New Trends in Set-off v. Recoupment Hot Topic in the Health Care Arena

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Apr 1999

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Bankruptcy courts have long made a distinction in the treatment of set-off and recoupment, but
have long disagreed on whether the government's attempt to offset pre-petition Medicare
overpayments constitutes set-off or recoupment. Last year brought no resolution of that debate.

By way of background, recall that set-off allows adjustments of mutual debts arising from
separate transactions.<a href="#1" name="1a">1</a> Section 553 of the Bankruptcy Code preserves any set-off rights a
creditor may have under applicable non-bankruptcy law. However, §362(a)(7) requires that
relief from the automatic stay be obtained before set-off rights may be exercised against a
debtor. If relief from stay is granted, the creditor can set off a pre-petition obligation the
debtor owed the creditor against a pre-petition debt the creditor owed the debtor. However, the
creditor cannot set off pre-petition debt against a post-petition debt (or vice versa).<a href="#2" name="2a">2</a>

In contrast, recoupment is an equitable doctrine that permits one party to a transaction to
withhold funds due the other party, as long as the debts arise from the same transaction.<a href="#3" name="3a">3</a>
Recoupment is generally defined as "the setting up of a demand arising from the same
transaction as the plaintiff's claim or cause of action, strictly for the purpose of abatement or
reduction of such claim."<a href="#4" name="4a">4</a> In order to constitute recoupment, the debts must arise from the
same transaction.<a href="#5" name="5a">5</a>

Although the Bankruptcy Code does not address recoupment, most jurisdictions hold that
recoupment is not subject to the automatic stay. In addition, unlike set-off, the creditor
generally can recoup pre-petition amounts the debtor owed the creditor from amounts it owes
the debtor post-petition.<a href="#6" name="6a">6</a> Thus, creditors invariably prefer recoupment to set-off.

The set-off/recoupment distinction, and specifically defining what constitutes a single
transaction or occurrence in the context of a health care transaction, has been the subject of
vigorous debate for several years. As demonstrated by the cases discussed below, the issue
remained a "hot topic" in 1998. In re TLC Hosps. Inc.<a href="#7" name="7a">7</a>

The debtor had operated three separate skilled nursing facilities, each under a different
Medicare agreement.<a href="#8" name="8a">8</a> After filing chapter 11, the debtor continued to operate its facilities until
it converted its case to chapter 7. At the time the debtor filed its chapter 11 petition, the
Department of Health and Human Services (HHS) had overpaid the debtor by $112,061 in
Medicare payments, and HHS owed the estate $68,871.16 for pre-petition services and
$46,952.84 for post-petition services.

The bankruptcy court ruled that HHS could set off and recover its pre-petition overpayments
against all pre-petition claims of the debtor, but rejected HHS' argument that it could recoup
pre-petition overpayments from post-petition payments due to the debtor, on the ground that
the debts were from different fiscal periods and therefore did not arise from the same
transaction.

On appeal, the district court permitted recoupment. The court rejected the debtor's argument
that Medicare's statutory right of set-off could not defeat the Bankruptcy Code's protections
over a debtor's post-petition income. The court stated that here, unlike Lee v. Schweiker,
recoupment was not directed at the program beneficiary but at a provider. The court noted that
because HHS did not offset until after the debtor had ceased operations, the recoupment did not
affect the debtor's ability to provide services.

In finding that the debts arose from the same transaction, the court rejected the view espoused
in University Medical Center that both debts must arise from a "single integrated transaction,"
finding that "[t]his standard is a significant departure from the previously employed definition
of 'transaction.'" The court stated that the Third Circuit had abandoned the accepted "logical
relationship" standard of "transaction" for a more stringent construction. Instead, the
district court held that the less stringent standard should apply and held that the relationship
constituted a single transaction, reasoning that

<blockquote>[i]n light of these protracted billing procedures governing the ongoing relationship
between Medicare and its providers, it is clear that the payments at issue "logically
relate" to one another; while this exchange of funds may stretch over an extended period
of time, it remains part of a continuous balancing process between the parties.<a href="#9" name="9a">9</a></blockquote>

<h3>In re AHN Homecare L.L.C.<a href="#10" name="10a">10</a></h3>

The debtor, a home health care provider participating in the Medicare program, filed an action
for declaratory judgment to determine the amounts owed between itself and the government
relating to an alleged overpayment. The debtor also sought to recover damages for violation of
the automatic stay based on the government's attempt to recoup the amount of overpayment from
interim payments due the debtor for post-petition services. HHS filed a motion to dismiss.

