On April 20, 2005, President George W. Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The consumer provisions have been well publicized, but BAPCPA also contains several provisions specifically aimed at health care reorganizations (the “Bankruptcy Health Care Amendments” or “Amendments”). These amendments impose additional duties on health care business debtors and grant new rights to patients and governmental entities.

Enhanced patient rights include appointment of a patient ombudsman and new requirements for patient transfers and handling of patient records. Additional regulatory power for government agencies include an exclusion, in some instances, from being subject to the automatic stay, additional oversight to review the transferability of property owned by nonprofit health care debtors and an administrative priority for expenses associated with the closing of a health care business. As widely reported, BAPCPA also significantly affects the rights of consumers to file for bankruptcy. Health care businesses are affected by consumer bankruptcies because a significant amount of discharged consumer debt is due to health care expenses. BAPCPA only marginally assists health care businesses in increasing collections.

Congress intended the Bankruptcy Health Care Amendments to promote the interests of patients and governmental entities by granting them new rights. Along with these new rights come uncertainty and confusion. In an effort to protect select interests, Congress has made health care bankruptcies more complex and expensive, less likely to succeed and potentially controlled by governmental regulators. As a result, future health care debtors and creditors will wrestle with new legal, policy and economic issues. With the exception of the provisions dealing with transfer of assets by nonprofit entities (which went into effect on April 20, 2005), most of BAPCPA goes into effect on October 17, 2005. Constituencies affected by the new Amendments must quickly understand their implications and burdens.

Health Care Business– Defined

The Bankruptcy Health Care Amendments generally apply to “health care businesses”. The definition contains two components: a two-part general definition, and a specific list of facilities or service providers that are examples of health care businesses. The general definition explains that a “health care business” is any profit or nonprofit “public or private entity that is primarily engaged in offering to the general public facilities and services for (i) the diagnosis or treatment of injury, deformity or disease; and (ii) surgical, drug treatment, psychiatric or obstetric care”.

Specific examples of “health care business” are: (i) general or specialized hospital; ancillary ambulatory, emergency, or surgical treatment facility; hospice; home health agency; and any other similar health care institution; and (ii) any long-term care facility, including any skilled nursing facility; intermediate care facility; assisted living facility; home for the aged; domiciliary care facility; and related “health care institutions” if they primarily provide room, board, laundry or personal assistance with activities and incidentals of daily living.

This broad definition excludes health maintenance organizations and raises other questions. For example, what did Congress intend by limiting the definition of health care business to only those entities that offer facilities and services to the “general public”? A group of doctors operating a private practice likely would be excluded. Are tribal health clinics excluded by this definition? Do diagnostic testing centers meet all the criteria? In Addition, the example of related “health care institutions” is quite broad and ambiguous.

Rights of Patients

Bankruptcy typically involves adjusting the rights of debtors and creditors. Patients, based solely on their status as patients, do not have independent standing to appear in a bankruptcy case. Unless patients have a claim against the debtor they generally will not be part of the reorganization (or liquidation) process. The current bankruptcy code does not protect patient rights or give patients a voice either in court or in negotiations with the debtor. The Amendments are designed to change this exclusion and preserve the quality of patient care during the course of a bankruptcy by requiring the appointment of a patient ombudsman and establishing a duty to transfer patients from a health care business debtor being closed; and ensure proper handling of medical records. Senator Grassley has commented that these patient protections will confer a “tremendous benefit for patients with a minimal impact on creditors and debtors”. Although it is valuable to protect patients, the new mechanism will raise legal and practical issues for affected parties. It is unclear what practical benefit these new code sections will provide. But one change is certain: debtors (and their creditors) will be forced to shoulder significant costs arising from the Amendments.

Appointment of a Patient Ombudsman

In order to give patients a voice in health care cases, the Amendments mandate the appointment of a patient ombudsman not later than 30 days after the bankruptcy filing unless the bankruptcy court finds a patient ombudsman is not necessary for the protection of patients. The patient ombudsman is authorized to receive compensation from the estate for services rendered and may employ professionals (such as lawyers or accountants) who must also be paid by the estate. The engagement of the patient ombudsman and any professionals they employ will be overseen by the bankruptcy court as will the payment of all fees and expenses of the ombudsman.

The patient ombudsman will monitor the quality of patient care and will report to the bankruptcy court every 60 days. If the patient ombudsman finds that the quality of patient care is “declining significantly or is otherwise being materially compromised,” the ombudsman must report to the bankruptcy court immediately. The ombudsman will use objective criteria to determine whether care is declining significantly or is being materially compromised. But the statute does not establish any standards for the ombudsman to follow. The statute contemplates two possible types of ombudsman: (i) those appointed to assess long-term care facilities who will, in most cases, be the state long-term care ombudsman; or (ii) patient ombudsmen appointed to assess facilities other than long-term care facilities, who need not, but may be, the state long-term care ombudsman.

