Medicare Providers, Beware of Government Recoupment

With the continuing uncertainty in health care markets, many health care providers (or those that represent health care providers) need to consider potential reorganization pitfalls. Since many of these providers (if not all) are Medicare participants, one important aspect of any reorganization strategy will be determining the role that the federal government will play. Specifically, it is important for providers to know what the government can and cannot do as it relates to Medicare reimbursements and its ability to recoup or set off previous Medicare overpayments.

Typically, a Medicare provider submits its reimbursement request to an intermediary, which in turn reviews and pays estimated reimbursements to the provider. The intermediary then performs an annual audit to reconcile the balance of payments; the audit is then used by the government to either remit any underpayments or alert the provider to overpayments. If the audit reveals overpayments, the government (1) enters into an agreement setting out the method by which the provider can return the overpayments over time or (2) deducts the overpayments from future reimbursements. An issue arises when the provider commences a bankruptcy proceeding before the applicable audit is complete and the audit subsequently reveals that overpayments were made prior to the bankruptcy. Thus, the question becomes the government’s ability, notwithstanding the automatic stay, to deduct such overpayments from future reimbursements for post-petition services. Such deductions, if permitted, would reduce valuable estate funds available to satisfy creditors and fund administration of the estate. Several federal circuit courts have considered this issue and focused their analyses on whether the government is permitted to use equitable recoupment to deduct pre-petition overpayments from post-petition reimbursements, and thus side-step the automatic stay provided for by § 362 of the Bankruptcy Code.

Recoupment is recognized as a defense to a demand for payment, as opposed to an affirmative claim against the debtor, and therefore is not subject to the automatic stay. 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. One of the first courts to consider the recoupment issue was the Third Circuit in University Medical Center.[1] In that case, the debtor, a defunct hospital, received pre-petition overpayments for reimbursements that the government sought to deduct from post-petition reimbursement obligations. The deductions would have starved the hospital financially. Accordingly, the hospital filed an adversary proceeding asserting that the deductions violated the automatic stay and demanded the immediate turnover of such funds. The Third Circuit ruled in favor of the hospital, finding that (1) the automatic stay applied because the government was not exercising its police powers but was acting to enforce contract rights; (2) the hospital had not assumed the Medicare provider agreement under § 365 of the Bankruptcy Code, so the terms thereof (which contained the government’s repayment rights) were not binding on the estate; (3) recoupment was not available because, under Medicare, each reimbursement year is considered a different transaction; and (4) equity required that the hospital receive payments for post-petition services. Specifically on the recoupment argument, the Third Circuit stated that for recoupment to apply, “both debts must arise out of a single integrated transaction” and that a single integrated transaction did not exist because each reimbursement year represented its own transaction.[2] To hold otherwise, the court reasoned, would stretch recoupment beyond its limits and essentially create an indefinite transaction that could span many years.

The D.C. and Ninth Circuits disagree with the reasoning in University Medical Center. In United States v. Consumer Health Services of Am. Inc.,[3] the D.C. Circuit expressly rejected the recoupment analysis of University Medical Center. There, the court reviewed the specific provisions of the Medicare statute that authorized the reimbursements and found that the statute contained language allowing the government to make reimbursements “with necessary adjustments on account of previously made overpayments or underpayments.”[4] The court reasoned that the Third Circuit’s decision effectively (and unjustifiably) read this language out of the operative statute. Thus, the D.C. Circuit held that since the government is required to “take into account pre-petition overpayments in order to calculate a post-petition claim ... Congress rather clearly indicated that it wanted a provider’s stream of services to be considered one transaction....”[5]

The Ninth Circuit, in Sims v. United States Dept. of Health and Human Services (In re TLC Hospitals, Inc.),[6] agreed with the D.C. Circuit. The court started its analysis by recognizing that in that circuit, for a transaction to be a “single transaction” for recoupment purposes, there needs to be a “logical relationship” between the two events. Accordingly, a “single transaction” can be found, even out of a series of occurrences, if there is a logical relationship between them. Applying this analysis, the court found that “[t]he 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.”[7] The Ninth Circuit further held that given the complexity of the Medicare system, overpayments might not be discovered until much later and that prohibiting subsequent recoupment would inhibit the purpose of the statute.

These cases represent the majority of circuits that have reported on the issue. Consequently, distressed health care providers should be cognizant that the government may use recoupment to reduce post petition reimbursement by pre petition overpayments. This recoupment might not violate the automatic stay and will likely hamper a provider’s restructuring efforts. In order to combat this result, prospective debtors need to closely monitor their reimbursements and engage the government and its Medicare partners early in the process to avoid the pitfall of government-reduced post-petition reimbursements.