated reimbursement claim. Under 42 U.S.C. § 405(h), federal courts may take jurisdiction over Medicare disputes only after a party exhausts applicable appeal processes within the Medicare system. A provider affected by a similar regulatory decision by the government — such as termination of a Medicare provider agreement — also faces this same obstacle. A financially unstable provider cannot survive this interim period of appeals without these reimbursements.

Healthcare providers file Chapter 11 to preserve or maximize the ongoing value of their assets and operations, which includes expediting judicial review of debtor-creditor matters, curing any alleged defaults and obligations, and administering or repurposing assets via third-party transactions. However, the federal courts (up through the circuit courts of appeal) are split regarding the plain language of 42 U.S.C. § 405(h) as it relates to bankruptcy courts' jurisdictional limitations, thus impacting a provider's protections in Chapter 11.

Section 405(h) only references 1331 and 1336 of Title 28 of the United States Code, and does not refer to Section 1334 of Title 28 (which grants bankruptcy court jurisdiction). Some circuit courts of appeal apply a strict application of the statute's plain language and the absence of a Section 1334 reference in prior Congressional amendments to determine that a requirement to exhaust administrative remedies is inapplicable in bankruptcy cases.

Other circuit courts of appeal look to the relatively clear legislative history to imply an intent that an exhaustion of administrative remedies applies even in federal bankruptcy court. A provider in bankruptcy currently has a petition on file with the United States Supreme Court for certiorari review of this issue, though the Court may not accept review.

Forum disputes also exist between network providers in bankruptcy and their private insurance payers, as most contracts contain arbitration clauses and administrative remedies provisions. There is some disagreement by courts as to the enforcement of arbitration clauses in this context, many times dependent on whether the underlying dispute is a “core” bankruptcy issue, which tends to remain in bankruptcy court like the sale of an asset or claims objection, or is a non-core matter such as a garden-variety breach of contract type claim, which generally gets sent to arbitration.

Payer Take-Backs As Setoffs or Recoupment

The government system regarding Medicare and Medicaid payments differs meaningfully from the private insurance company payments for HMO, PPO, POS and other Exchange insurance products. For instance, government payments to providers are made on an interim basis under a prospective reimbursement system, which results in payments before a determination that the services rendered are covered and costs are reasonable.

Fiscal intermediaries subsequently audit claims for reimbursement, for a period of up to several years from the date of submission, to determine the appropriateness of payments requested and made. If, after completion of the audit, the fiscal intermediary determines that a provider has been overpaid, the government has the right to recover the overpayments from the provider.

Due in large part to the prospective payment system, more courts than not find that the subsequent take-backs are recoupments as part of a single, integrated and ongoing transaction between the government and the payer — though there is still some differing circuit-level law across the country.

In the private insurance company setting, payments are not made on a prospective reimbursement system where claims are vetted and approved prior to initial payment. Yet, there are instances of payment error, which trigger requests for overpayment reimbursement. When the matter remains unresolved, many insurance company payers resort to unilateral take-backs where they apply their asserted reimbursement overpayment against a more recent valid claim of an unrelated patient. Thus, the private insurance company payers seemingly have a weaker argument to support that these take-backs are recoupments instead of a setoff.

This distinction between setoff and recoupment is important because setoffs are subject to the Bankruptcy Code's automatic stay (and generally not subject to the exception to the automatic stay for government enforcing its police and regulatory power), and generally setoff obligations fall within claims that can be sold free and clear in bankruptcy sales merely attaching to sale proceeds, but not applied against a bankruptcy purchaser of a provider license.

In addition, setoff may not be permitted by the court due to a lack of mutuality of obligation and otherwise would be deemed an improper postpetition recovery of a prepetition claim or otherwise violating the Bankruptcy Code's priority scheme for creditor distributions. Recoupments, however, are not subject to the automatic stay, the distribution scheme for creditors, and may not be discharged in a bankruptcy sale or plan confirmation — principally because under the recoupment doctrine these monies are deemed not to be property of the bankruptcy estate. However, payer recoupment actions remain an equitable defense remedy subject to judicial determination upon challenge by a provider.

For instance, some providers have argued that the imposition of unilateral take-backs by a payer — even if deemed as recoupment — is an impermissible violation of the anti-discrination provision of Bankruptcy Code Section 525. For example, in the Medicare context, provider debtors have argued that they cannot be compelled to pay prepetition obligations to the government as a condition for continued participation in the Medicare program during their bankruptcy.

