The intersection between Medicare and state Medicaid regulatory schemes on the one hand and bankruptcy proceedings on the other continues to be an interesting, often highly contested, source of bankruptcy litigation. In article in 2016, The Medicare Provider Agreement: Is it a Contract or Not?  And Why Does Anyone Care?, 71 Bus. Law. 1207 (2016), Samuel Maizel and I discussed the critical issue of whether provider agreements are properly considered an executory contract, subject to the cure requirements of Bankruptcy Code § 365 and requisite assumption of all, potentially large, overpayment liabilities, or if it should be considered a statutory entitlement which a debtor is authorized to sell free and clear under Bankruptcy Code § 363.  We offered several reasons why it should not be considered an executory contract, including the government’s own arguments in non-bankruptcy cases that a provider agreement is not a contract at all.  Since our article, at least two bankruptcy courts have reached the same conclusion.  See In re Center City Healthcare LLC, Case No. 19-11466 (Bankr. D. Del. Sep. 10, 2019) (Docket No. 681); In re Verity Health System of California Inc., Case No. 2:18-nk-20151 (Bankr. C.D. Cal. Sep. 26, 2019) (Docket No. 3146).  Although both decisions were later vacated because of settlement (Verity) and failure of the sale to close (Center City), they represent potential progress on a critical issue for healthcare debtors. 

Another complex issue in which the characterization and interpretation of Medicare and Medicaid provider agreements plays a role is the determination of whether the government’s deduction of provider liability from ongoing payments to the provider constitutes setoff or recoupment.  Generally, “setoff” refers to a creditor’s ability to deduct from a debt owed to the debtor an amount owed by the debtor on a separate obligation between the same parties, while “recoupment” refers to a deduction or rebate of an amount from a debt to the debtor arising out of the same transaction.  The consequences of the distinction are large: if the overpayment is considered a setoff, then (i) the automatic stay applies to prevent setoff post-petition and (ii) Bankruptcy Code Section 553 only allows setoff of pre-petition obligations against pre-petition claims.  If the overpayment is considered a recoupment, however, the stay does not prevent the government from recouping Medicare or Medicaid overpayments from reimbursements post-bankruptcy and the government is allowed to recoup a pre-petition overpayment from a post-petition claim.  Courts have developed two tests for determining whether obligations arise from a single transaction (and thus the doctrine of recoupment applies): (1) the “logical relationship test,” a broad, flexible approach which defines a single transaction to include many occurrences as long as they have a logical relationship; and (2) the “integrated transaction” test, which is a narrower test that requires the obligations to arise out of a single integrated transaction such that it would be inequitable for the debtor to enjoy the benefits of that transaction without meeting its obligations.  

In a recent hospital case in which Mr. Maisel represented the debtors, the Ninth Circuit’s opinion provides guidance on the dividing line between setoff and recoupment. See Gardens Regional Hosp. and Med. Center Liquidating Trust v. California (In re Gardens Regional Hosp. and Med. Center, Inc.), 975 F.3d 926 (9th Cir. 2020).  Garden Regional concerned whether the State could recoup two of the debtor’s obligations – (i) Hospital Quality Assurance (“HQA”) fees and (ii) fee-for-service obligations – from the State’s payments to the debtor for supplemental HQA payments under the state Medicaid program, Medi-Cal.  The Bankruptcy Court, while it cited our Business Journal in a footnote, found that, regardless of whether the provider agreement is a contract or a license, the fees and liability arose from the same transaction or occurrence.  Gardens Regional, 569 B.R. 788, 799 (Bankr. C.D. Cal. 2017). 

The Ninth Circuit affirmed in part and reversed in part.  The court agreed that the unpaid HQA fees had the necessary logical relationship to the HQA supplemental payments to characterize them as arising from the same transaction for purposes of recoupment.  With respect to the fee-for-service obligations, however, the Ninth Circuit found there was no logical relationship.  In so ruling, the Court found that in order to qualify as recoupment, the deduction of the fees must rest upon connections beyond the mere assertion of a statutory right to make the deduction.  975 F.3d at 939.  Further, a recitation of such a right in a contract, without more, does not establish the deduction is actually a recoupment.  Id. at 940.  The mere fact that both countervailing obligations were in some sense rooted in the parties’ contract is not sufficient, in and of itself, to provide the requisite legal relationship.  Id.             

Though the long-term impact of Garden Regional and other recent healthcare cases remains to be seen, they do give healthcare bankruptcy practitioners guidance on critical, recurring issues – and perhaps some hope that healthcare debtors can obtain relief in bankruptcy over the objection of governmental payers.