Are Medicare Provider Agreements Executory Contracts

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Dec/Jan 2000

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In today's health care environment, most health care facilities participate in the Medicare program by virtue
of Health Insurance Benefit Agreements (Medicare Provider Agreements) with the U.S. Department of
Health and Human Services (HHS) and/or the Health Care Financing Administration (HCFA). Medicare
Provider Agreements are the vehicle by which HCFA, through fiscal intermediaries, reimburses health care
providers for services rendered to Medicare patients. When a health care provider files for bankruptcy relief,
one issue that practitioners should consider is whether a Medicare Provider Agreement is an "executory
contract" subject to assumption or rejection as provided in §365 of the Bankruptcy Code. Although most
courts answer that question in the affirmative, some courts have questioned the conventional wisdom.

It behooves everyone involved with a bankrupt health care facility to consider this issue carefully before
automatically treating Medicare Provider Agreements as executory contracts; the costs of assuming a
Medicare Provider Agreement can be astronomical if a debtor has received overpayments in prior cost years
(which, by the way, currently accrue interest at the rate of 13.5 percent per annum). However, rejection is
not necessarily an option, as one needs a Medicare Provider Agreement in order to treat Medicare patients
and receive Medicare dollars. Accordingly, an analysis of this issue is essential.

In order to understand the dispute, it is necessary to re-examine a few basics regarding executory contracts.
Over the years, several definitions of "executory contract" have been developed by the courts, in the absence
of an explicit definition in the Bankruptcy Code. The most common of these, the so-called Countryman test,
states that an executory contract is a contract that is so far unperformed that the failure of either the debtor or
the non-debtor party to the contract to complete performance would constitute a material breach excusing the
performance of the other. See Countryman, "Executory Contracts in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…: Part I," 57 Minn. L. Rev.
439, 460 (1973)</a>. Cases adopting the Countryman test include <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Texscan Corp., 976 F.2d 1269 (9th Cir.
1992)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Steel Corp. v. Nat'l Fuel Gas Distribution Corp., 872 F.2d 36 (3d Cir. 1989)</a>; and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Newcomb, 744 F.2d 621 (8th Cir. 1984)</a>. In enacting the current Bankruptcy Code, Congress appears to have
adopted at least some portion of the Countryman test, as the legislative history to §365 indicates that
"executory contracts include contracts under which performance remains due to some extent on both sides."
S. Rep. No. 95-989, 95th Cong., 2d Sess. (1977).

One line of authority questioning the Countryman test is the so-called "functional approach." See
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, "A Functional Analysis of Executory Contracts," 74 Minn. L. Rev. 227 (1989)</a>. They hold that
the Countryman test is helpful, but not necessarily dispositive. Courts applying the functional approach
utilize a more flexible definition that works backward from an examination of the purposes to be
accomplished by rejection; if these have already been accomplished, then the contract cannot be said to be
executory. The only circuit court to explicitly adopt the functional approach is the Sixth Circuit, which first
did so in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Jolly, 574 F.2d 349 (6th Cir. 1978)</a>; see, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Dayton Country Club Co. (In re
Magness), 972 F.2d 689 (6th Cir. 1992)</a>. Whichever test the bankruptcy court adopts, if a Medicare
Provider Agreement is found to be an executory contract, then the debtor may only assume or reject such
agreement with court approval.

As noted above, the majority of courts have generally held that because Medicare Provider Agreements
typically require performance on both sides, such agreements are executory contracts. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
Medical Center v. Sullivan (In re University Medical Center), 973 F.2d 1065 (3d Cir. 1992)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Advanced Professional Home Health Care, 94 B.R. 95 (E.D. Mich. 1988)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Memorial Hospital of
Iowa, 82 B.R. 478, 479-80 (W.D. Wis. 1988)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Visiting Nurse Association of Tampa Bay Inc., 121
B.R. 114 (Bankr. N.D. Fla. 1990)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Tidewater Memorial Hospital Inc., 106 B.R. 876, 884 (Bankr. E.D.
Va. 1989)</a>. Under this line of authority, in order to assume a Medicare Provider Agreement, the debtor
would have to assume the obligation to repay all prior years' overpayments.

