Ninth Circuit Weighs in on Recoupment of Medicare Overpayments

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Nov 2000

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With the Ninth Circuit Court of Appeals' recent decision in the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re TLC Hospitals, ___ F.3d ___
(9th Cir. Sept. 12, 2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… W.L. 1280324</a>, financially distraught health care providers in the Ninth
Circuit will find themselves at the mercy of the Department of Health and Human Services. This is so
because the Ninth Circuit has concluded that Medicare overpayments are subject to recoupment. In order
to understand the dramatic effect of the Ninth Circuit's decision on health care entities, a little background
information is necessary.

<h3>Payment Procedures Under Health Care Provider Agreements</h3>

Health care providers serve Medicare and Medicaid patients pursuant to a "provider agreement." Under a
provider agreement, health care providers become eligible to receive reimbursements in accordance with
the statutory and regulatory schemes of the Medicare or Medicaid programs. These Medicare and Medicaid
programs require that estimated interim payments be made to health care providers at least every month.
The amount of each estimated interim payment is determined by the health care provider's cost report,
which is based on the Medicare/Medicaid patients treated.

At the end of the fiscal year, the cost reports submitted by the health care provider are audited to
determine the actual costs incurred vs. the amounts already paid to the health care provider during the
year. At the conclusion of this audit, a retroactive adjustment is made. If the monthly estimates made
during the year were less than the actual costs incurred by the health care provider, the health care
provider is entitled to receive a final payment adjustment making up the difference. However, if the
prepayments resulted in the health care provider receiving an overpayment, then the Medicare or
Medicaid program making such an overpayment has the ability to deduct those overpayments from any
future payments owed to the health care provider.

Not surprisingly, the vast majority of health care providers seeking bankruptcy protection have
significant liability for pre-petition overpayments made to them by the Medicare or Medicaid programs.
The determinative factor in such a debtor's reorganization proceeding is whether the government's rights
in such an overpayment situation constitute "set-off" rights or "recoupment" rights. If the government's
rights are merely set-off rights, then it will have only a pre-petition claim for such overpayments and will
be prevented by the automatic stay from exercising such set-off rights. Furthermore, the obligations of the
government to pay the health care company arising after the filing of the petition cannot be set off against
pre-petition overpayments.<a href="#1" name="1a">1</a> However, if the government's rights are in the nature of a "recoupment," then,
as explained below, the government is not subject to any of the above "set-off restrictions" and can
effectively choke off the debtor's cash flow, which will be needed to fund its reorganization effort.

<h3>Background of the TLC Case</h3>

TLC Hospitals Inc. was an operator of skilled nursing facilities that provided many of their services
subject to reimbursement by Medicare, a health insurance program administered by the U.S. Department
of Health and Human Services (HHS). In 1994, TLC filed a petition in bankruptcy court but continued to
provide Medicare nursing services for some time thereafter. Audits then revealed that HHS, at different
times, had both overpaid and underpaid TLC for its services. In order for recoupment to be available to a
creditor, the claims of such a creditor must arise from the same transaction from which the debtor's claim
against the creditor arises. Therefore, the question before the TLC court was whether the offsetting liabilities
arose from the same transaction such that HHS would be allowed to deduct pre-petition overpayments HHS
made to TLC from the sums it owed TLC for post-petition services. The TLC court concluded that HHS
could recoup in this manner.

More specifically, the parties in the TLC case disagreed as to whether HHS could deduct the amount
of the 1993 overpayments from the sums HHS owed TLC for the 1994 underpayments. At the time this
controversy arose in the bankruptcy court, HHS had made Medicare over-payments of $112,061 to TLC,
yet owed TLC's estate $68,871.16 for pre-petition services and $46,952.84 for post-petition services. The
overpayments, for the most part, related to services rendered in the 1993 fiscal period, and the
under-payments related to services rendered in the 1994 fiscal period.

Following an adverse ruling by the bankruptcy court, HHS appealed the denial of recoupment to the
district court. The district court reversed and remanded, concluding that HHS could recoup pre-petition
overpayments from these sums. The district court based its decision both on the equitable doctrine of
recoupment and on a statutory construction of the Medicare Act. TLC then appealed to the Ninth Circuit.

