Skilled Nursing Facilities in Chapter 11 Bankruptcy Cases: A Case Study of Senior Care Centers LLC

The health care industry continues to face financial challenges, as evidenced by more chapter 11 bankruptcy filings and closures by hospitals and other providers, including long-term-care facilities. Since late 2018, at least 19 hospitals around the country and owners or operators of more than 150 senior living facilities in Texas filed for bankruptcy protection.[1] The Senior Care Centers LLC (SCC) case,[2] currently pending in Dallas, illustrates that although bankruptcy affords some relief for health care providers, it is not a panacea for debtors or their creditors. As seen in the SCC case, (1) lease issues may arise that can be complex, costly and time-consuming to litigate; (2) revenue may be withheld post-petition based on regulatory requirements in connection with transfers of the facility, notwithstanding the pendency of the bankruptcy case; (3) lease rejection does not result in the debtor operator immediately vacating the property in the case of a skilled nursing facility or assisted living facility; and (4) a debtor may have to reorganize around facilities it no longer wishes to operate.

Background of Case

In 2018, Senior Care Centers LLC and its affiliate entities were one of the largest skilled-nursing providers in the country, operating 97 skilled-nursing facilities, nine assisted-living facilities and six hospice facilities located in Texas and Louisiana. SCC provided services to approximately 9,000 patients and had approximately 11,300 employees.[3]

The debtors leased their facilities from landlords through master leases or direct leases and operated their facilities pursuant to operator agreements with their landlords. The debtors’ two largest landlords were Sabra Healthcare REIT Inc. and affiliates of Granite Investment Group LLC.[4] SCC operated 30 facilities that were financed by HUD loans made to the landlords by certain HUD lenders, and these facilities were subject to HUD regulatory agreements.[5]

On Dec. 5, 2018, SCC and its 121 affiliated entities filed chapter 11 cases in the Dallas Bankruptcy Court. The debtors’ assets consisted of accounts receivable, personal property and leases. The debtors’ revenues were derived from third-party payors (i.e., Medicaid and Medicare) and/or patients. Approximately 30 percent of SCC’s revenue came from Medicaid reimbursements, which equated to approximately $25 million of income per month. SCC owed approximately $45.6 million to its operating lender, CIBC Bank USA, which held a security interest in the debtors’ accounts. The debtors also owed money to landlords, vendors and other trade creditors, including certain dental providers who provided on-site services at the facilities. The debtors’ bankruptcy filing was triggered by market conditions, a reduction in available credit from its operating lender, and payment defaults under the Sabra and Granite leases, resulting in termination notices being sent by the respective landlords in November 2018.[6] The debtors’ initial plan was to “right-size” the company and reorganize its facilities that performed the strongest financially.

Issues with Determining SCC’s Post-Petition Rental and Tax Obligations

Unlike many chapter 11 cases where a debtor may have a dispute with its secured creditor over the use of cash collateral or the sale of assets, the initial battles in the SCC case were between the debtors and their landlords. As of the petition date, SCC had not paid December rent on most of its facilities. The debtors obtained a favorable ruling from the bankruptcy court that they were not required to immediately pay the “stub rent” due for the period from Dec. 5-31, 2018, under applicable case law in the District.[7] There was also a contested hearing on the debtors’ obligation to pay 2018 ad valorem property taxes, which were included as “rent” in the leases. The debtors argued that the ad valorem taxes were a pre-petition obligation because they were assessed prior to the petition date, although the taxes were not finally due and payable until Jan. 31, 2019 (to avoid incurring penalties and interest). The landlords countered that the lease determined when the taxes were due and payable as opposed to the statute. The court ruled in favor of the debtors on this issue.

Sabra and Granite had additional issues concerning the status of their leases. During the first month of the bankruptcy case, the debtors filed a motion to reject some of the Sabra leases, and Sabra responded by filing an adversary proceeding seeking a declaratory judgment that its leases had been property terminated prior to the petition date.[8] The litigation was eventually settled, and the debtors filed a motion to approve the settlement and the transition of Sabra’s 40 facilities to new operators on Feb. 26, 2019. Under the terms of the settlement, Sabra agreed to waive its post-petition rent claims and release a substantial portion of its pre-petition claim. The court approved the settlement and form-of-operations transfer agreement on March 29, 2019.[9]

The battleground then shifted to the Granite leases. Shortly after the bankruptcy filing, the debtors filed a motion to reject 10 Granite leases nunc pro tunc to the petition date. Granite objected to the motion, claiming that the landlord had terminated the leases pre-petition. Granite also objected to nunc pro tunc relief since the debtors were still occupying and operating the facilities in question. The debtors countered as to whether the termination was proper, alleging that Granite had not obtained HUD approval of the lease terminations. SCC later supplemented its motion, adding four more Granite leases to be rejected. After the third month without any rental payment by the debtors, Granite filed motions for adequate protection and payment of administrative rent.

At the initial hearing on the Granite motions, the debtors responded, claiming they had no obligation to pay the contractual rent under 11 U.S.C. § 365(d)(3) based on Granite’s contention that the leases had been terminated. SCC argued that Granite’s claim for post-petition rent must be considered under § 503(b)(1)(A) and was limited to the amount of actual benefit to the debtors’ bankruptcy estate. While there is a presumption that the amount of benefit is the contract rate, the presumption is rebuttable, citing In re Imperial Beverage Group LLC.[10] The debtors alleged that the rental rates in the Granite leases were “above-market.”

