Over the past decade, arguably no industry experienced such dramatic regulatory change or consistent legislative uncertainty as healthcare. Today, continued efforts to repeal, defund, replace, or amend the Affordable Care Act—coupled with rising pharmaceutical costs, increased competition, massive capital investment expenses, etc.—virtually assure a challenging economic environment for healthcare companies for years to come.
However, given the stakes involved—and the unfortunate fact that healthcare restructuring provides little time for “on the job training”—practitioners must enter such engagements with a comprehensive understanding of the unique legal and regulatory landscapes healthcare companies face.
Broadly speaking, healthcare restructurings differ from “run-of-the-mill” corporate restructurings in two fundamental ways.
First, because the U.S. healthcare industry is one of the most highly regulated industries in the world, healthcare restructurings routinely implicate myriad state and federal laws. For instance, a hospital sale under section 363 of the U.S. Bankruptcy Code often triggers issues regarding patient privacy, the transferability of Medicare and Medicaid provider agreements, and government agencies’ recoupment rights. Likewise, closing a hospital (unlike most businesses) is a complicated, time-consuming process, and generally requires government approval. To ensure compliance with applicable regulations and the protection of government, patient and community interests, healthcare restructurings often require significant engagement with regulators, politicians, community groups, and patient advocates.
Second, in contrast to typical corporate restructurings—which usually focus on resolving financial disputes and maximizing value (e.g., rationalizing the company’s capital structure, shoring up liquidity concerns, or executing a swift operational turnaround)—in healthcare restructurings, lives actually hang in the balance. A preeminent concern is thus the care and well-being of patients. For instance, when the assets of healthcare providers are auctioned in a bankruptcy sale, the highest bid may not be the best bid (i.e., a bid that promotes the uninterrupted provision of healthcare services to an underserved community could trump a financially superior bid).
healthcare restructurings involve a maze of complex statutory schemes and diametrically opposed judicial authority. This article will:
Medicare and Medicaid reimbursements constitute the principal source of revenue for many healthcare providers. As such, Medicare and Medicaid provider agreements often represent one of the most important assets of a healthcare debtor. The significance of preserving, maximizing and monetizing the value of this asset in bankruptcy cannot be overstated.
Critical “provider agreement” issues to understand before seeking bankruptcy relief include:
A burgeoning split of authority exists regarding whether bankruptcy courts have jurisdiction to resolve Medicare overpayment and termination disputes. By way of background, section 405(h) of the Social Security Act requires healthcare providers to first exhaust all administrative remedies before seeking judicial review of a decision by the Centers for Medicare and Medicaid Services. The administrative appeals process, however, can take years. And while that process plays out, all Medicare and Medicaid reimbursement payments may dry up by operation of government action, effectively “killing” the provider before it has an opportunity to vindicate its rights.
The controversy regarding a bankruptcy court’s jurisdiction to resolve Medicare disputes before the exhaustion of all administrative remedies stems from the third sentence of section 405(h), which provides as follows:
The findings and decision of the Commissioner of Social Security after a hearing shall be binding upon all individuals who were parties to such hearing. No findings of fact or decision of the Commissioner of Social Security shall be reviewed by any person, tribunal, or governmental agency except as [provided in 42 U.S.C. § 405(g)]. No action against the United States, the Commissioner of Social Security, or any officer or employee thereof shall be brought under § 1331 or 1346 of Title 28 to recover any claim arising under this subchapter.1
For nearly three decades, the Ninth Circuit stood alone among the circuit courts in holding that section 405(h)’s plain text only bars jurisdiction under sections 1331 and 1346 of Title 28 (which grant federal courts jurisdiction over federal questions and certain cases involving the United States as a defendant), and does not prohibit bankruptcy courts from adjudicating disputes under 28 U.S.C. §1334.2
In contrast, the Third, Seventh, Eighth and Eleventh Circuits each found that section 405(h) contains a “hidden jurisdictional bar” based on legislative history evincing Congressional intent that courts generally lack jurisdiction to resolve Medicare disputes until all administrative remedies are exhausted.3
In short, when originally enacted in 1939, section 405(h) barred all actions brought under 28 U.S.C. §41 (which at the time contained nearly all the federal court jurisdictional grants now spread throughout Title 28). When Congress adopted the current version of section 405(h) in 1984, the revision was in a section titled “Technical Corrections.” And a neighboring section provided that none of the technical changes “shall be construed as changing or affecting any right, liability, status, or interpretation, which existed (under the provisions of law involved) before that date.”4
The Third, Seventh, Eighth and Eleventh Circuits viewed this language as expressing Congressional intent to leave the substantive scope of section 405(h) unchanged. Since the original version precluded judicial review until all administrative remedies were exhausted, so did revised section 405(h) based on the “recodification principle,” under which, when legislatures codify the law, courts presume that no substantive change was intended absent a clear indication otherwise.
