In re: Gardens Regional Hospital and Medical Center, Inc.

• Court: United States Bankruptcy Appellate Panel for the Ninth Circuit
• Decided: March 12, 2018
• Docket: CC-17-1198-LKuF
• Status: Unpublished

Opinion

FILED MAR 12 2018 1 NOT FOR PUBLICATION SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL 2 OF THE NINTH CIRCUIT

3 UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT 4 5 In re: ) BAP No. CC-17-1198-LKuF ) 6 GARDENS REGIONAL HOSPITAL ) Bk. No. 2:16-bk-17463-ER AND MEDICAL CENTER, INC., ) 7 ) Debtor. ) 8 ______________________________) ) 9 GARDENS REGIONAL HOSPITAL ) AND MEDICAL CENTER, INC., ) 10 ) Appellant, ) 11 ) v. ) M E M O R A N D U M* 12 ) STATE OF CALIFORNIA, and its ) 13 Department of Health Care ) Services, ) 14 ) Appellee. ) 15 ______________________________) 16 Argued and Submitted on January 25, 2018 at Pasadena, California 17 Filed - March 12, 2018 18 Appeal from the United States Bankruptcy Court 19 for the Central District of California 20 Honorable Ernest M. Robles, Bankruptcy Judge, Presiding _________________________ 21 Appearances: Samuel Maizel of Dentons US LLP argued for 22 Appellant; Kenneth K. Wang, Deputy Attorney General for the State of California, argued for 23 Appellee. _________________________ 24 Before: LAFFERTY, KURTZ, and FARIS, Bankruptcy Judges. 25 26 * This disposition is not appropriate for publication. 27 Although it may be cited for whatever persuasive value it may have (see Fed. R. App. P. 32.1), it has no precedential value. 28 See 9th Cir. BAP Rule 8024-1. 1 The bankruptcy court ruled that the State of California 2 Department of Healthcare Service’s (“DHCS”) postpetition 3 withholding of Medi-Cal and supplemental hospital quality 4 assurance (“HQA”) payments from the Debtor to recover unpaid HQA 5 fees constituted equitable recoupment of unpaid HQA fees and thus 6 did not violate the automatic stay. 7 We AFFIRM. 8 FACTS1 9 Chapter 112 debtor Gardens Regional Hospital and Medical 10 Center, Inc. formerly operated a hospital in Hawaiian Gardens, 11 California. Debtor had a Medi-Cal Provider Agreement with DHCS 12 and provided healthcare services to Medi-Cal beneficiaries. 13 A. The Medi-Cal Program 14 Medi-Cal refers to the California Medical Assistance 15 Program, through which federal Medicaid benefits are 16 administered. Under the Medicaid program, the cost of providing 17 healthcare to low-income people is shared between the state and 18 federal government, with states administering the Medicaid 19 program through their own specific plans. Medi-Cal is 20 California’s Medicaid plan, and DHCS administers it. 21 California is generally entitled to be reimbursed by the 22 federal government for 50 percent of Medi-Cal costs. 42 U.S.C. 23 § 1396b(a). To help cover its share of Medi-Cal costs, 24 1 For this factual recitation, we borrow heavily from the 25 bankruptcy court’s published opinion, In re Gardens Regional 26 Hospital and Medical Center, Inc., 569 B.R. 788 (Bankr. C.D. Cal. 2017). 27 2 Unless specified otherwise, all chapter and section 28 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532.

