Are health care provider agreements contracts or legal rights?

The intersection between Medicare and state Medicaid regulatory schemes, on the one hand, and bankruptcy proceedings, on the other, continues to be an interesting, often hotly contested, source of bankruptcy litigation. In a 2016 article The Medicare Provider Agreement: Is it a Contract or Not? And why does anyone care?, 71 Bus. law. 1207 (2016), Samuel Maizel and I discussed the critical question of whether vendor agreements are properly considered an executory contract subject to the adjustment requirements of Bankruptcy Code § 365 and the required assumption of all, potentially large, overpayment obligations, or if is considered a legal right that the debtor is authorized to sell free and clear under § 363 of the Bankruptcy Code. We have offered several reasons why it should not be considered an executory contract, including the government’s own arguments in non-bankruptcy cases that the vendor agreement is not a contract at all. Since our article, at least two bankruptcy courts have reached the same conclusion. See In re Center City Healthcare LLC, Case No. 19-11466 (Bankr. D. Del. Sept. 10, 2019) (Doc. No. 681); In re Verity Health System of California Inc., Case No. 2:18-nk-20151 (Bankr. CD Cal. Sept. 26, 2019) (Doc. No. 3146). Although both decisions were later overturned due to settlement (Verity) and failure to close the sale (Center City), they represent potential progress on a critical issue for healthcare debtors.

Another complex issue in which the characterization and interpretation of Medicare and Medicaid provider agreements plays a role is determining whether the government’s deduction of provider liability from ongoing payments to the provider constitutes a set-off or reimbursement. In general, “set-off” refers to the creditor’s ability to deduct from a debt owed to the debtor an amount owed by the debtor under a separate obligation between the same parties, while “recovery” refers to the deduction or discount of an amount owed to the debtor arising out of the same transaction . The implications of the distinction are large: if an overpayment is considered a set-off, then (i) the automatic stay applies to prevent post-petition set-off and (ii) Bankruptcy Code section 553 allows set-off only of pre-petition obligations appeal claims. However, if the overpayment is considered compensation, the stay does not prevent the government from recovering Medicare or Medicaid overpayments from post-bankruptcy recoveries, and the government is permitted to recover a pre-petition overpayment from a post-petition claim. Courts have developed two tests for determining whether obligations arise out of a single transaction (and therefore the doctrine of recovery applies): (1) the “logical connection test,” a broad, flexible approach that defines a transaction as involving many events, whereas because have a logical connection; and (2) the “integrated transaction” test, which is a narrower test that requires that the obligations arise from an integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without fulfilling its obligations.

In a recent hospital case in which Mr. Meisel represented the debtors, the Ninth Circuit’s opinion provided guidance on the dividing line between set-off and recovery. See Gardens Regional Hosp. and Med. Center Liquidating Trust v. California (In re Gardens Regional Hosp. and Med. Center, Inc.), 975 F.3d 926 (9th Cir. 2020). Garden Regional concerned whether the State could recover two of the debtor’s obligations—(i) hospital quality assurance (“HQA”) fees and (ii) fee-for-service obligations—from the State’s payments to the debtor for additional payments of HQA under state Medicaid program, Medi-Cal. The bankruptcy court, while citing our Business Journal in a footnote, found that regardless of whether the vendor agreement was a contract or a license, the fees and liability arose out of the same transaction or event. Gardens Regional, 569 BR 788, 799 (Bankr. CD Cal. 2017).

The Ninth Circuit affirms in part and reverses in part. The court agreed that HQA’s unpaid fees had the necessary logical connection to HQA’s additional payments to characterize them as arising out of the same transaction for recovery purposes. With respect to service fee obligations, however, the Ninth Circuit found that there was no logical connection. In that decision, the Court found that to qualify as compensation, the deduction of fees must rest on connections beyond the mere assertion of a legal right to make the deduction. 975 F.3d at 939. Moreover, stating such a right in a contract, without more, does not establish that the deduction is in fact compensation. ID. at 940. The mere fact that both countervailing duties were in some sense rooted in the parties’ contract is not sufficient by itself to provide the requisite legal relationship. ID.

While the long-term impact of Garden Regional and other recent healthcare cases remains to be seen, they provide guidance to healthcare bankruptcy professionals on critical, recurring issues – and perhaps some hope that healthcare debtors can obtain bankruptcy relief against the objection of government payers. .

Copyright ©2022 Nelson Mullins Riley & Scarborough LLPNational Law Review, Volume XII, Number 288

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