Health Care Bankruptcy: Not An Ordinary Chapter 11 Case

Various factors including increased competition and reimbursement landscape challenges led hospitals and other health care providers to file for bankruptcy over the last few years. For the remainder of 2017, due in part to the current uncertainty in the health care 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 Health Care Provider Chapter 11

The Patient Care Ombudsman

Health care provider bankruptcies differ from garden-variety Chapter 11 cases, as they address unique issues regarding 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 circumstances of the case. The ombudsman must report every 60 days regarding the quality of patient care. The fees of the ombudsman are paid by the bankruptcy estate and are entitled to administrative expense priority.

Government and Private Insurance Company Payers

Health care provider bankruptcies 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.

Pledging Government Receivables as Collateral

Many times 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 health care programs. These anti-assignment rules require that Medicare and Medicaid payments be made only to a deposit account over which the health care 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 workaround mechanism in which the government receivables 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. 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.

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 a health care 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. The federal courts 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. Some circuit courts have determined that a requirement to exhaust administrative remedies is inapplicable in bankruptcy cases; others have found that exhaustion of administrative remedies applies even in federal bankruptcy court. A provider in bankruptcy currently has a petition on file with the U.S. Supreme Court for certiorari review of this issue.

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.

Payer Take-Backs as Setoffs or Recoupment

The government system regarding Medicare and Medicaid payments differs meaningfully from private insurance company payments. 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. 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.

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. 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. 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 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. Recoupments, however, are not subject to the automatic stay nor the distribution scheme for creditors, and may not be discharged in a bankruptcy sale or plan confirmation. However, payer recoupment actions remain an equitable defense remedy subject to judicial determination upon challenge by a provider.

A Fight Worth Fighting For

The relationship between the Medicare/Medicaid programs and providers is captured in a written provider agreement, which afford providers a license/number to participate in the Medicare/Medicaid prospective reimbursement program. A dispute arises 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.

Providers and purchasers tend to argue that the provider licenses/numbers are not executory contracts and 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.

However, 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. Because of this, many times settlements are reached and workarounds are accomplished, such as setting up a portion of the sale proceeds in escrow or setting up a waterfall overpayment recovery scheme from the sale proceeds, other bankruptcy estate funds on hand and then perhaps a budgeted annual-capped amount from the purchaser.


Health care provider Chapter 11 cases are multifaceted and include additional parties and issues than in standard Chapter 11 cases. A financially distressed provider considering Chapter 11 is best served to 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.

Providers should aim to move the case to the sale and Chapter 11 plan process expeditiously where the jurisdictional, license and setoff-recoupment issues can be teed up and addressed in short order, during which time patient care can be properly maintained pending litigation and further settlement discussions with the creditor constituents.

—By David A. Samole, Kozyak Tropin & Throckmorton LLP

David Samole is a partner at Kozyak Tropin in Miami. He handles an array of corporate bankruptcy matters, as well as litigation on behalf of healthcare providers.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

 Click here for the original article.