This article examines four 2008 patient care ombudsman cases. In re Bridgeport Holdings Inc., __ B.R. ___, 2008 WL 2235330 (Bankr. D. Del. May 30, 2008), is not a health care case, but it provides important warnings to the directors and officers of health care businesses considering sales of the business or its assets. I am grateful to the Health Care Committee's Listserve Moderator, Bobby Guy, for pointing my attention to the Bridgeport Holdings case and its relevance to health care-related insolvencies.
In re Brotman Medical Center Inc. (Bankr. C.D. Cal.)
This case demonstrates how the patient care ombudsman and a hospital can work together toward the end of a successful reorganization. By an order dated Dec. 18, 2007, Judge Sheri Bluebond authorized the appointment of a patient care ombudsman. Suzanne Koenig of SAK Management Services, LLC and a co-chair of ABI's Health Care Committee was appointed the patient care ombudsman. Judge Bluebond excused the filing every 60 days as required by 11 U.S.C. 333(b)(2) of reports concerning the quality of patient care at the debtor's facilities, authorizing the submission of such reports if "there is something substantive to report that the Patient Care Ombudsman believes should be brought to the Court's attention."
Since her appointment, Ms. Koenig and SAK representatives have visited the debtor's facilities seven times-five times on announced visits, twice on unannounced visits-and has submitted two reports. During those visits, Ms. Koenig met with management, department heads, staff, physicians and patients (to the extent that she had written consents) to discuss patient care concerns and issues. The debtor cooperated with Ms. Koenig and SAK representatives. In her first report, Ms. Koenig was able to identify areas of concern related to patient care. In her second report, she noted that the debtor had addressed a number of those concerns. A number of staffing needs had been successfully addressed. The debtor was moving to more fully integrate physicians into its health care team. Certain changes outlined by Ms. Koenig had been made. Certain areas of concern remain, but overall the debtor is making significant improvements in addressing the patient care-related challenges it faces.
Finally, further to the cooperation that can exist between a debtor health care provider and the patient care ombudsman, in a court filing on April 8, 2008, Ms. Koenig urged the court to approve debtor-in-possession financing and the debtor's use of cash collateral. Ms. Koenig has not taken a position on the disputes between the debtor and its lenders. However, she urged the court to consider the funding needs for supplies and medical staff, among other needs. She also urged the court to consider the risks to the debtor's patients of transfer trauma in the event that the debtor was forced to shut down on an accelerated basis for lack of funding. In sum, Ms. Koenig was able to highlight the patient care concerns implicated by debtor-in-possession financing.
In re Valley Health System, 381 B.R. 756 (Bankr. C.D. Cal. 2008)
In Valley Health, the court granted the motion of the debtor, a California public health care district that operates a skilled nursing facility and three acute care hospitals, to excuse the appointment of a patient care ombudsman, pursuant to 11 U.S.C. §333(a)(1). The debtor's status as a health care business under 11 U.S.C. §101(27A) was never in question. The only question was whether the appointment of a patient care ombudsman was "not necessary for the protection of patients under the specific facts of the case." 11 U.S.C. §333(a)(1).
In granting the debtor's motion, the court considered a number of factors. However, the court's decision was grounded for the most part in the existence of: (1) external oversight and internal procedures that the court concluded ensured the quality of patient care at the debtor's facilities and (2) the debtor's clean regulatory history. Valley Health, 381 B.R. at 761-65. Specifically, the court noted that the debtor was subject to: (1) "substantial monitoring" by a variety of governmental agencies and independent accreditation agencies; (2) a "thorough" triennial certification process by the Joint Committee on Accreditation for Hospital Organizations (JCAHO); (3) scheduled triennial inspections and frequent unannounced inspections by the California Department of Public Health (CDPH) and (4) annual review and self-reporting requirements by the California Department of Mental Health (CDMH). Id. at 761. The court also noted: (1) the debtor's accreditation by JCAHO; (2) its compliance with applicable federal and state regulations; (3) the absence of any history of governmental action against the debtor for patient care deficiencies and (4) the debtor's extensive and "redundant internal procedures to ensure the highest level of patient care and to resolve expeditiously any patient complaints" and to implement improvements in patient care. Id. at 761-63. In considering such factors as the ability of patients to protect their rights, the likelihood of tension between the interests of patients and the debtor and the sufficiency of internal safeguards, the court found that the debtor's "extensive internal quality controls for monitoring patient care" and patients' access to the CDPH, the Centers for Medicare and Medicaid Services and JCAHO to report complaints concerning patient care militated against the appointment of a patient care ombudsman. Id. at 762-63. The court also noted the debtor's "proactive" survey program, which was designed "to identify and correct areas of potential regulatory non-compliance" before they became actual problems. Id. at 763. Finally, the court considered the expense inherent in the appointment of a patient care ombudsman, stating that "[g]iven the level of internal controls and oversight by federal, state, local and professional organizations, the services of a patient care ombudsman would be redundant." Id. at 764.