Until recently, the views of the Third, Seventh, Eighth and Eleventh Circuits appeared to reflect the emerging consensus. In July 2019, however, the Fifth Circuit addressed the controversy and reinvigorated the debate.5 The Fifth Circuit found that the statute’s plain language was controlling and Congress evinced a clear intent to change the law’s substance based on “the actual words of § 405(h)’s third sentence.”6
The circuit split may ultimately be resolved by Congress or the Supreme Court. In the interim, the fate of healthcare providers seeking expedited Medicare determinations through intervention of a bankruptcy court may depend upon the venue of the bankruptcy case.
In addition to the uncertainty regarding the resolution of disputes under provider agreements, there is also uncertainty on how courts characterize and treat provider agreements. That is, courts disagree on whether provider agreements are “executory contracts” (that can be assumed or assigned to a third party), or assets (that can be sold “free and clear” of all liens, claims, encumbrances and interests under Bankruptcy Code section 363(f)). The distinction is critical.
Generally speaking, a debtor can assume an executory contract or assign it to a third party as long as all monetary payment defaults are “cured,” and the contract counterparty receives “adequate assurance of future performance.”7 For a healthcare provider that received significant government overpayments before filing for bankruptcy, the “cure” cost may be prohibitive. In such a scenario, attempting to sell the agreement “free and clear” of such obligations may present an attractive alternative.
In the case of In re BDK Health Mgmt., a Florida bankruptcy court ruled that Medicare provider agreements constitute “statutory entitlements, not contracts,” and could thus be sold “free and clear” of the government’s recoupment rights and without “curing” the monetary obligations.8
Three primary factors drove the court’s conclusion:
In In re Vitalsigns Homecare, Inc., a Massachusetts bankruptcy court reached the precise opposite conclusion.9 The court observed that the “complicated statutory scheme” governing provider agreements “confers both benefits and burdens on providers,” and found that allowing a sale of provider numbers “free and clear” would grant a purchaser the benefits of such scheme without the associated burdens, thereby thwarting “a fundamental principle of the Medicare scheme” (i.e., protecting the taxpaying public.)10 In contrast, the court found that requiring the assumption of a provider agreement before its sale “harmonizes both the Medicare and Bankruptcy statutes” by preserving the Medicare regulation’s recoupment provisions and the Bankruptcy Code’s “free and clear” sale provision.11 Lastly, although the court expressed sympathy towards the goal of maximizing creditor recoveries, it found that its broad equitable powers “do not accord it a roving commission to do equity” and ignore the government’s rights under the Medicare regulations.12
Until recently, many courts and practitioners subscribed to the Vitalsigns approach and viewed provider agreements as executory contracts, subject to Bankruptcy Code section 365.13 However, a recent ruling called this orthodoxy into question.
In In re Verity Health Sys., of Cal., a California bankruptcy court concluded that provider agreements are not even “contracts,” let alone executory contracts that must be “cured” in connection with any proposed assumption or assignment, because: (i) a hospital’s “reimbursement entitlement is dictated by the Medicare statute and the regulations promulgated thereunder,” and (ii) “Provider Agreements lack a key feature found in all contracts—obligations imposed on both parties to the agreements.”14 With respect to the latter, the court observed that provider agreements impose no obligations on the government, and the obligations imposed on the providers did “not constitute consideration for contract purposes, since they merely restate the Debtors’ pre-existing legal obligations.”15
The court then considered whether provider agreements could be sold free and clear of liens, claims, and interests under Bankruptcy Code section 363(f). In answering that question affirmatively, the court remarked that provider agreements “are akin to a license issued by a government agency,” which can be sold under section 363. In particular, the court noted that “[t]he Provider Agreements create a statutory entitlement to bill the Medi-Cal program for providing Medi-Cal services . . . [and] [t]his right to receive reimbursement for providing healthcare services is a property interest.”16 As a result, the court authorized the debtors to sell their provider agreements free and clear of the government’s $55 million claim.
