The Bankruptcy Code and Medicare Regulations Conflict And the Winner Is...

The Bankruptcy Code and Medicare Regulations Conflict And the Winner Is...

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Health care insolvencies often involve disputes between the Bankruptcy Code and Medicare laws or regulations. The disputes often center around the cost report,[1] and the bankruptcy court typically must first determine whether it is has jurisdiction over the matter or if the health care provider must first exhaust its administrative remedies. See, e.g., In re St. Johns Home Health Agency Inc., 173 B.R. 238, 245-46 (Bankr. S.D. Fla. 1994) (absent exhaustion of administrative remedies, bankruptcy court did not have jurisdiction to determine whether the provider was overpaid). Recently, a dispute arose between the Bankruptcy Code and Medicare regulations regarding what, at times, is one of the most valuable assets held by an insolvent health care provider—the "Medicare recapture value."

Under Medicare regulations, a health care provider must file a final cost report after the health care provider's participation in the Medicare program is terminated. See 42 C.F.R. §413.24(f)(1). The health care provider has one year from the date of termination of its participation in the Medicare program to sell its assets in order to recognize any loss or gain on sale and recover from Medicare the "recapture" value, if any. See 42 C.F.R. §413.134(f)(3). Therefore, if a health care provider sells its assets for less than the Medicare depreciated book value within one year after its participation in Medicare is terminated, Medicare will owe the provider money. Alternatively, if the health care provider's assets are sold for more than the Medicare depreciated book value within one year after the provider's participation in Medicare is terminated, the health care provider will owe Medicare money.[2] If a health care provider does not sell its assets within one year after its participation in the Medicare program is terminated, any loss or gain upon sale is forfeited.


...the real lesson of Noonan is the need for advanced planning in health care insolvencies and the need to focus on the "hidden" asset with potentially high value...

Recently, the 1st Circuit considered whether it could extend the one-year deadline for selling assets following termination of a health care provider's participation in the Medicare program based on §105 of the Bankruptcy Code. In Noonan v. Secretary of Health and Human Services (In re Ludlow Hospital Society Inc.), ___ F.3d ___, 1997 WL 447583 (1st Cir. August 13, 1997), the debtor commenced a chapter 7 case on February 17, 1995, and terminated its participation in the Medicare program on that same date. Based on the Medicare regulations in effect, the chapter 7 trustee was required to file a final cost report within 45 days after the date of termination. The trustee sought, and was granted by the bankruptcy court, two extensions of time to file the final cost report. The Department of Health and Human Services (HHS) did not oppose the extensions of time to file the final cost reports.

Under the Medicare regulations, the trustee had until February 16, 1996, the one-year anniversary of the termination of the debtor's participation in the Medicare program, to sell the capital assets of the debtor. The trustee sought, and was granted by the bankruptcy court, an extension of the one-year deadline. The bankruptcy court based its decision, primarily, on §105 of the Bankruptcy Code. In addition, the bankruptcy court relied on the doctrines of estoppel and "law of the case" and held that the failure on the part of HHS to challenge the court's earlier decisions granting the trustee two extensions of time to file the final cost report equitably estopped HHS from challenging any extension of the one-year deadline to sell assets.

On October 16, 1996, the district court vacated the bankruptcy court's opinion and held that the bankruptcy court lacked subject jurisdiction over the matter. The trustee appealed to the 1st Circuit and, between the time that the trustee appealed the district court's opinion and the 1st Circuit ruled, the trustee sold the debtor's assets and filed a supplemental final costreport seeking $300,000 to $400,000 from Medicare, representing the loss on sale—a significant asset to the estate and its creditors.

Nevertheless, the 1st Circuit affirmed the district court, and the estate lost a valuable asset. In reaching its decision, the 1st Circuit found that there was no authority under the Bankruptcy Code to extend the one-year limitation for recovering any loss or gain on sale, as established by the Medicare regulations. The 1st Circuit held that it could not rely on §105 of the Bankruptcy Code to extend the deadline because the court was interpreting an issue arising under non-bankruptcy law:

Bankruptcy Code §105(a) may not be invoked to alter substantive debtor rights defined under applicable non-bankruptcy law. [Cites omitted] ... Since §105 itself is not a source of new substantive rights, the bankruptcy court may invoke §105(a) only if the equitable remedy utilized is demonstrably necessary to preserve a right elsewhere provided in the Code.