-2- 1 California enacted the Medi-Cal Hospital Reimbursement 2 Improvement Act of 2013 (the “RIA”), codified at California 3 Welfare and Institutions Code §§ 14169.50–14169.76. The RIA 4 requires most general acute care hospitals to pay a quarterly 5 Hospital Quality Assurance Fee (“HQA Fee”), which is assessed 6 regardless of whether the hospital participates in the Medi-Cal 7 program. Cal. Welf. & Inst. Code § 14169.52(a). The HQA Fee 8 allows California to obtain more healthcare funds from the 9 federal government, which generally matches state Medi-Cal 10 contributions dollar for dollar. 11 The HQA Fee is calculated using a complex formula based 12 primarily upon a hospital’s “patient days.” For example, “one 13 Medi-Cal day” means that a hospital treated one patient under the 14 Medi-Cal program for one day; “two Medi-Cal days” means either 15 that a hospital treated two patients under the Medi-Cal program 16 for one day each, or treated one patient under the Medi-Cal 17 program for two days. The formula for calculating the HQA Fee 18 takes into consideration a hospital’s annual fee-for-service 19 days, annual managed care days, and annual Medi-Cal days. Id. at 20 § 14169.51(as). 21 After the HQA Fees are collected and augmented by federal 22 matching funds, DHCS redistributes them to the hospitals through 23 various types of quality assurance payments, including: 24 1) direct grants to public hospitals in support of health 25 care expenditures, id. at § 14169.58(a)(1); 26 2) supplemental quality assurance payments to private 27 hospitals, id. at § 14169.54–55; 28

-3- 1 3) increased capitation payments3 to hospitals providing 2 treatment pursuant to Medi-Cal managed health care plans, id. at 3 § 14169.56; and 4 4) payments for children’s health care, id. at 5 § 14169.53(b)(1)(B). 6 The formulas under which the HQA Fees are assessed differ 7 from the formulas under which the HQA Fees and associated federal 8 matching funds are distributed. As a result, some hospitals 9 receive more money on account of their HQA Fee payments than 10 others. Therefore, in addition to allowing California to receive 11 more federal matching funds, the RIA performs a redistributive 12 function. 13 The RIA is only one component of a complex statutory scheme 14 governing Medi-Cal’s funding and administration. In addition to 15 receiving various types of payments under the RIA, hospitals are 16 also reimbursed for providing Medi-Cal services primarily through 17 two systems: a fee-for-service system and a managed care system. 18 In the fee-for-service system, DHCS enters into contracts with 19 hospitals to provide services to Medi-Cal beneficiaries and makes 20 direct payments to the hospitals. See generally id. at § 14132 21 et seq. (delineating the types of Medi-Cal benefits provided 22 through the fee-for-service system). In the managed care system, 23 DHCS contracts with managed care plans to provide healthcare 24 services to Medi-Cal beneficiaries. See generally id. at 25 § 14087.3 et seq. (setting forth standards governing contracts 26 3 27 A capitation payment is a per-month, per-person reimbursement on account of treatment provided to patients 28 enrolled in managed care plans.

-4- 1 between DHCS and managed care providers). The fee-for-service 2 and managed care systems allow hospitals to receive a baseline 3 reimbursement on account of the Medi-Cal services they provide. 4 The RIA supplements that baseline reimbursement for hospitals 5 that are eligible to receive payments under the Act. 6 B. Debtor’s Relationship with DHCS 7 Paragraph 2 of the provider agreement entered into between 8 Debtor and DHCS in November 2014 requires, as a condition for 9 participation as a provider in the Medi-Cal program, that Debtor 10 comply with all applicable provisions of California Welfare and 11 Institutions Code §§ 14000-14499.77. Among those provisions is 12 the requirement to pay HQA Fees. Cal. Welf. & Inst. Code 13 § 14169.52(a). Because Debtor provided healthcare to Medi-Cal 14 beneficiaries on a fee-for-service basis, it was entitled to 15 receive Medi-Cal fee-for-service payments (“Medi-Cal Payments”). 16 Debtor was also entitled to receive supplemental quality 17 assurance payments (“Supplemental HQA Payments”), calculated 18 under formulas contained in the RIA, on account of certain 19 services provided to Medi-Cal beneficiaries. 20 Debtor stopped paying quarterly HQA Fees in March of 2015; 21 by the petition date of June 6, 2016, it owed $699,173.15 in HQA 22 Fees. Postpetition, DCHS began withholding 20 percent of Medi- 23 Cal payments owed to Debtor and an unspecified percentage of the 24 Supplemental HQA payments owed to Debtor.4 By July 18, 2016, 25 DHCS had recovered the prepetition amount owing but continued the 26 4 27 The record does not reflect how much of the withheld amounts represent Medi-Cal Payments and how much represents 28 Supplemental HQA Payments.