The court in Valley Health also rejected the U.S. Trustee's contentions that: (1) "internal controls and external oversight common to all sophisticated health care businesses are insufficient to protect patients rights upon bankruptcy;" (2) an "inherent tension exists between a health care business and its patients rising to the level of a conflict of interest" once a health care business files for bankruptcy relief and (3) the debtor's employees are not "disinterested" with respect to patients' interests. Id. at 765. The U.S. Trustee had offered no evidence supporting those contentions. Id. Moreover, as the court noted, nothing in 11 U.S.C. §333(a)(1) requires as a prerequisite to excusing the appointment of a patient care ombudsman that the debtor's internal patient care quality controls be administered by "disinterested persons." Id. It bears noting, however, that although the appointment of a patient care ombudsman was excused, the court left open the appointment of one in the future if circumstances changed. Id.
In re Haven Eldercare LLC, 382 B.R. 180, 183-84 (Bankr. D. Conn. 2008)
In Haven Eldercare, the bankruptcy court held that a patient care ombudsman appointed under 11 U.S.C. §333(a)(1) is not entitled to interim compensation under 11 U.S.C. §331 and that the ombudsman's professionals are not entitled to direct compensation from the bankruptcy estate. In reaching its decision, the court recognized that the patient care ombudsman is expressly entitled to compensation pursuant to 11 U.S.C. §330(a)(1), but noted that the ombudsman is "conspicuously absent from the universe of individuals entitled to interim compensation under [11 U.S.C. §]331." Haven Eldercare, 382 B.R. at 183-84 (emphasis in original). The court also noted that the Code does not provide for the direct compensation of the ombudsman's professionals by the bankruptcy estate, but rather "seems to contemplate that in the first instance the compensation of such entities should be the responsibility of the [o]mbudsman, who may then seek to have such expenses reimbursed under [11 U.S.C. §]330(a)(1)(B)." Id. However, the court concluded that the ombudsman may not use the provisions of 11 U.S.C. §331 to obtain reimbursement for the fees charged by his or her professionals' fees on an interim basis. Id. at 183-84.
In re Starmark Clinics L.P., 2008 WL 938942 (Bankr. S.D. Tex. April 4, 2008)
Starmark Clinics contains an application of the law governing the patient care ombudsman that was probably not contemplated by the drafters of BAPCPA. Starmark Clinics, L.P. ("Starmark") provided outpatient services which one of its principals described as "cosmetic, " e.g., acne removal, dermatological laser treatments and injections of botox and other "fillers." The acne removal treatments are provided by cosmeticians, the laser treatments are provided by technicians, and the injections of botox and other "fillers" are performed by registered nurses. Marc Starko, one of the debtor's principals has advised the author that the debtor's staff have had extensive training and are certified to perform the services they provide. On its order to show cause, the court determined that Starmark was a "health care business" under 11 U.S.C. § 101(27A) and that its principal had failed to demonstrate that the appointment of a patient care ombudsman was unnecessary. Id. at * 4. Nevertheless, the court did not order the appointment of a patient care ombudsman. Rather, because there appeared to be no need for the debtor's financial reorganization and it appeared that the case was filed to obtain an unfair advantage in state court litigation, the court dismissed the case. Id. at ** 4-5. The court twice stated, however, that were the case to have remained in Chapter 11, the appointment of a patient care ombudsman would have been necessary. Id. at **4, 6. Indeed, the necessity of appointing a patient care ombudsman and the expense inherent in the appointment of one was deemed to support the dismissal of the case, as opposed to the appointment of a Chapter 11 trustee. Id. at * 6. As noted above, such a result was probably not contemplated by the drafters of BAPCPA.
