Bankruptcy Court Decision May Be the Bandage Needed By the Healthcare Lending Industry

You’ve seen the stories. On the front page of every newspaper in the United States you’ve seen the picture. An elderly person, sitting in what looks like a comfortably decorated room, supportive relatives by his or her side, and a caption quoting the nursing home resident’s expression of concern about having to leave the elderly care facility that has been home for the past ten years due to a bankruptcy. You can even name the players if you think about it—Mariner, Charter, Vencor, Lenox, Frontier and NewCare. It is easier to name the big nursing home companies that are in Chapter 11 than it is the companies that are not. When you do come up with a nursing home company not in Chapter 11, your mind automatically fills in "yet."

In addition to giving rise to the human turmoil reported by the press and monitored by state attorney generals’ offices, the spate of healthcare bankruptcies filed over the past year has also threatened the health of a segment of the financial industry—the healthcare lender. The threat is greater than simply having a sizable portion of an institution’s industry portfolio going into bankruptcy. In healthcare cases, debtors, trustees and creditors’ committees are not only seeking to reduce the amount of the claims asserted by healthcare lenders, but are asserting an ability to avoid their liens, even if the usual steps for obtaining and perfecting a security interest were followed. The theory turns on the novel nature of healthcare receivables. A recent case from the Bankruptcy Court in Massachusetts, however, may provide healthcare lenders with a way to stem the bleeding from these challenges.

Loans to healthcare entities usually look like any other asset-based loan. There is a loan agreement in which a borrowing base is set forth and a security interest is granted. The borrowing base is largely comprised of accounts receivable, and the security interest granted includes accounts receivable, accounts and their proceeds. The lender attempts to perfect its security interest through filing a financing statement with the appropriate state recording authority.

Healthcare receivables, particularly nursing home company receivables, however, bear little resemblance to accounts receivable in other industries. A significant percentage of a nursing home’s receivable base is comprised of amounts to be paid by state administrators of federal Medicare and Medicaid programs, which are subject to extensive statutory provisions and regulations promulgated by the Heath Care Financing Administration (HCFA). Those receivables that are not Medicare/Medicaid funded are largely funded by private insurers.

Those differences, that might at first blush be a source of comfort about the certainty of collection, have been the basis for challenge. Applying legal theories that require less creativity than one might expect, given the surprise by the drafters of healthcare loan documents when they are served with a pleading, the challengers to healthcare lenders’ secured interests assert both an invalid grant of a security interest and a failure of perfection in receivables.

The asserted bases for challenging the grant of a security interest in Medicare and Medicaid receivables are the anti-assignment provisions of the federal statutes relating to state administration of federal health care payment programs. Under Title XIX of the Social Security Act, 42 U.S.C. §§1395g(c), 1395u(b)(6) and 1396(a)(32), generally referred to as the Anti-Assignment Provisions, a state plan for administration of federal healthcare assistance programs must "provide that no payment under the plan for care or service provided to an individual shall be made to anyone other than such individual or the person or institution providing such care or service, under an assignment or power of attorney or otherwise." The Anti-Assignment Provisions go on to provide specific exceptions to the seemingly broad proscription on assigning government funded healthcare receivables, allowing assignments to a government agency or pursuant to a court order.

The statutory prohibition on assignment, assert the challengers, renders any assignment of Medicare and Medicaid receivables, of any sort, even an assignment for security purposes, invalid and unenforceable. While the challengers would argue that any pledge of an interest in Medicare and Medicaid receivables is invalid, avoidance of the lender’s interest is particularly appropriate where the loan documents contain a lock box provision requiring direct payment to an account subject to the control of the lending institution. Direct payment to any party other than the care recipient or the care giver, according to the challengers, is specifically prohibited by the Anti-Assignment Provisions.

The allegation of having an invalid grant of security is followed by the allegation that, even if there were some interest obtained, that interest was not properly perfected. This part of the challenge, however, is not dependent upon the vagaries of federal statutory interpretation, but is straight from the Uniform Commercial Code.

In attempting to perfect an interest in the Medicare and Medicaid receivables, healthcare lenders will generally take the usual step of filing financing statements with the appropriate state and local agencies. Perfection of a security interest through filing a financing statement is wholly the creation of Article 9 of the Uniform Commercial Code. While Article 9’s provisions are broad, they are not all encompassing. Section 9-104 of the Uniform Commercial Code provides several exceptions to Article 9’s coverage, and, therefore, to the ability to perfect an interest in property under its provisions. One of those exceptions, set forth in Section 9-104(g), is for "a transfer of an interest in or claim in or under any policy of insurance, except as provided with respect to proceeds . . . and priorities in proceeds."

