When the Mission Is More Than Obtaining The Highest Price

Monday, February 28, 2011 - 01:00

Editor: Please tell our readers about your practice at Kramer Levin.

Rogoff: I am a partner at Kramer Levin, specializing in out-of-court restructurings and Chapter 11 bankruptcies. I have been representing debtors since 1988 throughout many different industries. For the last four years, I have been specializing in healthcare providers, such as acute-care hospitals, nursing homes, hospices and home-health agencies. I was debtor's counsel for Bayonne Medical Center, a community-based, acute-care hospital in Bayonne, New Jersey and am currently debtor's counsel for St. Vincent's Catholic Medical Center, a complex healthcare system that provided a wide variety of services in New York City and Westchester County. Until last year, St. Vincent's operated the historic Greenwich Village hospital and the large Behavioral Health Center in Westchester County.

Editor: Please describe the plight of many not-for-profit hospitals today.

Rogoff: Distressed healthcare is quite different from dealing with a commercial, for-profit bankrupt entity. There are a variety of regulatory, public policy and community-related issues that arise in a distressed healthcare case as compared with a for-profit commercial company (like a retailer) in filing for Chapter 11. Many factors are hurting our traditional hospitals and healthcare provider systems. For one, there's more competition today for the services that were traditionally provided by acute-care hospitals in the past. Fewer patients results in an overbedding problem for community-based hospitals - too many empty inpatient beds as daily census goes down. There is competition from urgent care centers, ambulatory surgical centers, and newer technology available to physician practice groups, allowing physicians to do more procedures outside of acute-care hospitals. A few years ago, a medical procedure would require inpatient admission with one or two overnight stays. Now, it is same-day surgery. Insurers will not pay for longer stays either, curtailing bed utilization and diminishing revenues.

Editor: What other factors are affecting the financial health of not-for-profit hospitals?

Rogoff: Another factor affecting hospitals is reduced revenues from reimbursement sources, like Medicaid and Medicare. Many community-based hospitals rely on Medicaid, which is funded by federal and state contributions. But, as states suffer budget crises, there is pressure on Medicaid. In New York, for example, between 2007 and 2009 there were almost a billion dollars of cuts to Medicaid spending. This can be a huge revenue loss for smaller hospitals. Medicaid is a major issue today. States also have fewer dollars to fund charity care affecting hospitals in poorer communities.

Smaller community-based hospitals also lack negotiating leverage with private insurance payors. Private insurers fix reimbursement rates based upon the number of patients enrolled in the health plan who go to the hospital. Fewer enrollees means less leverage. This was a problem affecting both Bayonne Medical Center and St. Vincent's Hospital, whose competitors might have been paid more for the same procedures. If you were to take, for example, some of the reimbursement rates that are available to the larger healthcare systems and overlay them on the same services being provided by the smaller community-based hospitals, those smaller hospitals would immediately have an increase in their cash flow to service their operating expenses.

Two other factors converging in this perfect storm affecting various hospitals are that some smaller community-based hospitals are likely to be older facilities with large, antiquated infrastructures, requiring staffing throughout the building even though census is dropping; second, as technology improves, people want the latest procedures. The cost of purchasing or leasing the new equipment may be unmanageable while the hospital is still paying off its older equipment debt.

Editor: Please describe the difference between dealing with distressed hospitals in bankruptcy as compared with other bankrupt businesses.

Rogoff: For-profit debtors can fix their capital structure and operations and, ultimately, use new equity as a tool in cutting deals with creditors. With a distressed not-for-profit healthcare facility in bankruptcy, you can use the bankruptcy process to reject burdensome contracts and to sell assets; but there is no equity to provide upside benefits. The auto industry used equity as a key part of cutting deals with labor. For-profits can also outsource labor, if needed, to a less expensive location. But, a hospital cannot move its facilities to an area with lower labor costs. This means for a long-term solution you need to have a partnership with your labor that makes sense.

Editor: Are there equity players who might supply some capital funding for these hospitals?

Rogoff: If your state allows a for-profit to have an investment in a healthcare provider, the solution may be to attract equity from for-profit players. For example, last year, Cerberus Capital Management acquired Caritas Christi Health Care in Massachusetts in a deal valued at over $830 million. We did this for Bayonne Hospital, which was sold to a for-profit group using New Jersey law. But certain states, like New York, do not permit for-profits to acquire non-profit hospitals. Consequently, your sources of working capital are going to be debt. There are lenders who understand healthcare lending, such as GE Capital and TD Bank. There are also state-funded lenders, like the Dormitory Authority of the State of New York (DASNY). But, these are still lenders and more debt may not help a troubled hospital. It doesn't restructure the balance sheet.