With respect to the debtor's request for declaratory judgment as to the amount owing between
the parties, the court held that it did not have jurisdiction over the matter. The court found that
the matter "[arose] under" the Medicare Act, and that <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §405(h)</a>, which prohibits
judicial review of a decision by HHS until all administrative remedies have been exhausted,
"intended to preclude bankruptcy jurisdiction over matters 'arising under' the Medicare Act
until all administrative remedies had been exhausted."<a href="#11" name="11a">11</a> Because those remedies had not yet
been exhausted, the court held that it did not have jurisdiction to determine the amount owing
between the parties.

With respect to the debtor's claim that HHS had violated the automatic stay, the court first
affirmatively found that it had jurisdiction to hear the matter, as its determination of whether
HHS violated the stay did not arise under the Medicare Act, but under the Bankruptcy Code.<a href="#12" name="12a">12</a>
The court then found that the interim payments due the debtor arose from the same transaction
as the overpayment HHS sought to recover, reasoning that "[r]egardless of the length of time
between the payment and the repayment, 'recoupment is justified in the single contract cases
because there is but one recovery due on a contract, and that recovery must be determined by
taking into account mutual benefits and obligations of the contract.'"<a href="#13" name="13a">13</a>

<h3>In re Southern Institute for Treatment and Evaluation Inc.<a href="#14" name="14a">14</a></h3>

The debtor, a Medicare provider, owned and operated a community mental health center.<a href="#15" name="15a">15</a> After
filing its petition for chapter 11 relief, the debtor reported to HHS that it estimated that it had
been overpaid for the 1996 fiscal year by $617,272. The debtor proposed an extended
repayment plan to HHS, but HHS declined the offer, opting instead to "exercise its asserted right
of recoupment..."<a href="#16" name="16a">16</a> Through the fiscal intermediary, HHS withheld 100 percent of the debtor's
payment for services rendered post-petition. The debtor moved to hold HHS in contempt for
violating the automatic stay and to impose sanctions against HHS.

The court held that HHS' action was properly characterized as "recoupment" of the
pre-petition overpayment, as defined by Medicare regulations.<a href="#17" name="17a">17</a> The court reasoned that
"[w]hether recoupment is applicable in a particular bankruptcy case hinges on whether the
debtor's and the creditor's respective claims arise out of the same 'transaction'."<a href="#18" name="18a">18</a> The court
held the recoupment was applicable in this case, finding that "the ongoing flow of payments and
subsequent yearly adjustments constitutes one single transaction, irrespective of the periodic
filing and auditing of a cost report."<a href="#19" name="19a">19</a> Consequently, the court held that HHS had not violated
the automatic stay.

<h3>In re Healthback L.L.C.<a href="#20" name="20a">20</a></h3>

Healthback is a home health care agency under Medicare that provides home health services to
the elderly.<a href="#21" name="21a">21</a> After Healthback filed a petition for voluntary relief under chapter 11, HHS
began withholding funds from Healthback's current interim payments to recover both
pre-petition and post-petition overpayments to Healthback. Healthback filed a motion for HHS
to show cause why its actions did not violate the automatic stay. At the hearing, Healthback
requested that the court compel HHS to "release" the amounts HHS had withheld from
Healthback and prevent HHS from continuing to withhold interim payments.<a href="#22" name="22a">22</a>

HHS argued that (1) the bankruptcy court did not have jurisdiction over the matter because
Healthback failed to exhaust its administrative appeals, and (2) that withholding funds from
interim payments did not violate the automatic stay because the action constituted recoupment,
not set-off.

