Healthcare providers: Financial distress isn’t going away

Given the serious challenges and uncertainty facing the healthcare services industry, both in the political arena with the current attempts to repeal and replace the Affordable Care Act and from the strong financial and operational headwinds, providers facing financial and operational distress need greater insight into the process that management often perceives as the option of last resort—bankruptcy.

With strategic planning, good counsel, and sufficient runway, which are critical in restructuring healthcare providers, bankruptcy can be a valuable mechanism to preserve value, jobs, and continuity of healthcare services for communities. Acquiring distressed healthcare companies out of bankruptcy can also provide advantages to healthy healthcare businesses looking to increase their footprint, maximize economies of scale, and increase leverage with payor agreements. In short, financial restructuring should be brought from the back of management’s mind to the boardroom because ignoring financial and operational problems does not make them go away—it makes them worse.

Traps for the Unwary

Healthcare restructurings are extraordinarily complex because they involve not only the complications of typical bankruptcies but also require practitioners to navigate a minefield of healthcare-specific fiduciary, governmental, regulatory, and contractual issues. Substantial regulatory approvals from federal, state, and local levels, together with the need to ensure that the stream of government payments continues during the bankruptcy process, necessitate early planning. Bellyflops into healthcare bankruptcies don’t end well. Here are a few of the common healthcare stumbles to avoid.

Provider Agreements & Automatic Stay. Preserving payment streams and access to capital is key in bankruptcy, particularly in healthcare restructurings where the availability of cash is critical to continuity of patient care. One potential payment crisis that arises in bankruptcy is termination of the Medicare provider agreement by the Centers for Medicare & Medicaid Services (CMS). Generally, when a healthcare business files for bankruptcy, an “automatic stay” applies, preventing most parties to supply or provider agreements from terminating them. The automatic stay provides a breathing spell for debtors to deal with creditors. Despite the automatic stay in bankruptcy, CMS has often sought to terminate its provider agreements by using, among other things, the police or regulatory power exception to the automatic stay found in the Bankruptcy Code.

In one case, for example, the court allowed CMS to terminate the provider agreement despite the automatic stay, reasoning that the “police and regulatory powers” exception applied because CMS had a strong public policy interest in enforcing the qualification standards for Medicare participation. In another case where CMS terminated a skilled nursing facility’s (SNF) provider agreement in bankruptcy, a court determined that the bankruptcy court lacked authority to impose the automatic stay. Because the Medicare provider agreement is often a healthcare provider’s most significant asset, avoiding termination by demonstrating continued qualification is often the key to a successful bankruptcy process.

Administrative Freeze. Beyond termination of the Medicare provider agreement, healthcare providers in bankruptcy also face the possibility of an administrative freeze on payments by CMS. Perhaps one of the best recent examples of this is the Bostwick Laboratories Inc. bankruptcy case. Shortly after Bostwick Laboratories landed in bankruptcy, the U.S. Department of Justice on behalf of CMS instituted a temporary administrative freeze connected to alleged Medicare overpayments, creating an immediate liquidity crisis that likely would have caused Bostwick—and its planned asset sale—to collapse. Without access to the Medicare payments that provided roughly 40% of its revenues, Bostwick could not continue operating. Ultimately, CMS, Bostwick, and the buyer settled the matter, with concessions favoring CMS so that the freeze could be lifted.

CMS can attempt to use this temporary administrative freeze as a way to recoup or preserve its right of setoff for any claimed overpayments. Depending on where the bankruptcy case is filed, overpayments will be subject to either recoupment or setoff. Recoupment, unlike setoff, allows CMS to “net out” pre-petition Medicare/Medicaid overpayments against post-petition reimbursements free from the automatic stay. By contrast, setoff only permits pre-petition debts to be netted out under the Bankruptcy Code, and CMS must obtain court permission to exercise the right of setoff. If the bankruptcy case is filed in a court applying recoupment to overpayment liabilities, the healthcare provider could immediately suffer a severe liquidity crisis by putting post-petition reimbursements at risk, which will materially hamper, if not wholly destroy, the chances of a successful reorganization or asset sale. A healthcare provider facing bankruptcy will therefore want to carefully consider where to file the case.