-5- 1 withholding because Debtor failed to pay postpetition HQA Fees. 2 On May 2, 2017, Debtor filed a Motion for Order Granting 3 Relief Against the State of California and Its Department of 4 Health Care Services for Violating the Automatic Stay (the 5 “Motion”). Debtor argued that DHCS’s withholding of Medi-Cal and 6 Supplemental HQA payments was an impermissible setoff that did 7 not meet the standards for equitable recoupment and thus violated 8 the automatic stay. Debtor requested that the court find DHCS in 9 civil contempt and order it to pay Debtor $4,131,147.64 of 10 withheld payments. DHCS opposed, arguing that its withholding of 11 both types of payments satisfied the Ninth Circuit’s “logical 12 relationship test” for recoupment. 13 After hearing argument, the bankruptcy court issued written 14 findings and conclusions, concluding that the doctrine of 15 equitable recoupment allowed DHCS to withhold a percentage of the 16 Medi-Cal and Supplemental HQA Payments it owed Debtor for the 17 purpose of recovering unpaid HQA Fees. In re Gardens Reg. Hosp., 18 569 B.R. at 800. The bankruptcy court entered an order denying 19 Debtor’s motion to compel DHCS to turn over the withheld funds. 20 Debtor timely appealed. 21 JURISDICTION 22 The bankruptcy court had jurisdiction pursuant to 28 U.S.C. 23 §§ 1334 and 157(b)(2)(O). We have jurisdiction under 28 U.S.C. 24 § 158. 25 ISSUE 26 Whether the bankruptcy court erred in concluding that DHCS’s 27 withholding of a percentage of Medi-Cal Payments and Supplemental 28 HQA Payments owed to Debtor to recover unpaid HQA Fees was

-6- 1 permissible without relief from stay under the doctrine of 2 equitable recoupment. 3 STANDARD OF REVIEW 4 We review de novo the bankruptcy court’s application of 5 undisputed facts to the law concerning equitable recoupment. 6 Aetna U.S. Healthcare, Inc. v. Madigan (In re Madigan), 270 B.R. 7 749, 753 (9th Cir. BAP 2001) (citing Sims v. U.S. Dept. of Health 8 & Human Servs. (In re TLC Hosps., Inc.), 224 F.3d 1008, 1011 n.7 9 (9th Cir. 2000)). 10 DISCUSSION 11 A. Equitable Recoupment 12 Equitable recoupment is similar to setoff. Recoupment and 13 setoff each permit a creditor to deduct amounts owed to it by a 14 debtor from amounts it owes to the debtor. Nevertheless, “they 15 have differences with important consequences in the bankruptcy 16 context.” In re TLC Hosps., Inc., 224 F.3d at 1011. Section 553 17 of the Bankruptcy Code preserves the right of a creditor to 18 offset a prepetition debt it owes to the debtor against that 19 creditor’s prepetition claim. Before exercising its right of 20 setoff, the creditor must obtain relief from the automatic stay. 21 See Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 19 (1995); 22 § 362(a)(7). Section 553 does not permit setoff across the 23 petition date; pre- and postpetition claims may not be offset. 24 Recoupment, on the other hand, is not mentioned in the 25 Bankruptcy Code. Rather, it is a common law equitable doctrine 26 which has been defined as “the setting up of a demand arising 27 from the same transaction as the plaintiff’s claim or cause of 28 action, strictly for the purpose of abatement or reduction of

