The Role of an Examiner in Health Care Insolvencies

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Dec/Jan 2003

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On May 25, 2001, the California Department of Managed Health Care (DMHC) took control of the California
operations of Maxicare Health Plans Inc., a statewide Health Maintenance Organization (HMO) servicing 272,000
members. There were concerns about the HMO's ability to provide quality services to enrollees, and in particular,
there were questions surrounding the plan's solvency. Under the DMHC's action, J. Mark Abernathy, one of the
authors of this article and a director of the group then known as Peterson Consulting, was appointed the conservator
of Maxicare on the day he seized control of Maxicare's operations. Maxicare filed a chapter 11 petition later that
day. This posed an interesting dilemma for the DMHC: Should it hold firm on the conservatorship and fight
Maxicare's standing to file the petition, or allow Maxicare's bankruptcy proceeding to continue under certain
stipulated terms?

In order to facilitate an expeditious and orderly resolution to the controversy, Mr. Abernathy and the DMHC agreed
to stipulate the appointment of Mr. Abernathy as examiner. This reduced the risk of the provider network (the
only real value of the debtor) falling apart while a legal fight ensued on the conflicting authority.

This particular illustration is merely one of many instances of the appointment of examiners in a health
care bankruptcy case. While some of the issues arising from such appointments are not unique, in many ways the
role of an examiner is unique. The compromise described above raises interesting issues regarding the role of
examiners in health care insolvency cases generally.

<h3>Statutory Basis for the Appointment of an Examiner</h3>

Section 1104 of the Bankruptcy Code,<a href="#1" name="1a">1</a> the statutory basis for the appointment of an examiner, provides, among
other things, that an examiner may be appointed to conduct an investigation of the debtor as appropriate (where a
trustee has not been appointed) upon request of a party in interest or the U.S. Trustee, after notice and a hearing, if
such appointment is in the interests of creditors or othersto conduct an investigation of the debtor as appropriate.<a href="#2" name="2a">2</a>
The investigation may include fraud, dishonesty, incompetence, misconduct, mismanagement or irregularity in the
management of the affairs of the debtor of or by the current or former management of the debtor. The examiner
investigates "the acts, conduct, assets, liabilities and financial condition" and operations of the debtor, the
desirability of continuing the business and matters relevant to the case or formulation of a plan.<a href="#3" name="3a">3</a> The examiner can
file interim reports, and when the investigation is complete, the examiner files a final report to the court.<a href="#4" name="4a">4</a> These
reports are to include "any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct,
mismanagement or irregularity in the management of the affairs of the debtor, or to a cause of action available to the
estate."<a href="#5" name="5a">5</a> The decision of whether to appoint an examiner is discretionary with the bankruptcy court if the debtor's
liabilities are less than $5 million,<a href="#6" name="6a">6</a> and mandatory if the debtor owes more than $5 million in fixed, liquidated or
unsecured debts, other than to an insider.<a href="#7" name="7a">7</a> Despite the latter provisions in the Bankruptcy Code, examiners are not
generally appointed. However, in health care cases, the courts have often exercised their discretion with regard to the
appointment of an examiner.

For example, in In re First American Health Care of Georgia,<a href="#8" name="8a">8</a> the court sua sponte appointed an
examiner in the bankruptcy of the nation's largest privately held home health agency because the principals had been
convicted of Medicare fraud pre-petition and had appointed an "independent manager" to run the business while they
were imprisoned. The bankruptcy court granted a first-day motion to appoint the same firm selected by the now
convicted principals as independent management during the chapter 11 case. The court first held that it could sua
sponte appoint an examiner. It then held that cause to appoint an examiner existed because (1) while there was no
evidence that the independent management was committing fraud, the former management had been convicted of
fraud, and the plain language of §1104 provided that fraud by former management, which could serve as grounds for
appointment of an examiner; (2) the former management had selected the independent management, which created
the appearance of impropriety; (3) the involvement of an examiner would "contribute valuable perspective to a case
with many competing interests at stake;" and (4) "the resources available to the court, the U.S. Trustee and
individual creditors are insufficient...to evaluate many matters likely to arise" during the case.<a href="#9" name="9a">9</a> Of course, many of
these reasons would apply to other industries and other debtors, and if taken at face value would result in the
appointment of an examiner in many bankruptcy cases. Here, it seems to merely reflect the concern with which
bankruptcy courts treat health care insolvency cases where, in addition to the financial health of the debtor and
creditors, the lives of patients may be at risk.