Time will tell how courts resolve these issues in healthcare restructuring in the future. It is virtually certain, however, that such disputes will be hotly litigated.
The government’s “exclusion” and “termination” remedies relating to Medicare and Medicaid reimbursements are also issues that arise in healthcare bankruptcy cases and could materially impact a debtor’s revenue stream.
Exclusion is an extreme remedy, codified in 42 U.S.C. § 1320a-7, whereby the government can exclude a healthcare provider from receiving reimbursements for up to five years (or longer for parties that committed prior infractions). The remedy comes in two types: “mandatory” and “permissive.”
As the name implies, mandatory exclusion is required by the Office of Inspector General upon various criminal convictions, including: Medicare, Medicaid or other healthcare-related fraud; patient abuse or neglect; and felony convictions for unlawfully manufacturing, distributing, prescribing or dispensing controlled substances.
Permissive exclusion, in contrast, gives the Office of Inspector General discretion to cease reimbursements based on offenses such as:
Termination is another draconian remedy, codified in 42 U.S.C. § 4395cc(b), which allows the government to terminate a provider agreement if the provider: fails to comply substantially with the terms of the agreement; is excluded from participating in Medicare; or is convicted of a felony detrimental to the best interests of Medicare or its beneficiaries.
Obviously, exclusion and termination represent existential threats to a healthcare business. Unfortunately for healthcare providers, section 362(b)(28) of the Bankruptcy Code expressly exempts from the automatic stay the government’s pursuit of its exclusion remedies. Likewise, at least one court granted the government stay relief to pursue termination under the “police and regulatory power” exception found in section 362(b)(4) of the Bankruptcy Code.17
In short, healthcare providers should understand that bankruptcy may not always provide the refuge or “breathing spell” afforded to most corporate debtors, and it is not a “cure all” in every situation.
When a retailer faces an inventory shortage or lacks adequate staff, lives are generally not at risk. In contrast, when operations suffer at a hospital or a nursing home, or when a rural clinic serving an isolated area faces possible closure, vulnerable patients are put at risk. In recognition of this stark reality, unique rules designed to promote patient health and address community needs apply in healthcare bankruptcies.
The goal of a typical 363 sale is to maximize creditor recoveries by selecting the bid that represents the highest and best offer for the debtor’s assets. In a corporate bankruptcy, this determination usually centers on which proposal is superior monetarily. In a healthcare restructuring, however, courts do not “mechanically apply bankruptcy principles of ‘highest and best’ offer,” and a bid that promotes patient and community interests can trump an otherwise financially superior offer.18
Accordingly, a party interested in acquiring a healthcare business’ assets at an auction could consider addressing issues that advance public health interests or further the debtor’s healthcare mission.
In addition to increasing the value of its bid in the eyes of the court, such an approach may also likely garner support from key constituencies (e.g., regulators, employees, community groups, and patients).
Other unique Bankruptcy Code provisions designed to protect patients include those relating to the transfer of patients from a closing facility, the disposal of patient records (highly confidential documents under federal and state law), and granting administrative expense priority to associated costs.
First, in any Chapter 7 or 11 case, a debtor seeking to close a healthcare business must “use all reasonable and best efforts” to transfer patients to another appropriate healthcare business that is in the vicinity, provides substantially similar services, and maintains a reasonable quality of care.19
Second, when a debtor lacks funds to store patient records in the manner required by federal and state law, Bankruptcy Code section 351 requires that the debtor provide personal and publication notice that the records will be destroyed (or transferred to an insurance provider, if permitted by applicable law) unless claimed within one year.
Lastly, to incentivize compliance with these provisions, Bankruptcy Code section 503(b)(8) grants administrative expense priority to the expenses of closing a healthcare business, transferring patients, or disposing of patient records. This provision should be considered when decisions relating to the viability of a healthcare provider are deliberated and made.
