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Wrinkles Bedeviling Five Recent Hospital Insolvencies

Article

The Business Advisor

November 26, 2013

Hospital insolvencies and bankruptcies raise issues unique to the healthcare industry. However, the five recent (and ongoing) cases discussed below have generated some very interesting and unfortunate wrinkles.

1. Peninsula Hospital Center: Managerial Misconduct Before and after a Bankruptcy Filing

Even before entering bankruptcy, Peninsula Hospital Center and its affiliates (collectively, “Peninsula”) suffered significant financial, operational, clinical–and managerial–distress. Indeed, in July, 2011 the New York Department of Health (“NYDOH”) approved a plan of closure proposed by Peninsula. Peninsula withdrew the closure plan on August 11, 2011, but to no avail. On August 16, 2011, creditors filed an involuntary bankruptcy petition against Peninsula in the United States Bankruptcy Court for the Eastern District of New York (“EDNY Bankruptcy Court”). On September 19, 2011, citing concerns about patient safety and quality of care, the NYDOH prohibited Peninsula from admitting new patients. On the same day, Peninsula consented to the entry of an order for relief under the Bankruptcy Code and filed Chapter 11 petitions for each Peninsula debtor. Peninsula fired its President and CEO, Robert Levine (“Levine”), the next day. On September 21, 2011, the EDNY Bankruptcy Court entered an order for relief, and Peninsula reopened. The Peninsula bankruptcy cases are being jointly administered under Case no. 11-47056 (ESS).

By February, 2012, NYDOH had suspended the operations of Peninsula’s clinical labs for 30 days, thereby effectively suspending operations at Peninsula. On March 6, 2012, Lori Lapin Jones was appointed Chapter 11 Trustee (the “Trustee”) for the Peninsula debtors. By April 9, 2012, Peninsula had ceased operations. By May 8, 2013, the Trustee had sold the assets of the Peninsula debtors. She then focused on bringing avoidance actions and liquidating other claims of Peninsula. To that end, the Trustee has brought adversary proceedings against Levine and Peninsula’s debtor-in-possession lender, the lender’s principal, Steven Zakheim (“Zakheim”) and several of Zackheim’s affiliates. In both adversary proceedings, the Trustee seeks to recover “several million dollars” in damages.

The Trustee filed her complaint against Levine on August 18, 2013, asserting claims for (i) an almost complete abdication of his fiduciary duties of care and loyalty as president and CEO of Peninsula and (ii) breach of his employment agreement with Peninsula. The crux of the Trustee’s complaint is that Levine completely failed to manage Peninsula’s affairs for its benefit. Running through the Trustee’s allegations is a conclusion, both implicit and at some times explicit, that Levine’s decisions concerning Peninsula were tainted by a conflict of interest.

Specifically, the Trustee’s complaint alleges that, in 2009, on behalf of Peninsula, Levine entered into an Affiliation Agreement with Medisys Health Network (“MHN”). Although MHN was not to be an active parent of Peninsula, according to the Trustee, with Levine’s consent (or at least complete acquiescence), MHN took over Peninsula’s operations and integrated Peninsula into the MHN network. Specifically, MHN took over Peninsula’s finances, billing and collection functions, records (which Peninsula ultimately had to pay MHN to recover), parking administration and employee entry access system. The complaint also alleges that the services provided by MHN were more expensive and of lower quality than the same services that could be obtained from other providers and that excessive benefits flowed from Peninsula to MHN as a result the Affiliation Agreement.

According to the Trustee, as MHN asserted more control over Peninsula, Levine reduced his meetings with Peninsula department heads and his attendance at Peninsula’s weekly finance meetings. Levine also apparently knew at the time Peninsula entered into the Affiliation Agreement that MHN’s CEO was under investigation by the United States Department of Justice. According to the Trustee, when MHN abruptly terminated the Affiliation Agreement on August 11, 2011, which resulted in the NYDOH placing Peninsula on ambulance diversion and prohibiting Peninsula from admitting new patients, Levine did not consult counsel or try to enforce Peninsula’s rights under the Affiliation Agreement. Finally, following his dismissal from Peninsula, Levine became an Executive Vice President and the Chief Operating Officer of MHN. This fact seems to have informed the Trustee’s allegations that Levine’s actions (or, perhaps, more accurately, inaction) at Peninsula were tainted with a conflict of interest.

