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The COVID-19 pandemic has hit hospitals and health systems hard. Over the last few months, many have had to deal with surging capacity, limitations of personal protective equipment and staffing shortages.

Many have also experienced financial struggles. Surges in COVID-19 cases have caused hospitals to delay elective and nonemergency surgeries and medical procedures to free up capacity for treating those diagnosed with coronavirus. As more individuals stayed home under lockdown orders, inpatient volumes plummeted, profitable outpatient locations were forced to temporarily close their doors and many other specialty healthcare providers struggled to safely maintain the number of patients they see.

This has led to steep drops in revenue for hospitals and healthcare providers across the U.S. Over the four-month period of March through June 2020, the American Hospital Association estimates a staggering total financial impact of $202.6 billion in losses for the country’s hospitals and health systems. This comes out to an average of $50.7 billion in losses per month.

Accelerated by pressure from the pandemic, some hospitals and healthcare providers are taking drastic measures to try to stay afloat. Others are considering a sale or even filing for Chapter 11 bankruptcy. In fact, several hospitals have already done so this year. 

By filing for Chapter 11 bankruptcy, distressed hospitals and health systems can receive some short-term relief from creditors as they figure out their next move. Filing for Chapter 11 bankruptcy, as opposed to Chapter 7, allows these organizations to continue to operate throughout the process. Depending on the situation, an organization may file for Chapter 11 bankruptcy with the intent to restructure its debts, strengthen its balance sheet, sell to a third party, or pursue an orderly shut-down of the organization.

The decision of whether a hospital or health system should file for bankruptcy is best left to the organization’s management and board of trustees. But once an organization decides to file for Chapter 11 bankruptcy, there are a number of legal factors and considerations unique to the healthcare industry that these leaders must take into account. Having helped many hospitals and health systems navigate this complicated process, below are a few issues every organization should consider:

Navigating the pre-filing process

Before officially filing for Chapter 11 bankruptcy, there are a number of factors every hospital and health system must take into account. For example, organization leaders must assess the current state of their operating licenses and permits, including any certificates of need, federal and state registrations, and other regulatory authorizations and approvals. This information will be helpful in the event that the organization chooses to pursue a sale in conjunction with or after the bankruptcy process. They must also examine the organization’s existing contracts with payor networks, physicians and other service providers, and suppliers to help better assess the legal obligations and ongoing financial needs of the organization. All lease agreements, including real estate leases as well as leases associated with expensive medical equipment, should be closely analyzed before filing. Doing so may identify areas where the organization can cut down on expenses if they’re looking to restructure their debt. If the hospital or health system is closing down or seeking a sale, tracking down this information will help provide leaders with clarity regarding remaining obligations, prioritizing more valuable equipment leases, and potential concerns that buyers may raise in performing due diligence for a potential purchase.

Hospitals and health systems must also strategically plan when they must notify local, state, and federal agencies, such as the state Department of Health, the Centers for Medicare and Medicaid Services (CMS), and/or the state attorney general’s office, of their plans to file for Chapter 11 bankruptcy. These officials have an interest in maintaining their constituents’ access to healthcare services, and will therefore likely be involved in the bankruptcy proceedings. Some states even mandate advance notice of a hospital or health system’s intent to file for bankruptcy.

Of course, healthcare organizations may also need to notify employees if they plan to eventually shut down operations. The Worker Adjustment and Retraining Notification (“WARN”) Act requires any business with 100 or more full-time employees to provide these individuals with at least a 60-day notice in advance of any closing or mass layoff. If a hospital is just reorganizing, officially notifying employees may not be necessary.

Additionally, in certain states, official approvals must be obtained from the state Department of Health, state attorney general’s office and/or other state agencies before a hospital can be closed or, as discussed below, transferred to a buyer in the bankruptcy process. This procedure can be fairly complicated, with the potential for a public hearing in some instances, and requires expert counsel to help manage.

