In an effort to ensure survival, more hospitals are declaring bankruptcy to clear the way for marriages to stronger healthcare partners.
It's no panacea, but Chapter 11 of the federal bankruptcy code is becoming an increasingly popular tool for wiping the slate clean of burdensome liabilities and stringent collective bargaining agreements.
"This is a developing tool," said Charles Moerdler, a healthcare attorney at New York-based Strook & Strook & Lavan who represents hospitals that have applied the technique. Moerdler predicts Chapter 11 will be employed in markets nationally to facilitate restructurings of smaller, financially troubled hospitals.
New Jersey attorney David Ravin agreed. Ravin, a senior partner in Ravin, Sarasohn, Cook, Baumgarten, Fisch & Rosen in Roseland, N.J., said he anticipates an increase in hospital bankruptcies overall, including ones by hospitals that need to clean house for a potential mate.
"I happen to think there are going to be more and more healthcare-related entities that are going to hit the wall over the next couple of years," he said. "As a general proposition, probably the best way in the world to acquire a business and not worry about what skeletons are going to come out of the closet is through a Chapter 11."
Bankruptcy attorneys already report an uptick in the number of hospital Chapter 11 cases they are handling. Keith Shapiro, who heads the healthcare bankruptcy practice at Chicago's Holleb & Coff, used to see one or two cases every few years. Now Shapiro, who chairs the healthcare insolvency committee of the American Bankruptcy Institute, said he's seeing four to eight times that number.
Shapiro said an active market exists for rural and inner-city hospitals that can be sold as going concerns after cleaning up their liabilities through Chapter 11.
The Alexandria, Va.-based ABI, which just published a Health Care Insolvency Manual, tracks bankruptcies nationally but has no tally of the number filed by hospitals. Anecdotally, though, hospital bankruptcies are popping up as a prenuptial rite in urban and suburban markets where troubled hospitals are seen as potential feeders to larger, well-capitalized partners.
That's the dynamic in New York City, where years of hospital rate regulation have squeezed profit margins. The state lifted rate controls in January 1997, ushering in a new wave of competitive pressure.
This summer 197-bed Union Hospital of the Bronx, a not-for-profit, sought protection from creditors as part of a plan to restructure and reconfigure services. It's the hospital's second trip to bankruptcy court, but this time Union has a marriage partner in sight.
Under the latest plan, 458-bed St. Barnabas Hospital, also in the Bronx, is assuming an estimated $15 million of Union's assets, paying its allowed claims and contributing to its malpractice fund. Once Union emerges from bankruptcy, St. Barnabas will convert the facility to a diagnostic and treatment center.
Generally, before acquiring and converting distressed facilities, suitors will enter management agreements with the facilities to help them through bankruptcy, said Harry Madonna, head of the healthcare law department at Philadelphia's Blank Rome Comisky & McCauley.
That's what happened with Union. St. Barnabas agreed to manage the troubled hospital's day-to-day operations in December 1990. The hospital broke even between 1991 and 1993 after years of losses, but it was slapped with a number of malpractice suits with liabilities of an estimated $31 million to $43 million for events preceding St. Barnabas' involvement. Union filed its first plea for bankruptcy protection in September 1994.
Less than two years later, the hospital emerged free of the weighty malpractice debts. But it continued to carry $13 million of mortgage debt on an aging facility. Meanwhile, its payer mix shifted, with 90% of revenues coming from Medicaid and self-pay patients by 1997. Union claims the state's reimbursement rates were inadequate for its financial solvency, and a second bankruptcy filing resulted.
Troubled metropolitan hospitals often have little choice but to file for reorganization. Typically, the physical assets of a hospital in bankruptcy court are worth less than the outstanding debt on the facility and other liabilities, attorneys said.
"The problem is this: Because of the changes in reimbursement and because of the whole way healthcare is delivered now, frankly the value of a hospital is less than it was in the past," Madonna said. "If you've got $20 million of debt on a hospital that's only worth $10 million, you can't sell it. And the alternative is to get rid of some of the debt."
Furthermore, acquisitive partners might be dissuaded by future unknowns, such as uninsured malpractice liabilities. Those costs "make it virtually impossible to do any kind of merger (or sale)," said Lawrence Handelsman, a bankruptcy attorney at Strook. Bankruptcy, he said, provides a process for eliminating those burdens.
North Philadelphia Health System, which completed a Chapter 11 reorganization late last month, could be an example. The two-hospital system is operated under a management contract with Philadelphia's Mercy Health System.
As part of the system's turnaround plan, Mercy is investing $3.5 million of its own capital and will continue managing it through June 30, 1998. Mercy will continue to have a relationship with North Philadelphia Health System once the management contract lapses, although it's unclear exactly what form that relationship will take, said Lisa Borowski, a Mercy spokeswoman.
Mercy first intervened in May 1992, providing interim management to assess and stabilize the system's shaky operations. The agreement later was expanded, giving Mercy full responsibility for management. Bondholder documents indicate North Philadelphia Health System would have little chance of surviving if the restructuring plan hadn't been adopted. But now Mercy has a second chance to make something of the Medicaid-dependent system if it so chooses.
The federal bankruptcy code also helps providers undo collective bargaining agreements, a big factor in heavily unionized markets. Unwinding union agreements was one of the motivations in Union Hospital's Chapter 11 filing. More than 100 people are expected to be laid off from the hospital, which is mostly unionized.
But Chapter 11 filings have drawbacks, too, not the least of which is cost. Attorneys couldn't provide a ballpark figure for the cost of an average hospital bankruptcy, saying those costs vary widely depending on the size of the institution and the complexity of the case.
Certainly not everyone agrees Chapter 11 is good preparation for the altar.
Ivan Wood, a healthcare attorney in the Houston office of Baker & Hostetler, said sees little merit in Chapter 11 as a means for preparing to be acquired or merged into another healthcare organization. "When you file for bankruptcy, you are meat on the table, and so you cannot control who's going to win," he said. In a bankruptcy, anyone can come in and bid, he said.
In fact, Newark, N.J.-based United Healthcare System's bankruptcy filing last year incited a fight for the hospital's licenses between two suitors: Saint Barnabas Healthcare System in Livingston, N.J., and a partnership between Newark's University of Medicine and Dentistry of New Jersey and Cathedral Healthcare System (April 7, 1997, p. 48).
"I don't think that will be a trend," Wood said of bankruptcy filings, "and I think it's a pretty chancy way to do things."
But from the acquirer's perspective, said Strook's Handelsman, Chapter 11 is a useful tool because "you have a going concern rather than just an empty building."
As for creditors? Many investors would rather cut their losses, says Robert Apfel, president of New York-based Bondholders Communications Group. "They need to all row together . . . or else bigger disasters are awaiting them," he said.