The Need for an Examiner in Hospital Bankruptcies

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By Kenneth A. Rosen, Esq.

The views expressed herein are of the author only and are not necessarily shared by other persons at Lowenstein Sandler LLP. This article is not intended to provide legal advice. Each case is unique. The law is subject to interpretation.

One well-known and painful irony of COVID-19 is that many hospitals across America are struggling, even as healthcare has arguably never been more important.

These hospitals face an array of problems — from a reduction in elective procedures to a pivot to telehealth to high costs of new technology to falling government reimbursement rates. As a result, chapter 11 might be inevitable for many in the coming months and years.

But the process as currently outlined in the bankruptcy code has a major flaw – and now’s the time to fix it.

How the Bankruptcy Process is Unique for Hospitals

Even more so than in most cases, emotional ties, politics, self-preservation and self-interest overlay hospital bankruptcies. It is never politically correct for an elected official to support a local hospital’s closure — even if the hospital probably should close. It’s presumed that saving the hospital is in everyone’s best interest, a position buoyed by hospital boards of trustees, who will choose any alternative to closure.

Simultaneously, lenders concerned about reputational damage will defer to debtor hospitals, as no bank wants to send a message to the community (which includes its customers), that it is forcing a hospital closure. Lenders might believe that the debtor cannot or should not be saved, but they must be cautious of what they say in public to the judge.

Bankruptcy judges are said to be part social worker, part lawyer, part mediator and part financial analyst and they generally prefer reorganization over liquidation. Chapter 11’s goal is to preserve the going concern value of assets, which are usually worth more as a going concern than when liquidated. Bankruptcy judges also want to preserve jobs — especially in times of high unemployment.

These factors, on their own, are understandable and even admirable in some cases. But put them together, and you have a situation where the tough decisions aren’t always getting made.

Time for a Change?

Chapter 11 is largely premised on the principal of creditor oversight by a creditors committee. Creditors have a vote on a plan of reorganization and bankruptcy judges listen to all parties, including regulators, unions, the PBGC, indenture trustees, banks and landlords.

But that does not assure that the outcome of the case will be in the best interests of the entire community rather than select members of the community. What’s needed is a truly unvarnished and impartial view of what is best for the larger community – and for that view to be communicated to bankruptcy judges with in cases involving nonprofit hospitals.

The interests of the community and public at large sometimes must outweigh other interests, and too often, judges aren’t getting the right information to do the weighing. For example, in communities where too many hospitals compete for too few patients, some hospitals should close even if there is an approvable sale or confirmable reorganization plan. Being able to reorganize does not always mean that a hospital should be reorganized, and the current voices in the judges’ ears don’t always relay that information.

Saving a hospital that maintains an over-bedded market is bad for the healthcare delivery system and for the citizens it serves. Selling a nonprofit hospital to a for-profit hospital system that results in continuing the community over-bedded results in the same outcome, reducing surplus at surrounding hospitals as inpatient volume is spread thinner.

This isn’t to say that all struggling nonprofit hospitals should close. Sometimes, a hospital simply must be preserved because its absence would put the surrounding community at risk. Keeping truly essential hospitals open, even if pain must be inflicted on certain parties in interest (including lenders) is good public policy. Banks have an obligation to invest in the communities that they serve, and the risks associated with lending to nonprofit hospitals can be compensated for.

But what we really need is an outside voice who can provide necessary clarity about community needs to bankruptcy judges.

How to Make the Call

The bankruptcy code should require the appointment of an examiner in nonprofit hospital bankruptcy cases. The examiner would function similar to a public advocate or ombudsperson and render reports available to the court and other parties in interest as to what is in the long-term best interests of the community and public at large. An examiner would also provide valuable information – and frankly, cover — for elected officials, the bankruptcy judge, management, trustees and lenders.

The examiner should be available to opine about whether relief sought by or proposed to be granted to secured lenders is appropriate, whether relief from a collective bargaining agreement is really necessary, or if there alternatives, and whether confirmation of a plan or approval of a sale is merited after considering all macroeconomic and social factors. There’s also a broader question of how involuntarily reducing or extending secured debt should be less difficult if the examiner deems it essential to long-term feasibility — including, but not limited to, having the requisite funds for investment in order to maintain high quality care.

Put simply, these suggested revisions to chapter 11 would enable bankruptcy judges to receive independent advice from someone whose sole mandate is protection of the public interest. Such advice is in addition to input from the traditional advocates in a chapter 11 case.

This proposal simply recognizes that the many self-serving interests in a chapter 11 bankruptcy case often do not result in the best outcome in accord with public policy and for the community at large. The outcome of chapter 11 for one hospital has a direct impact on the cost and delivery of healthcare for an entire community – and the way to assure that the public interest is best served is the appointment of an examiner who serves as a public advocate or ombudsperson.

Ken Rosen is Chair of the Bankruptcy, Financial Reorganization & Creditor’s Rights practice group at the law firm of Lowenstein Sandler.

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