A Fight Worth Fighting For

The relationship between the Medicare/Medicaid programs and providers is captured in a written provider agreement. These agreements afford providers with a license/number to participate in the Medicare/Medicaid prospective reimbursement program. The licenses are not made available for everyone who submits an application. In this way, they are much like a liquor license or a taxicab medallion, in that there are a finite number made available at a given time — making them a relatively scarce commodity to purchasing providers who want to break into a new geographic market.

Disputes arise when the provider seeks a sale of assets in bankruptcy, including the provider number. The government's general position in bankruptcy is that the provider agreement is an executory contract subject to the Bankruptcy Code requirement that its obligations (the overpayments) must be cured before it can be assumed and assigned to a purchaser/assignee. In this way, it seeks to block the sale or impute successor liability until paid in full. The main policy argument is that a provider taking on the benefits of the prospective provider agreement must also take on the existing burdens as well.

Providers and purchasers tend to argue that the provider licenses/numbers are not executory contracts, but are licenses/assets that can be sold free and clear of the overpayment obligations existing at the time of the sale. The general rationale is that the provider license is not a negotiated agreement like most contracts, but is a regulatory form application that is completed and approved by the government. Also, a ruling requiring a cure prior to assumption/assignment or of potential successor liability either would block the sale or greatly diminish the value of the assets, impeding an ability to maximize value for case constituents.

Even if the provider license is not deemed to be an executory contract, if the overpayment recovery actions are deemed a recoupment, then more cases than not hold that a 363 sale still could not extinguish that claim against the purchaser. Consequently, many times settlements are reached and work-arounds are accomplished, such as setting up a portion of the sale proceeds in escrow or setting up a waterfall overpayment recovery scheme.

This process might recover first against that payer's payments due to the debtor's estate, next from funds held by the bankruptcy estate if generated by previous interim payer payments, then against any sale proceeds generated by the sale of the provider number, and finally only as needed against the entity to which the provider number is assigned — and some purchasers have negotiated annual, budgeted caps in connection with same. However, the lack of certainty and the need to spend money in litigation greatly diminishes the value of these assets and otherwise deteriorates their market.

Conclusion

Healthcare provider Chapter 11 cases are multi-faceted and include additional parties and issues than in standard Chapter 11 cases. A financially distressed provider considering Chapter 11 should find a properly vetted stalking-horse deal partner prior to filing the case, and engage in meaningful discussions with their payers and lenders, if possible.

*****
David A. Samole is a partner at Kozyak Tropin & Throckmorton, LLP in Miami. He may be reached at [email protected].

Various factors, including increased competition and reimbursement landscape challenges, have led hospitals, health systems, physician groups, assisted-living facilities and other providers to file for bankruptcy over the last few years. For the remainder of 2017, due in part to the current uncertainty in the healthcare industry and its legislative oversight, more financially distressed providers are considering Chapter 11 bankruptcy to effectuate closures, consolidation, restructurings and related transactions.

Expanding the Role Call in Healthcare Provider Chapter 11

The Patient-Care Ombudsman

Healthcare provider bankruptcies differ from garden-variety Chapter 11 cases. While providers deal with the usual staple of lenders, vendors and employees in Chapter 11, they also address patients' care, record-keeping and privacy rights, at times with intermediary oversight by a court-appointed patient-care ombudsman. The Bankruptcy Code requires the appointment of a patient-care ombudsman within 30 days after commencement of a “health care business” bankruptcy case, unless the court finds that an ombudsman is not necessary for the protection of the patients under the facts and circumstances of the case.

An ombudsman is required to monitor the quality of patient care, represent the interests of the patients during the bankruptcy case, and protect confidential patient records. If it is determined that the provider will need to shutter its operations for financial or regulatory reasons, or issues arise with insufficient quality of patient care, the provider could be required to transfer its patients to another facility providing substantially similar care within the vicinity, and adhere to related patient notice requirements.

The ombudsman must report to the bankruptcy court and parties-in- interest every 60 days regarding the quality of patient care. If the ombudsman determines that the quality of patient care is declining or otherwise is being materially compromised, he or she must detail that determination in a written report that must be filed with the court. The fees of the ombudsman, which may include the fees of any professionals retained by the ombudsman, are paid by the bankruptcy estate and are entitled to administrative expense priority. The anticipated expense of a patient care ombudsman is something that would need to be included in a cash collateral budget with the applicable secured lender.

