Protecting the Lender: Strategies for Extending Credit to Health Care Providers

Contrary to popular belief, lending to a doctor is risky business. The business of a health care provider is specialized, and therefore requires specialized lending. Lenders cannot simply repackage loan documents used for other industries, and having a lien on receivables may not alleviate the risk. Lenders must accurately value the collateral, and to do that, they must start by knowing what their collateral actually is and how much the provider will actually receive.

A. Know Exactly the Extent of Your Lien Rights

Receivables for health care providers fall into one of three categories:

1. Government accounts: which includes Medicare and Medicaid accounts. Anti-assignment rules preclude taking a lien on these accounts, and a discussion regarding these required specialized loan documents can be found at: Chrisandrea L. Turner, Stites & Harbison, Protecting the Lender: Strategies For Lending to Health Care Providers, YouTube (May 19, 2014).
2. Commercial accounts: which includes third-party payers and insurance companies.
3. Self pay accounts: which typically have a 5% to 10% collection rate.

B. Determine the Contractual Allowance

The contractual allowance is the expected return on a given charge, which will vary drastically based on category, location and the type of provider. In determining the contractual allowance, lenders should look to the historical performance of the provider on a cash basis. The risk in determining the contractual allowance is that many health care providers use accrual based accounting which means they estimate the amounts they think they will recover and reflect it as revenue, rather than actual realized amounts.

C. Determine the Advance Rate Based on True Expected Receivable Rate Not Gross Charges

The amount of collected payments realized is often just a fraction of the gross charges. In determining the advance rate, never use the gross charge amount. It will almost always be substantially lower than the payments received. Lenders should focus on historical contractual allowances and historical cash receipts of the provider.

D. Consider STARK Implications

STARK is a long standing amendment to the Social Security Act that prevents health care providers from creating “for profit” referral networks. The application of STARK rules are complex. Under STARK, a health care provider cannot have an interest in another provider to whom they refer.

Example of common STARK violation: A hospital hires a doctor and the doctor receives a bonus “per procedure” based on how many patients are referred to the hospital.

Why is STARK important to lenders? Because STARK violations can include:

• Disgorgement of receivables;
• Fines of up to $15,000 per violation; In cases where there is proof of a “scheme” the penalty can be as high as $100,000; and
• The health care provider can lose his/her Medicare provider number.

E. Consider RAC Audits & False Claims Act Implications

RAC, which stands for Recovery Audit Contractor, has recovered over $7 billion since 2009. The purpose of a RAC audit is to look for overbilling due to improper coding or for superfluous procedures used to inflate the charges. According to the Department of Health and Human Services, 42% of diagnostic and assessment claims are improperly coded in the provider’s favor.

Why are RAC audits important to lenders? RAC audits can clawback into a lender’s receivables up to five years of improper charges which may trigger bankruptcy.

What to do when a Health Care Provider Files Bankruptcy?

A. The Automatic Stay and Cash Collateral

As of the petition date, the lender’s cash collateral is what is in the control account that the lender has been sweeping on a daily basis. Daily sweeps of the borrower’s bank account after the date of the bankruptcy petition may well be in violation of the automatic stay.

Immediately upon learning of the filing of a bankruptcy petition, no matter what level–practice group or individual doctor– a lender should immediately seek legal counsel to obtain a court approved cash collateral agreement.

B. The Mechanics of a Section 363 Asset Sale

Frequently, Chapter 11 bankruptcy cases are no longer about reorganization and are more focused on the sale of the assets.

The Provider Number. Often the provider number is the most valuable asset because with it comes a provider’s ability to submit charges to Medicare and Medicaid and the provider’s patient base, which later turns into the receivable base. In a Section 363 asset sale, the law is fairly well-settled that the provider number can be sold and assumed as an executory contract.

The problem with assuming a provider number is most buyers want an order to buy the assets free and clear of all liens, but the Centers for Medicare & Medicaid Services (CMS) requires the buyer of a provider number agree to be liable for any “downstream” liabilities, which can include RAC audits and other upcoding violations.

State-Owned & Not-for-Profit Hospitals. Some states, if the health care facility is state-owned or not-for-profit, will require assets to be sold at an auction. This wide-open auction process may scare off potential buyers, thereby chilling the sale. For county owned hospitals operating under Chapter 9 of the Bankruptcy Code, Section 363 does not apply, so doing an asset sale may not ensure the assets will be free and clear of any liens.

Regulatory Red Tape & Certificates of Need. Each state determines the number of beds a health care facility may have at any given time to provide geographic uniformity in available services. Each state has its own rules transferring Certificates of Need.

The transfer of a Certificate of Need is often a highly political event which may result in regulatory litigation. The lender must carefully evaluate the risk involved in conducting a sale and obtain the necessary approvals for any Certificates of Need.

For lenders, knowing the risks involved in lending to the health care industry, both in and out of bankruptcy, can help avoid costly mistakes in the lending process. Careful attention to the attendant risks and early consultation with counsel is advised to triage a lending relationship with a health care provider such that the bank’s loan doesn’t end up in the fiscal emergency room.

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A recent YouTube presentation of this blog post is available here. The author wishes to acknowledge the assistance of Sarah Trevino who is a summer associate with Stites & Harbison and a rising 3L at Emory University School of Law.