An Issue That Just Wont Go Away

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Jul/Aug 2004

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More than six years ago, I wrote the first article for this column on the issue of whether Medicare<a href="#1" name="1a">1</a> had a right of
recoupment when it was owed money by a Medicare provider that had gone into a bankruptcy proceeding.<a href="#2" name="2a">2</a> The
issue simply refuses to go away, despite a lot of commentary<a href="#3" name="3a">3</a> and cases discussing it. Courts continue to wrestle
with this issue and continue to confuse some basic issues about the very concept of recoupment while doing so. The
recent cases of In re Slater Health Center Inc.<a href="#4" name="4a">4</a> and In re Holyoke Nursing Home Inc.<a href="#5" name="5a">5</a> show that the silver bullet
for this issue has not yet been discovered. Moreover, after more than a decade of litigation arising in
Medicare-provider bankruptcy cases, these two cases show that there continue to be new issues raised about a
debtor's rights vis-à-vis participation in the Medicare program.

Make no mistake about it: The health care industry is one of the most important and fastest-growing segments of
America's economy,<a href="#6" name="6a">6</a> and Medicare is still the 800-pound gorilla in health care in the United States, spending more
than $267 billion in 2002 for its more than 41 million enrollees. Because of its size and relative importance in this
industry, whether Medicare has the right to withhold payments—without regard for the automatic stay—owed to a
provider to pay itself amounts owed to it by that provider remains an important, and frequently case-dispositive,
issue.

The first appellate court decision on this issue was the Third Circuit's 1992 decision in In re University Medical
Center,<a href="#7" name="7a">7</a> where the court held that Medicare's adjustment of ongoing payments were a setoff rather than recoupment,
finding that recognition of a recoupment right in bankruptcy required "a single integrated transaction such that it
would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations."<a href="#8" name="8a">8</a>
Needless to say, this standard provided fertile grounds for controversy, based as it is on fairness to the debtor and
general notions regarding equity. This decision remained the leading circuit court opinion on the issue until 1997,
when the U.S. Court of Appeals for the District of Columbia in United States v. Consumer Health Services<a href="#9" name="9a">9</a> held
that Medicare's right to adjust ongoing payments to recover pre-petition obligations was a right of recoupment.

In 2000, the Ninth Circuit contributed to the discussion with its opinion in In re TLC Hospitals Inc.<a href="#10" name="10a">10</a> In TLC
Hospitals, the United States sought to keep monies owed to the debtor for Medicare underpayments in 1994 to
repay itself for overpayments to the debtor in 1993. The Ninth Circuit allowed this adjustment and did so by
adopting the "logical relationship" test derived from the common-law pleading rules concerning counterclaims. This
is not inappropriate, given that recoupment is the "ancestor" of the compulsory counterclaim presently set forth in
Rule 13(a) of the Federal Rules of Civil Procedure.<a href="#11" name="11a">11</a> In that context, the Supreme Court has said that "transaction"
is a word of flexible meaning, including a series of occurrences, depending not so much on the immediateness of
their connection as upon their logical relationship.<a href="#12" name="12a">12</a>

In Slater Health Center, the bankruptcy court found that Medicare had a right of recoupment, following the
Consumer Health-TLC Hospitals line of cases.<a href="#13" name="13a">13</a> However, the bankruptcy court went on to hold that it had the
power, on equity grounds, to deny Medicare authorization to exercise that right. It based this decision on a unique
issue present in the case. In the vast majority of Medicare recoupment cases, Medicare has overpaid for past services
because of the way Medicare reimburses providers of medical services for their work; it pays an estimated amount
based on a formula, and then audits an annual cost report submitted by the provider to determine whether it
overpaid or underpaid in a given fiscal year. If it determines it overpaid the provider, it is either repaid by the
provider directly or adjusts the ongoing payments to recover the prior overpayments. This system results in years
passing between an overpayment and the recovery of the overpayment. In Slater, Medicare claimed an overpayment
by virtue of a disallowance of the debtor's cost report based on a technicality. Because the debtor's cost report
included costs for services rendered by subcontractors that remained unpaid as of the petition date, those pre-petition
bills were claims to be paid, if at all, through the distribution in the bankruptcy case. Medicare statutes include a
provision that allows Medicare to disallow requests for reimbursement made by a provider based on any costs
incurred by that provider that are not paid within a year of the bills being submitted. In other words, because the
debtor in Slater did not pay its subcontractors for services rendered pre-petition, Medicare disallowed the debtor's
request to be paid for those costs. Thus, rather than a true overpayment where Medicare paid more for services than
it should have, here Medicare invoked a technicality to effectively obtain services from the subcontractors without
payment. On this basis, the bankruptcy court denied Medicare's recoupment right.