Government and Private Insurance Company Payers

Not every healthcare provider Chapter 11 will require the appointment and participation of a patient-care ombudsman, but every provider Chapter 11 will involve participation by payers including the government and/or private insurance companies. The provider versus payer terrain is difficult enough outside of bankruptcy, where federal and state governments have roles as payers and/or regulators, and both government and private insurance company payers simultaneously can be debtors and creditors of a healthcare provider relative to issues of underpayments, zero payments and overpayments. However, in a healthcare provider bankruptcy, these issues are complicated by disputed bankruptcy court jurisdiction over the provider reimbursements and payer claims reconciliation process relative to exhaustion of administrative remedies, the automatic stay, and setoff and recoupment rights, as well as disputing the treatment of provider agreement obligations in free and clear sales and/or assignments of executory contracts under Sections 363(f) and 365 of the Bankruptcy Code.

Many times, these matters affect a provider's ability to successfully reorganize or maximize the value of its assets in a bankruptcy sale, which otherwise would enable the provider or its purchaser to maintain operations, preserve the level of healthcare for patients and address its other constituents.

Pledging Government Receivables As Collateral

Often, receivables owed from a payer are pledged as collateral to a provider's lender, which again raises issues in the government payer context. Exercising remedies on government accounts receivable is complicated because the receivables are subject to related federal and state “Anti-Assignment Rules” affecting Medicare and Medicaid healthcare programs.

These Anti-Assignment Rules require that Medicare and Medicaid payments be made only to a deposit account over which the healthcare provider has sole control. Any attempt by a provider to assign these receivables in violation of the Anti-Assignment Rules may result in the termination of the provider agreement. However, parties have enacted a successful work-around mechanism in which the government receivables and their proceeds are deposited directly into a provider's bank account, and then the government payments are subsequently swept daily into a second deposit account under the lender's control.

Upon a provider bankruptcy filing, however, a lender must stop the automatic sweep of cash from the provider's account due to the Bankruptcy Code's automatic stay. Further, a lender's floating lien on after-acquired property provided in most loan documents is cut off as of the bankruptcy filing date — though the lender retains its lien on accounts receivable generated before the filing date, even if they are collected after the bankruptcy is commenced. As such, it is advisable for Chapter 11 providers and their lender to enter into cash collateral agreements subject to bankruptcy court approval, which typically provide for adequate protection payments and a negotiated budget, and may also include replacement liens on the provider's receivables and cash generated after the bankruptcy filing.

A Fight over Where to Fight with Payers

Outside of bankruptcy, the federal government and its contractors routinely withhold Medicare and Medicaid payments upon determining that a healthcare provider has been overpaid on a prior unrelated reimbursement claim. Under 42 U.S.C. § 405(h), federal courts may take jurisdiction over Medicare disputes only after a party exhausts applicable appeal processes within the Medicare system. A provider affected by a similar regulatory decision by the government — such as termination of a Medicare provider agreement — also faces this same obstacle. A financially unstable provider cannot survive this interim period of appeals without these reimbursements.

Healthcare providers file Chapter 11 to preserve or maximize the ongoing value of their assets and operations, which includes expediting judicial review of debtor-creditor matters, curing any alleged defaults and obligations, and administering or repurposing assets via third-party transactions. However, the federal courts (up through the circuit courts of appeal) are split regarding the plain language of 42 U.S.C. § 405(h) as it relates to bankruptcy courts' jurisdictional limitations, thus impacting a provider's protections in Chapter 11.

Section 405(h) only references 1331 and 1336 of Title 28 of the United States Code, and does not refer to Section 1334 of Title 28 (which grants bankruptcy court jurisdiction). Some circuit courts of appeal apply a strict application of the statute's plain language and the absence of a Section 1334 reference in prior Congressional amendments to determine that a requirement to exhaust administrative remedies is inapplicable in bankruptcy cases.

Other circuit courts of appeal look to the relatively clear legislative history to imply an intent that an exhaustion of administrative remedies applies even in federal bankruptcy court. A provider in bankruptcy currently has a petition on file with the United States Supreme Court for certiorari review of this issue, though the Court may not accept review.

Forum disputes also exist between network providers in bankruptcy and their private insurance payers, as most contracts contain arbitration clauses and administrative remedies provisions. There is some disagreement by courts as to the enforcement of arbitration clauses in this context, many times dependent on whether the underlying dispute is a “core” bankruptcy issue, which tends to remain in bankruptcy court like the sale of an asset or claims objection, or is a non-core matter such as a garden-variety breach of contract type claim, which generally gets sent to arbitration.

Payer Take-Backs As Setoffs or Recoupment

The government system regarding Medicare and Medicaid payments differs meaningfully from the private insurance company payments for HMO, PPO, POS and other Exchange insurance products. For instance, government payments to providers are made on an interim basis under a prospective reimbursement system, which results in payments before a determination that the services rendered are covered and costs are reasonable.