By entering bankruptcy, however, Peninsula may have gone out of the frying pan and into the fire. After consenting to the entry of an order for relief, Peninsula sought and obtained EDNY Bankruptcy Court approval of debtor-in possession financing from Revival Fund Group LLC (“Revival”). According to the Trustee’s August 30, 2013 complaint against Zackheim, members of his family (including his wife) and several business affiliates, the financing provided an avenue Zakheim to obtain control of the operations and assets Peninsula for his own benefit and the benefit of family members and affiliates. The Trustee asserts claims for (i) RICO violations; (ii) fraud on the EDNY Bankruptcy Court; (iii) fraud on Peninsula; (iv) fraudulent concealment; (v) equitable subordination; and (vii) breach of fiduciary duty. Ms. Jones also seeks to vacate the debtor-in-possession financing order.

The crux of the Trustee’s claims is that Zakheim, through family members and affiliates (which included the putative lender, Revival), utilized the debtor-in-possession funding to obtain control over Peninsula and integrate it into his healthcare empire. Zakheim was forced to work through affiliates because he was prohibited from having any direct or indirect involvement in healthcare businesses. Ms. Jones alleges that Zakheim controlled Revival and engineered the appointment of Todd Miller (“Miller”), as Peninsula’s post-petition CEO, even though Miller knew nothing about healthcare administration, took orders from, reported to and was even paid by Zakheim. According to Ms. Jones, Miller turned his earnings as Peninsula’s CEO over to Zakheim, which, if true, only underscores Miller’s status, not as Peninsula’s CEO, but as Zakheim’s agent.

Meanwhile, Zakheim installed himself at Peninsula and was making operational decisions, including hiring and firing decisions. According to the Trustee, members of Zakheim’s family and business associates carefully hid Zakheim’s control over Peninsula, lying to the EDNY Bankruptcy Court and the NJDOH if necessary. In support of her allegations in that regard, the Trustee points to testimony under oath in the Peninsula bankruptcy in which business associates and family members hid Zakheim’s control of Revival and Peninsula. The Trustee asserts that Zakheim’s control over Peninsula allowed him to operate Peninsula for his benefit and the benefit of his family and affiliates. With his involvement in and control over Peninsula carefully concealed, according to the Trustee, Zakheim was able to cause Peninsula to enter into business deals with and make transfers to Zakheim-controlled entities to the benefit (often undisclosed) of those entities.

The Levine and Zakheim adversary proceedings are in their infancy. One can expect them to be hotly litigated. However, to the extent that the Trustee proves her allegations against Levine, she will demonstrate that, in addition to risks unique to the healthcare industry, hospitals are vulnerable to the same managerial misconduct that plagues entities in other industries. Similarly, if the Trustee proves her allegations against Zakheim, his family members and his associates and affiliates, she will demonstrate the vulnerability of debtors-in-possession to unscrupulous debtor-in-possession lenders.

2. Community Activists and Healthcare Insolvencies: Interfaith Medical Center and Long Island College Hospital.

 Anyone who has handled a hospital closure (whether inside or outside of bankruptcy) knows about community and political involvement, if not outright interference, in making and implementing a closure decision. One need only think of the “Save Our Hospital” signs that dotted the lawns of the Bergen County, New Jersey communities served by Pascack Valley Hospital before its closure as part of its bankruptcy. Recent proposals to close two hospitals in Brooklyn demonstrate just how much community involvement can complicate the closure process.

A. Interfaith Medical Center: Pulling the Plug, but Not Just Yet.

 Interfaith Medical Center (“Interfaith”) serves Bedford-Stuyvesant and Crown Heights in Central Brooklyn. Interfaith has also served as a major mental health treatment facility for Brooklyn. However, like many hospitals serving low income populations, Interfaith has suffered significant financial distress. On December 2, 2012, Interfaith filed a Chapter 11 bankruptcy petition in the EDNY Bankruptcy Court (Case No. 12-48226-CCC).

