October 14, 2019

Provider Agreements: Does Two Make a Trend?

Client Alert
Melissa W. Jones | Tyler Layne | David E. Lemke

On the heels of the September decision in Center City Healthcare, LLC, d/b/a Hahnemann University Hospital, et al., Case No. 19-11466 (KG), in which federal bankruptcy Judge Kevin Gross ruled that the Hahnemann’s Medicare provider agreement, which provided that Hahnemann would hold certain residency slots [1], was a statutory entitlement that could be sold under sections 363(b) and (f) of the Bankruptcy Code, rather than being an executory contract that must be assumed and assigned pursuant to section 365 of the Bankruptcy Code, another judge from the opposite coast has come to a similar conclusion.

In re Verity Health System of California, Inc., et al., Case No. 18-20151, federal bankruptcy Judge Ernest Robles ruled late last month that Verity’s Medi-Cal [2] provider agreement was not an executory contract that could only be assumed and assigned pursuant to section 365 of the Bankruptcy Code. Like Judge Gross in Hahnemann, Judge Robles held that the Medi-Cal provider agreement is a statutory entitlement that can be transferred free and clear of interests under sections 363(b) and (f) of the Bankruptcy Code, including claims by the California Department of Healthcare Services (“DCHS”) relating to the provider agreement.

At issue in the Verity case was whether Medi-Cal provider agreements could be transferred to the purchaser of the debtors’ hospitals and related facilities without having to assume and assign such agreements under section 365 of the Bankruptcy Code and pay $30 million in liabilities for unpaid Hospital Quality Assurance Fees (“HQA Fees”) and another $25 million for over-payments which debtors owed to DHCS.  DHCS argued that the Medi-Cal provider agreements were executory contracts that could only be transferred to buyers if they were assumed Judge Robles rejected DHCS’s argument.

He held that the provider agreements were not contracts at all.

In reaching his conclusion, he found that the right to receive payment under the agreements is a manifestation of government policy, not a contractual right, and that the Medi-Cal provider agreements lack a key feature found in all executory contracts – obligations imposed on both sides. Judge Robles concluded that the provider agreements imposed no obligations on DHCS and that the debtors’ obligations under the provider agreements were nothing more than the debtors’ pre-existing legal obligations and “an agreement to comply with applicable laws is a gratuitous promise which does not provide the consideration necessary to make a contract enforceable.”

DHCS pointed the Verity court to a number of prior decisions in which courts held that provider agreements are executory contracts, including In re University Medical Center, 973 F.2d 1065 (3rd Cir. 1992),  which is often cited for that proposition. Judge Robles brushed these cases aside easily.  He concluded that the Court in University Medical Center simply assumed the provider agreement was an executory contract and that it ignored prior Third Circuit precedent where that Court had held, albeit in a different context, that provider agreements are statutory entitlements.  Judge Robles found that in the two other cases cited by DHCS that the debtors conceded that the provider agreements were executory contracts and the issue was not actually litigated.  Moreover, in one of those cases, the bankruptcy court disregarded binding precedent to the contrary. 

Having determined that the provider agreements were not executory contracts subject to assumption under section 365 of the Bankruptcy Code, Judge Robles went on to find that, as statutory entitlements, they were “property of the estate.” He compared the provider agreements to government-issued licenses, citing to Matter of Fugazy Express, Inc., 124 B.R. 426 (S.D.N.Y. 1991), where that court held that an FCC license was the property of the estate.  Judge Robles further ruled that, as the property of the estate, the provider agreements could, therefore, be sold free and clear of liens, claims and interests under section 363 of the Bankruptcy Code, including the $30 million in HQA Fees and the $25 million in over-payment liabilities.  Judge Robles cited to section 363(f)(5) of the Bankruptcy Code, which provides that property of the estate may be sold “free and clear of any interest in such property of an entity other than the estate” if the entity holding the interest “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”  Judge Robles found that DHCS’s claims for the HQA Fees and over-payment liabilities were “interests’ in the provider agreements and that such “interests” could be satisfied by a money satisfaction. In fact, that is the only way those liabilities could be satisfied. 

The Verity decision appeared to be a clean sweep for the debtors and for the hospital purchasers until the very end. The debtors asked the Court to include in the order a provision that DHCS’s recoupment rights “must be first exercised against payments due to the Debtors from Medi-Cal, then against funds held by the Debtors generated by past interim Medi-Cal payments, and then against any of the sale proceeds generated by the sale of the Provider Agreement.” The Court declined to provide such a ruling, stating that “the issue of applicability of recoupment subsequent to the sale of the Provider Agreements free and clear of claims and interests ha[d] not been sufficiently briefed.”  It is not clear what the Court meant by that statement.  But, if it meant that, even in Judge Robles’ view, DHCS might still be able to recoup the debtors’ HQA Fees and overpayment liabilities from Medi-Cal payments that subsequently come due to the purchasers, then that one final sentence may have taken back all that the prior 10 pages of the opinion had given.

[1] In Hahnemann, the debtors sold provider agreements related to graduate medical education training programs (i.e., residency programs), pursuant to which debtors were allocated a number of residency slots by CMS, for approximately $51 million, free and clear of Hahnemann’s provider agreement-related liabilities. 

[2] Medi-Cal is Calfornia’s state Medicaid agency.

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