Noonan, 1997 WL 447583 at *4-5. In this case, the right arose under the Medicare regulations and not the Bankruptcy Code.

The court also stated that it could not rely on "§105(a) if another, more particularized Code provision...impede[d] the requested exercise of equitable power." Id. at 5. The 1st Circuit found that the other Code section controlling its decision was §108(b). Noonan, 1997 WL 447583 at *6-9. Section 108(b) of the Bankruptcy Code allows the trustee additional time to, among other things, pursue actions that arise under non-bankruptcy law. Under this section, the trustee has the longer of 60 days after the entry of an order for relief or the deadline established under non-bankruptcy law to pursue any actions or rights belonging to the estate. Therefore, based on §108(b) of the Bankruptcy Code, the 1st Circuit found that it would be impermissible to extend the one-year deadline established by the Medicare regulations because the Bankruptcy Code itself did not allow such an extension of time. Id.

Finally, the 1st Circuit found the trustee's equitable estoppel argument unpersuasive. Noonan, 1997 WL 447583 at *2-3. The trustee again argued that HHS was estopped from objecting to any extension of the one-year deadline based on the failure of HHS to challenge the prior two extensions of time for filing the final cost reports granted by the bankruptcy court.[3] The 1st Circuit noted that the Medicare regulations expressly provide that an extension of time may be granted for filing a final cost report. Conversely, the Medicare regulations do not provide for any extension of time for recovering a loss or gain upon sale.

Therefore, as a result of the 1st Circuit's ruling, the estate and its creditors lost an asset valued at between $300,000 and $400,000. It seems that, based on the 1st Circuit's interpretation of §105, the opposite result could have been reached. Namely, considering §108 and the need to preserve and protect property of the estate, the court could have exercised its equitable powers to preserve the Medicare recapture for the estate and its creditors. Instead, the court indicated that the parties should seek an amendment of the Medicare regulations or the Bankruptcy Code so that trustees, who may be overburdened by the administration of a case or placed in a difficult position in trying to preserve the recapture value due to the short time frame, and the creditors, whose interests may be adversely affected, will not lose a valuable estate asset. Noonan, 1997 WL 447583 at *9.

For practitioners, the real lesson of Noonan is the need for advanced planning in health care insolvencies and the need to focus on the "hidden" asset with potentially high value—the Medicare recapture. In many health care insolvencies, the sale structure, timing and price is driven by the calculation of the loss or gain on sale because the Medicare recapture value often is more valuable than the hard assets themselves.


Footnotes

[1] A health care provider is required to submit a "cost report" to Medicare, on an annual basis. The cost report sets forth the actual services rendered to Medicare patients. The Health Care Finance Administration (or, more likely, an intermediary) reconciles the cost report against the estimated payments made to the health care provider over the past year to determine whether Medicare overpaid or underpaid the health care provider for the Medicare services actually rendered. As part of this process, a health care provider receives periodic reimbursements for the estimated annual depreciation of its capital assets, as determined under accepted accounting practices, provided that the assets are owned by the provider and used to provide services to Medicare recipients. Noonan v. Secretary of Health and Human Services (In re Ludlow Hospital Society Inc.), ___ F.3d ___, 1997 WL 447583 at *1 (1st Cir. August 13, 1997); see, e.g., 42 U.S.C. §1395x(v)(1)(O)(ii).[RETURN TO TEXT]

[2]See, e.g., WBQ Partnership v. Commonwealth of Virginia Department of Medical Assistance Services (In re WBQ Partnership), 189 B.R. 97 (Bankr. E.D. Va. 1995) (debtor sold assets free and clear of all liens, claims and interests for an amount in excess of the depreciated book value; Virginia Department of Medical Assistance Services, however, was enjoined from recovering the gain on sale from the purchaser and was required to assert a claim against the estate); P.K.R. Convalescent Centers Inc. v. Commonwealth of Virginia Department of Medical Assistance Services (In re P.K.R. Convalescent Centers Inc.), 189 B.R. 90 (Bankr. E.D. Va. 1995) (accord).[RETURN TO TEXT]

[3] The 1st Circuit, in its discussion, noted that HHS had little or no notice of the hearings regarding the trustee's requests for additional time to file the final cost report.[RETURN TO TEXT]

Journal Date: 
Wednesday, October 1, 1997