The Rare Case: A Successful Hospital Reorganization

In this age of pre-packaged, pre-negotiated, and chapter 11 liquidation cases filed to effectuate a sale, it is becoming increasingly rare to work on chapter 11 cases that are filed without a clear exit strategy, much less one where the debtor is able to successfully reorganize. In New Jersey, recent hospital bankruptcies such as Passaic Beth Israel, Pascack Valley, Barnert and Bayonne all ended in closures and/or sales. However, St. Mary’s Hospital [1] was able to avoid a similar fate and exited bankruptcy as a reorganized entity in March 2010. [2]

St. Mary’s, a nonprofit corporation that owned and operated a 287-bed general acute-care community hospital located in Passaic, N.J., filed a chapter 11 petition on March 9, 2009. [3] As of the petition date: (1) the New Jersey Health Care Facilities Financing Authority (NJHCFFA) held a secured claim against St. Mary’s for approximately $43 million, (2) the Healthcare Finance Group Inc. and some related entities (HFG) held secured claims against St. Mary’s in the collective amount of $11.8 million and (3) unsecured creditors held claims against St. Mary’s in the approximate amount of $27 million. [4] Due to a shortage of operating revenue, St. Mary’s also had unfunded accrued pension liability of almost $12 million. [5] In total, St. Mary’s identified liabilities of approximately $92 million in its statement of financial affairs with schedules filed with the bankruptcy court. [6]

In late 2008, St. Mary’s circulated a request for proposals in an effort to obtain a strategic partnership and/or a purchaser of its assets. [7] None of the offers received were deemed sufficient, and St. Mary’s determined that filing a chapter 11 petition was its best available alternative despite the fact that it had not negotiated an exit strategy with any of its creditor constituencies, and did not have an agreement to sell its assets through a § 363 sale. [8]

After entering into chapter 11, St. Mary’s continued to provide information to potential suitors, but it also began to focus on exiting bankruptcy through a stand-alone reorganization plan. As counsel and financial advisers to the official committee of unsecured creditors (the committee), we were contacted by a number of parties who were interested in submitting proposals to purchase St. Mary’s assets.  Accordingly, the committee facilitated the flow of information to such parties in order to provide a market test for any plan put forth by St. Mary’s, and to help ensure the maximum recovery for unsecured creditors.

Hospital bankruptcies often present their own unique challenges because, in addition to serving as major employers, communities often have emotional attachments to their local hospitals and a hospital closure can have a dramatic impact on the health and safety of a community. Furthermore, many hospital bankruptcies have political implications, and St. Mary’s was no different. The State of New Jersey was involved both as a creditor (NJHCFFA) as well as through the New Jersey Department of Health and Senior Services, the agency in charge of overseeing health care institutions and providing financing and charity care payments. The city of Passaic was active in the case because St. Mary’s was the last remaining hospital in the city, which could potentially have an impact on the local community and economy. As with most hospital cases, there was also an appointed health care ombudsman to monitor patient care as required under § 333 of the Bankruptcy Code. [9]

Many of St. Mary’s employees were represented by one of two unions, and St. Mary’s was successful in obtaining several temporary modifications of the collective bargaining agreements under § 1113(e) of the Code over the objections of the unions. [10] After evidentiary hearings were held, the bankruptcy court determined that modifications of the collective bargaining agreements under § 1113(e) were necessary in order to permit St. Mary’s to remain open and to have a limited time frame within which to attempt to reorganize and/or consummate a sale. [11] St. Mary’s was ultimately able to reach new collective bargaining agreements with the unions, which was an important step in formulating a viable reorganization plan.

Given the expense of operating in chapter 11, all parties agreed that timing was critical and it was in the parties’ best interests for St. Mary’s to exit bankruptcy quickly. The committee was faced with the challenge of balancing its desire to maximize returns to unsecured creditors with the knowledge that the case could slide quickly into a closure/liquidation. However, because there were several third parties expressing interest in acquiring St. Mary’s, the committee negotiated with such parties. During interactions with those interested parties, the committee obtained information about their plans for the hospital and proposals for the various creditor constituencies, as well as the availability and terms of any financing that would be required.

As St. Mary’s finalized and eventually filed a reorganization plan, the committee  continued to negotiate both with the St. Mary’s team and other interested third parties. Because of the significant financial and oversight position of the State of New Jersey, there were numerous discussions with state officials in order to try to coordinate these efforts. The committee believed that it would be extremely difficult to endorse a third-party bidder if the State of New Jersey would not lend its support.

As the confirmation hearing approached on St. Mary’s stand-alone reorganization plan, the committee was presented with two last-minute proposals that, on paper, would have provided substantially higher returns to unsecured creditors than what was being proposed by St. Mary’s. The committee evaluated these proposals and the fact that the State of New Jersey had ultimately decided to support St. Mary’s plan with the above dynamics in mind. Given the state’s position, the uncertainty about the actual feasibility of the alternative proposals and the additional administrative costs that would have been required to prolong the chapter 11 case, the committee decided to support St. Mary’s, but only after striking a better deal for the unsecured creditors than what was previously proposed.

While pre-packaged and pre-negotiated chapter 11 cases can be used effectively to maximize value in bankruptcy proceedings, they are more difficult to utilize in the context of hospital reorganizations where financial issues, while important, are not the only dominant consideration. Given the current state of health care, and with “over-bedding” problems remaining in many areas, [12] hospital filings will undoubtedly continue. However, the filing of a chapter 11 proceeding does not mean that a closure or sale is inevitable. Rather, although rare, St. Mary’s is an example of how a hospital can use the bankruptcy process to successfully reorganize and maximize value for all stakeholders.