Section 1221² of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) creates a sea change in health care insolvencies. In particular, §1221 casts into uncharted waters the bankruptcy sale process involving the assets of any not-for-profit health care business.³ The results of these changes certainly will include greater expense, greater delay, greater uncertainty and therefore, we fear, a less-active market of buyers, as well as depressed recoveries for nonprofit health care business, their estates and their creditors.

BAPCPA Provisions Impacting the Sale of Nonprofit Health Care Business Assets

A triad of new statutory provisions combines to implement these restrictions on the sales of the assets of not-for-profit enterprises in bankruptcy proceedings. These new provisions are found in the Code sections dealing with asset sales, plan confirmation and property of the estate. New §363(d) is the core provision; it requires the bankruptcy court to review any transfer of the assets of any "corporation or trust that is not a moneyed, business or commercial corporation or trust" under "applicable nonbankruptcy law" to assure the transfer is "in accordance with" such law. The same standard also applies to all "transfers of property" pursuant to a chapter 11 plan under new §1129(a)(16). Both §363(d) and §1129(a)(16) are already applicable because both new Code subsections became effective upon the enactment of the BAPCPA to any bankruptcy case, whether filed before or after BAPCPA's enactment on April 20, 2005.

Finally, BAPCPA also modifies §541 to add a new subsection. Section 541(f) now prohibits any transfers of "property that is held by a debtor" that is a not-for-profit corporation qualified under §501(c)(3) of the Internal Revenue Code to a non-§501(c)(3) entity unless the transfer is in accordance with the conditions that would apply under nonbankruptcy law.

BAPCPA §1221 further changes existing bankruptcy law by explicitly authorizing governmental agencies to participate in bankruptcy proceedings involving such transfers. BAPCPA §1221(d) invests the attorney general of the state in which the debtor is incorporated, was formed or does business with the standing to be heard in any proceeding involving §363(d). Strangely, this provision is not codified anywhere in Title 11. BAPCPA §1221(e) provides that new §363(d) is not to be construed as requiring the bankruptcy court to remand or refer any proceeding under §363(d) to any other court, or to require the approval of any other court, prior to the transfer of any property. This provision also is not codified in Title 11.

The Intersection of Charitable Trust Law and Bankruptcy Law

The changes to asset sales in bankruptcy under BAPCPA strongly impact the health care arena. Prior to BAPCPA, controversy swirled around the application of the Code to the transfer of the assets of not-for-profit hospitals and other health care entities. Nonetheless, courts consistently held that the Code and, in particular, §363(b) and (f), permitted the transfer of assets notwithstanding any nonbankruptcy restrictions on transfers. See, e.g., In re Allegheny Health, Education and Research Foundation, Case No. 98-25773 (Bankr. W.D. Pa.).⁴ Now, Congress has resolved the controversy squarely in favor of the restrictions nonbankruptcy law imposes on the transfer of assets of not-for-profit corporations. These restrictions are considerable. See, e.g., Kaplan, Harold, "The Charitable Trust Doctrine," ABI Journal, May 2004, p. 28.

Throughout the first 200 years of American jurisprudence, the common law governing charitable assets developed slowly. Applying the common law doctrines governing charitable law, including the doctrines of parens patriae and cy pres, state courts exercised jurisdiction over charitable assets.⁵ Parens patriae, the "power of the state to protect the public's interest in assets pledged to public purposes," was invoked to permit the state to act to protect charitable assets.⁶ The doctrine of cy pres was applied to determine how to address proposed changes in the use of charitable assets to most nearly carry out the original intentions of the donors.⁷

In the early 1990s, many nonprofit health care entities began to convert to for-profit entities.⁸ In response, and to supplement the applicable common law doctrines, many states enacted laws restricting the transfer of assets of nonprofit hospitals and other nonprofit health care-related businesses. These laws typically require the approval of the state attorney general after a detailed application and review process and/or otherwise limit the transferability of assets by such entities.⁹ For example, a California statute requires a nonprofit corporation that operates or controls a health care facility first to seek approval of the attorney general prior to entering into any agreement or transaction to "sell, transfer, lease, exchange, option, convey or otherwise dispose of its assets to a for-profit corporation or entity."¹⁰ Such provisions require the entity seeking such approval to prepare an extensive notice, providing detailed information including a description of the transaction; complete copies of all relevant transactional documents; a summary (to be entitled "Fair Market Value") that describes the estimated value of the entity's assets, the estimated value of the assets to be sold and the methods used in arriving at those valuations; a statement as to the proposed use of the net proceeds from the sale, including a statement of how such use meets the charitable purposes of the corporation; information regarding the impact on the delivery of health care services in the affected community; and two years of audited financial statements for the corporation, and the most recent unaudited financial statement.¹¹ This information becomes part of the public record and is available upon request under the California public records law.¹²