Bridgeport Holdings
Bridgeport Holdings Inc. and several affiliates who traded under the name of Micro Warehouse (collectively "Micro Warehouse") were victims of an improvident leveraged buy-out (LBO) in 2000 and the subsequent dot-com bust. Following the LBO, Micro Warehouse suffered almost continuous financial problems. Although Micro Warehouse's directors and management were aware of several options available to improve its financial condition, by October 2002 they had failed to implement any of those options. Indeed, it was only about a month before the Bridgeport Holding case was filed that Micro Warehouse's directors finally acceded to the urging of its secured creditors to hire a restructuring advisor.
On Aug. 19, 2003, Micro Warehouse's directors retained AP Services LLC, an affiliate of Alix Partners, as its restructuring advisor and Lawrence Ramaekers as a restructuring professional and appointed Ramaekers as Micro Warehouse's chief operating officer. Previously, on or about Aug. 8, 2008, Gary Wilson, an officer of Micro Warehouse, had contacted a competitor, CDW Corporation (CDW), about the possibility of an asset sale to CDW. Within three weeks of his appointment as chief operating officer, Ramaekers effectuated the sale of a substantial portion of Micro Warehouse's U.S. assets to CDW for $28 million. The U.S. assets were allegedly worth $126 million and were utilized in a portion of Micro Warehouse's business that had allegedly generated $900 million in annual revenues.
On Sept. 10, 2002, the day after the closing of the CDW sale, the Micro Warehouse entities filed chapter 11 bankruptcy petitions. A distribution plan was confirmed, and a liquidating trust (trust) was established. All of Micro Warehouse's causes of action were transferred to the trust. The trust sued CDW to avoid the sale of the U.S. assets as a fraudulent transfer and settled with CDW for $25 million. Thereafter, the trust sued, among others, the directors who had approved the CDW sale (collectively the "D&O defendants"), alleging inter alia, that they had breached their fiduciary duties of loyalty and care and had demonstrated a lack of good faith in connection with the sale. The D&O defendants moved to dismiss the suit for failure to state a cause of action. The court granted the denied motion, as it applied inter alia, to the trust's claims against the D&O defendants for breach of their fiduciary duties of loyalty and care and for a failure to act in good faith in connection with the CDW sale.
The D&O defendants contended that the trust's complaint failed to state a viable claim for breach of the fiduciary duty of loyalty because the trust did not allege that either the D&O defendants had engaged in self-dealing or lacked independence in connection with the sale to CDW. The court rejected that contention because it found that the trust's complaint stated a viable claim that the D&O directors had consciously disregarded their fiduciary duties to Micro Warehouse by failing to act in the face of a known duty to act. Bridgeport Holdings, 2008 WL 2235330 at **11-12. More specifically, the court found that the allegations contained in the trust's complaint supported a viable claim that the D&O directors had improperly abdicated to Ramaekers' crucial decision-making authority concerning the sale of the U.S. assets and had failed to adequately monitor his execution of the sale, "resulting in an abbreviated and uninformed sale process and approving the sale to CDW for grossly inadequate consideration." Id. at *13 (emphasis in the original). By virtue of those allegations, the court concluded, the trust's complaint stated a viable claim for breach of the fiduciary duty of loyalty. Id.
In reaching that conclusion, the court focused on the following allegations in the trust's complaint: (1) Ramaekers decided to sell the U.S. assets only three days after being retained; (2) a competitive bidding process was not established, and in fact, Micro Warehouse agreed to deal only with CDW; (3) no investment banker was hired to "shop" the sale; (4) only cursory contacts were made to search for strategic buyers, who were given insufficient time or access to information for due diligence; and (5) no consideration was given to contacting potential financial buyers. Id. The court was also concerned about the timeframe into which the negotiation and sale process had been compressed and that the final agreement very closely resembled CDW's initial offer. That assets allegedly worth $126 million were sold for $28 million also troubled the court, as did the characterization by independent financial analysts and potential purchasers of the sale of the U.S. assets to CDW as a "steal." Id.