The state long-term care ombudsman program establishes a network of paid employees and volunteers. It is unclear whether this provision calls for the appointment of a state level official, a regional representative or a volunteer. The United States Trustee should therefore initially consider the state long-term care ombudsman for cases involving long-term care facilities. In the case of state long-term care ombudsmen appointed to assess long-term care facilities, the standards for assessment by the patient ombudsman are clear because state long-term care ombudsman programs have developed standards for evaluation of long-term care facilities, a code of ethics, and protocols for investigation of long-term care facilities.

But in cases where a patient ombudsman is selected to assess health care businesses that are not long-term care facilities, the standards for assessment and investigation are not defined. Patient ombudsmen will need to carefully define standards for several reasons, including the fact that standards of state long-term care ombudsmen may not neatly translate to assessment of other types of facilities and may produce gaps in evaluation and investigation into health care businesses. This could prove problematic for patient ombudsmen that are evaluating health care facilities that do not provide long-term care. As someone retained to perform services compensated by the estate, patient ombudsmen will need to carefully perform their tasks and document the services provided or risk denial or reduction of their fees by the bankruptcy court. The bankruptcy court also may refuse to approve the fees if the assessment by a patient ombudsman proves to be flawed, incomplete or negligent.

Patient ombudsmen may also be deemed to owe a fiduciary duty to patients, the estate, or both. Generally, most professionals retained in bankruptcy cases owe fiduciary duty to their constituents. Patient ombudsmen will be required to perform their functions not only as an impartial investigator and patient advocate, but as a professional with a fiduciary duty. This raises other issues, such as liability insurance and who should pay for it.

The patient ombudsman is to be compensated by the bankruptcy estate pursuant to amended section 330. As a result, services performed by a patient ombudsman shall be paid for out of estate funds. Billing for these services will present logistical complications for state long-term care ombudsmen who do not have a billing system in place. Accordingly, appropriate compensation and reimbursement structures need to be considered.

Duty to Transfer Patients

Patients of health care businesses that are being closed need to be relocated to other facilities. The Bankruptcy Health Care Amendments impose a statutory duty on trustees and debtors to use all “reasonable and best efforts” to transfer patients from a health care business debtor that is being closed to an appropriate health care facility in the general vicinity that provides substantially similar services and maintains a reasonable quality of care. The patient ombudsman can be expected to play a significant role in this process.

Duty to Properly Dispose of Patient Records

The Amendments provide detailed procedures for disposing of patient records in a health care business bankruptcy case. Notice requirements on a health care debtor before disposing of patient records are substantial. The statute mandates that there are several patient interests that must be considered: (i) it is critical to preserve a patient’s medical history; (ii) insurance companies may not pay for services if there is an absence of historical documentation; and (iii) insurance companies may decline coverage absent full disclosure of pre-existing medical conditions.

But when a health care business is in bankruptcy, it may have inadequate resources to retain patient medical records in accordance with state or federal law. The Amendments allow for the alternate storage or destruction of patient medical records in cases where the debtor is unable to pay the cost of record maintenance. The debtor must comply with stringent notice requirements if it intends to arrange alternate storage or destroy patient files.

Expanded Rights of Governmental Entities

Governmental entities will be: (i) excepted from the automatic stay for regulatory action in connection with federal health care programs; (ii) able to regulate the sale of nonprofit entities; and (iii) entitled to receive administrative expense claims for costs associated with closing of a health care business.

Exception from the Automatic Stay

The automatic stay will be excepted from any governmental action related to the suspension of a debtor from participation in the “Medicare program or any other federal health care program”.

Health care businesses rely on participation in governmental health care programs for a substantial segment of their revenue stream. Approximately one-third of hospital revenues are derived from Medicare payments. Medicare regularly reviews the amounts paid to hospitals and other health care businesses and finds overpayments. In such cases the overpayments are offset against amounts owed by Medicare. Under present law, when a health care business files Chapter 11, the automatic stay, at least on its face, prohibits Medicare from making this setoff. In practice, this has resulted in many disputes and litigation, with no clear rule in place.

As a result, the new law excepts decisions of the Secretary of Health and Human Services related to program participation from the automatic stay. The Department of Health and Human Services’ (DHHS) leverage with debtors is thereby increased. This will effectively remove the bankruptcy court as a limitation on the administrative powers of the DHHS, which in turn will grant the DHHS a larger presence in the case. As the revenue stream from such programs is often fundamental to the viability of a health care business, DHHA will have an even more significant role in the outcome of health care bankruptcy cases.

This new provision contains expansive language and does not differentiate situations where the governmental acts in a regulatory capacity from efforts to protect pecuniary rights. The Bankruptcy Health Care Amendments thus elevate the government’s pecuniary interests above the interests of other creditors. This will likely result in an imbalance in the rights of creditors to the detriment of a health care business debtor’s reorganization efforts.

New Limitations on the Sale of Nonprofit Entities

BAPCPA places restrictions on the transferability of property belonging to nonprofit entities. Unlike most of the provisions of BAPCPA, amendments to Bankruptcy Code Sections 363, 541 and 1129 relating to nonprofits took effect on April 20, 2005 and are applicable to all bankruptcy cases pending on that date.

