INSIGHT: Selling Medicare Participation Rights Free and Clear of Debts to CMS

One of the most intractable problems faced in health-care restructurings is the borrower’s inability to transfer their Medicare relationships, as we noted in a prior article.

For many years, it had been assumed that a health-care provider’s entitlement to Medicare reimbursements is a contract right which—to be transferred in bankruptcy—must be assumed and assigned in its entirety, subject to all known and unknown liabilities to the government.

Predictably, the obligation to cure pre-existing defaults, including overpayment obligations to the government, and to be exposed to future Medicare audits for pre-acquisition debts significantly limits the universe of parties that are willing to purchase a health-care business out of bankruptcy.

Two recent bankruptcy decisions have cast doubt on this assumption and revealed a new path for health-care businesses to sell their Medicare reimbursement rights free and clear of the government’s recoupment rights. Both decisions were appealed, and although we promised readers an update as the appellate process played out, both matters have now been settled, eliminating the possibility appellate decisions would bring additional clarity.

Nevertheless, these cases provide valuable lessons as they demonstrate both a new strategy for selling Medicare rights free and clear of successor liability, and the perils associated with trying out that strategy against a resolute opponent with limitless resources.

Prior Assumptions

To participate in the Medicare program and receive reimbursement for services rendered, health-care providers must enter into provider agreements with the government. Provider agreements restate the duties of health-care providers and the government as established by applicable Medicare statutes and regulations.

Once a provider agreement is entered into, the Centers for Medicare & Medicaid Services (CMS) or its agents reimburse the provider for services or goods, but the CMS retains the right to conduct future audits and recoup later-discovered overpayments or debts arising under other statutes, including the False Claims Act. After-the-fact discovery of liability to the government can, quite suddenly, throw an otherwise sound health-care business into turmoil.

When a health-care provider enters bankruptcy, investment bankers are normally engaged to sell the debtor’s assets, including its highly valuable Medicare participation rights. For many years, practitioners assumed a provider agreement must be treated as an “executory contract” under Bankruptcy Code Section 365, which requires that all pre-closing defaults be cured and that the proposed assignee accept responsibility for all the debtor’s obligations.

Since Medicare regulations expose providers to audits for three years and impose successor liability upon a change of ownership, bankruptcy professionals have been resigned to the idea that these burdens are the price of acquiring a provider agreement in bankruptcy.

Predictably, the prospect of being forced to pay substantial sums for a seller’s past violations of law severely depressed investor appetite, meaning that only strategic competitors with their own provider agreements could participate in a sale for a bankrupt provider’s assets. Financial advisors, equity sponsors, and lenders that needed the debtor’s provider agreement to make the investment viable proceeded at their own risk.

Medicare Rights as Saleable Assets?

Two decisions in September 2019 cast doubt on this assumption and have potentially opened a new path for the acquisition of health-care providers in bankruptcy. Specifically, the bankruptcy courts of Delaware in In re Center City Healthcare LLC, Case No. 19-11466, ECF No. 681 (Bank. D. Del. Sep. 10, 2019), and the Central District of California in In re Verity Health System of California Inc., Case No. 2:18-bk-20151, ECF No. 3146 (Bankr. C.D. Cal. Sep. 26, 2019) held that Medicare participation rights are not rooted in contract, but rather constitute “statutory entitlements.”

Both courts found that the applicable provider agreements merely recite the statutory obligations of each party and are not, therefore, “executory contracts.” Rather, they are statutory entitlements that may be sold “free and clear” of pre-existing claims just like other assets.

While the precise contours of these decisions were left to be developed in future cases, their significance is profound. For decades, the government zealously defended the notion participation agreements were executory contracts governed by Bankruptcy Code section 365. Parties interested in acquiring Medicare participation rights were faced with the daunting prospect of curing all known defaults and assuming responsibility for unknown liabilities.

These decisions could change all that, and the government knew it. Allowing Medicare participation to be treated like inventory in a warehouse would allow debtors to escape liability for overpayments and even False Claims Act violations. Naturally, the government appealed both decisions and demonstrated its intention to guard against any change to well accepted industry norms.

Inconclusive Appeals

Shortly after these decisions were rendered, hope of additional guidance from the appellate courts was dashed. Approximately 75 days after the Verity Health decision, the parties reached a settlement whereby (i) the debtors agreed to transfer their provider agreements under Bankruptcy Code Section 365 and subject to the government’s rights, and (ii) the court’s sale order was vacated. Upon court approval of the settlement, the government’s appeal was promptly dismissed.

Likewise, in Center City Healthcare, the government appealed the sale order and obtained a stay pending appeal. The appeal was fully briefed and ready for decision by the end of November. Unfortunately, before the district court issued a ruling, debtor’s buyer terminated its purchase agreement, rendering the matter moot. The district court dismissed the appeal and the sale order was vacated.

Analysis

These decisions provide new hope for health-care providers, their lenders and equity sponsors where Medicare participation rights may serve as the foundation for a Chapter 11 sale. Even if the resolution of these appeals casts doubt over the strength of the lower court rulings, in both cases the parties made compelling arguments that, despite the longstanding supposition that provider agreements must be treated as executory contracts, they are actually “statutory entitlements” that may be sold like other assets free and clear of claims.

For equity sponsors and lenders to health-care businesses, these are two highly significant decisions. Indeed, if Center City Healthcare and Verity represent a correct interpretation of the Bankruptcy Code, then sponsors and lenders have a new path to consider each time a health-care company within their portfolio is in distress.

Whether the business, including its provider agreement, is sold by motion or through a plan, the sponsor and lender may be in a position to reinvest in the business and effectuate a successful turnaround.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Charles A. Dale III is a partner in Boston with Proskauer’s Corporate Department and a member of both the Business Solutions, Governance, Restructuring & Bankruptcy and Private Credit Restructuring groups. His practice focuses on direct lender and ad hoc groups of direct lenders, hedge funds and BDCs. He also offers extensive experience handling debt restructurings, reorganizations and distresses asset transactions.

Jessica G. Shearer is an associate in Proskauer’s Corporate Department and a member of the Private Credit group. She focuses her practice on representing private credit providers, including senior lenders, business development companies, mezzanine funds, small business investment company funds, insurance companies and sovereign wealth funds.

Elliot Stevens is an associate in Proskauer’s Corporate Department and a member of the Business Solutions, Governance, Restructuring & Bankruptcy Group.