 Initially, Interfaith attempted to reorganize by restructuring itself into a fiscally viable healthcare provider. Following a June 25, 2013 meeting with Interfaith, NYDOH advised Interfaith that it would only consider a restructuring plan that (i) allowed Interfaith to operate outside of bankruptcy, (ii) was delivered to NYDOH by July 9, 2013 and (iii) did not rely on any future funding by NYDOH. Interfaith timely submitted a working draft of such a plan to NYDOH. However, by letter dated July 19, 2013, NYDOH rejected the plan, advised Interfaith that it could not be resubmitted and directed Interfaith to submit a plan of closure. Less than a week later, by letter dated July 24, 2013, Interfaith’s secured lender, the Dormitory Authority of the State of New York (“DASNY”), advised Interfaith that its continued authorization to use DASNY’s cash collateral was conditioned on the submission and implementation of a closure plan. In exchange for the submission and implementation of a closure plan, DASNY agreed to make certain financial accommodations to Interfaith to fund the closure and the formulation of a plan of reorganization. Interfaith submitted a closure plan to NYDOH on July 25, 2013. A motion to approve the closure plan (“Closure Motion”), to which a proposed order approving the plan was attached, was filed with the EDNY Bankruptcy Court on July 30, 2013. Interfaith subsequently submitted amended closure plans to NYDOH on August 12, 2013 and September 10, 2013.

The anticipated closure of Interfaith has generated substantial controversy among the community. Community groups and activists (including New York Public Advocate and Mayor-Elect Bill De Blasio and organizations like The People’s Committee to Save Interfaith Medical Center) have protested the closing, decrying the negative impact on healthcare (particularly for low income people) in Central Brooklyn if Interfaith closes. The hearing on the Closure Motion, initially set for September 11, 2013, has been adjourned twice and is now scheduled for November 13, 2013. The second adjournment was granted, in part, to allow Mr. De Blasio to intervene in the case (Benson, B., “Brooklyn Hospital Plagued by Staffing Woes,” Crain’s New York Business (October 14, 2013). The third adjournment was granted to permit Mr. DeBlasio and others to present an alternative to closing Interfaith. Unfortunately, the most recently submitted proposed form of closure order will have to be further revised before it can be approved, because most of the deadlines it contains have passed. At the November 13, 2013 hearing, Chief Bankruptcy Judge Carla Craig further delayed the hospital’s closure by assigning the Interfaith case to mediation before Bankruptcy Judge Elizabeth Stong in an attempt to resolve the disputes among the various stakeholders. Judge Craig’s Order Assigning Matter to Mediation does not set a deadline for the conclusion of the mediation.

 Interfaith’s anticipated closing and the uncertainties plaguing its immediate future have also negatively impacted operations at the hospital. There has been an exodus of staff and difficulty in recruiting replacement staff. Three mass layoff notices have been sent out, generating rapid turnover and a spike in the use of per diem nursing staff. Benson, id. In late September, the NYDOH found significant deficiencies at the hospital’s laboratory. Id. Unfortunately for Interfaith and Central Brooklyn, the delays in reaching a resolution of the hospital’s future may well lead to death by a thousand legal cuts.

 B. Long Island College Hospital: Unpulling the Plug and Undoing a Transfer of a Hospital

155-year old Long Island College Hospital (“LICH”) has long been in financial trouble, but is not (yet) in bankruptcy. A holding company set up by The State University of New York Medical Center–Downstate (“SUNY”) acquired control over the real property and operations of the ailing hospital in 2011 from Continuum Health Partners, Inc. (“Continuum”), a non-profit hospital operator. At the time of the transfer to SUNY, Continuum itself had recommended closing the hospital.

SUNY was unable to return LICH to solvency and, in 2013, submitted a plan to NYDOH to close LICH, contract with a new operator for a smaller facility in Brooklyn and possibly sell LICH’s real property, which is apparently quite valuable. According to SUNY, LICH is losing approximately $15 million per month and is not financially viable at its current 275-bed facility. In any event, coming on the heels of the Interfaith bankruptcy filing, SUNY’s plan, which would have resulted in the virtually contemporaneous closure of two Brooklyn hospitals, generated significant controversy and public protests, including one at which Mayor-Elect Bill de Blasio was arrested.

