The Role of an Examiner in Healthcare Insolvencies

By:
Contributing Editor:
Samuel Maizel
Pachulski, Stang, Ziehl, Young, Jones & Weintraub P.C.:
Los Angeles , California
smaizel@pszyjw.com

J. Mark Abernathy
Navigant Consulting, Inc.,
Tampa , Florida
mabernathy@navigantconsulting.com

On May 25, 2001 , the California Department of Managed Health Care (DMHC) took control of the California operations of Maxicare Health Plans Inc., a statewide Health Maintenance Organization (HMO) servicing 272,000 members. There were concerns about the HMO's ability to provide quality services to enrollees and in particular, there were questions surrounding the Plan's solvency. Under the DMHC's action, J. Mark Abernathy, one of the authors of this article and a Director of then Peterson Consulting, was appointed the Conservator of Maxicare, and shortly thereafter, seized control of Maxicare's operations. Maxicare filed a Chapter 11 petition later that day. This posed an interesting dilemma for the DMHC of holding firm on the Conservatorship and fighting Maxicare's standing to file the petition, or allowing Maxicare's bankruptcy proceeding to continue under certain stipulated terms. In order to facilitate an expeditious and orderly resolution to the controversy, it was mutually agreed among Maxicare, Mr. Abernathy and the DMHC to stipulate to the appointment of Mr. Abernathy as Examiner. This reduced the risk of the provider network (the only real value of the debtor) falling apart while a legal fight ensued on the conflicting authority. This particular illustration is merely one of many instances where examiners have been appointed in a healthcare bankruptcy case. While some of the issues arising from the appointment of an examiner in a healthcare bankruptcy are not unique, in many ways the role of an examiner is unique. The compromise described above raises interesting issues regarding the role of examiners in healthcare insolvency cases generally.

Statutory Basis for the Appointment of an Examiner

Section 1104 of the Bankruptcy Code, [1] the statutory basis for the appointment of an examiner, provides, among other things, that an examiner may be appointed where a trustee has not been appointed, upon request of a party in interest or the United States Trustee, after notice and a hearing, to conduct an investigation of the debtor as appropriate. The investigation may include fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor of or by current or former management of the debtor, if such appointment is in the interests of creditors or others. [2] The examiner investigates "the acts, conduct, assets, liabilities, and financial condition" and operations of the debtor, the desirability of continuing the business and matters relevant to the case or formulation of a plan. [3] The examiner can file interim reports, and when the investigation is complete the examiner files a final report to the court. [4] These reports are to include "any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate." [5] The decision whether to appoint an examiner is discretionary with the bankruptcy court if the debtor's liabilities are less than $5 million, [6] and mandatory if the debtor owes more than $5 million in fixed, liquidated, unsecured debts, other than to an insider. [7] However, despite the latter provisions in the Bankruptcy Code, examiners are not generally appointed. However, in healthcare cases the courts have often exercised their discretion with regard to the appointment of an examiner.

For example, in In re First American Health Care of Georgia, [8] the court sua sponte appointed an examiner in the bankruptcy of the nation's largest privately held home health agency because the principals had been convicted of Medicare fraud prepetition and had appointed an "independent manager" to run the business while they were imprisoned. The bankruptcy court granted a first day motion to appoint the same firm selected by the now convicted principals as independent management during the chapter 11 case. The court first held that it could sua sponte appoint an examiner. It then held that cause to appoint an examiner existed because (1) while there was no evidence that the independent management was committing fraud, the former management had been convicted of fraud and the plan language of section 1104 provided that fraud by former management could serve as grounds for appointment of an examiner; (2) that the former management had selected the independent management created the appearance of impropriety; (3) that the involvement of an examiner would "contribute valuable perspective to a case with many competing interests at stake;" and (4) that "the resources available to the Court, the United States Trustee, and individual creditors are insufficient . . . to evaluate many matters likely to arise" during the case. [9] Of course, many of these reasons would apply to other industries and other debtors, and if taken at face value would result in the appointment of an examiner in many bankruptcy cases. Here, it seems to merely reflect the concern with which bankruptcy courts treat healthcare insolvency cases, where, in addition to the debtor and creditor being at risk, the lives of patients may also be at stake.

Role of the Examiner in the Maxicare Bankruptcy

The Examiner's duties and responsibilities in the Maxicare care included monitoring and overseeing all business operations of the Debtor, approving all disbursements and any sale transaction proposed by the Debtor. The Examiner's Order provided that the Examiner could retain professionals and the Examiner retained Peterson Consulting to provide business, financial and oversight consulting services on behalf of the bankruptcy estate. The Examiner consulted with the Debtor on a daily basis concerning, among other things, day to day business operations of the Debtor, its financial transactions and the appropriate adjudication and payment of provider claims. Specifically, the Examiner rendered services concerning the review and supervision of all accounting and financial aspects of the business and operations of the Debtor. Finally, the Examiner provided oversight to the resolution of creditor obligations, and compliance with the Debtor's obligations as Debtor in Possession. In other words, the Examiner in the Maxicare case was intimately involved in virtually every aspect of the Debtor's operations and bankruptcy case.

While the role of the examiner appointed in Maxicare is certainly broader than suggested by the plain language of section 1104, examiners with "expanded powers" are commonly found in healthcare insolvency cases. These expanded powers are derived from section 1106's allowing the bankruptcy court to order an examiner to perform "any other duties of the trustee that the court orders the debtor in possession not to perform." [10] According to the plain language of sections 1104 and 1106, as long as the work is not duplicative a court may appoint an examiner to perform virtually any task normally performed by a debtor in possession. [11] However, as described above the Examiner in the Maxicare case served more as a court appointed oversight on most, if not all, of the Debtor's postpetition operations and legal activities than merely performing duties not performed by the Debtor.

