The intersection of Federal Civil Enforcement: claims and healthcare restructurings

Intersection of Federal Civil Enforcement

Restructuring e-Newsletter - Global Insight


This article has previously been published in New York Law Journal and is reproduced with permission.

It is well known that the healthcare industry as a whole has undergone significant changes, challenges and uncertainties in recent years. Many hospitals, senior living facilities, pharmaceutical companies, laboratories and other healthcare providers are struggling to operate in an industry that has ever-changing state and federal regulations, increasing competition and demanding technological needs. Taken together, these challenges have caused a number of healthcare companies to financially struggle and have resulted in a number of restructurings.

Further complicating the financial and operational issues experienced by healthcare companies is the increased prevalence of governmental and quasi-governmental civil claims. Many healthcare companies have been the target of investigations under the False Claims Act by an interagency taskforce created in 2009 among the Department of Health & Human Services, Office of Inspector General, the Centers for Medicare & Medicaid Services (CMS), and the US Department of Justice (Dal) known as the Health Care Fraud Prevention and Enforcement Action Team. As a result of the government's efforts, the DOJ obtained more than US$2.5 billion in settlements and judgments in 2016 from civil cases involving fraud and false claims against the government by participants in the healthcare industry. In addition, an increasing number of healthcare providers face Medicare or Medicaid "charge-back" claims pursuant to which CMS seeks to recoup amounts previously paid to providers based on a review of prior payments which CMS retroactively determines were improper. In many instances, these government investigations and claims are the tipping points for already distressed healthcare companies causing them to seek Chapter 11 protection. As discussed herein, governmental involvement in these financial restructurings at the very least complicates the process of reorganizing these entities.


The False Claims Act, which was originally enacted in 1863 out of a concern that suppliers were defrauding the Union army during the Civil War, has become the government's primary tool for combatting alleged fraud. The False Claims Act generally imposes liability on any person or entity who knowingly submits a false claim to the government. Many actions brought by the government or an individual who has knowledge of a false claim (known as a "whistleblower" or "relator") under the False Claims Act involve healthcare-related claims, including actions against companies and individuals related to overpayments from state or federal government programs, improper billing practices and illegal kickbacks. A government investigation under the False Claims Act can have a devastating impact on a healthcare company by not only causing significant reputational damage and concern among the company's creditors and customers, but also by exposing the company to significant monetary penalties. While such penalties have resulted in meaningful benefits for the general public, including stricter compliance with applicable laws and funding for various government programs, the unexpected costs of a government investigation have caused healthcare companies, many of which provide critical goods and services to the general public, to suffer financial distress.

In order to seek relief from such financial distress, many healthcare companies have commenced cases under Chapter 11 of title 11 of the United States Code (the Bankruptcy Code). For example, on 25 May, 2017, 21st Century Oncology Holdings and certain of its affiliates, which collectively operate the world's largest network of cancer treatment centers and affiliated physicians (collectively, 21st Century Oncology), sought relief under Chapter 11 of the Bankruptcy Code in the US Bankruptcy Court for the Southern District of New York. In support of its bankruptcy filing, 21st Century Oncology noted that, although its operations were profitable, it needed to restructure its balance sheet because of, among other reasons, unforeseen government penalties and settlements. In particular, within two years of its bankruptcy filing, 21st Century Oncology entered into two settlement agreements with the DOJ that provided for the payment of over US$54 million to the DOJ to resolve certain inquiries under the False Claims Act related to 21st Century Oncology's billing practices and physician agreements. Similarly, on 7 June, 2015, Health Diagnostic Laboratory (HDL), which operated laboratories offering comprehensive testing for biomarkers that can indicate risk of cardiovascular disease, diabetes and related diseases, sought bankruptcy relief in the US Bankruptcy Court for the Eastern District of Virginia. HDL noted that it commenced a Chapter 11 case due to a liquidity crisis caused, in part, by HDL's agreement to pay the government US$47 million to settle allegations under the False Claims Act that HDL induced physicians to order unnecessary blood tests. 21st Century Oncology and HDL are not alone; rather, they are just two examples among an increasing number of healthcare companies that have sought bankruptcy relief because the unexpected costs of a government investigation have jeopardized their ability to operate as a going concern. Yet, the relief available to such companies in bankruptcy is significantly limited by government claims.