There are, however, differing views. For example, in the Medicaid context, some courts have held that
because provider agreements with state Medicaid agencies can be viewed as constituting a series of
one-year contracts, each one is a separate contract. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Willington Convalescent Home Inc., 39
B.R. 781, 791 (Bankr. D. Conn. 1984), rev'd on other grounds, 72 B.R. 1002 (D. Conn. 1987)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Dartmouth Nursing Home, 24 B.R. 256, 260</a>. Presumably, a debtor need not assume prior years' contracts
in order to receive the benefits of the current year's contract. Of course, these courts are still of the view
that provider agreements are executory contracts subject to assumption or rejection under §365.
Nevertheless, under this line of authority, a debtor's exposure should theoretically be limited to the current
year's contract and any overpayments received under that year's contract.

In some sense, this theory has been adopted and applied to Medicare Provider Agreements by those
courts that hold that HCFA cannot recoup pre-petition overpayments from post-petition Medicare
payments where they arise from different cost years. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Medical Center, 973 F.2d 1065</a>;

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Sun Healthcare Group Inc., 245 B.R. 779 (Bankr. D. Del. 2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Healthback L.L.C., 226 B.R.
464 (Bankr. W.D. Okla. 1998)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… American Healthcare of Ga. Inc. v. United States Dep't of Health and
Human Services (In re First American Healthcare of Ga. Inc.), 208 B.R. 985 (Bankr. S.D. Ga. 1996)</a>,
vacated by settlement. See, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Inc. v. Styles (In re Peterson Distrib. Inc.), 82 F.3d 956 (10th
Cir. 1996)</a> (assignment of credit card invoices and sale of products are not part of the same transaction even
though both agreements are embedded within the same contract); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Canners and Growers v.
Military Distribs. of Va. Inc. (In re California Canners and Growers), 62 B.R. 18 (Bankr. 9th Cir. 1986)</a>

(different and distinct transactions were embedded within one single agreement). To some extent, these
courts are holding that each cost year constitutes a new contract. Taking this argument to its logical end,
a debtor should be permitted to effectuate a severance of the various "cost-year contracts" embodied in the
single Medicare Provider Agreement, and only be required to assume the current year's "contract."

Authority does exist for severing independent contracts that are all contained within the body of one
physical contract. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Gardinier Inc. (In re Gardinier Inc.), 831 F.2d 974 (11th Cir. 1987)</a>. The court
must look to non-bankruptcy law to determine whether severability is permissible. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 976</a> (court looks
to Florida law to determine severability of contract); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Title Guaranty Co. v. Old Republic Nat'l Title
Ins. Co., 83 F.3d 735 (5th Cir. 1996)</a> (court looked to Texas law). For example, in Georgia, "[w]hether a
contract is entire or severable depends on the intent of the parties." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Jaje, 477 S.E.2d 101, 104
(Ga. 1996)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Grant, 209 S.E.2d 210 (Ga. 1974)</a>. This test is similar to the test employed by other
states. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 83 F.3d at 739</a>; see, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 831 F.2d at 976</a>. Accordingly, it may be possible to
argue that severing the various cost-year contracts embedded in the single Medicare Provider Agreement is
appropriate, and that the debtor need only assume the current year's "contract" (and cure overpayments
thereunder) in order to continue in the Medicare program. It is difficult to predict how the intent issue would
play out in this context, however.

Yet another approach to determining the issue of whether a Medicare Provider Agreement is an executory
contract appears in an unreported decision by the Middle District of Florida Bankruptcy Court. In In re BDK
Health Management Inc., Case No. 98-609-B1 (Bankr. M.D. Fla.), the bankruptcy court entered an Order
Authorizing Sale of Assets Out of the Ordinary Course of Business (filed Nov. 16, 1998). In the order, the
court considered the debtor's motion to sell its assets, including its various Medicare Provider Agreements,
to a third-party purchaser, free of all liens, claims and encumbrances (including recoupment and set-off rights,
if any, of HCFA and the Florida Medicaid agency), pursuant to §363(f) of the Bankruptcy Code. HCFA
objected to the motion, arguing that the Medicare Provider Agreements were executory contracts that must
be assumed and assigned to the third party purchaser pursuant to §365 of the Bankruptcy Code. HCFA further
argued that any order granting the assumption and assignment of the Medicare Provider Agreements would
have to provide for repayment of all overpayments, whether pre-petition or post-petition. In reply, the debtor
put forth a "necessity" argument, contending that the assets sought to be sold would have little or no
independent value apart from the Medicare Provider Agreements. The debtor flatly stated that if it could not
sell its assets, including the Medicare Provider Agreements, the debtor would be forced to cease operations
and liquidate, thereby almost certainly guaranteeing little or no distribution to unsecured creditors. This is in
contrast to $1 million in net proceeds if the sale were allowed to go forward.