Another examiner with greatly expanded powers was appointed in the healthcare case of In re Newcare Health Corporation, [12] where the bankruptcy court ordered the appointment of William A. Brandt, Jr., of Development Specialists, Inc., as examiner. In Newcare Mr. Brandt was granted the powers expressly laid out in section 1104 as well as "the powers and duties vested in a Debtor-in-possession or a chapter 11 trustee pursuant to the Bankruptcy Code." [13] The Newcare examiner was also authorized to (1) take possession of the debtor's books and records, (2) receive all monies generated by the debtor's operations, (3) make all payments of the debtor's expenses and determine whether to make such payments; (4) supervise and control all the debtor's employees, (5) have complete control and power over the debtor's operations, (6) engage professionals, (7) file documents as required by the Securities Exchange Commission, (8) prepare and file the debtor's tax returns, (9) direct the debtor's management company, (10) control the debtor's operating licenses, (11) oversee the debtor's compliance with state and federal laws and regulations, (12) control the debtor's borrowing of monies, (13) evaluate the debtor's contractual obligations, (14) oversee the debtor's reporting as required for the bankruptcy proceeding, (15) investigate and file a report regarding any claims by the debtor, (16) file a report on the likelihood of the debtor filing a confirmable plan, and (17) file plans on behalf of the debtor under 11 U.S.C. § 1129. A more comprehensive delegation of a debtor in possession's duties is hardly imaginable.

The Maxicare Examiner is a good example of how broad these powers can be in a healthcare bankruptcy case, and warrants some special attention. Obviously, in any bankruptcy case, an important part of the process is the administration of claims against the estate. Of course, in any healthcare case, "claims" is a term that is also used to describe the rights to payment that a doctor or other provider of healthcare services might have against an HMO like Maxicare. In any HMO case, the debtor must pay special attention to the timely and proper adjudication of postpetition claims, to maintain the provider network. The prepetition claims need to be adjudicated properly to facilitate an orderly settlement with the proofs of claims. In Maxicare, the Examiner had concerns pertaining to the claims processing operations of the Debtor and the impact on the creditors of the estate. The Debtor's claims adjudication process was grossly inadequate which resulted in material processing and payment error rates relative to the proper payment of claims. The process was exceedingly manual and very few automated checks and balances were built into the claims system to warn claims processors of potential processing or pricing errors. The Debtor knew it was adjudicating claims incorrectly yet continued to process pre- and postpetition claims erroneously. Industry and government standards call for processing error rates of no greater than 5% and payment error rates of no greater than 1%. The Maxicare Examiner conducted a claims audit that disclosed the Debtor's processing error rates ranged between 57% and 100%, depending on the line of business and processed date. Similarly, payment error rates (how much more than the true rates one pays for services as a percentage of the true rate) ranged between 16% and 144%. In addition to the review of all disbursements for claims payable, the Maxicare Examiner also compared the disbursements with the claims system to verify that all claims with a "paid" status in the claims system had a check generated for payment. By doing so, the Examiner identified almost $150,000 in postpetition claims that the claims system had indicated as having been paid that had not been paid. Clearly in taking these actions the Maxicare Examiner was not merely doing work other than that done by the debtor in possession, but served more like the Debtors' chief executive officer and chief financial officer.

In contrast to the roles of the examiners in Newcare and Maxicare, the examiner's role in the First American case was more limited, or at least more generally described. There the court's order merely reiterated the language of the statute appointing the examiner to "investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the continuance of such business," and to promptly file a report with the court after completing the investigation. Unlike the cases described above, the examiner was not authorized to retain counsel and was merely authorized to employ "clerical assistance" and be reimbursed for out of pocket expenses and an hourly rate for fees.

Conclusions

The bankruptcy court's concerns over the health of the patients in a healthcare bankruptcy case make the appointment of an examiner with expanded powers more likely. Once appointed, the complicated issues that arise in a bankruptcy case involving a healthcare entity almost ensure that the examiner will be more like a big brother than a distant cousin—the examiner is more likely to function as a second management team than as merely an investigator into historical events. Finally, at least in California where the DMHC is quite active in such cases, the appointment of the state appointed prepetition conservator as the postpetition examiner is now the rule rather than the exception.

[1] 11 U.S.C. §§ 101-1330 (2003).  

[2] 11 U.S.C. § 1104(c). 

[3] 11 U.S.C. § 1106 (b) states that an examiner shall perform the duties of a trustee listed in subsections (3) and (4) of subsection (a), which includes these duties.  

[4] 11 U.S.C. § 1106(a)(4). 

[5] 11 U.S.C. § 1106(a)(4). 

[6] 11 U.S.C. § 1104(c)(1); See In re Gilman Services, Inc., 46 B.R. 322 (Bankr. D. Mass. 1985). 

[7] 11 U.S.C. § 1104(c)(2). 

[8] 208 B.R. 992 (Bankr. S.D. Ga. 1996). 

[9] 208 B.R. at 994-95. 

[10] 11 U.S.C. § 1106(b).  

[11] Compare In re International Dist. Centers, Inc., 74 B.R. 221 (S.D.N.Y. 1987) (district court reverses appointment of "pseudo-trustee") with In re Boileau, 736 F.2d 503 (9^th Cir. 1984) (approved appointment of examiner with powers nearly identical to those of a trustee).  

[12] Case Nos. 99-44160 through 99-44182 (Bankr. D. Mass.) 

[13] See Stipulated Order Regarding The Powers of the Chapter 11 Examiner, In re Newcare Health Corp., Case No. 99-44161, entered on docket 08/23/99.

This information first appeared in the December/January issue of the ABI Journal. Reprinted with the permission of the American Bankruptcy Institute.