-7- 1 such claim.” Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 2 1392, 1399 (9th Cir. 1996) (citation omitted) (emphasis in 3 original). Unlike setoff, recoupment is not subject to the 4 automatic stay. In re TLC Hosps., Inc., 224 F.3d at 1011. 5 Additionally, recoupment “is not limited to prepetition claims 6 and thus may be employed to recover across the petition date.” 7 Id. (citation omitted). 8 In determining whether two events are part of the same 9 transaction, courts in the Ninth Circuit apply the “logical 10 relationship” test, analogous to the test used to determine 11 compulsory counterclaims, i.e., where the counterclaim arises 12 from the same aggregate set of operative facts as the initial 13 claim. In re Madigan, 270 B.R. at 755; see also Newbery Corp., 14 95 F.3d at 1399 (noting that recoupment has been analogized to 15 both compulsory counterclaims and affirmative defenses). In this 16 context, the word “transaction” is given a “liberal and flexible 17 construction.” In re Madigan, 270 B.R. at 755 (citations 18 omitted). A transaction may include “a series of many 19 occurrences, depending not so much upon the immediateness of 20 their connection as upon their logical relationship.” In re TLC 21 Hosps., Inc., 224 F.3d at 1012 (quoting Moore v. N.Y. Cotton 22 Exch., 270 U.S. 593, 610 (1926)). 23 In the final analysis, the obligations must be “sufficiently 24 interconnected so that it would be unjust to insist that one 25 party fulfill its obligation without requiring the same of the 26 other party.” In re Madigan, 270 B.R. at 755. As such, although 27 not required, courts often find that the “same transaction” 28 requirement is satisfied when corresponding liabilities arise

-8- 1 under a single contract. Id. at 758. “The rationale for 2 allowing recoupment in contract cases is that it would be 3 inequitable for the debtor to enjoy the benefits of a transaction 4 without also meeting [its] obligations.” Id. (citing Newbery 5 Corp., 95 F.3d at 1403). 6 In any event, as we explain in detail below, application of 7 the “logical relationship” test does not require that the 8 obligations of the counterparties be identical, or, particularly 9 in the context of a contract with a governmental entity intended 10 to promote a public policy, that the class subject to an anterior 11 obligation to the governmental agency be exactly the same class 12 that would reap a benefit under the subject contract. Rather, a 13 “logical relationship” may be found where there is an 14 interconnection between the obligations such that it is equitable 15 to treat them as the same transaction. 16 B. The bankruptcy court did not err in concluding that DHCS was entitled, under the doctrine of recoupment, to withhold 17 Supplemental HQA Payments owed to Debtor. 18 A primary purpose of the RIA is to “improve funding for 19 hospitals and obtain all available federal funds to make 20 supplemental Medi-Cal payments to hospitals.” Cal. Welf. & Inst. 21 Code § 14169.50(a). The HQA Fees imposed under the RIA are to be 22 “used to increase federal financial participation in order to 23 make supplemental Medi-Cal payments to hospitals, and to help pay 24 for health care coverage for low-income children.” Id. at 25 § 14169.50(d). 26 As noted by the bankruptcy court, the additional federal 27 matching funds generated by the HQA Fees enable DHCS to have 28 sufficient revenue to make Supplemental HQA Payments. Put

-9- 1 another way, without the HQA Fees, DHCS could not perform its 2 redistributive function, and Debtor would not receive any 3 Supplemental HQA Payments. Using a liberal and flexible 4 construction of the word “transaction” thus leads to the 5 conclusion that the HQA Fees are logically related to the 6 Supplemental HQA Payments. 7 On appeal, Debtor contends that there is no logical 8 relationship between its obligation to pay HQA Fees and DHCS’s 9 obligation to make Supplemental HQA Payments for three reasons. 10 First, the formulas used to calculate each parties’ liabilities 11 are different; second, licensed acute care hospitals are required 12 to pay HQA Fees even if they do not receive Supplemental HQA 13 Payments, i.e., the obligation to pay the HQA Fees is based 14 solely on licensure and not on any right to receive Supplemental 15 HQA Payments; and third, the amounts of the HQA Fees to be paid 16 bears no relationship to the amount of the Supplemental HQA 17 Payments a provider receives. 18 Debtor has not cited any authority to support these 19 arguments, and we agree with the bankruptcy court that Debtor’s 20 interpretation of the logical relationship test is too narrow. 21 The facts that (i) the fees and the reimbursements are calculated 22 using different formulas and (ii) the amounts paid and received 23 are not related do not change the fact that without the HQA Fees, 24 DCHS would have no resources with which to pay the Supplemental 25 HQA Payments. And the fact that some hospitals are exempt from 26 the requirement to pay HQA Fees but still receive Supplemental 27 HQA Payments does not change the fundamental fact that the source 28 of the funding for the Supplemental HQA Payments is, at least