The court held that the Medicare Provider Agreements at issue in the case were not executory contracts
at all, but simply assets of the debtor's estate. Accordingly, the court granted the debtor's motion and
approved the sale. Interestingly, in reaching its conclusion, the court commented on the fact that outside of
the bankruptcy courts, HHS and HCFA almost always argued that Medicare Provider Agreements were not
contractual relationships in the traditional sense, and that they did not create specific contractual obligations
running between the government and the health care provider. For example, the court noted decisions in
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Hospital v. Heckler, 706 F.2d 1130,1136-37 (11th Cir. 1983)</a> (holding that "[u]pon joining the
Medicare program, however, the hospitals received a statutory entitlement, not a contractual right." Although
the hospitals entered into an "agreement" with the secretary that they would abide by the rules of the Medicare
program, that agreement did not obligate the secretary to provide reimbursement for any particular expenses
such as Hill-Burton costs), cert. denied <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S. 1023 (1984)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Hospitals v. Schweiker, 708
F.2d 199, 201 (6th Cir. 1983)</a> ("[the health care provider] has not shown that the Medicare program
established a contractual relationship between the hospital and federal government); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Dallas Homecare
Alliance v. United States, 10 F.Supp.2d. 638, 647 (N.D. Tex 1998)</a> ("Plaintiffs argue that the Medicare
participation agreements between [HCFA] and the [health care providers] are essentially contracts. The court
disagrees and finds that the participation agreements are not contracts, for the right to receive payments under
the Medicare Act is a manifestation of government policy and, as such, is a statutory rather than a contractual
right"); Homecare Ass'n of America Inc. v. United States, 1998 U.S. Dist. Lexis 20515 (W.D. Okla. Aug.
1998) (holding that no contractual obligation existed between government and provider of Medicare services);

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Hospital and Medical Center v. Heckler, 590 F. Supp. 24, 30-31 (ED. Pa. 1983)</a> ("There is no
contractual obligation requiring HHS to provide Medicare reimbursement. Rather, upon joining the Medicare
program, providers gain a statutory entitlement to reimbursement. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §1395f(b)</a>. Thus, the amount of
reimbursement is governed not by contract but by statute—specifically, the Medicare Act's 'reasonable cost'
provisions").

The court went on to hold that Medicare Provider Agreements do not look like typical, garden-variety
contracts. For example, Medicare Provider Agreements impose no particular obligations on the government,
and the government derives no tangible consideration from the health care provider party to the "agreement."
Essentially, the agreement boils down to a recognition that the health care provider is entitled to treat Medicare
patients and be reimbursed for such treatment in accordance with the then-applicable Medicare statutes and
regulations. The court found, consistent with the decisions cited above, that the Medicare Provider
Agreements created "statutory entitlement" relationships rather than contractual relationships. Accordingly,
the court held that the agreements could be sold free of any prior-year overpayment liability and did not have
to be assumed (and overpayment liability cured) pursuant to §365. Obviously, if this decision were adopted
by other jurisdictions, it could well pave the way for health care debtors to shed their Medicare liabilities and
transfer their assets for their fair value, without regard to the sometimes massive Medicare overpayment
liability.

As the above discussion illustrates, a health care debtor may have certain options in making a decision
about how to deal with Medicare Provider Agreements that carry with them significant overpayment
liabilities. Counsel should be wary of jumping to the conclusion that such agreements must constitute
executory contracts subject to assumption or rejection under §365.

Journal Authors

Matthew W. Levin

Journal Date

Friday, December 1, 2000 - 12:00