The current pandemic will be historically disruptive to the health care industry. Hospitals and other medical facilities have already been weathering the financial implications of reduced Medicare and Medicaid spending, increased costs, the shift to more outpatient services, and greater demands for charity care. They will now also need to suspend profitable elective procedures and routine medical care to treat coronavirus patients. Moreover, many patients without coronavirus symptoms have become more reluctant to enter these facilities for routine medical care or procedures.
Due to the obvious need of Chapter 11 to cure these financial woes, it is important that creditors and others dealing with a medical facility know their rights, risks and advantages when confronted with a distressed business that is in or about to enter Chapter 11. The following are some preliminary considerations for when that situation arises:
1. Tail Coverage: “Tail”coverage is an insurance endorsement that simply prolongs the reporting period for claims against the insurance policy. It enables independent contractors, such as doctors, that have worked for a debtor to remain perpetually insured for occurrences at the medical facility while the doctors worked there even after non-renewal or cancellation of the policy. There are two basic types of professional liability insurance, occurrence-based and claims-made. An occurrence-based policy obviates the need for tail coverage because it means the policy responds to events that occur within the policy period regardless of when the claim is made. A claims-made policy, on the other hand, sets forth a finite period of time in which a claim must be reported or it will not be covered. Tail coverage fills this coverage gap in claims-made policies by extending the reporting period in perpetuity, and may be purchased as part of the practitioner’s primary policy or as a standalone. Many service providers are independent contractors who are provided insurance coverage by the medical facility. While their service contract may provide for the facility to provide tail coverage, this contract can be rejected by the facility within the framework of a Chapter 11. If the Debtor so elects, the provider will be unpleasantly surprised with a financial burden of paying for its own tail coverage with almost no recourse against the debtor medical facility.
2. Administrative Claims for Goods Delivered Within 20 Days of the Petition Date. The Bankruptcy Code provides an administrative priority claim for the value of goods sold and delivered to the debtor within the 20 days preceding its bankruptcy filing. The timing of payment of this administrative priority clam, which is the highest priority claim in non-individual Chapter 11 cases (behind only secured claims), is in the discretion of the bankruptcy court, but at the latest, it must be paid in full on the approval of a plan of reorganization. So, if a supplier sells and ships medical equipment which is physically received by the debtor within 20 days of its bankruptcy filing, the supplier is entitled to an administrative priority claim for the “value” of those goods, which will generally be price the debtor agreed to pay if it is in line with market prices.
3. Critical Vendor Status. Although this doctrine has recently been criticized, Bankruptcy courts generally allow the debtor to establish a critical vendor program whereby the debtor selects what it views as certain “critical vendors” whose pre-bankruptcy claims will be paid in full in exchange for a commitment to sell goods on credit during the reorganization case. The rationale behind such a program is that it enables the debtor to retain these “critical vendors” during the reorganization case, thereby maximizing the chances for successfully emerging from Chapter 11. Generally, to be a “critical vendor,” the creditor must supply a good or service which would be difficult for the debtor to obtain elsewhere. This type of program is usually established early in the case. Upon notice that a vendor has filed a Chapter 11 case, the supplier should immediately lobby the debtor to be designated as a critical vendor. This is the best form of insulation for a supplier to a Chapter 11 debtor against potential liability.
4. Assumption of Executory Agreement. Unless ordered otherwise, a debtor has until the time a plan of reorganization is approved to elect whether to assume or reject a contracts or personal property lease. During that time, the non-debtor party must continue to perform under the contract and is entitled to be paid the “reasonable value” of what it supplies. If a creditor becomes aware or suspects that a Chapter 11 filing is forthcoming and wants to extricate itself from the contract, it should consider taking steps to terminate it prior to the filing if there is a basis to do so. Generally, a lease or contract that is validly terminated prior to a bankruptcy filing cannot be resurrected after the bankruptcy is filed.
5. Preference Exposure. After watching their unsecured claim in a Chapter 11 become basically worthless, creditors are often subjected to a preference action seeking damages from the payments that they actually received from the debtor within 90 days before a bankruptcy filing. Often, these actions are simply to fund the administrative expense of the bankruptcy case. Common defenses to such an action are that the creditor provided new value to the debtor after receiving the payment or that the payment was received in the ordinary course of business. The ordinary course of business defense applies to both course of business between the debtor and the creditor and the course of business in the creditor’s industry. To avoid this quagmire, a creditor that is confronted with a financially distressed institution should place pressure on the debtor to pay for goods in advance to limits the creditor’s preference exposure.