Pursuing a seamless M&A transaction in bankruptcy

Many hospitals will file for Chapter 11 bankruptcy with the intent of pursuing a sale of the organization to a buyer interested in continuing the hospital’s business. Such a sale presents a number of operational issues that must be addressed and resolved. For example, healthcare operators must preserve the continuity and quality of care for all existing patients throughout the bankruptcy process. Accomplishing this will require that the buying entity receive and maintain all necessary permits and approvals for continuing operations prior to finalization of the transaction. In addition, reaching accommodations with the hospital’s labor unions in advance of filing will help insure the continuity of care at the outset of the Chapter 11 case.

The sale of a hospital or healthcare provider in bankruptcy is similar in many respects to other bankruptcy proceedings and is typically conducted via a bidding process. It is usually a public auction that allows all bidders to inspect the assets, assess the organization’s level of financial distress, perform their own due diligence, and make a bid that reflects their findings. These auctions can happen in court or offsite. When conducted offsite, the debtor’s management will sometimes oversee the auction. Other times, they may hire a third party. The results of such an offsite auction will eventually need to be presented to and approved by the bankruptcy court. The bankruptcy court will approve the “highest and best” bid for the purchase of the assets.

However, unlike traditional bankruptcy sales, both buyers and sellers must also lock down a number of critical regulatory approvals. The required reviews vary depending on the type of transaction, the entities involved, and the states in which the healthcare organizations operate. Federal and state approval requirements generally track to licenses and permits that are held by the selling entity in order to legally operate. CMS, the Drug Enforcement Administration (DEA), and the Nuclear Regulatory Commission (NRC) are federal agencies that require a notification and in certain circumstances the completion of agency forms. The respective state Department of Health and state Department of Human Services in which the selling entity operates will also need to be notified. The sale of a nonprofit healthcare entity also brings unique challenges, including approval from the state’s attorney general in circumstances where the protection of charitable assets becomes an issue.

Each state department has its own review process, which can significantly influence the total time required to receive all approvals. Generally, the process can take anywhere from three to four months, and it is critical that operators begin this process early on and stay on top of it.

Limiting liability when closing down the business

Unfortunately, bankruptcy sometimes ends in closing a hospital or healthcare center. This typically happens when the organization cannot be saved or sold due to deep financial distress. The hospital or health system’s leaders may be unable to secure financing or a potential buyer interested in keeping the doors open. This creates issues for patients that will need to be transferred or find a new location to receive care. Patient medical records will also need to be transferred to the patients’ new providers. This process is typically managed through the hiring of a custodian of records. Closing down a hospital or health system also opens up the organization to litigation. Lawsuits can come from patients that may perceive an organizational weakness and are looking for alternative care locations, employees that have lost their jobs, or even investors and public bondholders that may feel as though management didn’t take the right steps to save the organization. It is critical that organization leaders engage legal counsel early on in these proceedings to ensure that any potential liability is mitigated.

Benefits of experienced counsel

Considering the many intricacies of healthcare and the need to protect patients, filing for bankruptcy in the healthcare space can present significant challenges. It is critical that healthcare leaders carefully plan and consider the filing from all angles. This is where experienced legal counsel comes in. Having navigated this process in the past, our attorneys have expertise in both bankruptcy proceedings as well as the healthcare industry and can help guide hospital and health system leaders through this complex process.

Read additional articles in our Convergence: M&A in Healthcare series:

Healthcare M&A: Negotiating and Papering Key Aspects of a Deal

Healthcare M&A: The Case for Private Equity Investment in Medical Practices

Healthcare M&A: What Decision Makers Need to Know Before Partnering

Healthcare M&A: Unlikely Alliances in Healthcare: Payors and Providers Are Teaming Up to Create Value

Our transactional know-how is fueled by our extensive M&A client work. Over the last few years, Buchanan Ingersoll & Rooney has led 40+ major healthcare deals valued at more than $20 billion.