Proceedings brought to challenge asserted secured interests in health care receivables have asserted that Medicare and Medicaid receivables constitute government provided insurance payments. Relying on the lack of any Uniform Commercial Code provided definition of insurance, these challenges assert that any provision for payment from a third party from collective funds constitutes insurance excluded from Article 9’s scope.

Faced with these challenges, the lender’s first response is to point out the catastrophic impact of adopting the reasoning put forth. In the nursing home industry, which is deeply reliant on Medicare and Medicaid payments, and where the time between rendering services and cutting through the regulatory reporting requirements that ultimately leads to payment can exceed several months, the unavailability of an operating line of credit because the bulk of otherwise strong receivables can not be pledged could, the argument goes, bring elder care to a screeching halt. Without an operating line, the homes’ cash flow would be insufficiently consistent to guaranty the ability to buy food and medicine for patients.

Although there have been very few cases interpreting either the Anti-Assignment Provisions or the applicability of Article 9’s insurance policy exclusion to Medicare and Medicaid receivables, a recent case from the Bankruptcy Court in Massachusetts continues a tendency, if not yet quite a trend, to apply the gloss of the industry doomsday scenario propounded by lenders to read the statutory language to uphold the secured interest. A court with an early case presenting the issue, the United States Court of Appeals for the Fifth Circuit in Wilson v. First National Bank of Lubbock Texas (In the Matter of Missionary Baptist Foundation of America, Inc.) 796 F. 2d 752 (5th Cir. 1986) stated outright that the underlying policy of Medicare and Medicaid to ensure adequate high quality health care for the needy mandated that the Anti-Assignment Provisions "cannot be interpreted to prevent the kind of loan financing at issue in this case." Similar policy based decisions were rendered by various state courts, yet challenges continued.

In Official Unsecured Creditors’ Committee v. Chittenden Trust Co. (In re East Boston Neighborhood Health Center Corp.), 242 B.R. 562 (Bankr. D. Mass. 1999), the Bankruptcy Court took a less policy driven and more analytic approach than had been evidenced in most previous decisions on the issue of healthcare receivables. It approached the Anti-Assignment Provisions’ argument through scrutinizing the language of the statute. The Court noted that nothing in the Anti-Assignment Provisions expressly prohibits the grant of a security interest in Medicare or Medicaid receivables. Rather, the statute prohibits governmental insurers from making payment on the receivables to anyone other than the Debtor. According to the Court, "the statutes may impair the [lender’s] ability to seek payment on the receivables from the governmental insurer without the provider’s cooperation, but that cooperation may well be available, and the statutes do not impair the [lender’s] ability to enforce their security interests once payment has been issued."

The Bankruptcy Court in the East Boston Neighborhood Health Center case also found the security interest granted to have been properly perfected. It first held that the receivable was not due from a policy of insurance, but was due from the patient. Therefore, the collateral received by the lender was a patient owed account receivable, not a right to payment under an insurance policy. The coverage provided for this patient account receivable by Medicare, Medicaid or a private insurer, reasoned the Court, was property generated upon disposition of that patient account receivable, which falls squarely within the definition of "proceeds" under section 9-306 of the Uniform Commercial Code as incorporated into Section 9-104(g). Because Article 9’s exclusion of insurance from its coverage expressly did not exclude proceeds from coverage, those proceeds were within the perfection provisions of the Uniform Commercial Code and an interest in those proceeds could be perfected through filing a financing statement. As a backstop holding, the Bankruptcy Court went on to find that, even if the Medicare, Medicaid and private insurance payments were not proceeds, but were payments due under a policy of insurance, "it would not necessarily follow that the security interests were invalidly granted or invalidly perfected." Absent coverage by the U.C.C., interests in property could be perfected under other existing law. Because the actions taken by the lender of recording appropriate financing statements, even if not subject to perfection under Article 9, were "well-calculated to put the world on notice of the existence of the security interests," those interests were perfected.

Because there are a number of high-profile healthcare Chapter 11 cases currently pending, the issue of the ability to receive and perfect a security interest in healthcare receivables is almost certain to be revisited by another court. The East Boston Health Center decision does not guaranty the result in the next case in which the challenge arises. It is, however, at least a temporary patch for the healthcare lending industry.