The core question before the Ninth Circuit was whether HHS's overpayments for TLC's nursing
services in one fiscal year arise from the same transaction as its underpayments to TLC in a later fiscal
year. The Ninth Circuit concluded that the overpayments and underpayments from year to year are part
of the same transaction in the Medicare context, and therefore HHS was entitled to the equitable remedy
of recoupment. To support its one-transaction conclusion, the Ninth Circuit then went on to provide a
detailed analysis of the statutory and regulatory framework of the Medicare program, which supported
the court's one-transaction conclusion, and held that "under this specialized and continuous system of
estimated payments and subsequent adjustments, HHS's overpayments and its underpayments in a
subsequent fiscal year were parts of the same transaction for purposes of recoupment." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… supra ___
F.3d at ___</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… W.L. 1280324</a>, pg. 3.

<h3>Ninth Circuit Rejects Contrary Holding of the Third Circuit</h3>

TLC urged the Ninth Circuit to adopt the contrary interpretation of "transaction" utilized by the Third
Circuit in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Med. Ctr. v. Sullivan (In re University Med. Ctr.), 973 F.2d 1065 (3d Cir. 1992)</a>. There
the court held that in order for recoupment to apply, HHS's claim for the pre-petition overpayments and the
University Medical Center's claim for post-petition services "must arise out of a single integrated transaction
so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its
obligations."<a href="#2" name="2a">2</a> In effect, the Third Circuit required the "creditor's claim [to] arise out of the identical
transaction as the debtor's,"<a href="#3" name="3a">3</a> and the court explicitly rejected the logical-relationship test.<a href="#4" name="4a">4</a> Consequently,
HHS could not effect a recoupment to recover pre-petition overpayments in one calendar year from its
obligation to pay University Medical Center for services rendered post-petition in a subsequent calendar year.<a href="#5" name="5a">5</a>

After reviewing the opinion in University Medical Center, the Ninth Circuit found the Third Circuit's
reasoning unpersuasive and rejected it.<a href="#6" name="6a">6</a> According to the Ninth Circuit, the "fact that the overpayments and
underpayments relate to different fiscal years does not destroy their logical relationship or indicate that they
pertain to separate transactions." Id. Rather, it was the Ninth Circuit's conclusion that Congress "clearly
indicated that it wanted a provider's stream of services to be considered one transaction for purposes of any
claim the government would have against the provider."<a href="#7" name="7a">7</a>

<h3>Conclusion</h3>

For the vast majority of health care providers that would be required to file a bankruptcy petition in the
Ninth Circuit, the chances for reorganization have grown decidedly slimmer in the absence of an agreement
with HHS. Any health care provider who has received substantial Medicare or Medicaid overpayments will
not be protected by bankruptcy from HHS's efforts to recoup such payments from post-petition
reimbursements owed to a debtor. For many health care entities, reimbursements from Medicare or Medicaid
may be the difference between reorganization and liquidation. These entities will essentially be at the mercy
of HHS if they wish to reorganize. If HHS wishes to fully exercise their recoupment rights in a particular case,
then it is likely that the cash flow necessary for a reorganization will be unavailable and the debtor health care
entity may be dead on arrival.

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<h3>Footnotes</h3>

<a name="1">1</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Canners & Growers v. Military Distribution, 62 B.R. 18, 20 (B.A.P. 9th Circuit 1986)</a> (holding
that a pre-petition claim cannot be offset by post-petition obligations); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Village Craftsmen Inc., 160 B.R. 740, 745-46
(Bankr. D. N.J. 1993)</a> (stating that the application of automatic stay can block post-petition debt and set-off); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kleather,

208 B.R. 406, 413 (Bankr. S.D. Ohio 1997)</a> (stating that post-petition obligations of a creditor will not be offset). <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Med. Ctr., supra, 973 F.2d at 1081</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> Id. at 1080. <a href="#3a">Return to article</a>

<a name="4">4</a> Id. at 1081. <a href="#4a">Return to article</a>

<a name="5">5</a> Id. at 1082. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra, 2000 W.L. 1820324</a>, p. 4. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;, quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. v. Consumer Health Services of America Inc., 108 F.3d 390, 395 (D.C. Cir. 1997)</a>. <a href="#7a">Return to article</a>

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Journal Authors

James T. Markus

John F. Young

Journal Date

Wednesday, November 1, 2000 - 12:00