Medicare Provider Agreements in Bankruptcy: Executory Contracts or Assets that Can Be Sold Free and Clear (or Effectively Neither)?

With no foreseeable financial improvements on the horizon, management is faced with two options: Close the hospital or try to sell the business in bankruptcy free and clear of liabilities. But can management actually sell the business in bankruptcy free of CMS’s multi-million dollar overpayment claim? Maybe, but it may be increasingly difficult to do so over CMS’s objection if the buyer wants or needs an assignment of the debtor’s Medicare provider agreement and number. If the buyer intends to be paid by CMS for services provided to Medicare patients, it must have a provider number.

To date, CMS’s position has been that all liabilities that relate to the provider number travel with, and cannot be disassociated from, the provider agreement.

Some reported bankruptcy court decisions presume, without necessarily deciding (and without the debtor contesting), that a debtor’s Medicare provider agreement and associated provider number is an executory contract that cannot be assumed under section 365 of the U.S. Bankruptcy Code without the debtor also assuming all associated liabilities.

Treating Medicare provider agreements as executory contracts that must be assumed means that a buyer who takes an assignment of the provider agreement must pay all claims that CMS may have against the debtor, which may include penalties or claims under the Federal False Claims Act (for an example of a case where CMS argued that the buyer should be responsible for the debtor’s claims under the False Claims Act see In re Our Lady of Mercy Med. Ctr., No. 07-10609 (Bankr. S.D.N.Y. May 15, 2008) (Doc. 679)).

In the context of setoff and recoupment, some bankruptcy courts have determined that a new provider agreement is established each year between CMS and the provider; in these jurisdictions, the buyer’s assumed liability could be limited to the current year’s provider agreement. See, e.g., In re Univ. Med. Ctr., 973 F.2d 1065, 1080 (3d Cir. 1992). However, in other jurisdictions, the buyer could be liable for overpayments made within the previous five years.

Because the costs of assuming a Medicare provider agreement can be high if the debtor has received overpayments, the ability to sell provider agreements free and clear of liabilities to CMS can yield significant savings for buyers. Only two reported cases have considered whether Medicare provider agreements are executory contracts or are assets that can be sold free and clear of claims and interests under section 363(f) of the U.S. Bankruptcy Code. As explained below, the two cases reached different conclusions. Complicating the issue further, a recent Court of Appeals decision suggests that bankruptcy courts may lack jurisdiction over determinations affecting the provider number if there is an underlying dispute between the debtor and CMS that arises under the Medicare Act (which would include payment disputes).

In In re B.D.K. Health Management, Inc., the bankruptcy court concluded that Medicare provider agreements are statutory entitlements that can be sold free and clear of claims and interests. The court reasoned that: (i) the rights and duties of health care providers and CMS are set forth in statutes and regulations and not in agreements; and (ii) a provider must initiate administrative proceedings, not a lawsuit for breach of contract, to contest CMS’s reimbursement decisions. See In re B.D.K. Health Mgmt., Inc., 1998 WL 34188241, at *6 (Bankr. M.D. Fla. Nov. 16, 1998).

A Massachusetts bankruptcy court disagreed. In In re Vitalsigns Homecare, Inc., the bankruptcy court concluded that Medicare provider numbers arise out of executory contracts that cannot be assumed and assigned to buyers without the associated liabilities. The Vitalsigns court reasoned that requiring the provider agreement to be assumed harmonizes the Medicare and bankruptcy statutes without rendering either a nullity (since Medicare statutes and regulations explicitly provide for recoupment of overpayments and the U.S. Bankruptcy Code explicitly provides for free and clear sales).

Conflicted with the competing policy goals of the Medicare and bankruptcy statutory schemes, the Vitalsigns court approved the sale of the debtor’s provider number, but held that CMS could recoup overpayments from the buyer only after recouping overpayments against (i) any payments due by CMS to the debtor’s estate; (ii) any funds held by the estate that were generated by past Medicare payments; and (iii) the proceeds from the sale of the provider number. See In re Vitalsigns Homecare, Inc., 396 B.R. 232, 240 (Bankr. D. Mass. 2008).

