What Does Chapter 9 Bankruptcy Mean for Public Hospitals?

Since 2003, 17 different healthcare districts and public hospitals have declared Chapter 9 bankruptcy — debt reorganization specifically for government and municipal organizations.

Several of those hospital bankruptcies occurred in the past two years alone. These include Mendocino Coast District Hospital in Fort Bragg, Calif., Pauls Valley (Okla.) General Hospital, Hardeman County Memorial Hospital in Quanah, Texas, Westlake Regional Hospital in Columbia, Ky., and Charlton Memorial Hospital, a critical access hospital in Folkston, Ga., that was forced to close its doors in August.

According to a recent paper from Drinker Biddle, the surge in Chapter 9 bankruptcies from public hospitals has come about for several reasons. Reductions in federal and commercial payer reimbursements, a rise in uninsured and charity care patients, high costs associated with new regulatory requirements, lagging patient volumes, poor management and overly aggressive expansion plans are but some.

Requirements for Chapter 9 bankruptcy

Healthcare districts and public hospital authorities contemplating filing for Chapter 9 bankruptcy have to meet certain eligibility requirements, according to the Drinker Biddle paper. Namely, there are five main criteria.

•    The hospital/entity must be a municipality. That is, the hospital must be a public arm of the state. Hospitals that go through Chapter 9 bankruptcy are usually either county- or state-owned.

•    The municipality must be authorized to be a debtor. Usually, a public hospital is run by an authority that has the ability to take on debt, like issuing bonds to build or expand the hospital.

•    The municipality must be insolvent. According to Drinker Biddle, the U.S. Bankruptcy Code defines insolvency as a municipality that can't pay its debts as they become due. However, courts have said that does not mean a hospital has to be "cash insolvent." A hospital may still have some cash on hand, but it may not be able to pay its debt obligations this year, next year or, in some instances, longer term.

•    The municipality must show it has a plan of attack. In legalese, the hospital must "desire to effect a plan to adjust its debt." However, a hospital does not need to have a plan prior to filing for bankruptcy — it just needs to show evidence it wants to take reasonable action through bankruptcy.

•    The municipality must have negotiated with creditors before filing. This criterion is important because it shows a hospital is using bankruptcy as a last resort. To fulfill this requirement, a hospital must do one of the following: approve an adjustment plan with at least a majority of affected creditors; show it negotiated in good faith with creditors but was unable to reach a deal; indicate that negotiations are infeasible due to complexity; or show that one of its creditors tried to obtain a "preferential payment" and therefore could not negotiate with all creditors.

Potential advantages

Bankruptcy is never a desirable result for a healthcare organization, but public hospitals that face financial distress and must reorganize their debt could see some advantages in filing Chapter 9 bankruptcy, according to the Drinker Biddle paper. For example, creditors don't have an option to file petitions or competing plans of adjustment.

In addition, bankruptcy courts have limitations as to how much they can interfere with Chapter 9 debtors.

Potential burdens

Hospitals that look toward Chapter 9 face several challenges, most notably being the outlined eligibility requirements. The criteria are specific, but Drinker Biddle partners said there is usually more leniency for public hospitals to meet them.

"For healthcare districts and hospital authorities that operate public hospitals, a Chapter 9 filing involves a higher bar of eligibility, although the empirical data suggest healthcare districts and hospital authorities may perhaps be less likely to have their eligibility contested than other Chapter 9 debtors," according to the paper.

More Articles on Hospital and Bankruptcy:
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In Hunt of Partner, Fairmont General Hospital Files for Bankruptcy
9 Primary Reasons Why Hospitals File for Bankruptcy

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