Specifically, §362 of the Bankruptcy Code provides that the filing of a bankruptcy petition operates to stay the commencement or continuation of various proceedings and acts against the debtor and the debtor's property. The automatic stay is one of the most significant protections afforded to a debtor because it allows for a "breathing spell" during which the debtor can formulate a plan of reorganization. While courts have traditionally interpreted the scope of the automatic stay broadly to cover all actions against the debtor, the Bankruptcy Code delineates certain narrow exceptions. In particular, §362(b)(4) provides that an action by the government to enforce its "policy or regulatory power" may proceed notwithstanding the commencement of a bankruptcy case. Courts have held that government actions under the False Claims Act, which seek to prevent or stop a fraud and subsequently fix the amount of damages caused by such fraud, are exempted from the automatic stay as an exercise of the government's "policy or regulatory power." Accordingly, even after a bankruptcy filing, the debtor will need to deal with the ongoing litigation and investigation. While the government's collection efforts are stayed, the debtor's "breathing spell" and ability to turn its focus elsewhere are limited.

Additionally, healthcare companies considering bankruptcy relief following a government investigation should be cognizant of a debtor's limitations with respect to discharging government enforcement claims. To achieve the Bankruptcy Code's goal of providing a fresh start, debtors are typically able to discharge nearly every type of unsecured claim. Congress, however, recognized that liabilities that are the result of fraud should be exempted from a debtor's general right to discharge prepetition debts. Specifically, in 2005, Congress amended the Bankruptcy Code to, among other things, prohibit a debtor from discharging certain amounts owed under the False Claims Act. Similarly, debtors will also encounter limitations upon assuming Medicare and Medicaid provider agreements that may be subject to a recoupment claim by the government. In fact, courts have held that debtors cannot assume provider agreements and continue to benefit from the payments thereunder without also accepting the burden of a potential recoupment claim. Accordingly, debtors seeking to assume provider agreements do so at the risk of potentially having to make recoupment payments to the government in the future. Government claims, therefore, can cause a number of challenges in a healthcare company's restructuring.

Finally, recent case law indicates that bankruptcy courts have limited jurisdiction over issues related to Medicare or Medicaid programs. For example, in In re Bayou Shores SNF, 828 F.3d 1297, 1299 (11th Cir. 2016), cert. denied sub nom. Bayou Shores SNF v. Florida Agency for Health Care Admin., 137 S. Ct. 2214, 198 L. Ed. 2d 658 (2017), the operator of a skilled nursing facility (Bayou Shores) that generated approximately 90 percent of its revenue under its Medicare and Medicaid provider agreements, sought bankruptcy relief after the government sought to terminate Bayou Shores' provider agreements due to significant deficiencies identified during surveys conducted at the facility. Thereafter, the bankruptcy court enjoined the government from terminating the provider agreements on the basis that the provider agreements were property of the estate and that the automatic stay precluded the government from terminating the agreements. The Eleventh Circuit, however, reversed the bankruptcy court's decision and held that the bankruptcy court did not have jurisdiction over Medicare and Medicaid claims. The Eleventh Circuit's decision in Bayou Shores as well as decisions by courts in other districts divesting bankruptcy courts of jurisdiction to address key Medicare and Medicaid issues have left healthcare companies without a forum to address all of their issues and achieve a successful reorganization.

While government investigations protect the health and safety of the general public, they can have a damaging impact on a healthcare company's ability to operate as a going concern. Healthcare companies facing such investigations may be left with no other choice but to seek bankruptcy relief. In doing so, however, companies should be prepared to navigate around the limitations they will likely encounter in addressing government civil enforcement claims in bankruptcy.