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Generating Value From Hospital Sales

By: Allan H. Ickowitz
09/03/08

A wave of healthcare facility bankruptcies is providing opportunities for potential buyers to capture unrealized value and turn the facilities around financially. Early bidders on such facilities, however, must take care to avoid pitfalls in the process if they are to take full advantage of any bankruptcy opportunity.

The Current Climate: In Southern California, there have been a number of significant closures and bankruptcy cases involving healthcare facilities. While some worry that the trend is worsening, other healthcare facility owners and operators have perceived and acted on opportunities to resuscitate afflicted facilities by selling them to enterprises such as large healthcare systems looking to expand in a particular geographic and/or specialty area and that are in a position to turn the institution around. Recently, the Moreno Valley Community Hospital, in Southern California, was sold – due to operating losses - in a public hospital district bankruptcy case to a large hospital client. Other recent healthcare bankruptcies or closures include Brotman Medical Center, Centinela Freeman Medical Center Memorial Campus and the Robert F. Kennedy Medical Center. Regionally, 14 emergency rooms have closed in the last six years, including 10 in Los Angeles County.

The Advantages: The buyers of these facilities may enjoy certain advantages. Chapter 11 of the Bankruptcy Code is designed to promote reorganization and revitalization of the on-going business or an opportunity to find a "white-knight" who will purchase assets and generate value for the creditors. Buying assets under 11 U.S.C.§ 363, therefore, allows the purchaser to receive assets "free and clear" of a variety of liabilities and potential claims relating to the healthcare institution's operations prior to a sale under a court order.

A bankruptcy trustee or debtor in possession may sell property of the bankruptcy estate outside the ordinary course of business after notice and a hearing. A so-called "section 363 sale," is often characterized as "cleansing" assets that might otherwise be subject to certain liens, encumbrances, interests or environmental and malpractice claims. A section 363 sale may transfer the acquired assets free and clear of any such liens, claims and encumbrances. The power of the section 363 order to "purify" encumbered and problematic assets motivates many acquirers to condition their hospital purchases with the blessing of the Bankruptcy Court's order.

This advantage is very attractive to those purchasers interested not only in the facilities' tangible products, but also intangible assets such as; trademarks, brand names, patents, licenses, and copyrights. In recent years, the commercial value of intangible assets has been increasing and maximizing value in bankruptcy cases.

There also may be significant advantages to a prospective purchaser in assuming the role of the "stalking horse" in a bankruptcy sale. The stalking horse bidder reaps certain benefits in most cases through the sale procedures established by the Court. These include "break up" fees in the event that the initial offer is outbid and requirements relating to minimum overbids and other criteria for qualifying competing bids. The stalking horse is usually able to define the transaction by setting the price and conditions of the asset-purchase agreement and typically has more time to conduct due diligence than later bidders.

The Potential Pitfalls: Healthcare entity bankruptcies, however, raise unique issues with respect to Bankruptcy Court and creditor oversight, including; financing, transactions outside the ordinary course of business and the disposition of assets (including in Chapter 9 cases concerns raised by governmental healthcare regulatory oversight).

The flip side of the advantages under a section 363 sale is that the bankruptcy process is public, and the sale is almost always subject to higher and better offers – either at an auction or vis-à-vis an alternative bidding process. Additionally, asset purchasers of healthcare facilities may face possible successor liability issues arising from unknown tort and other claims. Although these claims may arise pre-petition, they often do not become known until after the bankruptcy filing. Of course, successor liability issues are present even in non-bankruptcy sales, but there are generally more remedies available for buyer against a seller of assets in the context of bankruptcy cases.

In addition to the section 363 considerations, potential purchasers of a healthcare facility must be cognizant of concerns unique to the industry, including patient privacy and the important role of regulatory authorities. Additionally, the Bankruptcy Act of 2005 included amendments that specifically impact healthcare bankruptcies.

Finally, potential acquirers may encounter local community support or opposition as well as State and Federal regulators who may be able to provide aid on behalf of the local communities.

Precautions: The section 363 sale can include pitfalls, but with diligence and skilled advisers, sophisticated buyers can obtain unrealized values from a healthcare facility in need of immediate resuscitation. Potential buyers should consult experienced bankruptcy counsel for guidance through the myriad procedural requirements of the Bankruptcy Code, Bankruptcy Rules and local court rules. Without such guidance, the problems of the seller could easily become the problems of the buyer.

Allan H. Ickowitz is Co-Chair of the Financial Services Practice Group and specializes in the bankruptcy, creditors' rights and workout areas including commercial, real estate and related litigation. He can be reached at aickowitz@nossaman.com.

 

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