It’s Complicated: Regulatory Challenges to Healthcare Provider Bankruptcies

Industry-specific regulatory challenges complicate many debtors’ attempts to reorganize in bankruptcy. Indeed, those challenges may effectively preclude a debtor from reorganizing in bankruptcy. For example, colleges and universities are not expressly precluded from seeking relief under the Bankruptcy Code. Nevertheless, because students attending colleges or universities in bankruptcy are no longer eligible for federal financial aid, a bankruptcy filing is the death knell for most colleges and universities, dependent as they are on their students’ federal financial aid eligibility for revenues. Recent developments in healthcare provider bankruptcies demonstrate and underscore the significant regulatory challenges complicating the reorganization of healthcare providers, even to the point of effectively precluding reorganization in bankruptcy. This article will briefly address four of those cases.

Bayou Shores SNF, LLC
The July 11, 2016 opinion of the U.S. Court of Appeals for the Eleventh Circuit in In re Bayou Shores SNF, LLC (Docket No. 15-13731) addressed the issue of whether a debtor’s failure to exhaust its administrative remedies deprived the bankruptcy court of subject matter jurisdiction over the question of whether the debtor could assume its Medicare and Medicaid provider agreements as part of a plan of reorganization. Florida-based Bayou Shores SNF, LLC (“Bayou Shores”) filed a bankruptcy petition in response to a notice of termination issued by the Center for Medicaid and Medicare Services of the U.S. Department of Health and Human Services (“HHS”). The admitted goal of the petition was to prevent the termination of Bayou Shore’s Medicare provider agreements with HHS and the Florida Agency for Health Care Administration (“AHCA”).¹ The termination of those agreements would have deprived Bayou Shores of the Medicare and Medicaid reimbursements that provided approximately 95 percent of its revenues.

Over the objection of both HHS and AHCA, the bankruptcy court confirmed Bayou Shores’ chapter 11 plan of reorganization which provided, inter alia, for Bayou Shores’ assumption of its provider agreements with them. The district court reversed the confirmation order to the extent that it authorized the assumption of the provider agreements, and the Eleventh Circuit affirmed. The Eleventh Circuit concluded that the bankruptcy court had lacked subject matter jurisdiction over the assumption of the provider agreements, because Bayou Shores had not exhausted its administrative remedies in response to HHS’s notice of termination. The Eleventh Circuit grounded its conclusion in the provisions of 42 U.S.C. § 405(h), which generally preclude resort to judicial review of HHS’s determinations of Medicare-related issues, such as HHS’s determination to terminate Bayou Shores’ provider agreement, until all administrative remedies had been exhausted.

However, the Bayou Shores saga is not over yet. The Eleventh Circuit’s ruling created a circuit split with respect to a previous opinion of the U.S. Court of Appeals for the Ninth Circuit in In re Town & Country Home Nursing Servs., 963 F.2d 1146 (9th Circ. 1991). On February 2, 2017, Bayou Shores filed a petition for writ of certiorari with the U.S. Supreme Court (Docket No. 16-967). The response of HHS and AHCA is due on May 5, 2017. Particularly in light of the current uncertainty of the future makeup of the court, it is not clear how the Supreme Court will resolve the split. Arguments that support a reversal of the Eleventh Circuit’s ruling include the following: (i) 42 U.S.C. § 405(h) does not expressly preclude recourse to courts exercising federal bankruptcy jurisdiction; (ii) Congress has had ample opportunity to amend the statute to expressly include such courts in the statute’s purview; and (iii) a debtor’s proposed assumption of a provider agreement arguably raises bankruptcy and not Medicare issues. It also bears noting that most healthcare providers rely heavily on Medicare and Medicaid for revenue. Appealing an HHS notice of termination is a lengthy and time-consuming process. Hence, the loss of Medicare and/or Medicaid revenues while administrative remedies are exhausted would preclude the reorganization of most debtor healthcare providers.² The Supreme Court’s ruling could be crucial to the viability of many healthcare provider reorganizations.

Parkview Adventist Medical Center
In a case that it characterized as “an important case resting at the intersection of the Bankruptcy Code and Medicare Law,” the U.S. Court of Appeals for the First Circuit expressly declined to “add [its] voice to the circuit split on [the] difficult issue” of whether 42 U.S.C. § 405(h) deprived the bankruptcy court of subject matter jurisdiction over a Medicare question pending the debtor’s exhaustion of administrative remedies. Parkview Adventist Medical Center v. United States, 842 F.3d 757, 758, 760 (1st Cir. 2016). Instead, the First Circuit decided the issue on the merits.