On appeal, the U.S. District Court for the District of Rhode Island disagreed with the bankruptcy court,
holding that Medicare's rights were not that of recoupment, instead describing the adjustments thusly:

<blockquote>
In basing its decision on recoupment analysis, the bankruptcy court overlooked the fact that the issue of recoupment
arises only where there are two reciprocal obligations and it is necessary to determine whether one can be offset
against the other. There is no need to consider recoupment when there is a single obligation to the debtor and the
only issue is whether the amount in question must be deducted in order to calculate the sum owed to the debtor. In
such cases, since the debtor has no claim to the amount in question, there is nothing that can be offset.<a href="#14" name="14a">14</a>
</blockquote>

Of course, what the district court has done here is merely restate the definition of "recoupment" and refuse to call it
by its true name. The U.S. Supreme Court has long held that recoupment is the setting up of a demand arising from
the same transaction as the plaintiff's claim to abate or reduce that claim. Almost 70 years ago, the Supreme Court
held that "recoupment is in the nature of a defense arising out of some feature of the transaction upon which the
plaintiff's action is grounded."<a href="#15" name="15a">15</a> Recoupment, therefore, is merely the means used to determine the proper liability
on the amounts owed.<a href="#16" name="16a">16</a> This definition of recoupment is virtually identical to the district court's description of the
"non-recoupment" right exercised by Medicare in Slater.

In a decision only available on an electronic database, In re Holyoke Nursing Home Inc. (decided less than four
months after the decision in Slater), the First Circuit has effectively repudiated the district court's reasoning<a href="#17" name="17a">17</a> in
Slater. In Holyoke, the First Circuit joined with the Ninth and District of Columbia Circuits in holding that
Medicare's right to adjust ongoing payments against post-petition payments was a right of recoupment and,
therefore, not subject to the automatic stay. In a footnote, the First Circuit declined to address the theory upon
which the district court decided Slater, referring to the argument that the adjustment of ongoing payments only
determined what was owed as merely an "alternative argument advanced by HCFA."<a href="#18" name="18a">18</a>

Finally, the First Circuit in Holyoke seemed to limit the kind of equitable reasoning employed by the bankruptcy
court in Slater, finding that (1) there was no reason in such cases to invoke equity to undermine a party's
recoupment rights, and (2) it would be inequitable to allow health care providers to use public funds obtained by
overcharging Medicare to pay their creditors rather than returning those funds to the Medicare program to defray the
costs of providing Medicare services.<a href="#19" name="19a">19</a> Of course, whether this is correct in the unique circumstances found in
Slater—where Medicare was not overcharged but merely invoked a technicality to deny payments to a bankruptcy
estate—is another question.

One final issue raised in the Slater case that may well be unique to that case is that the debtor went on to assume
the Medicare Provider Agreement, arguing that it did not have to cure the "overpayment" caused by the disallowance
of the costs for unpaid subcontractor obligations because such obligations were not an "actual pecuniary loss" to
Medicare.<a href="#20" name="20a">20</a> The bankruptcy court agreed with that reasoning, pointing out that the medical services were actually
provided to the Medicare beneficiaries, and that any pecuniary loss would be suffered by those parties who had
provided the Medicare services, but were to be paid, if at all, through the eventual distribution in the bankruptcy
case.<a href="#21" name="21a">21</a> The bankruptcy court relied on Texas American Oil Corp. v. U.S. Dept. of Energy,<a href="#22" name="22a">22</a> where the trustee
objected under §726(a)(4) of the Bankruptcy Code<a href="#23" name="23a">23</a> to a claim filed by the Energy Department based on alleged
overcharges by a subsidiary of the debtor. The trustee argued that because monies paid on the claim were not going
to be paid to the alleged victims of the overcharges, it was not a claim for actual pecuniary loss but more in the
nature of remedial or enforcement obligations. The U.S. Court of Appeals for the Federal Circuit agreed with the
trustee, holding that the claim could be subordinated under §726(a)(4).<a href="#24" name="24a">24</a> The bankruptcy court in Slater found the
reasoning in Texas American analogous and persuasive, and held that the claim asserted by Medicare was also not a
pecuniary loss claim that the debtor had to cure to be able to assume the Medicare Provider Agreement.<a href="#25" name="25a">25</a>

In conclusion, the decisions in Slater and Holyoke demonstrate that even after a decade of litigation, the issues
surrounding Medicare's right to adjust post-petition payments to recover pre-petition obligations from a debtor are
no closer to being resolved: Old issues continue to arise and be misunderstood, while new issues are still being
discovered.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Medicare is the national health insurance program for people age 65 or older, some people under 65 with disabilities and people with end-stage renal disease. The Medicare
Program is administered by the Centers for Medicare and Medicaid Services (CMS), which was formerly known as the Health Care Financing Administration (HCFA). It is referred
to as "Medicare" herein. <a href="#1a">Return to article</a>