A New Sale Methodology

Application of these public-review statutes in the bankruptcy context will add to the required actions and expense incident to any sale of heath care business assets. The additional effort begins with the preparation of the approval application or a request for a waiver from those requirements. The steps required under these statutes create the opportunity for further delay and expense. For example, some statutes expressly authorize the attorney general to hire its own experts or consultants to assist the attorney general in its review and evaluation of the application.

The application of these types of statutes also will introduce considerable uncertainty in the sale process. For example, one statute provides the attorney general the opportunity to withhold his or her decision on an application for up to 180 days without offering any safe-harbor requirements that might assure approval.¹³ In California, the process also can be delayed and subject to the vagaries of the political process because the attorney general must conduct one or more public meetings before issuing a decision whether to approve a sale of the nonprofit's assets.

Many of these statutes also contemplate limitations on transfering the net proceeds generated from the sale. At a minimum, these statutes require consideration of whether the proceeds of the proposed transaction will be used in a manner consistent with the nonprofit health care entity's original charitable purpose.¹⁴

Bankruptcy rules governing §363 sales are relatively brief and very flexible. Practitioners and courts have developed and regularly utilize a wide array of processes, invoking Bankruptcy Rule 6004, to move a proposed sale through the bankruptcy court. The process varies based on, among other factors, whether the debtor is or is not operating; whether continued availability of financing is threatened; whether there is, or is not, a "stalking horse" bid; whether the "stalking horse" seeks any buyer protection (sometimes referred to as "break-up fees" or expense reimbursements); whether an auction is contemplated; whether qualifying the bidders in advance of any auction is necessary or appropriate; and whether reliable valuations are available.

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Lenders considering making debtor-in-possession financing available to any nonprofit health care business...must be prepared to accommodate the lengthy, expensive and uncertain process contemplated by the state statutes governing the sale of such entity's assets.

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The flexibility of Bankruptcy Rule 6004 has not hindered an active market for §363 sales. To date, no Bankruptcy Rules have been proposed or adopted to shape the process applicable to sales under §363(d). Section 1221(d) of BAPCPA provides some significant guidance in not requiring the reference of any §363(d) matter to any nonbankruptcy court. Presumably bankruptcy courts will step up and oversee whatever process is required to comply with applicable nonbankruptcy law. Bankruptcy Rule 6004 should provide bankruptcy courts with a basis, and an appropriate degree of flexibility, to fold the nonbankruptcy process into the §363(d) sale process.

It appears that no matter how the process under §363(d) eventually is put into practice, any sale of nonprofit health care business assets will be subject to greater scrutiny, with the possible dissemination of the application information as a public record and public meetings being held on the appropriateness of the proposed sale. It remains to be seen, however, how the BAPCPA provisions ultimately will shape this process; whether the BAPCPA provisions will place a state attorney general in a position under §363(d), as a practical if not a legal matter, to veto a sale; and whether the bankruptcy court's authority will be eroded.

Concluding Observations

Given the onerous nature of these state law provisions and the potential expense, delay and uncertainty created by these provisions, the potential impact of BAPCPA is far-reaching. Incorporating these state laws into the bankruptcy process and applying them both to sales before a chapter 11 plan under §363(d) and to sales pursuant to a chapter 11 plan under §1129(a)(16) are fundamental changes to the challenges faced by nonprofit health care businesses in financial distress. The changes to the law under §1221 seem destined to decrease the pool of prospective buyers for the assets of a debtor health care business. It stands to reason, then, that less competition among likely buyers will result in a likely decrease in the potential sale price obtained for the assets of such a health care business. These developments may create opportunities for prospective buyers, but they pose genuine risks to the estates and creditors of nonprofit health care businesses. At a minimum, a debtor health care business will have to carefully plan its approach to a chapter 11 case.