<h3>Role of the Examiner in the Maxicare Bankruptcy</h3>

The examiner's duties and responsibilities in the Maxicare case included monitoring and overseeing all
business operations of the debtor, and approving all disbursements and any sale transactions proposed by the debtor.
The examiner's order provided that the examiner could retain professionals, and the examiner retained Peterson
Consulting to provide business, financial and oversight consulting services on behalf of the bankruptcy estate. The
examiner consulted with the debtor on a daily basis concerning, among other things, day-to-day business operations
of the debtor, its financial transactions and the appropriate adjudication and payment of provider claims.
Specifically, the examiner rendered services concerning the review and supervision of all accounting and financial
aspects of the business and operations of the debtor. Finally, the examiner provided oversight to the resolution of
creditor obligations and compliance with the debtor's obligations as a debtor-in-possession (DIP). In other words,
the examiner in the Maxicare case was intimately involved in virtually every aspect of the debtor's operations and
bankruptcy case.

While the role of the examiner appointed in Maxicare is certainly broader than that suggested by the plain
language of §1104, examiners with "expanded powers" are commonly found in health care insolvency cases. These
expanded powers are derived from §1106, which allows the bankruptcy court to order an examiner to perform "any
other duties of the trustee that the court orders the [DIP] not to perform."<a href="#10" name="10a">10</a> According to the plain language of
§§1104 and 1106, as long as the work is not duplicative, a court may appoint an examiner to perform virtually any
task normally performed by a DIP.<a href="#11" name="11a">11</a> However, as described above, the examiner in the Maxicare case served more
as a court-appointed oversight on most, if not all, of the debtor's post-petition operations and legal activities than
merely performing duties not performed by the debtor.

Another examiner with greatly expanded powers was appointed in the health care case of In re Newcare
Health Corp.,<a href="#12" name="12a">12</a> where the bankruptcy court ordered the appointment of William A. Brandt Jr. of Development
Specialists Inc. as examiner. In Newcare, Mr. Brandt was granted the powers expressly laid out in §1104 as well as
"the powers and duties vested in a [DIP] or a chapter 11 trustee pursuant to the Bankruptcy Code."<a href="#13" name="13a">13</a> The Newcare

examiner was also authorized to (1) take possession of the debtor's books and records, (2) receive all monies
generated by the debtor's operations, (3) make all payments of the debtor's expenses and determine whether to make
such payments, (4) supervise and control all the debtor's employees, (5) have complete control and power over the
debtor's operations, (6) engage professionals, (7) file documents as required by the Securities and Exchange
Commission (SEC), (8) prepare and file the debtor's tax returns, (9) direct the debtor's management company, (10)
control the debtor's operating licenses, (11) oversee the debtor's compliance with state and federal laws and
regulations, (12) control the debtor's borrowing of monies, (13) evaluate the debtor's contractual obligations, (14)
oversee the debtor's reporting as required for the bankruptcy proceeding, (15) investigate and file a report regarding
any claims by the debtor, (16) file a report on the likelihood of the debtor filing a confirmable plan and (17) file
plans on behalf of the debtor under 11 U.S.C. §1129. A more comprehensive delegation of a DIP's duties is hardly
imaginable.