With respect to the jurisdictional argument, the court determined that it had jurisdiction to
hear the matter under <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §1334(a)</a>, which grants exclusive jurisdiction over all cases
under Title 11 to the district courts, which may then refer the cases to the bankruptcy
courts.<a href="#23" name="23a">23</a> Additionally, the court determined that <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §1334(e)</a> granted exclusive
jurisdiction over all property of the debtor and the estate, wherever located.<a href="#24" name="24a">24</a>

The court rejected HHS' argument that the exclusive jurisdiction over all Medicare issues was,
in the first instance, under the administrative jurisdiction of the HHS, and that the court could
not exercise jurisdiction until the debtor had exhausted its administrative remedies. The court
explained that "judicial review"

<blockquote>is an adjudicatory process to directly determine the legality of a decision...[Its]
purposes...are (1) to determine the authority of the agency, (2) to determine
compliance by the agency with procedural requirements, and (3) to ensure that the
agency action is not arbitrary, capricious or an abuse of process...<a href="#25" name="25a">25</a></blockquote>

As the proceeding did not concern any administrative decision of HHS, then the court was not
engaging in "judicial review," and the court had jurisdiction.<a href="#26" name="26a">26</a>

With respect to HHS' argument that its actions constituted recoupment, the court characterized
the issue as
<blockquote>whether an essentially, open-ended application of the definition of "single integrated
transaction" should apply to a Medicare reimbursement scheme, pursuant to the District
of Columbia Circuit [in Consumer Health Svcs.], or if a discrete division of transactions
can be applied to the Medicare scheme, as presented by the Third Circuit [in University
Medical Center].<a href="#27" name="27a">27</a></blockquote>

The court adopted the rationale of the Third Circuit, finding that "as a matter of logic, each
provision of services...is a separate transaction and contract." The court found that the
seemingly "continuous nature" of the reimbursement contract was a "manufactured and
temporary distinction" because the actual final adjustments made annually by HHS "reflect and
correspond to each actual separate service provided by the debtor." Thus, the court held that the
single contract governing the relationship between the debtor and HHS covered several separate
and discrete transactions. As such, HHS' actions constituted set-off and violated the automatic
stay.

<h3>Conclusion</h3>

Three of the four cases discussed above conclude that the government's actions constitute
recoupment rather than set-off. If the 1998 cases are any indication, health care debtors may
find bankruptcy courts less willing to protect their post-petition Medicare income where they
have received pre-petition overpayments.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Peterson Distr. Inc., 82 F.3d 956 (10th Cir. 1996)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §553(a)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Distr., 82 F.3d at 958</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re University Medical Center, 973 F.2d 1065, 1079 (3d Cir. 1992)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Distr., 82 F.3d at 960</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> But, see, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Medical Center, 973 F.2d at 1080</a> ("[T]he ability to recoup across the petition boundary is questionable."). <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… B.R. 709 (N.D. Cal. 1998)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 710</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 714</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> 222 R. 804 (Bankr. N.D. Tex. 1998). <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 809-10</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 810</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 811</a> (quoting In re Heffernan Memorial Hosp. Dist., 192 B.R. 228, 231 (Bankr. S.D. Cal. 1996)) (other internal quotations omitted). <a href="#13a">Return to article</a>

<a name="14">14</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… B.R. 962 (Bankr. S.D. Fla. 1998)</a>. <a href="#14a">Return to article</a>

<a name="15">15</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 963</a>. <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 964</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 965</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> Id. <a href="#18a">Return to article</a>

<a name="19">19</a> Id. (relying on <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… States v. Consumer Health Svcs. of America, 108 F.3d 390 (D.C. Cir. 1997)</a>). <a href="#19a">Return to article</a>

<a name="20">20</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… B.R. 464 (Bankr. W.D. Okla. 1998)</a>. <a href="#20a">Return to article</a>

<a name="21">21</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 467</a>. <a href="#21a">Return to article</a>

<a name="22">22</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 468</a>. <a href="#22a">Return to article</a>

<a name="23">23</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 469</a>. <a href="#23a">Return to article</a>

<a name="24">24</a> Id. <a href="#24a">Return to article</a>

<a name="25">25</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 469</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 470</a>. <a href="#26a">Return to article</a>

<a name="27">27</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 477</a>. <a href="#27a">Return to article</a>

Journal Authors

Angelyn M. Wright

Gary W. Marsh

Journal Date

Thursday, April 1, 1999 - 12:00