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Section 363(f) Provides Little Muscle in Healthcare Bankruptcy Cases

Picture this scenario: a 300-unit regional hospital in Ruraltown, USA, derives a significant amount of its revenue through its participation in government-sponsored Medicare and Medicaid programs and the hospital’s entitlement to prospective reimbursements from the government. Operations have been stagnant year-over-year for the past five years. Management tells the board that there can be no hiccup or event affecting the hospital’s revenue stream, or hospital operations will no longer be viable.

The hospital has had a rough time recruiting doctors because of the size and geographic remoteness of Ruraltown. The demographics of Ruraltown have made it impossible for the hospital to redirect its revenue stream away from the government reimbursement program toward more private pay. Also, the cost of goods the hospital must buy keeps rising above inflation rates annually. The hospital has few choices when it comes to vendors because few suppliers service Ruraltown, given how difficult it is to get there.

The hospital participates in the inpatient prospective payment system (IPPS) under a healthcare service provider agreement. The hospital has been provided with a certification number (CCN) by the Centers for Medicare and Medicaid Services (CMS) under which federal healthcare reimbursements are made. Reimbursements, however, are subject to setoff and recoupment, provided the federal government has overpaid reimbursements in any prior period.

Under the provider manual, the Medicare program allows for audits and has an administrative process for appealing the government’s decisions. As with any government-sponsored program, it can take a substantial amount of time to get through that process. The provider manual also provides that the federal government can suspend Medicare payments if there is evidence that the hospital is in financial distress or if it learns of an imminent bankruptcy filing. 

A special board meeting has been called at which management informs board members that a Medicare audit has revealed that the accounting department miscoded Medicare submissions, resulting in an overpayment to the hospital equal to one month’s operating expenses. As a result, CMS withheld reimbursements to the hospital, which will leave the facility in a negative cash position in two weeks. Management also tells the board not to worry because they have a solution to the immediate liquidity issue as well as plans to address the problem on a long-term basis.

Management informs the board that a buyer is willing to step into operations immediately under a services agreement and cover the shortfalls until the sale closes. The buyer owns a convenience store chain and wants to diversify its holdings. The buyer has identified the hospital’s CCN as one of the assets it must have as a condition to closing the sale. The purchaser views the CCN as an asset independent of the provider agreement. Furthermore, the buyer has indicated that it has no intention of purchasing the provider agreement to avoid successor liability to the government under the reimbursement program. Is the buyer correct?

Management explains that the buyer will only purchase the hospital through a sale in bankruptcy because Section 363(f) allows the buyer to purchase the hospital free of liens, claims, and encumbrances, all of which attach to the proceeds of a sale. Management assures the board that there is little risk to the deal falling through because the issues between the hospital and the government under the reimbursement program will not carry forward to the buyer. Is management correct?

Unique Considerations

While Section 363(f) does provide that the hospital can sell all or substantially all of its assets to a buyer with the best offer, Section 363(f)(1) provides that the sale can only be free and clear of any interest in the property if “applicable non-bankruptcy law permits.” The interplay between Medicare/Medicaid and bankruptcy laws makes healthcare bankruptcy cases unique.

Section 363(f) does not extinguish federal government rights of setoff and recoupment against future reimbursements. An example of a setoff would be the government not paying a future reimbursement due to a tax obligation owed by the hospital to the IRS. Courts hold that for setoff mutuality purposes, different arms of the government are considered a single creditor. The automatic stay does apply, however, so relief from the Bankruptcy Court is required to exercise the right.


Bankruptcy courts have steered clear of trying to harmonize the purposes of the Bankruptcy Code with the policies of the federal healthcare reimbursement programs.


Recoupment, on the other hand, is an exception to the automatic stay and permits the government, including CMS, to withhold payment of future reimbursements post-petition against an overpayment made prepetition without first seeking court approval. Recoupment is an equitable doctrine and only arises out of the same transaction or occurrence.

In In re Gardens Reg’l Hosp. & Med. Ctr., Inc., 569 B.R. 788 (Bankr. C.D. Cal. 2017), the Bankruptcy Court was confronted with the issue of whether the doctrine of recoupment permitted the state of California to withhold a percentage of Medi-Cal payments owed post-petition to recover hospital quality assurance fees that were not paid by the debtor before it filed bankruptcy. Because the obligations of the debtor and the state arose from the same transaction or occurrence, the court permitted recoupment.

Overlaying Section 363(f), and because “applicable non-bankruptcy law permits” the doctrine of recoupment, the sale of the Ruraltown hospital to the buyer would not extinguish successor recoupment liability under Section 363. 

Bankruptcy courts have steered clear of trying to harmonize the purposes of the Bankruptcy Code with the policies of the federal healthcare reimbursement programs. Rather, the courts will not touch issues pertaining to the Medicare/Medicaid reimbursement program, and when presented with requests for relief, have determined that provider disputes are outside the jurisdiction of the Bankruptcy Court, or they have skirted the jurisdiction issue altogether. See, e.g., MMM Healthcare, Inc. v. Santiago, 563 B.R. 457, 475 (Bankr. D.P.R. 2017), in which the Bankruptcy Court refused to rule on a summary judgment motion seeking a determination whether the termination of a provider agreement was an exclusion from the automatic stay. See also, Home Care Providers, Inc. v. Hemmelgarn, 2017 BL 221083 (7th Cir. June 27, 2017), in which the 7th U.S. Circuit Court of Appeals, when presented with an appeal of a Bankruptcy Court’s injunction preventing the government from terminating a provider agreement, refused to rule on the merits. Rather, the court determined that the appeal was moot because the provider agreements in question expired by their own terms prior to the ruling by the District Court.

Turning to the provider license, the prospective Ruraltown buyer is incorrect in its belief that it could purchase the CCN without regard to the provider agreement. Unlike a personal service contract with a physician, the hospital may assume and assign its provider agreement to the buyer, which in this case would be critical. Otherwise, it would take far too long for a convenience store owner with no previous relationship to the healthcare sector to undertake the application process and be approved quickly enough by the government to continue to participate in the Medicaid/Medicare reimbursement program post-closing. 

The buyer’s position that it can buy the CCN as an asset independent of the provider agreement is not one of first impression. The government has consistently taken the position that provider agreements and the licenses issued thereunder are executory contracts, and overpayments, as with any other obligation, must be cured before they can be assumed and assigned to a buyer. Providers have argued that the license itself results from the completion of a form subject to government approval and is not a negotiated instrument, but a majority of courts have sided with the government on this issue. In practical terms, it does not matter because Section 363(f) does not extinguish recoupment liability. So either way, the government will get paid. 

Voting Aye

Considering all of this, how would the author vote as a director on the board of the Ruraltown hospital? He would agree to sell the hospital in a bankruptcy proceeding, because Section 363 affords the transparency of the sale process. In healthcare bankruptcies, protections built into the Bankruptcy Code insure a forum to supervise the quality of patient care being administered and foster negotiated settlements.  

Trey Monsour

Trey Monsour

Polsinelli PC

Trey Monsour is a shareholder in the Houston office of Polsinelli PC. He has extensive insolvency, restructuring, commercial bankruptcy, and workout experience, and counsels clients on company issues, counterparty issues, lender and financial issues, buyer and seller issues both from a practical perspective and in bankruptcy litigation. Monsour currently represents a large hospital chain in a number of disputes implicating both bankruptcy and healthcare-related issues.

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