-10- 1 indirectly, the revenue generated by the HQA Fees. Even 2 conceding that the relationship between the Supplemental HQA 3 Payments and the HQA Fees is not linear, the relationship is 4 “sufficiently interconnected so that it would be unjust to insist 5 that one party fulfill its obligation without requiring the same 6 of the other party.” In re Madigan, 270 B.R. at 755. From this 7 standard, it follows that a “logical relationship” may exist even 8 when the transactions at issue do not correspond exactly. 9 C. The bankruptcy court did not err in concluding that DHCS was entitled, under the doctrine of recoupment, to withhold 10 Medi-Cal Payments owed to Debtor. 11 As noted, the provider agreement between Debtor and DHCS 12 requires, as a condition of being a Medi-Cal provider, that 13 Debtor comply with all applicable provisions of California 14 Welfare and Institutions Code §§ 14000-14499.77. Among those 15 provisions is the requirement to pay HQA Fees; if fees are not 16 timely paid, DCHS may immediately begin to deduct the unpaid 17 assessment and interest from Medi-Cal Payments owed to the 18 hospital. Cal. Welf. & Inst. Code § 14169.52(a) and (h). 19 Accordingly, when it executed the provider agreement, Debtor 20 agreed that DHCS could withhold unpaid HQA Fees from Medi-Cal 21 Payments. Based on this agreement, we conclude that the logical 22 relationship test is satisfied. 23 Despite this agreement, Debtor contends that no logical 24 relationship exists between the HQA Fees and the Medi-Cal 25 Payments for the same reasons Debtor disputes a logical 26 relationship between HQA Fees and Supplemental HQA Payments: 27 (i) DHCS’s obligation to make Medi-Cal Payments arises from the 28 fact that Debtor is a Medi-Cal participant, while Debtor’s

-11- 1 obligation to pay HQA Fees is based solely on licensure; (ii) the 2 respective amounts are calculated using different formulas; 3 (iii) there is no express reference in the provider agreement to 4 recoupment or offset or the HQA program; (iv) the bankruptcy 5 court’s analysis was too superficial because it lacked a detailed 6 analysis of the obligations between the parties; and (v) the 7 Medi-Cal provider agreement cannot create a logical relationship 8 because it is a form document, citing Saint Joseph’s Hospital v. 9 Dep’t of Public Welfare of Pennsylvania (In re Saint Joseph’s 10 Hospital), 103 B.R. 643, 656 (Bankr. E.D. Pa. 1989); Kings 11 Terrace Nursing Home & Health Related Facility v. New York State 12 Dep’t of Social Services (In re Kings Terrace Nursing Home & 13 Health Related Facility), No. 91 B 11478 (FGC), 1995 WL 65531 14 (Bankr. S.D.N.Y. Jan. 27, 1995), aff’d, 184 B.R. 200, (S.D.N.Y. 15 1995); and Hollander v. Brezenoff, 787 F.2d 834 (2d Cir. 1986). 16 We do not find these arguments persuasive. While true that 17 Debtor would have to pay HQA Fees even if it did not participate 18 in the Medi-Cal program, Debtor could not have become a Medi-Cal 19 provider without agreeing that unpaid HQA Fees could be withheld 20 from Medi-Cal Payments. And Debtor does not explain how the fact 21 that the amounts are calculated using different formulas impacts 22 its agreement to the withholding of Medi-Cal Payments to recover 23 unpaid HQA Fees. Similarly, Debtor does not explain why 24 incorporating statutory requirements into the terms of the 25 provider agreement negated Debtor’s consent to those terms or 26 severs the logical relationship between the HQA Fees and the 27 Medi-Cal Payments. 28 As for the bankruptcy court’s analysis, we find no fault