The proposed closure of the hospital also generated judicial opposition. An action to enjoin the LICH’s closure was filed in the Supreme Court of New York in Kings County by a number of plaintiffs, including nurses, union members and an organization named Concerned Physicians of LICH, LLC. In September, 2013, Judge Johnny Lee Baynes issued a temporary restraining order prohibiting the hospital’s closure. He also ruled that Bill De Blasio lacked standing to intervene in the action. A month later, on October 15, 2013, Judge Baynes issued a permanent injunction, prohibiting SUNY from closing LICH based on any plan that had previously been submitted to the NYDOH and reaffirming his earlier ruling that Bill De Blasio lacked standing to intervene in the action. Judge Baynes also noted in his ruling that that NYDOH may not have complied with the notice provisions of 10 NY CRR § 401.3(g), which, Judge Baynes concluded was unconstitutionally vague. As a result of Judge Bayne’s ruling, NYDOH must now revise those notice provisions before a new closure plan can for LICH can be entertained. SUNY plans to appeal Judge Baynes’ ruling.

The proposed closure of LICH generated additional litigation over the propriety of the transfer of LICH from Continuum to SUNY. On August 20, 2013, New York Supreme Court Judge Carolyne E. Demarest reversed her 2011 order approving the transfer of LICH to SUNY, thereby effectively stripping SUNY of control over those assets. In support of her decision, Judge Demarest found that the losses LICH was generating were no greater than those anticipated by SUNY at the time it assumed control of the hospital. Judge Demarest indicated in her ruling that the control and management of LICH be returned to Continuum. Continuum has not indicated any interest in resuming control of LICH, although it reportedly has the resources and experience to do so. According to Judge Demarest, there is now “a need to create an alternative governing body for LICH.” Judge Demarest did not appoint a trustee for LICH. However, she did appoint two ombudsmen for the hospital, at least one of whom, Dr. Jon Berall, has been tasked to see that the State does not take any action to close the hospital. Dr. Berall accuses the State of doing just that. Judge Demarest also granted Bill DiBlasio leave to intervene in the action before her.

 In recent developments, on November 6, 2013, citing a shortage of medical specialists, SUNY partially shut LICH down, diverting ambulances and barring new admissions. Ambulance service was restored to the hospital on November 8, 2013. Meanwhile, the anticipated LICH closure has generated a legislative response. State Senator William R. Larkin (R) has sponsored a bill expressly designed to “give ‘community members, healthcare providers, labor unions, payers, businesses and consumers a reasonable opportunity to speak’” before a hospital can close, or reduce the hours for, its emergency room. See Brush, P, “New York Bill Would Require Hearings on ER Closure Plans,” Law 360 (Health) (Oct. 30, 2013) at http://www.law360.com/articles/484308/print?section+health. The bill enjoys bipartisan support. Id. If passed, the bill would require a public hearing, on ten days notice to the public, at least six months before a hospital closes or reduces hours for an emergency room. Id. The bill would also prohibit the payment of bonuses to executives at hospitals that have closed, or reduced hours for, for an emergency room. Id. In sum, the bill would institutionalize community involvement in the decision to close a hospital.

 3. Oncure: What about the Contracts?

Oncure Holdings, Inc. and certain affiliates (collectively, “Oncure”) provide office space, equipment and management services to doctors specializing in the treatment of cancer. Oncure entered into Management Services Agreements (“MSA’s”) with physician groups. The physician groups entered into Member Physician Agreements (“MPA’s”) with individual physicians. There is no direct contractual relationship between the physicians and Oncure. However, the MSA’s between Oncure and the physician groups obligate the MPA’s to include certain provisions that clearly benefit Oncure. In any event, substantially all of Oncure’s revenues are generated ultimately from the services provided by the physician members of the physician groups. For that reason, a successful reorganization of Oncure depends on the MSA’s and the MPA’s remaining in place.