Prior to June 15, 2015, Parkview Adventist Medical Center (“Parkview”) operated a hospital in Maine that providedboth inpatient (covered by Medicare Part A) and outpatient (covered by Medicare Part B) services. Parkview maintained a Medicare provider agreement with HHS and participated in the Medicare program. By letter dated June 15, 2015, Parkview advised HHS that it was: (i) withdrawing from the Medicare program as an acute care provider; (ii) filing a chapter 11 bankruptcy petition the following day; (iii) ceasing operations as an acute care hospital provider effective as of the date of an order of the bankruptcy court approving the cessation; (iv) transitioning acute care services to another provider, and (v) operating thereafter solely as an outpatient clinic. On June 16, 2015, Parkview filed its chapter 11 bankruptcy petition.

By letter dated June 19, 2015, HHS replied that it would terminate Parkside’s Medicare Part A (hospital) provider agreement effective June 18, 2015³ on the basis that it no longer operated as a hospital for purposes of the Medicare provisions of the Social Security Act and would not reimburse Parkview for services provided after that date. The Maine Department of Human Services issued Parkview a conditional license limited to providing outpatient services during the pendency of the bankruptcy case. Parkview objected to HHS’s termination of its provider agreement, contending that the termination would adversely affect Parkview’s bankruptcy transition plan. HHS advised Parkview that it would reinstate the provider agreement if Parkside agreed to resume admitting inpatients. Parkview responded by filing a motion to compel HHS’s post-petition compliance with the provider agreement, the termination of which, according to Parkside, violated, inter alia, § 362 of the Bankruptcy Code. The bankruptcy court denied the motion. The district court affirmed on appeal. On subsequent appeal, the First Circuit affirmed. Parkside, 842 F.3d at 760.

In upholding the district court’s opinion, the First Circuit determined that HHS’s termination of the provider agreement with Parkside furthered the general policy of ensuring that Medicare reimbursements are not being made to institutions that fail to meet the applicable Medicare qualification standards. Parkside, 842 F.3d at 764. Here, as the First Circuit pointed out, the standards were those for hospitals, and

“[r]eimbursing Parkview pursuant to the provider agreement after it had taken actions to disqualify itself from the Medicare program, rendering it unable to provide services required by that program, would have been a waste of public moneys.”

Id. at 764. Reimbursing Parkside after its self-disqualification as a hospital for purposes of Medicare would threaten HHS’s ability to enforce Medicare’s “carefully articulated regulatory structure.” Id. The First Circuit also noted that HHS was not, by terminating the provider agreement, seeking monetary recovery from Parkside. Id. In other words, HHS was not protecting its pecuniary interests when it terminated the provider agreement. Relying on the foregoing analysis, the First Circuit concluded that HHS’s termination of the provider agreement was an exercise by HHS of its police powers and, for that reason, was exempt from the automatic stay by virtue of the provisions of 11 U.S.C. § 362(b)(4). Id.

The fact situation in Parkview is unusual to say the least. Arguably, Parkview triggered the termination of its provider agreement with HHS by its ill-conceived letter of June 15, 2015. For that reason, it may be tempting to dismiss the First Circuit’s opinion as an outlier. Nevertheless, Parkview does provide courts in healthcare provider bankruptcies with authority to broadly read the police powers exception to the automatic stay to cover actions (like contract terminations) that would violate the automatic stay if a private party had engaged in the same or similar actions.

Vanguard Healthcare, LLC et. al.
Investigation of several nursing homes in Tennessee by HHS and the Tennessee Bureau of Investigation (“Tennessee”) resulted in a determination that they had billed Medicare and TennCare (Tennessee’s Medicaid program) for grossly substandard services and that some of them had submitted false documents to TennCare. On May 6, 2016, the nursing homes filed chapter 11 bankruptcy petitions in the U.S. Bankruptcy Court for the Middle District of Tennessee in a case jointly administered under the name of In re Vanguard Healthcare, LLC, et al., and case number 16-03296. Without seeking relief from the automatic stay from the bankruptcy court, HHS and Tennessee filed a complaint under the False Claims Act (31 U.S.C. §§ 3729-3733) with the U.S. District Court for the Middle District of Tennessee seeking a determination that the nursing homes had violated the False Claims Act by submitting claims for reimbursement for the substandard services they provided. Subsequently, HHS and Tennessee filed a motion with the district court seeking a determination that the automatic stay did not apply to or bar their suit under False Claims Act, which the district court granted.

