Healthcare Providers Face Increasing Financial Pressure and Bankruptcy Risk

by BakerHostetler
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The health of the healthcare industry can be summarized as follows: as go federal reimbursement rates, so goes the financial viability of healthcare providers, whether hospitals, nursing homes or medical practices. These declining reimbursement rates, combined with the uncertainty surrounding implementation of the Affordable Care Act (ACA), have put especially severe strains on middle-market healthcare providers that face the double shock of rising healthcare costs and declining revenues tied directly to reductions in the federal reimbursement rates for Medicare and Medicaid and price pressure from private insurers driven, in part, by implementation of the ACA.

For larger providers, like hospitals, declining revenues can lead to a vicious cycle of cost-cutting, layoffs and downgraded credit ratings, which drive up borrowing costs and further strain liquidity. The direct relationship between revenue and federal reimbursement rates is felt even more acutely by private practices, which have been shuttering at an increased pace as physicians increasingly are looking to the economies of scale provided by private hospitals.

Although financial pressures have caused medium- to smaller-sized providers to struggle, their distress also has provided larger and healthier players with greater opportunity to acquire assets, practice groups and patients. In this way, turmoil in the industry has accelerated the gap between the healthy and sick providers, presenting opportunities and risks for those providers that have maintained or increased their revenues in this challenging environment.

If middle-market healthcare providers continue to struggle with declining revenues and less access to credit, as is widely expected, the industry soon may start to see a new wave of bankruptcy filings, further separating healthy companies from their struggling competitors and leading to industry consolidation. Despite their advantageous position, financially healthy healthcare providers should be proactive in monitoring and dealing with more troubled providers to mitigate their risks should a bankruptcy occur, and/or position themselves to best take advantage of distressed asset values and physician and practice mobility.

In general, the more a healthy healthcare provider deals with a distressed counterpart, the greater the risk a bankruptcy by the latter poses to the former. These risks are particularly acute in the areas of contracts between the parties, collection of receivables, exposure to claw back actions by a debtor or bankruptcy trustee and greatly diminished recoveries. For example, the Bankruptcy Code overrides many aspects of state law regarding contracts, invalidating breach and termination provisions triggered by a counterparty seeking relief under the bankruptcy laws. Further, the bankruptcy laws generally permit a debtor to assign contracts to third parties absent a counterparty’s consent or over its objection. On the flip side, a physicians’ group in bankruptcy may decide to reject an affiliation agreement with an incumbent hospital, leaving it with a claim in the bankruptcy case worth pennies on the dollar.

In addition, the bankruptcy laws pose challenges for those healthcare companies who sell or purchase goods and services from troubled providers. As troubled suppliers find themselves in more and more distress, they may face liquidity pressures from their financing sources, as well as tightened trade terms from their suppliers. This poses a risk for healthcare companies dependent on that supplier, particularly where the supplier provides a scarce or specialized product and alternative sourcing is difficult. Conversely, a distressed buyer of goods and services will tend to stretch out or delay payments, putting its supplier at risk of preference or other avoidance liability. Finally, the not-for-profit status of some healthcare providers compounds the challenges faced by their creditors and contract parties. For example, the Bankruptcy Code forbids creditors from initiating an involuntary bankruptcy case against an insolvent company while state law prohibitions on the debtor company exchanging debt for equity reduce avenues for satisfying claims or developing a viable business plan.

Where there is risk, there also is the potential for reward. For financially healthy healthcare providers, opportunity abounds to take advantage of declining values to acquire new businesses, assets or even whole practice groups at distressed prices. Moreover, the bankruptcy laws generally permit an acquirer to take purchased assets free and clear of liens, encumbrances and other liabilities, and provide the purchaser with the certainty of a court order blessing the sale. Finally, with interest rates at historical lows, inexpensive financing costs coupled with distressed asset valuations puts financially healthy healthcare companies in a prime position to expand and capture market share from their bankrupt competitors.

To maximize the opportunities afforded by the industry’s financial troubles while simultaneously seeking to minimize risk, the healthy provider should consider taking some or all of the following illustrative steps:

  • Carefully review contracts with distressed providers for termination events and whether the contract may be nonconsensually assumed and/or assigned in a bankruptcy case;
  • Carefully monitor troubled purchasers of goods and services to ensure compliance with ordinary course trade terms, and consider requiring advance payments or cash on demand;
  • Investigate the availability and ability to source alternative goods and services from financially troubled suppliers; and
  • Investigate asset or practice group acquisitions at reduced valuations and stripped of most liabilities.

Based on the continued turbulence in the market, and the increased number of healthcare providers facing insolvency, we would encourage you to discuss the risks and opportunities posed by these challenging times with our financial restructuring attorneys, who have deep experience navigating healthcare bankruptcies from a variety of perspectives and specialize in developing proactive solutions to minimize risk and maximize opportunities posed by a healthcare provider’s financial distress.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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