The Oncure debtors filed Chapter 11 bankruptcy petitions in the United States Bankruptcy Court for the District of Delaware (“DE Bankruptcy Court”) (jointly administered under Case No. 13-11540 (KG)) on June 14, 2013. Oncure proposes to reorganize by selling its business to Radiation Therapy Services, Inc. (“RTI”). On July 17, 2013, Oncure filed a plan of reorganization that provided for the sale of its assets and a disclosure statement. Unfortunately for Oncure (and RTI) a number of the physicians who are parties to MPA’s with the physician groups don’t want to work with RTI. On July 23, 2013, several of those physicians (collectively, “Objecting Physicians”) filed an Adversary Complaint for Declaratory Relief in (“Declaratory Complaint”) the DE Bankruptcy Court seeking, inter alia, a declaration that the termination of the MPA’s would not violate the automatic stay in the Oncure bankruptcy. On August 19, 2013, Oncure filed an amended plan of reorganization and disclosure statement, which did not reference either the Declaratory Complaint or address any concerns by Oncure about the effect that a judgment in favor of the doctors would have on its ability to reorganize. The DE Bankruptcy Court approved the amended disclosure statement on August 22, 2013.

Six days later, on August 28, 2013, Oncure filed a motion to dismiss the Declaratory Complaint asserting that awarding the requested declaratory relief would negatively impact Oncure’s reorganization efforts. Oncure also contended that: (i) the Objecting Physicians’ claims were not ripe for adjudication, (ii) Oncure was a third party beneficiary of the MPA’s, and, for that reason (ii) the termination would violate the automatic stay and/or the confirmation discharge in the Oncure bankruptcy. The Objecting Physicians opposed the motion to dismiss, contending that (i) the non-compete provisions contained in the MPA’s were unenforceable under applicable state law and (ii) selling Oncure’s business to RTI would not be in the best interests of their patients. Oncure and the physicians also traded ad hominem attacks. Oncure’s motion to dismiss and the Objecting Physicians’ opposition have been fully briefed and await Bankruptcy Judge Gross’s ruling.

Regardless of Judge Gross’s ruling, the case is a stark reminder to debtors whose successful reorganization is dependent on the ability to assume and assign contracts to address (by negotiation or, by motion, if necessary) any potential opposition to assumption or assignment as early in the reorganization as possible. Oncure is also a stark reminder to non-debtor counterparties to contracts with a debtor in the healthcare industry who have legitimate concerns about the affect of an assumption or assignment of a contract on patient care and safety to detail those concerns to the bankruptcy court and not simply rely on conclusory statements.

4. Sound Shore Medical System: What about the Nursing School?

Numerous hospitals and medical centers medical centers have established or affiliated with nursing schools. Shore Medical System (“Sound Shore”), which includes Mount Vernon Hospital (“Mt. Vernon”), is no exception. Dorothea Hopfer School of Nursing (Hopfer) has long been affiliated with Mount Vernon. Sound Shore and several affiliates, including Mt. Vernon (but not Hopfer), filed Chapter 11 bankruptcy petitions in the United States Bankruptcy Court for the Southern District of New York (“SDNY Bankruptcy Court”) on May 29, 2013 (Jointly administered under Case No. 13-22840). As has become common in Chapter 11 cases, Sound Shore is reorganizing through a sale of its business and assets. To that end, on August 8, 2013, the SDNY Bankruptcy Court entered an order authorizing the sale of Sound Shore to Montefiore Health System (“MHS”). NYDOH approved the sale on October 22, 2013, and the sale is expected to close this fall.

 The sale briefly raised the question of Hopfer’s fate. Hopfer’s website states that “. . . Hopfer . . . is an important program and [MHS] is committed to supporting its on-going role training the nurses of tomorrow.” Nevertheless, the sale to MHS generated concerns that MHS might close Hopfer. There was even talk of Hopfer being transferred to and integrated into Mercy College in Dobbs Ferry, New York, with which Hopfer has had a joint program allowing its RN’s to complete their BSN’s at Mercy. Despite earlier concerns, Hopfer reopened for the fall term on August 24, 2013 and is accepting applications for the Spring term that commences in January, 2014. Federal tuition assistance under Title IV is not available at present, but alternatives are being evaluated. Nevertheless, it is clear from Hopfer’s experience that an affiliated nursing program can add a significant wrinkle to a hospital bankruptcy, and a hospital bankruptcy can expose an affiliated nursing programs to the risk of closure.