Although Vitalsigns and B.D.K. are the only reported decisions that have considered whether Medicare provider agreements are executory contracts or assets that can be sold free of CMS’s claims, the issue has surfaced in other bankruptcy cases; however, the courts in those cases never ruled on the issue because the buyers reached agreements with CMS regarding liability on future claims. See, e.g., In re Our Lady of Mercy Med. Ctr., No. 07-10609 (Bankr. S.D.N.Y. Jul. 8, 2008); In re Specialty Hosps. of Wash., LLC, No. 14-00279 (Bankr. D.D.C. Dec. 2, 2014).

A recent example of a negotiated settlement occurred in In re Specialty Hospitals of Washington, LLC. There, the buyer agreed to make a substantial payment to CMS (and other divisions of the federal government) in order to obtain the government’s approval of the sale, which resulted in the transfer of the debtors’ Medicare provider numbers to the buyer. The buyer’s negotiated payment to CMS was substantially less than the cure amount that would have been required if the provider agreement had been assigned to the buyer without a settlement with CMS (assuming such assignment could occur—see Bayou Shores discussion below). Given that the buyer was funding both the hospital’s negative cash flow and the bankruptcy case, the buyer’s ultimate savings might have been greater had it closed on the sale earlier by agreeing to pay CMS a higher settlement amount. See The Clock Keeps Ticking: Time Considerations When Buying Healthcare Assets and Funding a Bankruptcy Case through Closing, Jan. 15, 2016.

The Eleventh Circuit’s recent In re Bayou Shores SNF, LLC decision complicates the assumption-assignment issue by suggesting that any unresolved dispute between the debtor and CMS that is not purely bankruptcy in nature bars a bankruptcy court from exercising jurisdiction over the Medicare provider number; an issue addressed in neither Vitalsigns nor B.D.K. Specifically, 42 U.S.C. § 405(h) requires exhaustion of administrative remedies prior to judicial review of CMS determinations under the Medicare Act (including payment determinations). Even worse, for debtors and their buyers, section 405(h) appears to provide that bankruptcy courts lack any jurisdiction whatsoever to adjudicate claims against CMS “arising under this subchapter” (meaning disputes arising under the Medicare Act).

Bayou Shores highlights that section 405(h) is very broadly interpreted by courts. There, a nursing facility filed for bankruptcy after learning that CMS was terminating its provider agreement because of patient safety concerns. Hours after seeking bankruptcy protection, the bankruptcy court enjoined CMS from terminating and cutting off payments under the provider agreement. The bankruptcy court later confirmed a chapter 11 plan that allowed the debtor to assume the provider agreement. At all times, CMS challenged the bankruptcy court’s jurisdiction over the provider agreement. See In re Bayou Shores SNF, LLC, 2016 WL 3675462 (11th Cir. July 11, 2016).

On appeal, the Eleventh Circuit affirmed the district court’s reversal and agreed that the bankruptcy court was without jurisdiction to issue orders enjoining CMS’s termination of the provider agreement because the CMS-debtor dispute (i.e., whether the debtor was providing proper care to patients) arose under the Medicare Act and thus was subject to the jurisdictional bar in section 405(h). See id. at *25–26.

The Eleventh Circuit’s holding is significant because it allows CMS to raise any non-bankruptcy dispute as a basis for depriving the bankruptcy court of jurisdiction under section 405(h), and as a result, may allow CMS to unilaterally prevent healthcare facilities from reorganizing in chapter 11. See also In re St. Johns Home Health Agency, Inc., 173 B.R. 238, 242 (Bankr. S.D. Fla. 1994) (although holding that “42 U.S.C. § 405(h) does not divest th[e] Court of subject matter jurisdiction to consider a request for authority to assume the Provider Agreement,” denying debtor’s request to assume provider agreement because the court could not effectively grant the relief the debtor sought (assumption of the provider agreement with a limited cure amount)).

In cases where patient safety is not at issue or the debtor’s dispute with CMS is purely monetary, settlements with CMS allowing for the transfer of provider numbers will likely continue to be negotiated, especially if the debtor has sufficient funding to continue operating in bankruptcy during the often lengthy regulatory approval process. It will not be surprising, however, if CMS increasingly relies on 42 U.S.C. § 405(h) (and the holding in Bayou Shores) to try to prevent bankruptcy courts from approving any sale or assumption of Medicare provider agreements that is not acceptable to CMS. If successful, CMS would have significant leverage to force buyers to assume debtors’ liabilities to CMS or agree to higher settlement amounts.

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