With state and local governments facing daunting financial challenges, chapter 9 for "government units" is becoming a more likely option. In California, state law permits communities to form "health care districts" that are authorized to issue bonds through public offerings and use the proceeds to establish health care facilities within the district. When a health care district files a chapter 9 case, the intersection between public finance, health care law and bankruptcy creates its own set of novel problems.
Valley Health System (district) is a California local health care district that filed for chapter 9 in December 2007. During the case, Bankruptcy Judge Peter Carroll issued two published decisions that addressed issues not squarely confronted in any previous chapter 9 cases.
In the first case, the indenture trustee for the district's bondholders (by far its largest creditor) moved to dismiss the case based on its contention that the district did not meet the qualifications for chapter 9 relief. In the second case, the district moved for an order that a health care ombudsman, ordinarily required by Bankruptcy Code §333(a)(1), not be appointed. The following is a summary of both decisions.
Voluntary Petitions; Qualification: In re Valley Health System, 383 B.R. 156 (Bankr. C.D. Cal. 2008)
Following the district's filing of its chapter 9 petition, the indenture trustee for the bonds issued by the district filed an objection to the district's petition, claiming that the district was ineligible for relief under chapter 9 because it failed to establish that negotiation of an adjustment of its debts before the filing of the petition was impracticable, as required by Code §109(c)(5)(C).
In chapter 9, the order for relief is not entered as of the filing of the petition. Instead, the district must give notice to creditors and, only after no objection has been filed or following objection, if the court has approved the filing of the petition, will an order for relief be entered. To qualify for relief under chapter 9, an entity must meet the statutory criteria set forth in Bankruptcy Code §109(c), which includes the requirement that "[a]n entity may be a debtor under Chapter 9 of this title if and only if such entity...(5)(A) has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter; (B) has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter; (C) is unable to negotiate with creditors because such negotiation is impracticable; or (D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title."
The bankruptcy court held that the district was eligible for relief under chapter 9, pursuant to §109(c)(5)(C), even though it had not tried to negotiate a plan of adjustment, because negotiations with its creditors were "impracticable." The court found that the requirements of §109(c) were satisfied because (1) the district owed approximately $100 million to several thousand creditors; (2) before the chapter 9 filing, the district communicated with its major creditors (including the indenture trustee and the unions), advised them of its intention to seek chapter 9 relief and assured them that it would negotiate a plan consistent with the requirements of chapter 9; (3) the district's board of directors approved the filing only after a public meeting, noticed in accordance with state law, at which attendees were advised of the board's intention to file; and (4) the district's decision was made only after a review of all options (including an unsuccessful ballot measure asking voters to approve the restructuring of debt and the sale of assets) and with the guidance of expert consultants along with corporate, bond and bankruptcy counsels. Finally, as to the issue of "impracticability," the court found that negotiations with creditors was not practicable during the 37 days following voter rejection of the restructuring measure, given the district's liquidity crisis, the number of its creditors, the risk of loss to its assets and its resulting inability to construct a realistic plan of adjustment in that timeframe. Accordingly, the court declined to dismiss the chapter 9 petition.
Patient-care Ombudsman: In re Valley Health Sys., 381 B.R. 756 (Bankr. C.D. Cal. 2008)
The district moved for an order that appointment of a patient-care ombudsman was unnecessary for the protection of patients under the specific facts and circumstances of the case. The Office of the U.S. Trustee opposed the motion on the grounds that Congress mandates the appointment of a patient-care ombudsman under Code §333(a)(1) whenever a health care business files bankruptcy.
To determine whether appointment of the ombudsman should be excused, the court considered: "(1) The cause of the bankruptcy; (2) The presence and role of licensing or supervising entities; (3) the District's past history of patient care; (4) The ability of the patients to protect their rights; (5) The level of dependency of the patients on the facility; (6) The likelihood of tension between the interests of the patients and the District; (7) The potential injury to the patients if the District drastically reduced its level of patient care; (8) The presence and sufficiency of internal safeguards to ensure appropriate level of care; and (9) The impact of the cost of an ombudsman on the likelihood of a successful reorganization." Finally, citing these factors, as well as "(1) the high quality of the District's existing patient care; (2) the District's financial ability to maintain high quality patient care; (3) the existence of an internal ombudsman program to protect the rights of patients; and/or (4) the level of monitoring and oversight by federal, state, local or professional association programs which renders the services of an ombudsman redundant," the court held that "the appointment of a patient care ombudsman pursuant to §333(a)(1) is not necessary at this time under the specific facts of this case."
The court indicated that it would consider the appointment of a patient-care ombudsman at any time during the pendency of the case "if the court finds a change in circumstances or newly discovered evidence that demonstrates the necessity of an ombudsman to monitor the quality of patient care and protect the interests of patients."