Kenneth A. Rosen

Get ready for a spate of healthcare bankruptcies.

The sector is facing some ugly realities. Medicaid payments are not keeping up with inflation and the disproportionate number of deaths in nursing homes as a result of COVID-19 may draw stricter regulatory scrutiny, as well as litigation. Additionally, states facing budget crunches will likely reduce reimbursements.

This means anyone in healthcare sector to know the ins and outs of chapter 11.

How to know the players involved

Chapter 11 has two primary goals — increase sales and reduce expenses. But that’s increasingly difficult for healthcare businesses because of government oversight, complex reimbursements, case and payer and state and federal recoupments. Additionally, healthcare bankruptcies often involve additional players, i.e., elected officials, unions, regulators and patients, whose concerns and interests may conflict with those of the debtor.

Specifically regarding nursing homes, there can be a push/pull between jeopardizing patients and closing a facility that provides needed services — especially for people who are disadvantaged. The public interest will weigh heavily on the bankruptcy judge.

How to effectively communicate

Effective communication is also key. As in most Chapter 11s, management should develop a communications plan to keep employees aware that their pay and benefits will continue. But for health care companies, plans must include updating patients and their family members that patient care will not erode. Further, appropriate state regulatory authorities should be alerted in advance and assured that required remediation or repairs will be made on time.

Finally, smart organizations should be prepared to explain to the media that the filing (presumably) was the result of external causes, burdensome contracts/leases, excess leverage, etc., all of which will be remedied as part of the Chapter 11 process.

How oversight works

When a healthcare business files for Chapter 11, an ombudsman is often appointed to monitor the quality of patient care and represent the interests of the patients — unless the bankruptcy court deems that unnecessary. This is part of how bankruptcy courts examine how a health care business operates. One frequently cited court decision listed the following factors: (1) cause of the bankruptcy; (2) presence and role of licensing or supervising entities; (3) history of patient care; (4) ability of patients to protect their rights; (5) level of dependency of the patients on the facility; (6) likelihood of tension between the patient’s interests and the debtor; (7) potential injury to patients if the debtor drastically reduced its level of patient care; (8) presence and sufficiency of internal safeguards to ensure the appropriate level of care; and (9) impact of the cost of an ombudsman on the likelihood of a successful reorganization.

Another court listed additional factors: (1) quality of the debtor’s current patient care; (2) debtor’s financial ability to maintain quality care; (3) whether the debtor has an internal ombudsman program; and (4) level of oversight of the debtor by governmental and professional association programs.

Additionally, secured lenders often demand the appointment of chief restructuring officers (CRO) as a condition to the lender providing consensual funding for reorganization. The CRO manages the bankruptcy process, but their duties can overlap with the ombudsman. Ideally, the CRO will have demonstrable skills to reduce the likelihood of an ombudsman being appointed.

How the bidding process works

How do you win a bid in a bankruptcy auction? It’s simple — bid better than anybody else.

But a bid can be better without being higher, provided the bidder is better capitalized and is fully financed without contingencies — such as licensability. In bankruptcy cases involving health care, courts may also consider the importance of preserving the provider’s services to the community. Prior penalties, historic quality of care and preferences of regulators regarding the bidder also may be factors.

How automatic stays work

The automatic stay (equal to an injunction) stops litigation against a debtor upon commencement of Chapter 11, with an exception being police and regulatory matters. Regulators cannot continue collection efforts for a civil or monetary penalty. But state and federal regulators will continue many of their functions as if the Chapter 11 case had not started.

With respect to health care bankruptcies, the automatic stay does not apply to recoupment. Thus, the government may exercise its right of recoupment without court approval.

How to build a budget

A debtor’s bank will require a 13-week budget. It should include a line item for a potential ombudsman’s fees and project anticipated reimbursement delays, increased payroll or other costs to bring care up to par, likely recoupments and costs of remediation or repairs required or requested by the ombudsman or by regulators.

It’s also important to understand how privacy law applies. Several non-bankruptcy laws protect patient privacy (e.g., the Health Insurance Portability and Accountability Act of 1996) and debtors must continue to comply with these laws once they file for bankruptcy. The potential compliance costs in the event of closure should be included in the budget as a contingency item.

If a healthcare business will close, it must transfer patients to another facility subject to regulatory oversight. The costs incurred in notifying patients of the impending destruction of their records as well as the closure costs must be funded. If the debtor is administratively insolvent, the costs of destroying these records potentially could be surcharged against a lender’s collateral.

It is best to have a contingency line item in the 13-week budget for potential closure-related costs with an agreed upon cap. However, the lender may require a reserve from funds otherwise available to the debtor.

How to deal with investigations

A principal function of a creditors committee is investigating debtor’s financial and business affairs. A committee investigation can delve into such matters as inter-company transactions, common management, insider transactions, related-party transactions, sale/leaseback of real estate, prior shareholder withdrawals, pre-bankruptcy sponsor or management fees and whether COVID-19 was the primary cause or only the precipitating cause of bankruptcy. It is important for management to do a self-analysis of these issues because they may become the creditors’ leverage points in future negotiations. The risk of paying back funds to the estate (and the costs associated with such litigation) to settle with creditors in chapter 11 should be weighed in pre-bankruptcy workout negotiations intended to avoid Chapter 11.

Chapter 11 for healthcare facilities requires unique planning because of the additional parties in interest at the negotiating table. The likely demands and requirements of each of them (and their underlying motivation) must be anticipated in advance to avoid business disruption, loss of management credibility, delay in emerging from bankruptcy protection and closure.

Kenneth A. Rosen is the New York-based partner and chair of the Bankruptcy, Financial Reorganization & Creditors’ Rights practice group at law firm Lowenstein Sandler.