Regulatory Approvals. In addition to the liquidity issues that the government may create by its reaction to a healthcare provider’s bankruptcy, the government also continues to control the licenses and other regulatory requirements governing the healthcare business. Specifically, despite the bankruptcy proceeding, management must continue to “manage and operate” the business “according to the requirements of the valid laws of the state” in which the business is conducted. Historically, states have not provided leniency to bankrupt healthcare providers because of concerns with patient safety. Further, each state has specific laws and regulations governing the transfer of healthcare assets. Regardless of a bankruptcy proceeding, the healthcare provider and purchaser must not only obtain necessary operating licenses or certificates of need but also the consent of the state attorneys general tasked with ensuring that the transfer of healthcare assets is in the public’s interest. Planning for these ongoing operational and transfer requirements is therefore paramount to a successful bankruptcy process.

To illustrate how agencies and regulators can drastically alter Chapter 11 bankruptcies, in one recent case, a full-service teaching hospital and SNF consented to an involuntary bankruptcy petition in New York, and the New York Department of Health (DOH), CMS, the U.S. Attorney General, and the Public Health and Planning Council eventually determined the outcome of the proceeding. Three days after the petition, the DOH stated that it was “extremely concerned about the current ability of [the hospital] to admit new patients in a manner that maintains patient safety and meets minimum standards required by the State Hospital Code” and then immediately prohibited the hospital from accepting new patients (though it allowed the hospital to reopen the following month). A few months later, after the DOH conducted another survey of the clinical lab and found “serious deficiencies,” the DOH issued two summary orders suspending the lab for 30 days and then suspending operations at the hospital for the same period because it reasoned that operating without a lab posed a danger to patients. The U.S. Trustee then filed a motion to appoint a Chapter 11 trustee to the case, pointing to the DOH orders as evidence of the hospital’s mismanagement. As a result, the court appointed a trustee, divesting management from control over the case.

Other Issues for Consideration in Healthcare Restructurings

Nonprofits. Boards and management for healthcare providers must consider how they are exercising their fiduciary duties when a healthcare business passes into the zone of insolvency, and because many providers are nonprofits, the board of trustees must also follow its “duty of obedience” to the nonprofit’s charitable mission, purposes, and goals. Sage advice from experienced healthcare restructuring counsel is a must.

Patient Protections. Within 30 days after a “healthcare business” files bankruptcy, the court will order the appointment of a patient care ombudsman (PCO) to monitor the quality of patient care and to represent the interests of patients. The PCO is empowered to monitor patient care, interview physicians, provide reports to the court concerning patient quality care concerns, and move the court to remedy deficiencies. If the PCO has concerns with patient care, it could seek relief from the court to implement changes, which could materially alter a provider’s business and margins. In addition to the appointment of the PCO, healthcare businesses that file bankruptcy to liquidate their assets have an obligation to “use all reasonable and best efforts” to transfer patients to an appropriate healthcare facility near the closing facility that can provide those patients with substantially similar services.

Medical Records Retention/Destruction. The Bankruptcy Code may relieve a liquidating healthcare business from requirements to properly maintain medical records, which could save millions of dollars. To take advantage of this relief, however, the business must provide extensive notice and allow patients to reclaim their records for one year. Only then may the healthcare company notify the “appropriate federal agencies” to request that they accept the records. If no agency accepts the records, the healthcare provider must destroy them.

Antidiscrimination. The Bankruptcy Code protects healthcare businesses in bankruptcy by prohibiting the government from refusing to renew or seeking to exclude providers from participating in the Medicare program because the provider filed bankruptcy or has become insolvent. This provision serves as a potential defense for providers to consider in the bankruptcy context.

Critical Thinking at Critical Times

Despite the uncertainty in the healthcare industry, healthcare providers can control when they ask for help and who they ask. Working with experienced, trusted lawyers, turnaround consultants, investment bankers, and other restructuring professionals who specialize in insolvency is a prerequisite to success.

By Jonathan Edwards, partner in Alston & Bird’s Bankruptcy & Financial Restructuring group, and Sarah Ernst, partner in the firm’s Health Care group.

The views, opinions and positions expressed within these guest posts are those of the author alone and do not represent those of Becker's Hospital Review/Becker's Healthcare. The accuracy, completeness and validity of any statements made within this article are not guaranteed. We accept no liability for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with them.

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