Mid-Atlantic Health Law TOPICS

Health care providers presently face heightened economic challenges caused by reductions in reimbursement and utilization. These pressures are further exaggerated by provider mergers and acquisitions, some of which will prove to be sensible, while others will not.

The foregoing is already resulting in health care providers assuming more risk and more debt. Such events, in turn, may cause an increase in the number of health care companies going bankrupt. In fact, some foresee the health care industry facing a financial crisis in the near future not unlike the nationwide real estate crisis of the late 1980s and early 1990s, which caused real estate developers and investors to crowd bankruptcy courts for years.

A. Anatomy of the Bankruptcy Process

The federal bankruptcy laws provide a mechanism for health care providers, like consumers and businesses of all types, to resolve debt crises through a pragmatic framework for addressing the causes of and solutions to financial distress. The bankruptcy process is the product of federal legislation, most of which is embodied in the Bankruptcy Code.

When a debtor files for bankruptcy protection, an injunction is immediately imposed, preventing most kinds of collection efforts by creditors. The injunction, known as the "automatic stay," provides the debtor with a "breathing spell" in which to identify and to address the events which necessitated the bankruptcy filing without the interference of creditors. The automatic stay remains in place during a bankruptcy case until the bankruptcy court enters an order terminating the stay or modifying the stay as to a particular creditor.

The bankruptcy court in which the case is pending also inherits jurisdiction over the debtor's property, known as the bankruptcy "estate." After the commencement of a bankruptcy case, the debtor (or the bankruptcy trustee) is not entitled to dispose of property from the debtor's bankruptcy estate outside of the ordinary course of the debtor's business without approval of the bankruptcy court.

Finally, the Bankruptcy Code creates a regime for determining the validity, amount and priority of the claims asserted by a debtor's creditors, with the bankruptcy court acting as final arbiter of such claims. This framework provides an effective alternative to the ad hoc methods of responding to creditors' collection efforts outside of bankruptcy.

The price of seeking bankruptcy protection is the requirement that the debtor give "open book" disclosure to the bankruptcy court and its creditors, with respect to the debtor’s assets, liabilities and financial condition.

B. Chapter 11 of the Bankruptcy Code

Among other alternatives, a business debtor may use bankruptcy law to reorganize its affairs, and survive as a viable going concern. The bankruptcy laws relating to reorganization are found in Chapter 11 of the Bankruptcy Code.

Perhaps the most important consideration for business debtors at the outset of a Chapter 11 case is whether, and to what extent, the debtor will be able to use its operating revenue to fund its business operations. Cash flow issues may be particularly acute for health care providers which depend substantially on Medicare/Medicaid receivables or payments from HMOs or other plan providers as a source of income.

Section 363 of the Bankruptcy Code creates a mechanism for the debtor to obtain authority to use "cash collateral." Cash collateral consists primarily of the proceeds of the debtor’s business operations which are subject to a secured creditor's lien. The bankruptcy court may authorize the debtor to use cash collateral over the secured creditor’s objection, provided that the debtor is capable of providing the secured creditor with adequate protection of its security interest in the form of additional collateral or otherwise.

Chapter 11 offers a business debtor several strategies designed to improve its operating performance. For example, the Bankruptcy Code affords the debtor an opportunity to reject its burdensome contracts and leases, and under some circumstances to assume, or even assign to a third party, contracts and leases which are valuable to the debtor’s estate.

The debtor may also take advantage of Bankruptcy Code provisions governing the sale of property of the estate, free and clear of liens, as a means of disposing of unnecessary assets and improving its cash position. A large and diverse business debtor may attempt to streamline its operations by seeking authority to sell entire divisions in this manner. Procedures also exist for the debtor to seek authority to obtain post-petition financing or refinancing to fund its ongoing operations.

C. Emerging from Chapter 11

After the Chapter 11 debtor has identified and begun to address the problem areas affecting its enterprise, its attention shifts to emerging from Chapter 11 as a reorganized going concern. The mechanism under the Bankruptcy Code for achieving this result is for the debtor to obtain confirmation of a plan of reorganization.

A plan of reorganization is, in essence, a contract between the debtor and its creditors. Such a plan creates classes into which the allowed claims of the debtor’s creditors are placed, and describes the manner in which the assets of the debtor’s estate are to be distributed among those classes. Typically, upon the bankruptcy court's confirmation of a plan of reorganization, creditors are entitled to satisfaction from the debtor on account of their claims only to the extent, and in the manner, provided under the plan. Moreover, upon confirmation of the plan, the debtor emerges from Chapter 11 to resume its operations, free from the constraints imposed under the Bankruptcy Code, and subject only to the debtor’s obligations under the plan.

D. Summary

The foregoing is merely an overview of the benefits and protections available under the federal bankruptcy laws to businesses experiencing financial difficulty. These benefits and protection are available to struggling health care operations to the same extent as they are available to the business community at large.