In concluding that the trust had stated a viable claim against the D&O defendants for breach of the fiduciary duty of care, the court rejected the D&O defendants' invocation of the business judgment rule and the exculpation clauses in the applicable certificates of incorporation. Id. at **15-22. The D&O defendants could not rely on the exculpation clause because, as the court had previously determined, the trust had stated a viable claim for breach of the fiduciary duty of loyalty. Id. at **19-22. Nor could the business judgment rule immunize them from suit, because the trust had alleged that they had "failed to inform themselves, prior to approving the sale to CDW, of all material information available to them." Id. at *18. In that regard, the court noted the D&O Defendants' failure to (1) hire an investment banker to shop the deal or value the U.S. assets and (2) obtain a fairness opinion in connection with the CDW sale. Id.
The court also denied Ramaekers' motion to dismiss the trust's claim that he violated his fiduciary duty of care to Micro Warehouse. Id. at * 25. In doing so, the court expressly relied on its analysis of the trust's claims against the D&O defendants, as well as the trust's allegation that Raemakers' had failed to draw on his "unique experience with financially-distressed companies" in connection with the CDW sale. Id. The court also rejected Ramaekers' contention that the D&O defendants' approval of the sale insulated him from any liability for any damages resulting from the sale. In so doing, the court found that the trust's allegations, to the effect that the D&O defendants had completely abdicated their decision-making authority in connection with the CDW sale to Ramaekers, supported a claim that he caused any damages Micro Warehouse suffered as a result from the sale. Id.
Although it is not a health care case and was decided under Delaware law, Bridgeport Holdings provides a number of warnings to the directors and officers of any health care business contemplating a sale of the business or its assets, an option more likely to be considered by such directors and officers as the pressure to "rationalize" the health care industry increases. Perhaps the most important warning is that allegations of either self-dealing nor a lack of independence in connection with such a sale may not be necessary prerequisites to a viable claim for breach of the fiduciary duty of loyalty; the allegation that the officers and directors failed to act in the face of a known duty may be sufficient. Bridgeport Holdings teaches, moreover, that the abdication by the officers and directors of a health care business of all decision-making authority concerning such a sale to a third party-even an experienced restructuring professional-and the failure to adequately supervise his or her implementation and execution of the sale process may constitute such a failure to act in the face of a known duty. Consequently, before approving the sale of a health care business or its assets, including a sale recommended by an experienced restructuring professional, the officers and directors of a health care business must be satisfied that: (1) all reasonable alternatives to a sale have been considered; (2) the sale procedures are reasonably likely to generate the best and highest price; (3) there has been sufficient time under the circumstances for the negotiation and consummation of the sale transaction; (4) the sale is adequately advertised or shopped; (5) adequate efforts to locate and contact potential buyers have been made and (6) the proposed sale price is reasonable.
Bridgeport Holdings should also serve as a warning to the directors and officers of a health care business that the business judgment rule will not immunize them against claims for breach of the fiduciary duty of care arising out of the sale of the business or its assets unless the decisions concerning the sale are made on an informed basis. In other words, to enjoy the protections of the business judgment rule, directors and officers must have made reasonable efforts to obtain the information necessary to adequately evaluate a proposed sale of the business or its assets and have considered all of that information before approving the sale. This duty to make decisions on an informed basis is especially important in connection with high-profile transactions like the sale to CDW. As demonstrated by Bridgeport Holdings, there is no shortage of analysts, financial experts and disappointed bidders who have no compunction about publicly expressing, both in and out of court, their opinion that the purchase price obtained for a business and its assets constituted a "steal."
In conclusion, it bears noting that the court in Bridgeport Holdings was clearly troubled by the repeated failure of the D&O defendants to implement any of the options that might have improved Micro Warehouse's financial performance following the LBO (id. at **2-4), although the court discomfort in that regard did not expressly figure into its reasoning. Like Micro Warehouse, hospitals and other health care providers currently face financial challenges requiring the consideration and implementation of creative solutions. Indeed, a recent study by Alvarez & Marsal, "Hospital Insolvency: the Looming Crisis," which is featured in this newsletter, concludes that hospital boards and administrations must be more aggressive in addressing financial and operational challenges if they are to survive. In addition to its other lessons, therefore, Bridgeport Holdings teaches that directors and management of health care providers must be more proactive and aggressive in addressing the challenges the health care industry faces if they are to avoid losing the provider to a "fire sale" like the "fire sale" in Bridgeport Holdings.