But, when hospitals face liquidity issues, they cannot be minimized. Money is needed to meet payroll and buy supplies (like blood). Prior to its 2010 bankruptcy, St. Vincent's Hospital went through a very public process to locate a new sponsor working with New York Governor Patterson's "Task Force" (comprised of state and local elected officials, union leaders, lenders, and others). To allow this process to proceed, the state and St. Vincent's lenders gave emergency loans - needed for payroll and immediate supplies. The same occurred with Bayonne Medical Center, where, once it entered Chapter 11, new funds were needed to keep it going. Because the largest employer in Bayonne was the hospital, whose many employees also lived in Bayonne, the closure of the hospital would have had a direct impact on the city. So, the city issued bond debt and made an emergency loan to allow Bayonne Hospital to continue operating in Chapter 11 long enough to find a buyer. Because New Jersey allows for-profits to acquire hospitals, we ultimately sold the operations to a joint venture for-profit buyer. These efforts saved a community hospital that would have closed.

Editor: What are some of the practical issues that make a healthcare bankruptcy different from a commercial bankruptcy?

Rogoff: The key difference in healthcare bankruptcies is that you literally have lives at stake. Whatever the financial restraints on a company in bankruptcy, there has to be a safe way of continuing to provide for patient care during the bankruptcy process. Whether the purpose of the bankruptcy is to reorganize the hospital or, as in the case of St. Vincent's, the liquidation and transfer of the services, patient safety is paramount. That means not only having adequate funding for the Chapter 11 costs, but also making sure that your decisions are being guided by what is appropriate for patients.

Recognizing that healthcare bankruptcies are different from other types of bankruptcies, the Bankruptcy Code has special rules, including a requirement that when a healthcare provider goes into bankruptcy, the court will appoint a "patient care ombudsman" whose responsibility is to monitor the healthcare provider's operations, assuring that they are being handled in a way that safely addresses the needs of patients. Bankruptcy judges rely on the ombudsman to bring to their attention any unsafe processes or any concerns about continuing the operations of the hospital during the bankruptcy period. The ombudsman works with management, interviews physicians, staff and patients, and files reports on a quarterly basis, the purpose of which is to keep the judge apprised of the hospital's condition.

Healthcare providers are also subject to substantial regulatory oversight. This is unchanged in Chapter 11, and debtors must be prepared to work closely with the state's department of health. And if the hospital is implementing a closure or a transfer to a third party, the regulatory authorities will need to approve closure plans and certificates of need for the new sponsors, etc. Most bankruptcy sales are consummated shortly after the "363 sale order" is entered, but healthcare transfers can sometimes take months longer to consummate pending state approvals. The debtor's estate has to be prepared to fund operations until the deal closes.

Another important difference in this process is that most healthcare providers, certainly in the New York area, are not-for-profit entities. They have a charitable mission, and the trustees or directors have a duty of obedience to that charitable mission. The mission typically governs quality healthcare or specialized services (like behavioral health). That duty to the charitable mission is something that bankruptcy courts will give a degree of respect to in Chapter 11, unlike commercial bankruptcies, where maximizing creditor recoveries is paramount. For example, in United Healthcare, the debtor was a Newark, New Jersey-based hospital specializing in children. The hospital was unable to do its own reorganization, and the commissioner of health recognized that preserving children's healthcare was key. Two bidders came forth - one was willing to preserve the operations and the other sought to drop some of the previously provided services. The commissioner and the debtor agreed to go with the buyer who agreed to preserve the services. They went to the bankruptcy court for approval. The other buyer came in with an offer to pay more. The bankruptcy judge - following the normal for-profit reaction of maximizing value - would not approve the sale to the lower bidder. On appeal, the district court reversed and recognized that the state's views and board's view on healthcare mission should have been taken into account. It wasn't about the highest recovery when patient care would have been affected.

We had similar issues in St. Vincent's. We needed to transfer our behavioral-health hospital in Harrison, New York, sitting on 66 acres of developed and undeveloped land. The behavioral-health hospital was a very important provider of behavioral-health treatment and services in New York State, not only with inpatient facilities in Westchester but also with clinics and residences throughout New York City. Our challenge was to determine the best way to transfer those services intact. There was no viable absorption plan for these patients if St. Vincent's Westchester closed. Through a deliberative process, we located a purchaser, St. Joseph's Medical Center, that committed to maintaining all services. The state was not prepared to let these services close, either.

Meanwhile, the real property (66 acres) was subject to various mortgages. Some of our creditors wanted us to simply close the facility to sell real estate. But, St. Vincent's specialized services were important to the state. Closure without a transfer of services was an untenable option for the hospital. Ultimately, we settled the issue with our creditors to allow the sale and transfer to proceed. The ability to raise these issues and bring about an outcome that preserved the services came about primarily, if not only, because there is recognition by courts in bankruptcy cases that the healthcare mission is a factor that you need to put into the mix. To me personally, the Saint Vincent's Westchester transfer of services is a tremendous success story on the use of Chapter 11 for a struggling healthcare provider. The services were preserved and the assets were transferred without the legacy debt being attached.

Please email the interviewee at arogoff@kramerlevin.com with questions about this interview.