18th Annual King & Spalding Health Law And Policy Forum: Healthcare Companies Face Unprecedented Challenges

Sunday, March 1, 2009 - 01:00
Deloitte Financial Advisory Services LLP
Arthur J. Steinberg
Robert Clarke

Hector G. Calzada, Jr.

Robert Clarke

Editors Note: The 18th Annual King & Spalding Health Law and Policy Forum took place on February 17, 2009, at the Four Seasons Hotel in Atlanta, Ga. The Forum led off with a panel discussion of the unprecedented challenges faced by healthcare companies in today's distressed economy. Our interviewees facilitated the conversation. This interview is an effort to capture some of the highlights of that discussion .

For more information about revisions made in the last two or three years to the Bankruptcy Code relevant to the healthcare area as well as a description of the dynamic when a hospital is being sold, a provider agreement is conveyed and there are amounts owed to the government under the provider agreement. (See the memorandum and article included with the version of this interview on our Website.)

Editor: What is causing the perfect storm that is keeping hospital executives up at night?

Calzada : Revenue uncertainty, margin compression and the credit crisis make it difficult to meet working capital requirements. This creates a level of uncertainty that jeopardizes their organizations' ability to continue operating as they have in the past.

Editor: How are healthcare providers being affected by macroeconomic trends that are overhanging the entire economy?

Calzada: Most importantly right now, the rising consumer price index is being reflected in higher operating costs, which compresses margins affecting all sectors of the healthcare industry. Volatility affects access to capital, including credit. Creditors are also concerned about recoverability. Decreased valuations and market volatility have contributed to reduced valuations of healthcare companies. The consequent drying up of credit affects all of corporate America, including healthcare providers, with the major uncertainty being the changes in government reimbursement policies for Medicare and Medicaid.

Clarke : I echo what Hector was saying about the impact of this "perfect storm." Many healthcare providers have had dramatic reductions in liquidity, increases in their debt to capital ratio, depressed operating margins and are moving toward a significant risk of either a technical default under debt covenants or an actual payment default. These conditions will become apparent to creditors who are monitoring their performance. If healthcare providers can't reverse this course, this could then lead to a debt modification or a prepackaged bankruptcy or a bankruptcy filing downstream. Many are now being subjected to some pretty tight oversight going forward from their bond insurer or bond trustee. A provider in this condition may not be viewed as a viable stand alone option any longer and will need to look at some alternative strategic options, including affiliation, merger or sale.

Editor: What is the role of a Cash Acceleration And Margin Preservation Plan?

Calzada: When we are called in to assist a healthcare company endure challenging economic circumstances, one of the tools we use is a Cash Acceleration And Margin Preservation Assessment. Essentially it is a look at how to accelerate cash flow collections while establishing longer term strategies for improving margins. It assists our client by suggesting strategies that have been applied with success by other clients.

Clarke : The Asssessment is a menu of strategies that an organization can use to rehabilitate itself and to achieve a valuation that the market expects in its sector of the overall healthcare industry. The Assessment breaks these strategies down into four broad categories. These categories are Revenue Stabilization/Growth, Operating Cost, Asset Efficiency and Capital Structure.

Editor: Give a few examples of such strategies.

Clarke: Under the Revenue Stabilization/Growth category, one strategy to improve yield is to reduce uncompensated care through more effective third party eligibility processes - effective third party eligibility processes can convert "no pay" patients to government pay patients. Another might be to grow patient volume by making investments in clinical programs.

In the Operating Cost category, a possible strategy might be to reduce the use of the costly Emergency Room by investing in community clinics. One might seek to improve Asset Efficiency by working out consignment arrangements with suppliers that push the risks associated with higher priced items, particularly implants, back to the manufacturer or wholesaler.

Editor: Arthur, how important is the role played by organizations like Deloitte?

Steinberg: A Plan such as that discussed by the folks from Deloitte is important because it causes healthcare providers to focus on the things that they can do to manage in a more difficult environment. Financial advisors like Deloitte are value-added. They are not going to do what management does. They are there to add a broad range of experience with respect to operating in a troubled environment that existing managements frequently lack. The new player on the block is able to institute reforms that existing people, who are entrenched, can't do. Yes, I think they are critical.

Editor: What are the pluses of bankruptcy?

Steinberg : Even before the overall economic crisis hit, the healthcare business was not in great shape. Margins were continually being compressed by reductions in government reimbursements. Now their plight is much worse for the reasons described by Hector and Bob. An Assessment such as that described by them can help defer going into bankruptcy or even avoid it. When an entity actually has to go into bankruptcy, it is usually a very sick patient at that point in time. It is very easy to file an entity into bankruptcy whether it is a healthcare provider or in another business field. The really hard part is to reorganize that entity and have it successfully rehabilitated.

Avoiding bankruptcy is very important. In the healthcare area, there are overwhelming statistics showing that if you file for bankruptcy you will probably end up in a sale or an ultimate shut down.

Healthcare entities file for bankruptcy for really two reasons: one is to create breathing room for an operational fix or utilize some of the tools of the bankruptcy code to improve the prospects for future success or two for a sale to another hospital. The bankruptcy code has provisions which minimize successor liability, and a purchaser who acquires a financially troubled entity wants to make sure that they are not going to get burdened with the problems of that entity.

Chapter 11 also gives you a breathing spell from litigation and allows you deal with your tort liability in an organized fashion and to stop from having to defend each of those litigations individually. It allows you to get out of unprofitable contracts. You may be able to get out of collective bargaining agreements under certain circumstances.

Reorganization allows you ultimately to pay your creditors through a reorganization plan less than 100 cents on the dollar. It allows you to take your debt that had matured or is maturing and restructure it so that it stretches out for a longer period of time. It allows you to potentially reset the interest rate on your debt to a lower market rate.

It allows you, if you had debts that were unsecured or undersecured (meaning that the collateral is less than the value of debt), to get the benefit to not accruing interests on those obligations in bankruptcy. In effect, you have an interest free loan. It allows you to do a wide range of things to make operational performance improve and to restructure your balance sheet.

Bankruptcy proceedings provide all the tools required to manage the liability side of the balance sheet. A talented manager can use these tools to build the long-term sustainability of its business. The key in most instances is to make the revenue line healthy.

Editor: What are the minuses of bankruptcy?

Steinberg: Bankruptcy involves significant costs. It is a much more cumbersome to operate in Chapter 11. Out of the ordinary course transactions need to be court approved, which means you have additional costs and time lag to implement transactions. You also pay for your creditors committee's professionals, which is an additional expense.

You may not get trade credit after bankruptcy. It may be more difficult to attract and retain skilled medical professionals if they are not sure of your long term viability. If the hospital has a teaching program, it may make it more difficult to attract students. It is a more publicized admission that you are going through financial difficulties. Also, there is still a stigma attached to filing for bankruptcy on the theory that if you are financially strapped, you are probably not going to provide the best possible healthcare.

Editor: Should alternatives be considered before filing for bankruptcy?

Steinberg : Definitely. Bankruptcy gives you more time to consider your options. However, it should not be your first choice. You do as much as you can outside of bankruptcy and actually use the ultimate threat that there could be a bankruptcy as a basis for negotiation for the best possible result. To the extent that you can do your rehabilitation outside of a public forum and spotlight, you are always better off.

Please email the interviewees at asteinberg@kslaw.com, hcalzada@deloitte.com, and robclarke@deloitte.com with questions about this interview.