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Provider Agreements can be sold free and clear of future liabilities

September 13, 2019

Hospitals with residency programs may be able to sell those residency programs free and clear of certain liabilities associated with the provider agreements that dictate their funding. Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware surprised the bankruptcy and healthcare communities on Sept. 5, 2019, when he ruled that certain Medicare provider agreements related to graduate medical education training programs at Hahnemann University Hospital could be sold for approximately $54 million to Tower Health. First, the ruling in Center City Healthcare, LLC, d/b/a Hahnemann University Hospital et al., Case No. 19-11466, establishes that provider agreements may be sold free of the Debtors’ liabilities under 11 U.S. Code § 363 (as opposed to treating such agreements as executory contracts under 11 U.S. Code § 365). Secondly, even though a hospital is no longer treating patients, the court found that merely referring patients to other providers and transferring medical records was enough to satisfy the regulations requiring a hospital be open. Although this decision will likely be appealed, the prospects that it will survive the appellate process has significant ramifications for buyers and sellers of healthcare assets.

Why Does This Matter?

A provider agreement is an agreement between the Center for Medicare and Medicaid Services (“CMS”) and a hospital that allows hospitals to be reimbursed for services to Medicare beneficiaries. To obtain a provider agreement, a hospital must apply for initial certification, which enables CMS to determine that the provider is qualified to provide health care services to patients.

What makes these provider agreements worth seeking Court approval of a sale of these assets is the possible government money that comes attached. With each Medicare provider agreement, qualifying hospitals receive a limited number of residency slots eligible for funding for approved graduate medical education programs. Hospitals typically cannot, on their own, increase or decrease the number of residency slots to reflect their demand, but rather face a lengthy annual regulatory process to alter their number of slots.

These residency slots have all the characteristics of precious metals - limited, rare, and valuable – but without any applicable market to extract that value. Before this ruling, residency slots (without the consent of CMS) were relegated by CMS to being an untapped source of potential proceeds in an asset sale. Therefore, Judge Gross saw fit to essentially create an open market for residency slots in bankruptcy – to the initial tune of $54 million.

What Changed?

Prior to last Thursday, Medicare provider agreements were largely thought of as executory contracts in the context of bankruptcy and were handled pursuant to Section 365 of the Bankruptcy Code. Judge Gross, however, upended that notion when he definitively declared that provider agreements (at least as they relate to residency slots) are statutory entitlements because they do not obligate either the United States or the provider to do anything which is not contained in the law and regulations. Judge Gross found support in his ruling at the appellate level[1] and from an article in the ABA’s Business Lawyer publication,[2] all of which construe provider agreements as statutory entitlements.

Although the District of Delaware sits in the Third Circuit, Judge Gross found that the case University Medical Center vs. Sullivan, 973 F. 2d 1065, 1075 (3d Cir. 1992) was not controlling in its classification of provider agreements. In University Medical, the Third Circuit construed provider agreements as executory contracts, which are assignable pursuant to Section 365 of the Bankruptcy Code and carry with them successor liability. Judge Gross explained that the Third Circuit in University Medical assumed, without actually deciding, that provider agreements were executory contracts. When faced with determining this specific matter, Judge Gross’s found provider agreements do not meet the Third Circuit’s definition of executory contracts, and are therefore statutory entitlements that can be sold free of the Debtors’ liabilities. He rejected CMS’s argument that the Third Circuit previously found that a provider agreement was an executory contract, even going so far as to overrule the government’s objection that placement of residency slots was an issue for CMS to determine.

The ruling also found that the Debtors can sell residency slots separate from the hospital itself and rejected CMS’s contention that it must consent to such assignment or sale. Because the provider agreements are statutory entitlements, debtors are entitled to sell them free and clear pursuant to Code Section 363, with no responsibility for any successor liability. In this way, provider agreements are similar to licenses issued by government agencies, which are property of a debtor’s estate and are transferable to a third party for consideration,[3] or in this case, available to the highest bidder.

How is this Decision Possible?

Last week’s ruling resurrects a line of thinking thought laid to rest by In re Bayou Shores SNF, LLC, 828 F.3d 1297 (11th Cir. 2016), which ruled that the bankruptcy court lacked jurisdiction to limit the government’s ability to recoup from future owners of the healthcare facility. How multiple bankruptcy courts can decide quite oppositely on the same issues harkens back to the equitable powers granted to them by the Bankruptcy Code. The spirit of Section 105 is interspersed throughout Judge Gross’s ruling, notably when he cites his concerns for the “benefit of the community” and describes the price escalation from $7.5 million to $54 million during the auction process as a “stunning success” and in the “debtor’s best interests.”

Provider agreements have proved to be a point of controversy in bankruptcy precedence, and Judge Gross’s ruling has now joined the fray for healthcare debtors looking to maximize the value of their estates in bankruptcy. The decision will likely be appealed – the Judge even stayed his ruling for seven days to allow such action. It is difficult to determine how district or appellate courts will view the decision given the precedent on both sides of the argument. However non-bankruptcy courts decide, courts operating in equity always retain the possibility of ruling differently. At the very least, the decision may create much more interest in distressed healthcare assets since buyers will not be required to assume unknown liabilities under provider agreements.

Hunter Thornton contributed to this report.

[1] Memorial Hospital v. Heckler, 706 F.2d 1130 (11th Cir. 1983); PAMC Ltd. v. Sebelius, 747 F.3d 1214 (9th Cir. 2014).

[2] Samuel R. Maizel & Jody A. Bedenbaugh, The Medicare Provider Agreement: Is It a Contract or Not? And Why Does Anyone Care?, 71 Bus. Lawyer 1207 (Fall 2016).

[3]Matter of Tak Commc'ns, Inc., 985 F.2d 916, 917 (7th Cir. 1993).

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