Competitive forces and market pressures to deliver health care in an economical, more efficient manner have caused major restructuring, consolidation and reorganization in the health care industry. In this restructuring, an increasing portion of health care provider revenues are derived from participation in the Medicare and Medicaid programs. These programs provide health care for the elderly, disabled and those who are otherwise unable to afford health care.

Health care providers service Medicare and Medicaid patients pursuant to a "provider agreement." Under a provider agreement, health care providers become eligible to receive reimburse-ments in accordance with the statutory and regulatory schemes of the Medicare or Medicaid programs. These programs provide for interim payments to health care providers, and these payments are generally audited on an annual basis and adjusted to account for prior overpayments or under-payments. Not surprisingly, many health care providers seeking bankruptcy protection have significant liability for pre-petition overpayments from the Medicare or Medicaid programs. The treatment of these claims is the subject of conflicting statutory and regulatory policies of the Bankruptcy Code and applicable Medicare and Medicaid regulations.

Prior to the enactment of the Bankruptcy Code, the Supreme Court ruled in Perez v. Campbell, 402 U.S. 637, 91 S.Ct. 1704 (1971), that a state could not refuse to renew a driver’s license of a debtor, who had a tort judgment resulting from an automobile accident that was discharged in bankruptcy. The Supreme Court held that such discriminatory treatment by a governmental unit arising from a discharged debt conflicted with the fresh-start policies of the Bankruptcy Act.

In 1978, Congress codified and expanded this anti-discriminatory principle in §525(a) of the Bankruptcy Code. This section was designed to prevent governmental units from frustrating policies favoring a fresh start of a debtor under the Bankruptcy Code.

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...the anti-discrimination and fresh-start policies preclude the debtor from being compelled to pay pre-petition overpayment obligations as a condition for continued post-petition participation in the Medicare or Medicaid programs.

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A government unit may not deny, revoke, suspend or otherwise refuse to renew a license, permit, charter, franchise or other similar grant to, condition such a grant to, discriminate with respect to such a grant against...a person that is or has been a debtor under this title or a bankrupt or a debtor under the Bankruptcy Act or another person with whom such bankruptcy or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title...has been insolvent before the commencement of the case under this title or during the case but before the debtor is granted or denied a discharge or has not paid a debt that is dischargeable in the case under this title...

Thus, §525(a) essentially provides that governmental units may not discriminate against entities in a manner that contradicts the fresh-start policy of the Bankruptcy Code.

However, Medicare cost reim-bursement regulations provide that in the event of a bankruptcy or insolvency of a provider, "any payment to the provider will be adjusted by the government, notwithstanding any other regulation or program instruction regarding the timing or manner of such payments to a level necessary to ensure that no overpayment to the provider is made." 42 C.F.R. §423.64(i). This regulation, on its face, seems to directly contradict the anti-discrimination/fresh-start provisions of the Bankruptcy Code as set forth in §525(a).

In practice, entities administering Medicare and Medicaid programs do not generally violate §525(a) as overtly as Medicare regulations prescribe. Rather, they attempt to recover pre-petition over-payments under theories of setoff and recoupment by seeking relief from the automatic stay. Although several courts have addressed the issue of the relative rights of such parties, few courts address the issue of whether or not such actions contradict the anti-discrimination provisions set forth in the Bankruptcy Code. Two cases do address this issue. Both cases found that the anti-discrimination and fresh-start policies preclude the debtor from being compelled to pay pre-petition overpayment obligations as a condition for continued post-petition participation in the Medicare or Medicaid programs.

In In re St. Mary Hospital, 89 B.R. 503 (Bankr. E.D. Pa. 1988), the Department of Health and Human Services (HHS) sought to recoup approximately $353,000 of pre-petition overpayments of Medicare reimbursements. HHS sought to recoup these overpayments against post-petition Medicare advances and remittances payable to the debtor-in-possession health care provider. The bankruptcy court concluded that HHS could not mandate the debtor to repay its pre-petition indebtedness as a condition for assuming its provider contract. The court specifically stated that "the debtor cannot be compelled to pay pre-petition obligations to HHS as a condition for continued participation by HHS in the Medicare program at the debtor hospital." 89 B.R. at 503.

The St. Mary’s court concluded "that although §365(b)(1) would otherwise appear to require the debtor to allow its recoupment rights as a condition for utilization of its Medicare provider contract in the future, §525(a) eliminates that condition. Id at 512. The court further noted "Congress expressly encouraged the courts to stretch the contours of the anti-discrimination ban in §525(a)...furthering the ‘fresh-start’ of the debtor hereby unshackling it from the pre-petition Medicare overpayment liabilities is precisely the policy enunciated in the fountain head of §525(a), the Supreme Court’s decision in Perez v. Campbell." Id at 513. See, also, In re University Medical Center, 93 B.R. 412, 416-17 (Bankr. E.D. Pa. 1988); but see University Medical Center v. Sullivan, 122 B.R. 919, 924 (E.D. Pa. 1990) (affirming bankruptcy court’s decision but finding the court made no findings on the record to support the HHS’s inactions were "motivated by discrimination.")

Outside the health care insolvency arena, there are a number of cases that have found that continued participation in subsidized programs or licensed activities cannot be conditioned upon cure or repayment of what are otherwise dischargeable pre-petition obligations. See In re Walker, 927 F.2d 1138 (non-payment of discharged debt was improper basis for automatic license revocation); In re Harris, 85 B.R. 858, 862 (Bankr. D. Colo. 1988); In re General Development Corp., 163 B.R. 216 (governmental authority could not deny platting and replatting actions to be conditioned on payment of discharged pre-petition taxes); In re Curry, 148 B.R. 966 (Public housing authority could not require debtor to cure pre-petition rent to retain possession of public housing); Gibbs v. Housing Authority of City of New Haven, 76 B.R. 257 (D. Conn. 1983) (same); In re Szymecki, 87 B.R. 14 (Bankr. W.D. Pa. 1988) (same); In re Suttler, 71 B.R. 780 (Bankr. E.D. Pa. 1987) (same). A health care provider’s continued participation in the Medicare and Medicaid program is analogous to these cases that preclude a government unit from denying benefits or conditioning further rights upon curing pre-petition dischargeable debts.

Certain procedural activities of various governmental agencies also support the contention that these governmental agencies, by seeking repayment of pre-petition overpayments, are acting in a discriminatory fashion under §525(a). Outside of bankruptcy, governmental agencies typically audit their payments on an annual basis. However, it is not uncommon in the context of a reorganization, for such agencies to immediately commence an audit after the petition, thus, deviating from their normal traditional actions of an annual audit. Such action demonstrates discriminative treatment that may violate §525(a).

Although there are a number of cases addressing the issue of assumption/rejection issues as they relate to various provider agreements, few of these cases have focused on whether actions by HHS or other agencies to obtain repayment of pre-petition overpayments violate §525(a). In fact, there appear to be no reported decisions suggesting that such actions are permissible under §525(a). Rather, the two reported decisions addressing the issues suggest that such actions violate the fresh-start principals of the Bankruptcy Code and therefore are unenforceable. Furthermore, because government units are precluded from discriminating against entities solely by virtue of their status as debtors-in-possession, then a debtor-in-possession should be free to reject its pre-petition provider agreement, and thereby eliminate any setoff or recoupment liability and be authorized to simultaneously execute a new post-petition provider agreement.