The automatic stay generally bars the commencement or continuation of litigation against a debtor in bankruptcy on a pre-petition claim. See 11 U.S.C. § 362(a)(1). However, relying on the analysis and reasoning in In re Universal Life Church, Inc., 128 F.3d 1294, 1298 (9th Cir. 1997) and In re Commonwealth Companies, Inc., 913 F.2d 518, 526 (8th Cir. 1990), the district judge determined that the False Claims Act suit filed by HHS and Tennessee constituted an exercise by the United States and Tennessee of their respective police powers and not an action to preserve their pecuniary interests. The district court concluded that the False Claims Act suit served to effectuate important public policy of policing the integrity of the government’s dealings with those to whom it pays money by deterring fraudulent billing and the submission of false documents. Similarly, because HHS and Tennessee were not seeking to collect on a judgment, the suit did not improve their position vis-à-vis other creditors of the Vanguard Healthcare debtors; the only “pecuniary” impact was to fix the amount of their general unsecured claims. Hence, pursuant to 11 U.S.C. § 362(b)(4), the suit was not barred by the automatic stay.

The False Claims Act suit against the Vanguard Healthcare debtors will almost certainly negatively impact their attempt to reorganize. Defense against a False Claims Act suit is very expensive. HHS and Tennessee may be able to interpolate from a sample of patients and records to establish their case, leaving the Vanguard Healthcare debtors with the expensive, time-consuming, and unenviable task of proving a negative – that they did not provide grossly inadequate patient care all while trying to reorganize debtors which may, in fact, be providing deficient care to their patients. Additionally, damages can be enhanced (doubled or trebled) in False Claims Act cases. In sum, the expense, delay, and burdens inherent in defending against a False Claims Act case could preclude the reorganization, and ensure a liquidation, of the Vanguard Healthcare debtors.

Bostwick Laboratories
Even absent the potential termination of a Medicare or Medicaid provider agreement, reimbursement issues bedevil healthcare providers. On March 15, 2017, Bostwick Laboratories, Inc. and certain affiliates (collectively, “Bostwick”) filed chapter 11 bankruptcy petitions in the U.S. Bankruptcy Court for the District of Delaware (Case No. 17-10570). Bostwick provides cancer testing services at a testing facility in New York and, like most healthcare providers, derives a significant portion of its revenues from Medicare and Medicaid reimbursements which, in Bostwick’s case, approximates 40 percent. In her first-day declaration, Bostwick’s CFO, Tammy Hunt, blamed the bankruptcy filing on “unexpected and severe cuts to the Medicare physician fee schedule in 2013,” resulting in significant revenue reductions that could not be offset by cost reductions and the streamlining of operations. See Case No. 17-10570 ECF No. 3 at ¶¶ 18-21. No doubt also negatively impacting Bostwick’s financial situation was the $2.7 million balance on a $7 million settlement Bostwick reached with the United States in August 2014 to resolve claims that Bostwick had billed Medicare for unnecessary cancer tests.

The bankruptcy filing did not immediately provide Bostwick with the breathing room debtors need and seek to reorganize their affairs. On March 17, 2017, two days after the bankruptcy filing and ten minutes before the “first day” hearings, the United States instituted a temporary freeze on Medicare reimbursements due Bostwick. The freeze was a prelude to the United States recouping overpayments it may have made to Bostwick from reimbursements due to Bostwick. In contrast to setoff, recoupment does not require prior relief from the automatic stay. See 11 U.S.C. §§ 362(a)(7), 553. Third Circuit precedent limits the United States’ exercise of recoupment, however, permitting the United States to recoup overpayments only during the cost year in which the bankruptcy petition was filed from reimbursements otherwise due the debtor for post-petition services, but only as to post-petition services provided during the same cost year. See University Medical Center v. Sullivan, 973 F.2d 1065, 1081-82 (3rd Cir. 1992). Recovering overpayments from one cost year by withholding reimbursement for services provided during another cost year constitutes a setoff requiring prior relief from the automatic stay. Id. at 1084. Nevertheless, because Bostwick relies heavily on Medicare reimbursements for revenue, the United States’ proposed freeze on Medicare reimbursements would have deprived Bostwick of funds it needs to reorganize.