<a name="2">2</a> Maizel, Samuel R., "Medicare's Recoupment Rights Get More Confusing," Am. Bankr. Inst. J., Vol. XVI, No. 7, Sept. 1997. <a href="#2a">Return to article</a>

<a name="3">3</a> See, e.g., Burton, Daniel C., and Waldrep Jr., Thomas W., "Medicare and Medicaid Receivables: Recoupment or Setoff?," 21 Am. Bankr. Inst. L.J. 18 (June 2002). <a href="#3a">Return to article</a>

<a name="4">4</a> 306 B.R. 20 (D. R.I. 2004). <a href="#4a">Return to article</a>

<a name="5">5</a> Holyoke Nursing Home Inc. v. Health Care Financing Administration (In re Holyoke Nursing Home Inc.), 2004 U.S. App. Lexis 1203 (1st Cir. June 8, 2004). <a href="#5a">Return to article</a>

<a name="6">6</a> Health care spending in the United States exceeded $1.6 trillion in 2002, up from $1.4 trillion in 2001 and $1.3 trillion in 2000, according to a report issued by the CMS. This
represented a growth rate of 9.3 percent for 2002, the latest year for which actual spending figures are available, compared to 8.5 percent in 2001, and marked the sixth
consecutive year in which health spending grew at an accelerated rate. <a href="#6a">Return to article</a>

<a name="7">7</a> 973 F.2d 1065 (3d. Cir. 1992). <a href="#7a">Return to article</a>

<a name="8">8</a> 973 F.2d at 1081. <a href="#8a">Return to article</a>

<a name="9">9</a> 108 F.3d 390 (D.C. Cir. 1997). <a href="#9a">Return to article</a>

<a name="10">10</a> Sims v. United States Dept. of Health and Human Servs. (In re TLC Hospitals Inc.), 224 F.3d 1008 (9th Cir. 2000). <a href="#10a">Return to article</a>

<a name="11">11</a> Coplay Cement Co. v. Willis & Paul Group, 983 F.2d 1435, 1440 (7th Cir. 1993). <a href="#11a">Return to article</a>

<a name="12">12</a> Moore v. New York Cotton Exch., 270 U.S. 593, 610 (1926). <a href="#12a">Return to article</a>

<a name="13">13</a> Slater Health Center Inc. v. United States, et al. (In re Slater Health Center Inc.), 294 B.R. 423, 430 (Bankr. D. R.I. 2003). <a href="#13a">Return to article</a>

<a name="14">14</a> Slater Health Center, 306 B.R. at 25. <a href="#14a">Return to article</a>

<a name="15">15</a> Bull v. United States, 295 U.S. 247, 262 (1935). <a href="#15a">Return to article</a>

<a name="16">16</a> See, e.g., Reiter v. Cooper, 507 U.S. 258, 265 n.2, 113 S. Ct. 1213, 1218 n.2 (1993). <a href="#16a">Return to article</a>

<a name="17">17</a> The decision in Holyoke is binding on the District of Rhode Island, which is in the First Circuit. <a href="#17a">Return to article</a>

<a name="18">18</a> 2004 U.S. App. LEXIS 11203 *8, fn 1. <a href="#18a">Return to article</a>

<a name="19">19</a> Id. at 9. <a href="#19a">Return to article</a>

<a name="20">20</a> Section 365(b)(1) of the Bankruptcy Code provides that "[i]f there has been a default in an executory contract...the trustee may not assume such contract...unless...the trustee (A)
cures, or provides adequate assurance that the trustee will cure, such default; (B) compensates, or provides adequate assurance that the trustee will promptly compensate, a party
other than the debtor to such contract...for any actual pecuniary loss to such party resulting from such default; and (C) provides adequate assurance of future performance under
such contract...." 11 U.S.C. §365(b)(1) (emphasis added). <a href="#20a">Return to article</a>

<a name="21">21</a> 294 B.R. at 432. <a href="#21a">Return to article</a>

<a name="22">22</a> 44 F.3d 1557 (Fed. Cir. 1995). <a href="#22a">Return to article</a>

<a name="23">23</a> Section 726(a) provides the priority for payment of allowed claims in a bankruptcy case and states that, after payment for any general unsecured claims, they will be paid a
distribution "in payment of any allowed claim...for any fine, penalty or forfeiture...to the extent that such fine, penalty, forfeiture or damages are not compensation for actual
pecuniary loss suffered by the holder of such claim." 11 U.S.C. §726(a)(4) (emphasis added). <a href="#23a">Return to article</a>

<a name="24">24</a> 94 F.3d at 1570-71. <a href="#24a">Return to article</a>

<a name="25">25</a> 294 B.R. at 433. <a href="#25a">Return to article</a>

Journal Authors

Samuel R. Maizel

Journal Date

Thursday, July 1, 2004 - 12:00

Bankruptcy Rule

2004