A decision from the U.S. Bankruptcy Court for the District of Delaware in the True Health Diagnostics Chapter 11 case could continue a trend in which bankruptcy courts give healthcare debtors more leverage over the Centers for Medicare and Medicaid Services (CMS) and state agencies administering Medicaid programs. While the litigation related to the decision has not been finally decided, the decision has important implications.

True Health Bankruptcy and CMS Preliminary Injunction

True Health Diagnostics and certain of its affiliates commenced voluntary Chapter 11 cases in the bankruptcy court in 2019. A holdback of all Medicare payments due to True Health by CMS was a precipitating factor leading to the bankruptcy filing, as those payments accounted for approximately 30% of the company’s revenue. CMS instituted the holdback in response to what it alleged were fraudulent billing activities by True Health dating back to 2015. True Health commenced the Chapter 11 cases to facilitate a sale of its assets and the confirmation of a plan of liquidation. On the first day of the Chapter 11 cases, True Health commenced an adversary proceeding against CMS and certain other governmental agencies seeking a preliminary injunction to enforce the automatic stay and prevent CMS from withholding Medicare payments owed to True Health post-petition, as CMS had been doing prepetition.

CMS opposed the preliminary injunction on two grounds. First, CMS argued the bankruptcy court lacked jurisdiction to enforce the automatic stay and enjoin CMS from withholding Medicare payments post-petition because True Health had not first exhausted its administrative remedies under the relevant Medicare statutes and regulations. Second, CMS argued that even if the bankruptcy court had jurisdiction to enforce the automatic stay and issue the injunction, CMS’ withholding of payments post-petition was excepted from the automatic stay as an action in furtherance of CMS’ regulatory and police powers.

The court issued the preliminary injunction over CMS’ opposition. In response to CMS’ jurisdictional arguments, the bankruptcy court relied on the holding of the U.S. Court of Appeals for the 3rd Circuit in University Medical Center v. Sullivan. In that case, the 3rd Circuit held exhaustion of administrative remedies was not required where there was an independent basis for bankruptcy court jurisdiction. In True Health’s case, the bankruptcy court noted the question before it was not the appropriateness of the Medicare payment holdbacks themselves. Instead, the question was whether CMS’ actions in continuing to withhold Medicare payments post-petition violated the automatic stay, over which the bankruptcy court has jurisdiction.

The bankruptcy court also rejected CMS’ arguments that the post-petition Medicare payment holdbacks did not violate the automatic stay. As an initial matter, the bankruptcy court found that True Health’s right to receive the payments was clearly an asset of True Health’s bankruptcy estate. Turning to CMS’ arguments regarding the regulatory and police power exception to the automatic stay, the bankruptcy court found that such an exception did not apply in True Health’s case. Such an exception would only apply when the government is promoting public safety and welfare or effectuating public policy. In True Health’s case, CMS was doing neither. It was merely attempting to enforce its pecuniary interest as a private actor would over the interests of other unsecured creditors.

CMS Appeals and Bankruptcy Court Confirms Plan

CMS appealed the preliminary injunction and immediately sought a stay pending appeal, which the district court denied. In the meantime, buoyed by the post-petition Medicare payments from CMS, True Health was able to propose a plan of liquidation. CMS objected to the plan, arguing that it did not contain sufficient reserves to pay CMS back post-petition holdbacks in the event it was successful on appeal of the preliminary injunction. The bankruptcy court rejected that argument, partially relying on the fact it had already ruled CMS was unlikely to succeed on that appeal, and confirmed True Health’s plan on Nov. 27, 2019. CMS appealed the confirmation order, but a stay pending appeal of that order was denied on Dec. 5, 2019, and the plan of liquidation went into effect and was substantially consummated on Dec. 6, 2019.

On Mar. 27, 2020, the district court issued a memorandum opinion dismissing the appeal of the preliminary injunction. In doing so, the district court accepted True Health’s argument that the appeal from the order granting the preliminary injunction was an impermissible appeal of an interlocutory order for which CMS did not obtain leave and for which insufficient grounds existed. The district court found that it would be inappropriate to let the appeal of the preliminary injunction proceed when the bankruptcy court had not concluded building its factual record in the adversary proceeding.

True Health, however, has sought to dismiss the adversary proceeding, arguing that it served its purpose by providing the debtors with sufficient liquidity to confirm a plan of liquidation and that continued prosecution of the adversary proceeding would be an unnecessary expense. CMS opposes dismissal on the basis that dismissal would prejudice CMS by removing one potential vehicle for it to recover the post-petition payments it made consistent with the preliminary injunction. As of writing, the appeal of the confirmation order is in the process of being briefed, and the bankruptcy court has ordered supplemental briefing on True Health’s motion to dismiss the adversary proceeding.

Implications

The True Health Chapter 11 case is one of several recent bankruptcy cases where bankruptcy courts have been unwilling to allow the government to exercise the level of control over healthcare debtors’ bankruptcy cases as it has been permitted in the past. In addition, bankruptcy courts also appear resistant to challenges by the government to such courts’ jurisdictional authority to exercise oversight of healthcare debtors’ bankruptcy estates.

The bankruptcy court’s decision in the True Health Chapter 11 case, particularly if the confirmation order is upheld on appeal and the adversary proceeding is dismissed, will undoubtedly give healthcare debtors more leverage over CMS and state Medicaid agencies than they once had. Furthermore, when read in concert with other recent bankruptcy decisions related to the interplay of the bankruptcy process and Medicare and Medicaid payments, the bankruptcy court’s decision in the True Health Chapter 11 case appears to be part of a healthcare debtor-friendly trend.

The Delaware bankruptcy court in the case In re Center City Healthcare, LLC, et al. and the United States Bankruptcy Court for the Central District of California in the case In re Verity Health System of California, Inc., et al. recently held that Medicare (in Center City) and Medicaid (in Verity) provider agreements are not executory contracts but statutory entitlements that may be sold free and clear of prepetition liabilities. By upsetting the conventional belief that such provider agreements are executory contracts, the decisions in the Center City and Verity Chapter 11 cases, like the decision in the True Health Chapter 11 case, demonstrated that healthcare debtors may have more leverage over CMS and state Medicaid agencies than once thought.

Those decisions give healthcare debtors powerful tools to leave prepetition liabilities to CMS and state Medicaid agencies in the past and proceed with a plan that maximizes value for all creditors and does not allow CMS or state Medicaid agencies to better their positions to the detriment of that value-maximizing process.

Tyler Layne and John Tishler are partners at Waller Lansden Dortch & Davis.