First, BAPCPA places an additional limitation on the transferability of property by adding a new subsection (f) to Section 541 (defining “property of the estate”). Property belonging to a nonprofit entity that is tax-exempt under Internal Revenue Code Section 501(c)(3) can only be transferred to another 501(c)(3) tax-exempt entity. But, the bankruptcy court may allow a transfer to an entity that is not a 501(c)(3) entity “only under the same conditions as would apply if the debtor had not filed a case under this title”. This is a clear restriction on a debtor’s ability to transfer assets of 501(c)(3) entities. Under Section 541(f), the debtor must now show that any transfer of assets is in compliance with applicable non-bankruptcy law.

Before BAPCPA, assets owned by nonprofit entities could be transferred to a for-profit entity, absent an objection, without having to meet the regulatory requirements of non-bankruptcy law. As a result, before BAPCPA any non-bankruptcy law restrictions were invalidated and could not preclude a proposed sale. But BAPCPA amends Bankruptcy Code Sections 363, 541 and 1129 to provide state regulators added leverage to enforce state law limitations on the transfer of assets of nonprofit entities.

BAPCPA amends Section 363(d) to explicitly provide that sales of assets of a nonprofit debtor are now subject to “non-bankruptcy law that governs the transfer of property” of nonprofit entities. As a result, state law will now become a significant consideration in the transfer of assets belonging to nonprofit entities.

Section 1129(a)(16) contains a similar limitation on the transferability of assets. In order for a bankruptcy court to confirm a chapter 11 plan, the court must find that all transfers of property under the plan were made in accordance with applicable provisions in non-bankruptcy law that govern the transfer of property by a nonprofit. BAPCPA also requires that bankruptcy courts not confirm a plan under chapter 11 without consideration of the possibility that BAPCPA’s changes would substantially affect the rights of a party in interest who first acquired rights with respect to the debtor after the commencement of such a pre-enactment case.

These three provisions create a major shift in the structure of the sale of hospitals in bankruptcy. Health care executives and their advisors must now consider non-bankruptcy statutory and regulatory limitations on transferability on the sale of assets belonging to nonprofit entities. Sales consummated before April 20, 2005 may still be affected by these provisions if the debtor’s chapter 11 plan is confirmed at any point after April 20, 2005. Debtor’s professionals and asset purchasers need to carefully review their transactions and possibly involve regulators before confirmation to ensure there is no objection to a sale that has already been consummated or to confirmation on the basis of non-compliance with non-bankruptcy law governing the disposition of assets belonging to nonprofit entities.

Administrative Costs and Expenses for Closing Health Care Business

“Actual and necessary” costs and expenses of closing a health care business incurred by a trustee or a governmental actor for disposing of patient records or transferring of patients will be priority administrative expenses of the estate. While this provision does not appear to create significant changes to current law on administrative expenses it does demonstrate Congressional interest to elevate these costs and likely an intent to ensure that health care businesses are not simply abandoned, but are shut down in an orderly fashion. It could also be argued that the reference to “governmental actor” suggests Congressional intent to ensure the appropriate governmental agency may step in to oversee the closing if necessary. This is especially true when combined with other new provisions, including the duty to transfer patients.

While the statute lists a few items that qualify as administrative expenses, other costs and expenses could be eligible for treatment as administrative expenses. The provision is not limited to disposal of records or transfer of patients but only lists those expenses as examples of expenses contemplated by the provision.

Will Health Care Business Benefit From BAPCPA’s Consumer Provisions?

BAPCPA has been widely reported as remedial legislation intended to curb abusive bankruptcy filings by individuals. In 2004, approximately 1.6 million individuals filed for bankruptcy in the United States. The current statutory framework is perceived as too permissive and does too little to discourage individuals from filing Chapter 7. BAPCPA is designed to make individual Chapter 7 filings less attractive. Unfortunately, recent studies indicate that the number one cause of consumer bankruptcy filings is medical costs. Under BAPCPA, many individuals will be required to repay a portion of their debts in 3-5 years as spelled out in a Chapter 13 plan. BAPCPA will certainly increase the transaction costs related to discharge or repayment of consumer debt, but it is unclear whether overall increases in debt repayment will be anything more than marginal.

Summary

BAPCPA tacitly recognizes the well-documented causal relationship between the rise in health care costs and bankruptcy but fails to address the causes of fiscal crisis. However, the Bankruptcy Health Care Amendments guarantee governmental agencies new rights in bankruptcy proceedings contributing to further imbalances in the health care system. Also, the corresponding duties placed on bankruptcy estates will increase the costs associated with health care bankruptcies with corresponding decreases in the available funds for distribution to junior creditors. This may adversely impact health care businesses’ ability to reorganize. Similarly, the increase in administrative expenses will act as a tax on reorganizing health care businesses, which in turn will lessen the chances of a successful restructuring.

Ultimately, the Bankruptcy Health Care Amendments will present new challenges and questions for the courts. Executives, governmental officials and health care professionals must confront these changes as another piece of federal legislation that significantly alters the landscape of the distressed health care industry and imposes new obligations on its participants.

This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired.