Recent headlines have starkly illuminated the headwinds facing health care providers struggling to recover from a host of financial pressures. Many providers have resorted to filing for bankruptcy protection as a way, among other things, to right-size their balance sheets or effect a sale of their assets or businesses.

Recognizing the special problems faced by health care providers (and their patients) in bankruptcy, Congress amended the Bankruptcy Code in 2005 to add many provisions that apply specifically to a debtor that is a "health care business." One of those provisions mandates the appointment of a "patient care ombudsman" to protect the rights of patients in any chapter 7, chapter 9, or chapter 11 case filed by a health care business, unless the bankruptcy court concludes that the appointment is unnecessary to protect patients under the circumstances. Two bankruptcy courts recently addressed this issue. 

In La Familia Primary Care, P.C., 2023 WL 5310817 (Bankr. D.N.M. Aug. 17, 2023), the U.S. Bankruptcy Court for the District of New Mexico ruled that a small rural medical practice providing primary-care services did not qualify as a "health care business" under the Bankruptcy Code, and that, even if it did meet the statutory definition, the appointment of a patient care ombudsman was not necessary to protect the practice's patients. 

In In re Parkchester Oral and Maxillofacial Surgery Associates PC, 2023 WL 5761923 (Bankr. S.D.N.Y. Sept. 6, 2023), the U.S. Bankruptcy Court for the Southern District of New York similarly concluded that no patient care ombudsman need be appointed for a dentistry and dental surgery facility in the absence of any allegations or evidence of patient care problems.  

Financial Challenges Faced by Health Care Providers 

According to data from financial and legal analysis firm Reorg Research, Inc., the volume of U.S. health care provider bankruptcies in 2023 has been the greatest in the last five years, with 74 filings through the end of November. Of those bankruptcy cases, 27 were filed by providers with at least $100 million in liabilities, compared to seven in all of 2022, 10 in 2021, 16 in 2020, and 20 in 2019. 

In addition to pandemic-driven issues that emerged beginning in 2020, the financial woes of health care providers can be attributed to a number of factors, including: increased competition; capital market constraints; labor disputes; the need for investment in additional personnel and technology; the erosion of profitability due to the evolution from a "fee for service" payment model to a "bundle of services" payment model; liquidity problems caused by government payment disputes; operational changes; and increased pharmaceutical and other supply cost pressures. These and other factors (e.g., the highest inflation rate in four decades at the end of 2022) have led an increasing number of financially distressed providers to consider bankruptcy as a vehicle for effectuating closures, consolidation, restructurings, and related transactions. 

Appointment of Patient Care Ombudsmen in Health Care Business Bankruptcy Cases 

Certain provisions were added to the Bankruptcy Code in 2005 that deal specifically with a debtor that is a "heath care business." 

Among them is section 101(27A) of the Bankruptcy Code, which provides that a "health care business": 

(A) means any public or private entity (without regard to whether that entity is organized for profit or not for profit) that is primarily engaged in offering to the general public facilities and services for— 

(i) the diagnosis or treatment of injury, deformity, or disease; and 

(ii) surgical, drug treatment, psychiatric, or obstetric care; and 

(B) includes— 

(i) any— 

(I) general or specialized hospital;

(II) ancillary ambulatory, emergency, or surgical treatment facility;

(III) hospice;

(IV) home health agency; and

(V) other health care institution that is similar to an entity referred to in subclause (I), (II), (III), or (IV); and 

(ii) any long-term care facility, including any— 

(I) skilled nursing facility;

(II) intermediate care facility;

(III) assisted living facility;

(IV) home for the aged;

(V) domiciliary care facility; and

(VI) health care institution that is related to a facility referred to in subclause (I), (II), (III), (IV), or (V), if that institution is primarily engaged in offering room, board, laundry, or personal assistance with activities of daily living and incidentals to activities of daily living. 

11 U.S.C. § 101(27A). 

Other than the statutory definition of "health care business" in section 101(27A), provisions added to the Bankruptcy Code in 2005 that apply specifically to "health care business" debtors include: 

(1) section 351 (as supplemented by Rule 6011 of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules")), which creates procedures for the disposal of patient records by a health care business; 

(2) sections 704(a)(12), 1106(a)(1), and 503(b)(8), which provide procedures and restrictions governing transfers of patients of a closing health care business and create an administrative expense priority for health care business closing expenses; and  

(3) section 362(b)(28), which exempts from the automatic stay the "exclusion" of a debtor from participation in Medicare or any other federal health care program by the U.S. Secretary of Health and Human Services due to, among other things, criminal convictions, civil liability for fraud or obstruction of an investigation or audit, license revocation or suspension, failure to take corrective action, claims for excessive charges or unnecessary services, and the failure of certain organizations to furnish medically necessary services. 

In addition, section 333 of the Bankruptcy Code provides that the bankruptcy court "shall" appoint a "patient care ombudsman" not later than 30 days after the commencement of any health care business's chapter 7, chapter 9, or chapter 11 case, "unless the court finds that the appointment of such ombudsman is not necessary for the protection of patients under the specific facts of the case." The ombudsman serves as a "patient advocate," as distinguished from a representative of creditors, entrusted with monitoring the quality of patient care, representing the interests of patients, and reporting to the bankruptcy court every 60 days on the status of patient care. See 11 U.S.C. § 333(a)(1), (b)(2).

In determining whether a patient care ombudsman is necessary under the specific facts of a case, many courts have examined the following nine nonexclusive factors: 

(1) the cause of the bankruptcy; 

(2) the presence and role of licensing or supervising entities; 

(3) [the] debtor's past history of patient care; 

(4) the ability of the patients to protect their rights; 

(5) the level of dependency of the patients on the facility; 

(6) the likelihood of tension between the interests of the patients and the debtor; 

(7) the potential injury to the patients if the debtor drastically reduced its level of patient care; 

(8) the presence and sufficiency of internal safeguards to ensure appropriate level of care; [and] 

(9) the impact of the cost of an ombudsman on the likelihood of a successful reorganization. 

In re Alternate Family Care, 377 B.R. 754, 758 (Bankr. S.D. Fla. 2007). According to the court in In re Valley Health Sys., 381 B.R. 756, 761 (Bankr. C.D. Cal. 2008), other factors to be considered can include:

(1) the high quality of the debtor's existing patient care; (2) the debtor's financial ability to maintain high quality patient care; (3) the existence of an internal ombudsman program to protect the rights of patients, and/or (4) the level of monitoring and oversight by federal, state, local, or professional association programs which renders the services of an ombudsman redundant. 

Id. at 761 (citing Collier on Bankruptcy ¶ 333.02 (15th ed. 2007)); accord In re Aknouk, 648 B.R. 755 (Bankr. S.D.N.Y. 2023) (ruling that a chapter 11 dental provider established that a patient care ombudsman was unnecessary to protect its patients where, among other things, the cause of the bankruptcy (i.e., the debtor's alleged failure to remit employer contributions to a union), was unrelated to patient care; the debtor, which was regulated by the state, had been operating for 25 years in good standing and had no history of compromised patient care or malpractice claims; the debtor had sufficient internal mechanisms to monitor patient care; and the cost of an ombudsman could be the difference between positive and negative cash flow); In re Mississippi Maternal-Fetal Medicine, P.A., 2021 WL 1941627, at **3–4 (Bankr. S.D. Miss. Feb. 18, 2021) (applying the Alternate Family Care factors and ruling that an ombudsman was unnecessary because, among other things, there was no evidence that the debtor's standard of care was deficient, the costs of appointment could adversely affect the debtor's ability to reorganize, and the bankruptcy filing was not precipitated by concerns relating to quality of patient care or to patient privacy matters). 

"The weight given to the factors is at the discretion of the reviewing court." In re Flagship Franchises of Minn. LLC, 484 B.R. 759, 762 (Bankr. D. Minn. 2013) (citing In re N. Shore Hematology-Oncology Assocs., P.C., 400 B.R. 7 (Bankr. E.D.N.Y. 2008)). 

A simplified alternative (the "Huckaby test") to the nine-factor Alternate Family Care test was proposed by Nicholas A. Huckaby in his law review article titled Toward A Workable Standard for Appointing A Patient Care Ombudsman: Proposed Changes for Applying § 333 of the Bankruptcy Code, 48 U. Tol. L. Rev. 367 (2017). In his article, Huckaby advocated a three-step test whereby the court would consider "whether patient care is a concern in the case," whether safeguards have been implemented to protect patients, and "the financial impact an ombudsman will have on the debtor." Id. at 369. 

Bankruptcy Rule 2007.2 sets forth the procedure for appointing a patient care ombudsman. It provides that the court "shall" order the appointment of an ombudsman unless it determines that the appointment is unnecessary based on a motion filed by a party in interest "no later than 21 days after the commencement of the case or within another time fixed by the court." Fed. R. Bankr. P. 2007.2(a). Bankruptcy Rule 2007.2(d) provides that, upon the motion of a party in interest, the court may terminate the appointment of an ombudsman if it finds that the appointment is not necessary to protect patients. 

If the court appoints an ombudsman, Bankruptcy Rule 2015.1 obligates the ombudsman to file certain reports with the court, as prescribed by section 333(b)(2) of the Bankruptcy Code. Further, section 330(a) of the Bankruptcy Code provides that patient care ombudsmen are entitled to apply for compensation from the estate. 

Other provisions of the Bankruptcy Code apply more generally to nonprofit (eleemosynary) entities, which include many hospitals and other health care providers. For example: (i) section 303(a) prohibits the filing of an involuntary bankruptcy case against "a corporation that is not a moneyed business, or commercial corporation," which has been construed to include nonprofit entities; (ii) section 1112(c) of the Bankruptcy Code prohibits the conversion of a chapter 11 case to a chapter 7 liquidation if the debtor "is not a moneyed, business, or commercial corporation"; and (iii) section 363(d)(1) of the Bankruptcy Code provides that, "in the case of a debtor that is a corporation or trust that is not a moneyed business, commercial corporation, or trust," a trustee or chapter 11 debtor-in-possession may use, sell, or lease estate property "only in accordance with nonbankruptcy law applicable to the transfer" of the debtor's property. In addition, most courts have construed the "absolute priority rule" in section 1129(b), which precluded distribution of value under a chapter 11 plan to, among other entities, shareholders without full payment of creditors, to be inapplicable to nonprofit debtors because they generally do not have equity interests. See, e.g., In re General Teamsters, Warehousemen and Helpers Union, Local 890, 265 F.3d 869 (9th Cir. 2001); In re Havre Aerie No. 166 Eagles, 2013 WL 1164422 (Bankr. D. Mont. Mar. 20, 2013).

In addition, certain issues arising in bankruptcy cases have special significance for health care providers. These include: (i) disputes regarding the ability of a federal or state agency to terminate a health care debtor's Medicare or Medicaid provider agreement; (ii) special problems regarding recoupment and setoff in cases involving alleged Medicare and Medicaid overpayments to health care providers; and (iii) disputes regarding the assumption and assignment of provider agreements in connection with the sale or closure of a health care provider.

La Familia

La Familia Primary Care, P.C. (the "debtor") is a New Mexico corporation that provides primary medical care to patients in a small town with approximately 6,000 residents in northern New Mexico. As of 2023, the debtor's sole remaining doctor and owner was Dr. Misbah Zmily, a board-certified physician in internal medicine practicing since 1996. In addition to Dr. Zmily, the debtor employs a physician's assistant and a registered nurse practitioner. The debtor also provides medical care to two nearby nursing homes as well as a local high school. A large percentage of its patients are on Medicare or Medicaid. The debtor and Dr. Zmily had a good reputation in the community, and no malpractice, substandard patient care, improper record-keeping, or privacy violation claims had ever been asserted against either of them. 

In January 2022, Medicare notified the debtor that it would not pay for osteoarthritis treatments using drugs provided to the debtor beginning in 2020 by pharmaceutical company BioLab Sciences because Medicare concluded that the results obtained for patients did not warrant the $4,000 charge per treatment. Medicare also claimed the right to "claw back" all the payments it had ever made to the debtor for such treatments—approximately $3.6 million—and to set off against this amount funds otherwise payable to the debtor as reimbursement for services to Medicare patients. 

The setoff caused the debtor to lose most of its cash flow, and the debtor filed for chapter 11 protection in July 2023 in the District of New Mexico. The debtor filed a motion to dispense with the requirement in section 333 of the Bankruptcy Code that the court appoint a patient care ombudsman in the case. The Office of the United States Trustee (the "UST") opposed the motion, arguing that the debtor met the definition of "health care business" under section 101(27A)(A) and that the appointment of an ombudsman was necessary.  

The bankruptcy court granted the debtor's motion, ruling that the debtor was not a "health care business" as defined by section 101(27A) or, alternatively, that the appointment of a patient care ombudsman was not necessary for the protection of the debtor's patients. 

At the outset of his opinion, U.S. Bankruptcy Judge David T. Thuma noted that, because the debtor operated on a "very thin margin," any additional administrative expense (including the costs associated with an ombudsman) could cause it to shut down, which would be a severe blow to the town's residents as well as the debtor's nursing home patients. La Familia, 2023 WL 5310817, at *2. 

The bankruptcy court then examined whether the debtor was a "health care business" pursuant to section 101(27A). Initially, Judge Thuma stated that "[s]ection 101(27A) is not easy to parse" and, due to its ambiguity, courts have struggled with two questions in applying the definition:

[F]irst, must a debtor come within both subsections (A) and (B) to be a health care business. Or is it enough to come within either subsection; and second, if it is enough to come within either subsection (A) or (B) and a debtor seems to qualify under subsection (A), must the debtor's business be similar to the businesses listed in subsection (B)? 

Id. at *3.  

Based on lawmakers' sometimes inconsistent usage of "and" or "or" in the Bankruptcy Code and other court decisions addressing the issue, Judge Thuma was persuaded that "an entity is a health care business if it comes within either subsection (A) or (B)" of section 101(27A). Id. at *4 (citing Aknouk, 648 B.R. at 760; In re Smiley Dental Arlington, PLLC, 503 B.R. 680, 685 (Bankr. N.D. Tex. 2013)). He reasoned that "[i]f all the 'ands' in § 101(27A) are construed as conjunctions, very few entities would qualify as health care businesses." For example, Judge Thuma explained, homes for the aged, hospices, and home health agencies would not meet the definition because they do not "provide facilities and services for the treatment of injury, deformity, or disease," as provided in section 101(27A)(i). Likewise, he noted, "the strictly 'conjunctive' reading would require that hospitals also be long-term care facilities, and vice versa, as well as qualifying under subsection (A)," thereby effectively excluding nearly all health care businesses from the scope of the definition. Id.

According to Judge Thuma, the better reading of section 101(27A) is that: 

[T]he word "includes" at the beginning of subsection (B) applies to "health care business," rather than to subsection (A). Thus, the section should be read: "health care business" means [the definition in subsection (A)] and also includes [the examples of hospitals and long-term care facilities in subsection (B)]. That is the construction that makes the most sense. The drafters apparently wanted [§ 333] to apply to hospitals, long-term care facilities, and also to debtors coming within the subsection (A) definition. 

Id.  

Next, the bankruptcy court concluded that debtors satisfying section 101(27A)(A) need not be similar to hospitals, long-term care facilities, or the other health care providers listed in section 101(27A)(B). Judge Thuma reasoned that, if lawmakers had intended to limit the definition of a "health care business" to entities similar to the entities listed in "subsection (B) (whatever that might be), [Congress] could have omitted subsection (A) entirely; the 'catch-all' subclauses (B)(i)(V) and (B)(ii)(VI) would have been sufficient." Id. at *5. 

The bankruptcy court agreed with the UST that the debtor did not qualify as a "health care business" under section 101(27A)(B). However, because the debtor did not offer facilities and services to the public for "surgical, drug treatment, psychiatric, or obstetric care," the court found that the debtor also did not qualify as a health care business under section 101(27A)(A). "[P]rescribing antidepressants, without more," Judge Thuma wrote, "is not tantamount to providing psychiatric care." Id. at *6.  

Moreover, applying the Alternate Family Care and Valley Health factors, the bankruptcy court ruled that, even if the debtor were a "health care business," the appointment of a patient care ombudsman was not necessary to protect the debtor's patients. According to Judge Thuma, those factors "weigh[ed] heavily against" such an appointment. Among other things, he noted that: the debtor provided no inpatient treatment; its patients did "not face the prospect of being turned out on the street if Debtor fails to reorganize"; the debtor's patient care was good; the debtor would be "squeezed for cash" until Medicare began paying postpetition bills; and the debtor could "ill afford additional administrative expenses." Id. at *8. 

Finally, the bankruptcy court emphasized that, while bankruptcy courts do not hesitate to appoint a patient care ombudsman in hospital and nursing home cases, "they are reluctant to do so in small business cases" such as the one before it. According to Judge Thuma, "[i]t is not an issue of statutory construction, but rather the conclusion that, with a typical small doctor's or dentist's office, the benefit of an ombudsman (if any), is substantially outweighed by the attendant expense and disruption." Id. 

Parkchester 

Bronx, New York, dentistry and dental surgery provider Parkchester Oral and Maxillofacial Surgery Associates PC (the "debtor") filed for chapter 11 protection in the Southern District of New York on June 28, 2023. On July 12, 2023, the UST filed a motion for the appointment of a patient care ombudsman for the debtor. The debtor opposed the motion, arguing that the appointment was not necessary for the protection of its patients. 

The UST argued that, in ruling on the motion, the court should consider the Huckaby test factors rather than the nine-factor Alternate Family Care test or the supplementary four-factor test considered by some courts. According to the UST, in each of the 15 reported decisions since 2007 in which those factors were applied, the court ruled that a patient care ombudsman was unnecessary, suggesting that the factors themselves must be improperly skewed. The Parkchester bankruptcy court rejected the UST's argument and held that the appointment of an ombudsman was unnecessary. 

According to U.S. Bankruptcy Judge Michael E. Wiles, the UST's contention that courts in all of the post-2007 reported decisions applying the Alternate Family Care factors have ruled that an ombudsman was not necessary is misleading. In the vast majority of cases involving health care businesses, he explained, an ombudsman is appointed with no opposition or written decision. Moreover, Judge Wiles noted, the post-2007 cases cited by the UST involved dentists' practices and similar businesses that technically qualified as health care businesses, but had not experienced patient care concerns justifying the appointment of an ombudsman. Finally, Judge Wiles wrote, "I see little difference between the simplified formulation [in the Huckaby test] and the [Alternate Family Care] list of factors … [which] are in many ways … just sub-parts of the inquiry that help to guide a court in making the three-part decision that Mr. Huckaby has recommended." Parkchester, 2023 WL 5761923, at *3. 

Although Judge Wiles found the Alternate Family Care factors to be informative, he determined that factor nine—"the impact of the cost of an ombudsman on the likelihood of a successful reorganization"—was inappropriate because no such consideration is expressly included in section 333 of the Bankruptcy Code. Section 333, he emphasized, "directs the court to determine whether an ombudsman is 'necessary for the protection of patients,'—not whether it is 'convenient,' or 'cost-effective,' or whether it might interfere with a debtor's financial reorganization." Id.  

Applying the remaining factors, Judge Wiles concluded that no patient care ombudsman was necessary to protect the debtor's patients. Among other things, he found that: (i) the debtor's financial problems had nothing to do with patient care; (ii) the debtor's licenses were up to date and the debtor had no history of patient care issues or patient complaints; (iii) because the debtor provided dentistry and dental surgery (rather than, for example, nursing home services to particularly vulnerable patients), its patients were able to protect their rights; (iv) the debtor's patients did not depend on its services, which could readily be provided elsewhere if patients were dissatisfied with such services; and (v) the debtor had adequate resources to conduct its business and to maintain the high quality of its existing patient care. 

The bankruptcy court accordingly denied the UST's motion for the appointment of a patient care ombudsman for the debtor. 

Outlook

Lawmakers understandably were motivated by the need to protect patients when they amended the Bankruptcy Code in 2005 to add the series of provisions that specifically apply to health care businesses filing for bankruptcy protection. However, Congress also understood that these safeguards need not necessarily apply in every case.

La Familia and Parkchester are perfect examples. In La Familia, the bankruptcy court carefully parsed the confusing language of section 101(27A) of the Bankruptcy Code to conclude that the appointment of a patient care ombudsman was not warranted, both because the small-town medical practice debtor did not qualify as a "health care business," and the circumstances—i.e., the existence of adequate patient protection measures—were such that the added expense involved was simply not justified under section 333. In Parkchester, the bankruptcy court similarly determined that an ombudsman was not necessary because the debtor had no patient care issues and its financial condition was not likely to create any, based upon the nature of the health care services that it provided.

Read the full Business Restructuring Review.