Chapter 9: An Rx for Health Care Districts And Public Hospital Authorities?

Four (4) recent chapter 9 cases by a public health care district in the Northern District of California and by local hospital authorities in Kentucky, Oklahoma and Texas—raise the issue whether chapter 9 may increasingly be seen as a means for public hospitals facing financial distress to restructure (or adjust) their debts. Since the beginning of 2003, seventeen (17) health care districts and hospital authorities have sought to adjust their debts through chapter 9 proceedings.1 Seven (7) of those cases health care district and hospital authority chapter 9 debtors who have filed since the beginning of 2003, eleven (11) successfully confirmed a plan of adjustment, one was dismissed as being ineligible to file for chapter 9, one was dismissed after nearly nine (9) years of chapter 9 protection for failure to prosecute, and four others were either recently filed or have not yet confirmed a plan. Further highlighting the possibility of an increase in chapter 9 filings by public hospital authorities and health care districts is a recent letter to Congress from the National Rural Hospital Association, warning that a have been filed since June 1, 2011. Of the seventeen 2013 report by the Office of the Inspector General of the Department of Health and Human Services could cause many rural hospitals to lose their designation as critical "necessary providers," which in turn would result in those hospitals no longer being eligible to receive preferential (i.e., 101%) Medicare reimbursements.2

Reasons for Filing

In their pleadings filed with the bankruptcy court these seventeen entities cite a wide range of reasons for the financial distress which led them to seek to adjust their debts through chapter 9 of the Bankruptcy Code over the last decade. Several indicated that they were small rural or suburban hospitals that faced immense financial pressures, including frequent changes to and/or reductions in government and insurance reimbursement rates, service populations with a significant number of uninsured or underinsured persons resulting in substantial charity care and bad debt expenses, the cost of complying with new regulatory requirements, and an inability to generate sufficient patient volumes to be able to invest in updated equipment and technology and to attract and retain specialists and other staff. At least two entities noted the loss of financial assistance from the county governing body, while two others cited the failure or frustration of ballot initiatives to authorize a bond issuance or the sale of a distressed health care entity or a hospital district tax to provide a consistent revenue stream. Others cited poor management or aggressive plans for expansion that were ultimately unsustainable because of inadequate revenues. For still others, consequences arising from the termination of a management agreement—either the resulting claims of the terminated management entity or a drop-off in billing and collections because of the health care provider's own lack of expertise in an area previously handled by the management entity—were noted as reasons contributing to the filing of a chapter 9 petition. Only one entity cited obligations to employees under current collective bargaining agreements as a reason for seeking chapter 9 protection.

This article examines some of the ways in which chapter 9 differs from chapter 11, the traditional chapter for business reorganizations, and how those differences may translate into advantages or disadvantages for health care districts and public hospital authorities contemplating chapter 9 bankruptcy.

Chapter 9 affords several advantages to a would-be municipal debtor:

No provision for creditors to file an involuntary bankruptcy petition against a municipality No provision for creditors to file a competing plan of adjustment Less onerous procedure and more-lenient legal standard for rejecting collective bargaining agreements Limitations on the authority of Bankruptcy Courts to interfere with political or governmental powers, property or revenues, or income-producing property of chapter 9 debtors Subordination of lien on special revenues to necessary operating expenses of the project or system But Chapter 9 also involves several burdens that a Chapter 11 debtor would not face:

More burdensome eligibility requirements Continuation of indenture trustee and/or bondholders' liens on special revenues acquired by the debtor postpetition More difficult to cram down confirmation of plan of adjustment over objection of secured creditors Eligibility for Chapter 9

In general an entity must meet a higher standard for eligibility under chapter 9 of the Bankruptcy Code. Section 109(c) of the Bankruptcy Code sets forth the criteria that an entity must meet in order to be a debtor under Chapter 9:

(i) entity must be a municipality;

(ii) entity must be specifically authorized, in its capacity as a municipality or by name, to be a debtor under Chapter 9 by State law or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under Chapter 9;

(iii) entity must be insolvent;

(iv) entity must desire to effect a plan to adjust its debts; and (v) entity must either (a) have obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under Chapter 9, (b) have negotiated in good faith with creditors and have failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under Chapter 9, (c) be unable to negotiate with creditors because such negotiation is impracticable, or (d) reasonably believe that a creditor may attempt to obtain a transfer that is avoidable as a preference under section 547 of the Bankruptcy Code.

11 U.S.C. § 109(c). As noted in a recent decision in In re City of Stockton, "Chapter 9 is unique among voluntary Bankruptcy Code cases in that a municipality must litigate its way to the order for relief before restructuring its debt. . . . . Such a proceeding is like a qualifying round in a competition; success leads only to the main event - the process of achieving a viable plan of adjustment" (In re City of Stockton, California, 493 B.R. 772, 776 (Bankr. E.D. Cal. 2013). A number of courts have held that "§109(c)'s eligibility requirements [should be construed broadly in order] in to provide access to relief in furtherance of the [Bankruptcy] Code's underlying policies." See, In re Valley Health Sys., 383 B.R. 156, 163 (Bankr. C.D. Cal. 2008), Int'l Ass'n of Firefighters, Local 1186 v. City of Vallejo (In re City of Vallejo), 408 B.R. 280, 289 (9th Cir. BAP 2009), In re Pierce County Housing Auth., 414 B.R. 702,710 (Bankr. W.D. Wash, 2009), In re Suffolk Regional Off-Track Betting Corp. d/b/a Suffolk OTB, 462 B.R. 397 (Bankr. E.D.N.Y. 2011).

The Entity Must Be a Municipality

The first eligibility requirement for an entity seeking to be a debtor under Chapter 9 is that such entity be a municipality. Pursuant to section 101(40) of the Bankruptcy Code the term "municipality" means a political subdivision or public agency or instrumentality of a State. The Bankruptcy Code does not define the terms "political subdivision," "public agency" or "instrumentality" of a state.

Municipality Must Be Specifically Authorized to Be a Debtor

The second eligibility requirement is that the municipality must be specifically authorized in its capacity as a municipality or by name, by state law or by a governmental officer or organization empowered by state law to make such authorization, to be a debtor under Chapter 9. Currently, eleven (11) states provide blanket authorization for municipalities to file for Chapter 9.3 Sixteen (16) states have authorized municipal bankruptcy filings subject to certain conditions.4 Such conditions include: written consent of the governor and/or other state officials (Connecticut, Kentucky, Louisiana, Ohio, Pennsylvania), limitation upon the types of municipal entities that may file for Chapter 9 (Colorado, Idaho, Illinois, Oregon), requirement that the filing entity have adopted a resolution authorizing the filing (Idaho, Montana, Washington), written approval by the governor...