Despite the crisis that enveloped the case during its first week, Bostwick could be deemed an example of “all’s well that ends well.” By March 20, 2017, Bostwick, Poplar Healthcare PLLC (the proposed debtor-in-possession lender and stalking horse bidder), and the United States had reached a compromise pursuant to which the United States would release its freeze, allow Medicare reimbursements to be paid to Bostwick. However, the settlement also recognizes the United States’ setoff rights and expressly allows recoupment as permitted by University Medical Center.⁴

Arguably, being subject to recoupment or setoff claims makes healthcare provider debtors no different from other debtors. However, Medicaid and Medicare reimbursements provide a significant portion of the revenues of most healthcare providers. Recoupment or setoff of overpayment claims (which can be quite large) against reimbursements for post-petition services could easily deprive a debtor of the revenues it needs to reorganize. For that reason, setoff and recoupment claims have a greater potential to derail a reorganization in a healthcare provider’s bankruptcy case than they do in bankruptcy cases filed by debtors in most other industries.

Conclusion
The title of a 2009 movie starring Meryl Streep and Alec Baldwin encapsulates the regulatory challenges facing healthcare provider bankruptcies – It’s Complicated. Much of that complication arises from the three roles federal (Medicare) and state (Medicaid) healthcare financing agencies play in those bankruptcies: regulator, creditor, and significant revenue source. As governmental entities, those agencies enjoy freedom of action vis-à-vis bankruptcy that private creditors lack. As demonstrated by the Eleventh Circuit’s ruling in Bayou Shores, statutory requirements like exhaustion of remedies may effectively preempt provisions of the Bankruptcy Code, such as those governing the assumption and rejection of contracts or the confirmation of a plan of reorganization. Indeed, such “preemption” may preclude the bankruptcy court’s exercise of subject matter jurisdiction to adjudicate matters typically regarded as core bankruptcy issues if they can be characterized as “Medicare” or “Medicaid” issues.

As demonstrated by the First Circuit’s opinion in Parkview, the post-petition termination of an executory contract (e.g., a Medicare provider agreement) that would be barred by the automatic stay if brought by a private party becomes an exercise of police power exempt from the automatic stay by 11 U.S.C. § 362(b)(4) if brought by a governmental entity. Similarly, as demonstrated by the holding in Vanguard Healthcare, litigation against a debtor (e.g., a False Claims Act suit) that is normally stayed by 11 U.S.C. § 362(a)(1) might be exempted from the automatic stay as an exercise of police power.⁵ As underscored by the crisis that consumed the first week of the Bostwick case, recoupment and setoff rights held by HHS and state health financing agencies loom large in healthcare provider bankruptcies, even if the amount of a purported overpayment has not been liquidated. The end result of those challenges could be the inability of providers with operational deficiencies or significant overpayment liability to reorganize.

If you have any questions concerning the issues addressed in this article, contact the author at dcrapo@gibbonslaw.com or (973) 596-4500.

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¹ AHCA administers Florida’s Medicaid program. A termination of Bayou Shores’ Medicare provider agreement would have resulted in a termination of its Medicaid provider agreement with AHCA. See 42 U.S.C. § 1396a(a)(39); Fla. Stat. § 409.913(14).
² For a more detailed discussion of this point, see Samuel R. Maizel and Michael B. Potere, “Killing the Patient to Cure the Disease: Medicare’s Jurisdictional Bar Does Not Apply to Bankruptcy Courts,” 32 Emory Bankr. Dev. J. 19 (2015).
³ According to its website, Parkview had discharged all of its inpatients by 4:00 p.m. on June 18, 2015 and was no longer admitting inpatients, but was continuing to treat patients on an outpatient basis.
⁴ The proposed settlement also guarantees the payment in full of the outstanding $2.7 million balance of the pre-petition settlement between Bostwick and the United States, suggesting that the HHS freeze was primarily motivated by HHS’s concerns about the payment of the $2.7 million settlement balance.
⁵ It bears noting that the district court in Vanguard Healthcare expressly left open the question of whether a qui tam suit brought by a private citizen under the False Claims Act would enjoy the police power exemption of § 362(b)(4).