The Maxicare examiner is a good example of how broad these powers can be in a health care bankruptcy
case and warrants some special attention. Obviously, in any bankruptcy case, an important part of the process is the
administration of claims against the estate. Of course, in any health care case, "claims" is a term that is also used to
describe the rights to payment that a doctor or other provider of health care services might have against an HMO
like Maxicare. In any HMO case, the debtor must pay special attention to the timely and proper adjudication of
post-petition claims to maintain the provider network. The pre-petition claims need to be adjudicated properly to
facilitate an orderly settlement with the proofs of claims. In Maxicare, the examiner had concerns pertaining to the
claims-processing operations of the debtor and the impact on the creditors of the estate. The debtor's
claims-adjudication process was grossly inadequate, which resulted in material processing and payment error rates
relative to the proper payment of claims. The process was exceedingly manual, and very few automated checks and
balances were built into the claims system to warn claims processors of potential processing or pricing errors. The
debtor knew it was adjudicating claims incorrectly, yet continued to process pre- and post-petition claims
erroneously. Industry and government standards call for processing error rates of no greater than 5 percent and
payment error rates of no greater than 1 percent. The Maxicare examiner conducted a claims audit that disclosed
that the debtor's processing error rates ranged between 57 and 100 percent, depending on the line of business and
processed date. Similarly, payment error rates (how much more than the true rates one pays for services as a
percentage of the true rate) ranged between 16 and 144 percent. In addition to the review of all disbursements for
claims payable, the Maxicare examiner also compared the disbursements with the claims system to verify that all
claims with a "paid" status in the claims system had a check generated for payment. By doing so, the examiner
identified almost $150,000 in post-petition claims that the claims system had indicated as having been paid that
had not been paid. Clearly, in taking these actions, the Maxicare examiner was not merely doing work other than
that done by the DIP, but served more like the debtors' chief executive officer and chief financial officer.

In contrast to the roles of the examiners in Newcare and Maxicare, the examiner's role in the First
American case was more limited, or at least more generally described. There, the court's order merely reiterated the
language of the statute appointing the examiner to "investigate the acts, conduct, assets, liabilities and financial
condition of the debtor, the operation of the debtor's business and the continuance of such business," and to
promptly file a report with the court after completing the investigation. Unlike the cases described above, the
examiner was not authorized to retain counsel and was merely authorized to employ "clerical assistance" and be
reimbursed for out-of-pocket expenses and an hourly rate for fees.

<h3>Conclusions</h3>

The bankruptcy court's concerns over the health of the patients in a health care bankruptcy case make the
appointment of an examiner with expanded powers more likely. Once appointed, the complicated issues that arise in
a bankruptcy case involving a health care entity almost ensure that the examiner will be more like a big brother than
a distant cousin; the examiner is more likely to function as a second management team than as merely an
investigator into historical events. Finally, at least in California where the DMHC is quite active in such cases, the
appointment of the state-appointed pre-petition conservator as the post-petition examiner is now the rule rather than
the exception.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> 11 U.S.C. §§101-1330 (2003). <a href="#1a">Return to article</a>

<a name="2">2</a> 11 U.S.C. §1104(c). <a href="#2%20a">Return to article</a>

<a name="3">3</a> 11 U.S.C. §1106 (b) states that an examiner shall perform the duties of a trustee listed in subsections (3) and (4) of subsection (a), which includes these duties. <a href="#3a">Return to article</a>

<a name="4">4</a> 11 U.S.C. §1106(a)(4). <a href="#4a">Return to article</a>

<a name="5">5</a> 11 U.S.C. §1106(a)(4). <a href="#5a">Return to article</a>

<a name="6">6</a> 11 U.S.C. §1104(c)(1); see In re Gilman Services Inc., 46 B.R. 322 (Bankr. D. Mass. 1985). <a href="#6a">Return to article</a>

<a name="7">7</a> 11 U.S.C. §1104(c)(2). <a href="#7a">Return to article</a>

<a name="8">8</a> 208 B.R. 992 (Bankr. S.D. Ga. 1996). <a href="#8a">Return to article</a>

<a name="9">9</a> 208 B.R. at 994-95. <a href="#9a">Return to article</a>

<a name="10">10</a> 11 U.S.C. §1106(b). <a href="#10a">Return to article</a>

<a name="11">11</a> Compare In re International Dist. Centers Inc., 74 B.R. 221 (S.D.N.Y. 1987) (district court reverses appointment of "pseudo-trustee"), with In re Boileau, 736 F.2d 503 (9th Cir.
1984) (approved appointment of examiner with powers nearly identical to those of a trustee). <a href="#11a">Return to article</a>

<a name="12">12</a> Case Nos. 99-44160 through 99-44182 (Bankr. D. Mass.). <a href="#12a">Return to article</a>

<a name="13">13</a> See Stipulated Order Regarding the Powers of the Chapter 11 Examiner, In re Newcare Health Corp., Case No. 99-44161, entered on docket 08/23/99. <a href="#13a">Return to article</a>

Journal Authors

J. Mark Abernathy

Samuel R. Maizel

Journal Date

Monday, December 1, 2003 - 12:00

Bankruptcy Rule

2003