Fiscal intermediaries subsequently audit claims for reimbursement, for a period of up to several years from the date of submission, to determine the appropriateness of payments requested and made. If, after completion of the audit, the fiscal intermediary determines that a provider has been overpaid, the government has the right to recover the overpayments from the provider.

Due in large part to the prospective payment system, more courts than not find that the subsequent take-backs are recoupments as part of a single, integrated and ongoing transaction between the government and the payer — though there is still some differing circuit-level law across the country.

In the private insurance company setting, payments are not made on a prospective reimbursement system where claims are vetted and approved prior to initial payment. Yet, there are instances of payment error, which trigger requests for overpayment reimbursement. When the matter remains unresolved, many insurance company payers resort to unilateral take-backs where they apply their asserted reimbursement overpayment against a more recent valid claim of an unrelated patient. Thus, the private insurance company payers seemingly have a weaker argument to support that these take-backs are recoupments instead of a setoff.

This distinction between setoff and recoupment is important because setoffs are subject to the Bankruptcy Code's automatic stay (and generally not subject to the exception to the automatic stay for government enforcing its police and regulatory power), and generally setoff obligations fall within claims that can be sold free and clear in bankruptcy sales merely attaching to sale proceeds, but not applied against a bankruptcy purchaser of a provider license.

In addition, setoff may not be permitted by the court due to a lack of mutuality of obligation and otherwise would be deemed an improper postpetition recovery of a prepetition claim or otherwise violating the Bankruptcy Code's priority scheme for creditor distributions. Recoupments, however, are not subject to the automatic stay, the distribution scheme for creditors, and may not be discharged in a bankruptcy sale or plan confirmation — principally because under the recoupment doctrine these monies are deemed not to be property of the bankruptcy estate. However, payer recoupment actions remain an equitable defense remedy subject to judicial determination upon challenge by a provider.

For instance, some providers have argued that the imposition of unilateral take-backs by a payer — even if deemed as recoupment — is an impermissible violation of the anti-discrination provision of Bankruptcy Code Section 525. For example, in the Medicare context, provider debtors have argued that they cannot be compelled to pay prepetition obligations to the government as a condition for continued participation in the Medicare program during their bankruptcy.

A Fight Worth Fighting For

The relationship between the Medicare/Medicaid programs and providers is captured in a written provider agreement. These agreements afford providers with a license/number to participate in the Medicare/Medicaid prospective reimbursement program. The licenses are not made available for everyone who submits an application. In this way, they are much like a liquor license or a taxicab medallion, in that there are a finite number made available at a given time — making them a relatively scarce commodity to purchasing providers who want to break into a new geographic market.

Disputes arise when the provider seeks a sale of assets in bankruptcy, including the provider number. The government's general position in bankruptcy is that the provider agreement is an executory contract subject to the Bankruptcy Code requirement that its obligations (the overpayments) must be cured before it can be assumed and assigned to a purchaser/assignee. In this way, it seeks to block the sale or impute successor liability until paid in full. The main policy argument is that a provider taking on the benefits of the prospective provider agreement must also take on the existing burdens as well.

Providers and purchasers tend to argue that the provider licenses/numbers are not executory contracts, but are licenses/assets that can be sold free and clear of the overpayment obligations existing at the time of the sale. The general rationale is that the provider license is not a negotiated agreement like most contracts, but is a regulatory form application that is completed and approved by the government. Also, a ruling requiring a cure prior to assumption/assignment or of potential successor liability either would block the sale or greatly diminish the value of the assets, impeding an ability to maximize value for case constituents.

Even if the provider license is not deemed to be an executory contract, if the overpayment recovery actions are deemed a recoupment, then more cases than not hold that a 363 sale still could not extinguish that claim against the purchaser. Consequently, many times settlements are reached and work-arounds are accomplished, such as setting up a portion of the sale proceeds in escrow or setting up a waterfall overpayment recovery scheme.

This process might recover first against that payer's payments due to the debtor's estate, next from funds held by the bankruptcy estate if generated by previous interim payer payments, then against any sale proceeds generated by the sale of the provider number, and finally only as needed against the entity to which the provider number is assigned — and some purchasers have negotiated annual, budgeted caps in connection with same. However, the lack of certainty and the need to spend money in litigation greatly diminishes the value of these assets and otherwise deteriorates their market.

Conclusion

Healthcare provider Chapter 11 cases are multi-faceted and include additional parties and issues than in standard Chapter 11 cases. A financially distressed provider considering Chapter 11 should find a properly vetted stalking-horse deal partner prior to filing the case, and engage in meaningful discussions with their payers and lenders, if possible.

*****
David A. Samole is a partner at Kozyak Tropin & Throckmorton, LLP in Miami. He may be reached at [email protected].