-12- 1 with it. The court examined in detail the obligations of the 2 parties. Although its analysis may not have matched the analysis 3 done by the Ninth Circuit in TLC Hospitals, that case did not set 4 out a bright-line standard or list of factors for analyzing 5 recoupment scenarios. Ultimately, the analysis is an equitable 6 one in which the court must determine, under the facts presented, 7 whether the obligations at issue are “sufficiently interconnected 8 so that it would be unjust to insist that one party fulfill its 9 obligation without requiring the same of the other party.” 10 In re Madigan, 270 B.R. at 755. 11 The argument that the Medi-Cal provider agreement could not 12 be the basis for a logical relationship because it is a form 13 document does not appear to have been made in the bankruptcy 14 court; thus, we need not consider it. See O’Rourke v. Seaboard 15 Surety Co. (In re E.R. Fegert, Inc.), 887 F.2d 955, 957 (9th Cir. 16 1989). In any event, none of the cases Debtor cites involve the 17 application of the logical relationship test. 18 Debtor also urges the Panel to consider Indiana Family and 19 Social Services Administration v. Saint Catherine Hospital of 20 Indiana, LLC, (In re Saint Catherine Hospital of Indiana, LLC), 21 511 B.R. 117 (S.D. Ind. 2014), rev’d on other grounds, 800 F.3d 22 312 (7th Cir. 2015). The facts of that case are similar to those 23 here, but with some important differences. The debtor in that 24 case was an acute care hospital that treated Medicare and 25 Medicaid patients. Like California, the State of Indiana had 26 imposed a “hospital assessment fee” or “HAF” to facilitate 27 increased reimbursement for hospital care to Medicaid patients. 28 Prepetition, the Indiana Family and Social Services

-13- 1 Administration (“FSSA”) withheld Medicaid payments to the debtor 2 to recover unpaid HAFs and continued the withholding 3 postpetition. On appeal from the bankruptcy court, the district 4 court held that the withholding was not permissible as a 5 recoupment because (i) the statute that authorized the HAF was 6 separate from the regular pay-for-service arrangement; (ii) the 7 obligation to pay the HAF was triggered solely by the hospital’s 8 status as an acute care facility; and (iii) the initial 9 assessment was “frontloaded” in a way that rendered it akin to a 10 tax. The court thus concluded that the obligations did not arise 11 from the same contract or transaction. The case is 12 distinguishable from our facts, however, in that there was no 13 contract or statute that permitted FSSA to withhold Medicaid 14 payments to the hospital to recover the HAF debt. Accordingly, 15 Saint Catherine Hospital is not persuasive. 16 One final point. Throughout its argument, Debtor seems to 17 contend that it would be unfair to permit one party to a contract 18 unilaterally to dictate terms that essentially authorize 19 equitable recoupment – such as, here, requiring (i) an 20 acknowledgment of and an agreement to abide by obligations 21 arising under statutes and regulations, and (ii) an agreement 22 that violations of those statutes and regulations would lead not 23 merely to a breach of the subject contract, but would also permit 24 the governmental entity to exercise the contract remedy of 25 recoupment. Were the provider contracts between private, 26 independent, economic actors, we might find this argument worthy 27 of consideration. Here, however, as a government entity, the 28 State is guided by public policy considerations rather than

-14- 1 solely economic ones. Indeed, it is abundantly clear from a 2 review of the governmental programs that are the subject of this 3 dispute that DHCS’s purpose in entering into these agreements is 4 not to create a profit center related to the provision of 5 critical medical services, but to create and fund programs that 6 will adequately serve the needs of its citizens, and will incent 7 participants in these programs to provide the revenue that funds 8 these necessary programs. As such, we see nothing inequitable or 9 unfair in holding Debtor to its obligations under the provider 10 agreement and applicable state law. 11 CONCLUSION 12 The bankruptcy court did not err in ruling that DHCS’s 13 withholding of a percentage of Medi-Cal Payments and Supplemental 14 HQA Payments owed to Debtor to recover unpaid HQA Fees was 15 permissible under the doctrine of equitable recoupment and was 16 thus not a violation of the automatic stay. 17 Accordingly, we AFFIRM. 18 19 20 21 22 23 24 25 26 27 28

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