California Bankruptcy Court Rules that Provider Agreements Are Statutory Entitlements, Not Executory Contracts

Verity Healthcare Assistance of California scored a major victory in the U.S. Bankruptcy Court for the Central District of California when the court ruled that provider agreements between hospitals owned by Verity and the California Department of Health Care Services (DHCS) were in the nature of statutory entitlements, not executory contracts, and as such did not need to be assumed to be transferred.[1] The decision paved the way for the transfer of four of Verity’s hospitals to the purchaser free and clear of all liabilities, which included the hospital’s obligation to pay past-due fees related to their provider agreements.

Background

The question put before the court in Verity was whether the debtors could sell substantially all of the assets of four hospitals free and clear of past-due fees arising in connection with provider agreements between the debtors and DHCS. Previously, the court had entered an order approving the sale of substantially all of the assets of four of Verity’s hospitals to Strategic Management Inc. (SGM). As a condition to the closing of the sale, SGM required that there be resolution of the alleged financial defaults existing under each provider agreement.

The fees allegedly due by the debtors consisted of approximately $30 million in quarterly quality assurance fees.[2] The debtors also were allegedly liable for approximately $25 million in Medi-Cal fee-for-service overpayments. The DHCS took the position that the provider agreements were executory contracts and that the provider agreements could not be transferred unless the debtors first assume the provider agreements under § 365 of the Bankruptcy Code, then cure the delinquent HQA and overpayments.[3]

The debtors argued that the provider agreements were not executory contracts, therefore it was unnecessary for the debtors to assume the provider agreements under § 365 in order to transfer the agreements to SGM. The debtors argued that provider agreements are statutory entitlements to participate in the Medi-Cal program and should be treated as licenses that can be sold free and clear of claims, liens and encumbrances pursuant to § 363(f).[4]

The Bankruptcy Court Decision

The bankruptcy court agreed with Verity and found that the provider agreements were not contracts and therefore not subject to assumption and assignment under § 365. In reaching this conclusion, the bankruptcy court first analyzed whether the provider agreements were executory contracts and acknowledged that if they were, they could only be transferred to a seller if they are first assumed by the debtors, and that to assume an executory contract, the debtors would need to either cure all the defaults under the contract or provide adequate assurance that the defaults would be cured promptly.[5]

However, the bankruptcy court found that the provider agreements were not contracts. In reaching its decision that the agreements were not contracts, it looked to decisions involving Medicare provider agreements because in the bankruptcy court’s opinion, there was no meaningful difference between the provider agreements and a Medicare provider agreement. The court found that both types of agreements allow hospitals to obtain reimbursements from the government for providing health care services and that in both cases the hospital’s reimbursement entitlement is dictated by Medicare statute.

In analyzing the available case law involving Medicare provider agreements, the bankruptcy court determined that there is no contractual obligation requiring the Department of Health and Human Services to provide Medicare reimbursement. Instead, upon joining the Medicare program, providers gain a statutory entitlement to reimbursement. Thus, the amount of reimbursement is governed not by contract but by statute.[6]

The bankruptcy court analyzed the cases cited by DHCS that held that Medicare provider agreements are executory contracts. The bankruptcy court found that the authorities were unpersuasive because the issue of whether the provider agreements were executory contracts versus statutory entitlements was not litigated and instead the courts in these cases simply assumed, without meaningful analysis, that the provider agreements were executory contracts.[7]

Having found that the provider agreements were not contracts, the court then needed to determine whether the provider agreements could be sold free and clear of all liens, claims and interests under 11 U.S.C. § 363(f). Relying on In re Fugazy Exp. Inc.,[8] the court held that the interests such as a provider agreement constitute “property of the estate” under § 541 that may be sold under § 363. The bankruptcy court found that provider agreements are akin to a license issued by a governmental agency, and therefore that provider agreements may be sold under § 363.

The court acknowledged that provider agreements may be sold free and clear of liabilities only if one or more of the conditions specified in § 363(f)(1)-(5) is satisfied. Here, the court found that this provision is satisfied because the DHCS could be compelled in a legal or equitable proceeding to accept a money satisfaction of such interest. The court found that the interest that the DHCS holds in provider agreements is its right to receive payment of the liabilities, and that because DHCS could be compelled to accept a money satisfaction of its interest in a legal or equitable proceeding, provider agreements may be sold free and clear of DHCS’s interests under § 363(f)(5).

Conclusion

This decision appears to pave the way for hospitals and other health care institutions to shed liabilities arising from defaulted Medicare provider agreements through § 363 sales. Not surprisingly, DHCS has filed an appeal with the U.S. District Court for the Central District of California, so the final word has not yet been spoken. Also, the bankruptcy court did not address the impact of the sale of the provider agreements on DHCS’s recoupment rights. Although the debtors asked the bankruptcy court to address those rights in the sale order, the bankruptcy court refused to address the issue of the applicability of recoupment subsequent to the sale of the provider agreements free and clear of all liens, claims and encumbrances because the issue had not been sufficiently briefed. However, the bankruptcy court left it open for interested parties to raise the issue by way of motion.