Given the continued uncertainty surrounding the future of the Affordable Care Act, coupled with the numerous stressors constantly threatening to tip healthcare providers into financial distress, the healthcare industry will likely remain a fertile source of work for financial restructuring professionals for years to come. By internalizing the lessons contained herein, and with careful planning and forethought, you will be able to help your clients navigate complex issues in healthcare restructuring.
1. 42 U.S.C. § 405(h) (emphasis added).
2. See In re Town & Country Home Nursing Serv., Inc., 963 F.2d 1146 (9th Cir. 1992).
3. See, e.g., In re Bayou Shores SNF, LLC, 828 F.3d 1297 (11th Cir. 2016) (bankruptcy court lacked jurisdiction to review Medicare claims under 28 U.S.C. § 1334), cert. denied Bayou Shores SNF, LLC v. Fla. Agency for healthcare Admin., 137 S. Ct. 2214 (2017); Bodimetric Health Servs., Inc. v. Aetna Life & Cas., 903 F.2d 480 (7th Cir. 1990) (district court lacked jurisdiction to review claims under 28 U.S.C. § 1332 (diversity jurisdiction)); Nichole Med. Equip. & Supply, Inc. v. TriCenturion, Inc., 694 F.3d 340, 346-47 (3d Cir. 2012); Midland Psychiatric Assoc. Inc. v. U.S., 145 F.3d 1000, 1004 (8th Cir. 1998).
4. Pub. L. No. 98-369, 98 Stat. 1162, §2664(b).
5. See Benjamin v. U.S., SSA (In re Benjamin), 2019 U.S. App. LEXIS 22233, *8 (5th Cir. 2019).
6. Id. at *9.
7. 11 U.S.C. § 365.
8. 1998 Bankr. LEXIS 2031 (Bankr. M.D. Fla. 1998).
9. 396 B.R. 232 (Bankr. D. Mass. 2008).
10. Id. at 240.
12. Id. at 241.
13. See e.g., In re Univ. Med. Ctr., 973 F.2d 1065 (3d Cir. 1992); In re Heffernan Mem’l Hosp. Dist., 192 B.R. 228 (Bankr. S.D. Cal. 1996); In re St. Johns Home Health Agency, Inc., 173 B.R. 238 (Bankr. S.D. Fla. 1994).
14. 2019 Bankr. LEXIS 2983 (Bankr. C.D. Cal. Sept. 26, 2019).
15. Id. at *15.
16. Id. at *18-*19
17. See Parkview Adventist Med. Ctr. v. U.S., 842 F.3d 757 (1st Cir. 2016).
18. See, e.g., In re HHH Choices Health Plan, LLC, 554 B.R. 697, 710 (Bankr. S.D.N.Y. 2016) (“the Bethel proposal is more fully aligned with the [hospital’s] mission. Bethel proposes to continue . . . the care facilities, not merely to compensate some of the residents for the effects of losing those facilities. Having a care facility in the same community, near to the residents’ homes and friends, was part of the original stated mission of [the debtors]. Under the Bethel proposal, the facility would continue for the benefit of current residents, and the facility would continue to be marketed in that same way to new residents, which is more consistent with the original mission”).
19. 28 U.S.C. §§ 704(a)(12) and 1106(a)(1).
©All Rights Reserved. September, 2020. DailyDACTM, LLC
Gregory A. Kopacz is an Associate in the Sills Cummis & Gross P.C. Creditors’ Rights/Bankruptcy Reorganization Practice Group. He represents debtors, official and ad hoc committees, lenders and strategic parties in insolvency proceedings, distressed transactions, out-of-court workouts and related litigation. His professional profile may be viewed at http://www.sillscummis.com/professionals/attorneys/gregory-a-kopacz1.aspx.
Andrew H. Sherman is Chair of the Sills Cummis & Gross P.C. Creditors’ Rights/Bankruptcy Reorganization Practice Group. He represents clients in a broad range of complex business reorganizations, debt restructurings and insolvency matters throughout the U.S. His professional profile may be viewed at: http://www.sillscummis.com/professionals/attorneys/andrew-h-sherman.aspx.
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