Ultimately, Granite and the debtors resolved the first lease-rejection motion and stipulated to the payment of “fair, use, and occupancy” (FUO) charges for each facility for the period of January through March 2019.[11] The FUO was calculated using a formula based on the monthly operating cash surplus (actual revenue less ordinary course expenses, excluding taxes, property insurance or other impounds to be funded under leases). The debtors and Granite agreed to use this formula for the next group of Granite leases the debtor rejected, but negotiations broke down on the remaining 10 leases, which were rejected in mid-July 2019. By fall 2019, Granite was claiming that administrative rent in excess of $6 million was due under the leases and objected to the debtors’ plan of reorganization for failing to provide for the payment of its administrative claims under the plan. During this same period, the debtors filed a motion to approve the closure of one of the Granite facilities and threatened to close other facilities leased from Granite if the facilities were not transitioned to a new operator.[12] Ultimately, Granite, the debtors and the unsecured creditors’ committee reached a settlement on the eve of the confirmation hearing on Dec. 3, 2019. Under the settlement, Granite agreed to transfer its remaining facilities to new operators or an interim operator by Dec. 31, 2019, and to accept $300,000 for its administrative rent claims. In return, the debtors agreed to continue to operate the remaining facilities until the end of the year and provide other transitional services. The Granite lease litigation was protracted and expensive for the debtors’ bankruptcy estate, as well as Granite.[13]

Vendor Hold and CHOW Hold

Another major challenge for the debtors during the course of the bankruptcy cases was a vendor hold that was implemented in spring 2019. Unbeknownst to creditors and the court, SCC was having liquidity problems because it had not received Medicaid reimbursements since March 2019 from the Texas Health and Human Services Commission (HHSC), the state agency that administers the Texas Medicaid program. SCC knew there was (1) a “vendor hold” arising from a dispute with certain third-party dental providers, and (2) a Change of Operator (CHOW) hold (hereinafter defined) implemented by HHSC in connection with the pending transfer of the 40 Sabra facilities.[14] Pursuant to Section 19.201 of the Texas Administrative and applicable regulations, HHS initiated payment holds (CHOW hold) during the 90-day temporary license period for the facilities in order to reconcile claims for overpayment or underpayment. The debtors determined that the vendor hold had inadvertently been applied to all Texas Medicaid funds due to the debtors for most of their Texas facilities. There also was an improper early CHOW hold for claims for services provided the week before the CHOW hold should have gone into effect.

When efforts to resolve the vendor hold with the HHSC and the managed care organizations (MCOs) were unsuccessful, the debtors filed an emergency motion for order to show cause[15] on May 30, 2019, requesting that the MCOs be ordered to appear and show cause as to why they should not be sanctioned and held in civil contempt due to the “willful violations of the automatic stay in failing to release Medicaid funds due to the Debtors.”[16] The debtors claimed in their motion that there was a total hold of over $40 million, of which $25.79 million was being improperly withheld. At the emergency hearing on the motion to show cause, the HHSC acknowledged that the vendor hold was mistakenly done company-wide, and HHSC had requested that the MCOs release the vendor holds. The court issued an order requiring the debtors, HSSC and the MCOs (which did not appear through counsel at the emergency hearing) to appear for a status conference the following week. On June 3, 2019, the HHSC filed a status report stating that the MCOs had released the vendor holds and were in the process of making payments in the total amount of $9.2 million. The CHOW hold on the transferred Sabra facilities remained in place.

On Oct. 29, 2019, more than four months later, the committee and CIBC filed a joint motion to compel HHSC and the MCOs to pay more than approximately $6.5 million being held in connection with the Sabra transfers and other subsequent transfers so that the debtors would have sufficient funds on hand at confirmation.[17] At the time of confirmation, vendor holds remained in place, and on Jan. 14, 2020, the debtors claimed that approximately $1.9 million was still outstanding.

The CHOW hold and vendor hold clearly affected the debtors’ ability to pay post-petition operating expenses, including rent, requiring emergency relief from the court. The outstanding receivables became even more critical as the debtors’ moved toward confirmation.

Confirmation of Debtors’ Plan

On the one-year anniversary of the chapter 11 filings, the debtors obtained confirmation of their plan of reorganization.[18] The debtors’ confirmed plan provides for the reorganization of 22 facilities (out of the original 112 facilities) using exit financing of $21 million to pay off the pre-petition lender and pay administrative claims (including cure payments for leases being assumed by the debtors and professional fees). Over a month later, however, the debtors’ plan has not gone in effect because the exit financing has not closed. While the debtors have reduced their overall operating expenses in 2020 because they are no longer operating any of the rejected Granite facilities, bankruptcy expenses continue to accrue. At a Jan. 14, 2020, hearing, the debtors stated that the U.S. Trustee’s fees for the first quarter of 2020 will be $5 million. Professional fees will also continue to accrue.[19] The debtors will have spent over $20 million in professional fees (not including U.S. Trustee fees) to terminate operations of 90 facilities and reorganize 22 facilities in their chapter 11 cases.

Conclusion

The SCC case demonstrates how lease issues for a long-term care facility can be complex, protracted and costly, and lease rejection does not relieve a debtor of its obligations to operate the facility. Unlike retail cases, where a landlord can exercise termination rights pre-petition following a lease default and generally obtain possession of its leased premises quickly after the bankruptcy filing, a health care facility has the human element of patients and/or residents, which alters normal landlord/tenant practice. In addition, bankruptcy does not circumvent or shorten the state and federal regulatory requirements relating to the transfer or closure of facilities. Debtors, creditors and, particularly, landlords need to be mindful of these considerations.