The Bottom Line

The Bankruptcy Court for the Central District of California determined the Attorney General’s approval was not required for the sale of a non-operating, non-profit hospital because the hospital no longer qualified as a “health facility” upon its closure. Section 363(d)(1) of the Bankruptcy Code requires that sales of non-profit assets be done “only in accordance with nonbankruptcy law applicable to the transfer of property[.]” California state law requires the Attorney General’s approval for any sale of material assets of a non-profit health facility to a for-profit entity. CAL. CORP. CODE § 5914(a) (West 2017). “Health facility” is defined under California state law as a facility that operates for the diagnosis, care, prevention and treatment of human illness – the key word being “operates”. CAL. HEALTH & SAFETY CODE § 1250 (West 2017). Because the hospital closed its doors and no longer accepted patients, it was no longer operating and therefore was not considered a health facility. If the hospital was no longer a health facility, it was not required to obtain state approval to sell its assets, or, at a minimum, show compliance with the applicable state law standards for such sales.

What Happened?

In In re Gardens Regional Hospital and Medical Center, Inc., Case No. 16-17463 (Bankr. C.D. May 15, 2017) (the “Hospital”), the Debtor previously operated a non-profit 137-bed acute care hospital with an intensive care unit, a cardiac unit and an emergency department. Due to financial difficulties and a large number of indigent patients, the Hospital filed for bankruptcy. Within the first two months of the bankruptcy case, the Court approved a sale of the operating Hospital to Strategic Global Management, Inc. (“Strategic”), a for-profit entity, for $19.5 million. Strategic assigned its rights to KPC Global Management, LLC (“KPC”). Per California Corporation Code § 5914(a), the Debtor sought the California Attorney General’s (the “Attorney General”) approval to sell its assets.

The Attorney General approved the sale under certain conditions, including a requirement to provide $2.25 million per year in charitable care for six years. The Attorney General’s conditions increased Strategic and KPC’s acquisition cost by approximately $21 million. Strategic, the Debtor and representatives of two unions representing the Debtor’s employees met with representatives of the Attorney General to request modification of the conditions. The Attorney General issued a letter denying the modification request. In light of the Attorney General’s conditions, Strategic and KPC exercised their option to terminate the asset purchase agreement.

By the time the sale fell apart, the Debtor had exhausted nearly all of its debtor-in-possession financing. The Debtor found it nearly impossible to obtain any additional financing and were on the verge of running out of cash. Thus, the Debtor sought and received approval of an emergency motion to close the Hospital in accordance with the Hospital’s charitable mission of sustaining public health and welfare. If the Hospital continued to admit new patients without the funds to run the Hospital, the public health and welfare of its patients would be jeopardized.

The Debtor subsequently sought to sell a number of its assets, including its building lease, suspended hospital license and pharmacy and laboratory licenses and permits (the “Assets”). The proposed purchaser, American Specialty Management (“American Specialty”), offered to purchase the Assets for $6.6 million, $12.9 million less than the purchase price Strategic had offered. The Debtor asserted it was not required to obtain the Attorney General’s consent because the Hospital was closed.

The Court determined that state approval was not necessary because the Hospital no longer qualified as a “hospital facility” under section 1250 of the California Health & Safety Code, which defines health facility as “a facility . . . that is organized, maintained, and operated for the diagnoses, care, prevention, and treatment of human illness . . . to which the persons are admitted for a 24-hour stay or longer . . . .” CAL. HEALTH & SAFETY CODE § 1250 (West 2017). Even if the Debtor continued to “control” the Hospital and American Specialty intended to re-open the hospital, the Hospital currently had no operations, could not diagnose or care for patients, or admit patients for a 24-hour stay or longer. The Court also asserted its ruling did not conflict with the legislative intent of the California statutes because “with the charitable assets being exhausted, nothing remains to be protected by the Attorney General.”

The Court also swiftly shut down the Attorney General’s concern that health facilities will begin to deliberately close their services to avoid the process of obtaining the Attorney General’s approval. In light of the tremendous loss of value, the court stated “it defies credulity to assume that other non-profit hospitals would voluntarily close to escape the Attorney General’s review of a sale, when closure results in such significant value destruction.”

The Bankruptcy Court’s ruling also denied the Attorney General’s application for a stay pending appeal of the sale order. The Attorney General has filed an appeal requesting the U.S. District Court for the Central District of California overrule the Bankruptcy Court’s ruling that the closed hospital did not qualify as a health facility.

Why This Case is Interesting

On its face, the decision is a straight-forward application of the definition of a health facility under California law. By determining that a non-operating provider was not required to comply with the statute, the court could proceed to approve the sale under section 363, including section 363(d)(1). As an initial matter, the decision acts as a reminder that sales of non-profit assets may require a review and compliance with applicable state law. However, legislative history to section 363(d) likewise states that the decision need not be made by the applicable non-bankruptcy forum, but rather that the bankruptcy court need only consider whether the sale is consistent with applicable nonbankruptcy law. Therefore, a health care provider as debtor seeking to sell assets as a going concern and facing the prospects of a denial by an attorney general, reviewing the sale under the charitable guidelines, could seek to have the bankruptcy court determine the merits of the sale under applicable nonbankruptcy law as well as the purposes of section 363. By centralizing the issues before the bankruptcy court, a debtor could best ensure that all of the purposes of the restructuring, including the continuation of health care operations and maximizing going concern value, are preserved. Each case will turn on its dynamics (for example, is the state review being done under general charitable entity guidelines or based upon healthcare guidelines), but consideration of “applicable nonbankruptcy law” may best be made by the forum seeing the entire picture of the restructuring.