The parties in interest that are creditors of nonprofit health care businesses also face their own set of major adjustments to the effects of BAPCPA on asset sales, and chapter 11 cases in general, involving nonprofit health care businesses. Lenders to any nonprofit health care business are particularly vulnerable to the changes that derive from BAPCPA. Such lenders are well advised to review the risks that now accompany any loans in their portfolios to nonprofit healthcare businesses. Lenders considering making debtor-in-possession financing available to any nonprofit health care business also must be prepared to accommodate the lengthy, expensive and uncertain process contemplated by the state statutes governing the sale of such entity's assets. These state laws, as well as other nonbankruptcy law—from common law charitable trust doctrines to laws pertaining to successor liability—now affect the transfer of any nonprofit health care assets in any bankruptcy and will continue to be the subject of great interest in the charitable, health care and bankruptcy communities.

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Footnotes

¹ Board Certified in Business Bankruptcy Law by the American Board of Certification. Return to article

² BAPCPA, Pub. L. No. 109-8 (2005), §1221. Return to article

³ BAPCPA adds §101(27A), broadly defining a "health care business" to include "any public or private entity (without regard to whether that entity is organized for profit or not-for-profit)" that is primarily engaged in offering to the general public facilities and services" related to any facet of the health care industry. See Id. §1101. Return to article

⁴ With more than $1.3 billion in debt, Allegheny Health, Education and Research Foundation (AHERF) was the largest nonprofit health care provider to seek chapter 11 protection. AHERF's assets were sold though §363 sales over the challenges of the Attorney General for the Commonwealth of Pennsylvania, and its attempts to invoke the jurisdiction of Pennsylvania's Orphans' Court. Return to article

⁵ Donohoe, Kevin F., "Crossroads in Hospital Conversions—A Survey of Nonprofit Hospital Conversion Legislation," 8 Annals of Health Law 39, 45 (1999). Return to article

⁶ Id. at 45-46. Return to article

⁷ Id. at 47. Return to article

⁸ Id. at 40. Return to article

⁹ See, generally, Ariz. Rev. Stat. Ann. §§10-11251 - 10-11254 (West 2005); Cal. Corp. Code §§5913-5919 (West 2005) and Cal. Code Regs. Tit. 11, §999.5 (West 2005); Colo. Rev. Stat. Ann. §10-16-324 (West 2005); Conn Gen. Stat. Ann. §§19a-486 - 19a-486h (West 2005); D.C. Code §§44-601-610 (2005); Ga. Code Ann. §§31-7-400 - 31-7-412, 31-7-1 and 31-7-89.1 (West 2005); Haw. Rev. Stat. §§432C-1 - 432C-7 (LexisNexis 2004); La. Rev. Stat. Ann. §§40:2115.11 - 40:2115.22 (West 2005); Md. Code Ann. State Gov't. §§6.5-101 - 102, 6.5-201 - 6.5- 203, 6.5-301 - 307 and 19-327 (2005); Neb. Rev. Stat. §§71-20, 103 - 71-20, 114 (2005); N.H. Rev. Stat. Ann. §§7:19 - 7:19b (West 2005); Ohio Rev. Code Ann. §§109.34 - 109.35 (LexisNexis 2005); Or. Rev. Stat. Ann. §§65.800, 65.803 to 65.815 (West 2005); R.I. Gen. Laws §§23-17.14, et seq. (2004); S.D. Codified Laws §47-24-17 (2005); Va. Code Ann. §§55-531 - 55-533 (West 2005); Wash. Rev. Code Ann. §§70.44.007, 708.44.240 and 70.44.300 (West 2005); Wis. Stat. Ann. §165.40 (West 2005). In addition, many state statutes address the sale of a nonprofit entity's assets outside the "regular course of business" of such entity and place restrictions on such transfer. See, e.g., Ariz. Rev. Stat. Ann. §§10-11202; Colo. Rev. Stat. Ann. §7-132-102. Return to article

¹⁰ Cal. Corp. Code §5914(a). Return to article

¹¹ Cal. Code Regs. Tit. 11, §999.5(d). The regulations provide for a process by which a nonprofit health care entity may request waiver of this approval and consent process. At this writing, there do not appear to be any court opinions describing situations in which a waiver may have been granted. Moreover, the attorney general's discretion over any waiver request limits the access to a more expedited process. Other states' laws, such as Ohio's, offer no such opportunity. Return to article

¹² Cal. Code Regs. Tit. 11, §999.5(c)(3). Other states, such as Ohio, have similar statutes. Ohio Rev. Code Ann. §§109.34 - 109.35. Return to article

¹³ Ohio Rev. Code §109.35(C). Return to article

¹⁴ See, e.g., Cal. Corp. Code §5917(e); Ohio Rev. Code §109.35(B)(3). Return to article