Lending to the Healthcare Industry: What to Expect From Medicare Receivables
Attorney Samuel Maizel examines important aspects of lending against Medicare receivables, specifically
setoff and recoupment rights, as well as the length of time it can take for Medicare to make payments and
Samuel R. Maizel,
Partner, Dentons US
America spends nearly 18% of its gross domestic product on healthcare.1 So it’s only natural that many lenders look to this industry as a source for borrowers, and have significant questions about lending in the healthcare market. Their concerns are real, because many healthcare providers obtain significant percentages of their cash flow directly or indirectly from Medicare, a federal program that provides health insurance for some 40 million people aged 65 and older in the U.S.2 by far the largest pay or for healthcare services in America.
In 2013, 13% of the federal budget was spent on Medicare with benefits totaling $583 billion. Interested lenders should be aware of the actions Medicare could potentially take which affect their priority for payment and the legal issues related to those positions.
There are many unique aspects involved in lending into the healthcare industry, and the industry’s relationship with the Medicare program of which potential lenders should be aware. The Medicare program is administered by the Centers for Medicare and Medicaid Services (CMS), part of the U.S. Department of Health and Human Services, which works with private companies that review claims, make the payments and audit the accounts. However, these contractors are not the real party in interest, which is always the U.S. government. Parties become eligible for payment by the Medicare program by entering into an agreement, usually referred to as a “provider agreement” or a “supplier agreement” with CMS.
“Medicare rules require that payments can only be made to the entity with which the program has such an agreement,” says Shane Passarelli, senior vice president of Capital One Bank. “This requires a different approach for lenders who use “control agreements” seen in most non-healthcare accounts receivables transactions.” To mitigate this issue, healthcare lenders traditionally have a “three-tiered-lockbox” system. The first lockbox, in the name of the provider, receives the Medicare payments. A second lockbox, in the name and control of the lender, is established for all non-government receipts. The first two lockboxes are swept, sometimes on a daily basis, into a third lockbox, which is usually in the name and control of the lender and often referred to as a central concentration account. In addition, typically there is some type of depositary agreement, often referred to as a “tri-party” agreement in situations where the lender and depositary institution are not the same, wherein the provider and lender stipulate with the depositary bank not to redirect payments without the consent of the lender. “The complexities of these arrangements underline the necessity of working with an experienced financial partner,” said Passarelli.
Although some believe that the Federal Anti-Assignment Act3 (the act) makes it impossible to take a security interest in the receivables owed by Medicare to a provider of goods or services, the act merely limits the ability of a secured lender to avail itself of the usual remedies against a defaulted lender. For example, typically a secured creditor can compel a third party, which owes its account-debtor money, to instead pay the secured creditor directly. While the act precludes that remedy, courts have held that the act does not bar a party from giving a security interest in Medicare receivables. Thus, while a secured creditor cannot compel Medicare to pay it directly, it can attach, and ultimately foreclose on, Medicare receivables once the funds are deposited in the borrower’s bank accounts.
Further, a secured lender should be aware that Medicare can assert a right to adjust ongoing payments to a borrower if it previously overpaid that provider or supplier, or if that party is deemed to have committed fraud or some other act which can create liability.4 This right to adjust payments to recover a prior overpayment or other debt is referred to as a right of recoupment or setoff. Setoff is an equitable right of a creditor to deduct a claim it has against the debtor from a debt it owes to the debtor, arising out of a separate transaction; recoupment is different in that the mutual obligations arise out of the same transaction or occurrence. Both setoff and recoupment require that the mutual obligations be between the same parties, however courts have generally agreed that the U.S. is one party for mutuality purposes and can set off or recoup claims held by different agencies. Thus, Medicare can set off or recoup monies owed to a healthcare business against that business’ unpaid obligations to another federal agency such as the IRS.
Both setoff and recoupment can be affirmative defenses or counterclaims. However, that distinction is usually not significant.5 Nonetheless, as noted, recoupment differs from setoff in that the opposing claims must arise from the same transaction. Recoupment is a compulsory counterclaim to the original claim, and is less subject to attack by a disgruntled creditor. In many ways, recoupment is a much stronger offset right. Perhaps the most frequently asserted basis for a recoupment right is that the mutual obligations arose from a contract between the parties. Medicare’s “contractual” relationship, if any, exists because of the provider agreement signed by the parties. However, in addition to these common law rights of recoupment and setoff, Medicare’s recoupment and setoff rights are supported by statute.6
The Uniform Commercial Code (UCC) does not alter CMS’ recoupment and/or setoff rights, or its priority for repayment.7 Under the UCC, an “assignee” of an account — the secured creditor with a security interest in the account receivable — is subject to all the terms of the contract between the third party (the account debtor) and borrower (the assignor), and any defense or claim arising from the contractual relationship. These are “recoupment” claims. In addition, a secured party (the assignee), is also subject to any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment. These are “setoff” claims.
Courts which have addressed these issues have confirmed that a secured creditor is subject to an existing right of setoff or a third party’s right of recoupment, whether or not it existed before the secured creditor perfected its lien. For example, In re Columbia Hospital for Women Medical Center, Inc.,8 demonstrates that the court held the secured creditor’s liens were subject to a right of setoff if that right of setoff was in existence when the assignment was made. The decision In re Nuclear Imaging Systems, Inc.,9 also addresses the priority of payment in the context of secured healthcare financing. In this case, the company had entered into a financing agreement that gave its lender a security interest in its Medicare receivables. Medicare moved for relief from the automatic stay imposed at the beginning of a bankruptcy case to set off its prior overpayments against ongoing payments. The secured lender opposed the motion, claiming, inter alia, that its rights as a secured creditor had priority over the government’s setoff rights. However, the court noted that the UCC provided that a creditor’s right of setoff may be asserted against assets otherwise subject to a security interest if the setoff right arises before notification of the account assignment, and that the government’s statutory right to offset Medicare payments was published in the U.S. Code. Thus, all secured creditors were on notice of the government’s setoff rights before any grant or perfection of a security interest could occur. The court also noted that a secured creditor must actually notify any other parties with a potential claim against the accounts receivables of the assignment prior to the right of setoff arising; the mere filing of a financing statement is not sufficient because the other, unsecured creditor, has no obligation to check UCC filings. The lender in this case offered no evidence that the Medicare program received actual notice of the security interest before its right of setoff arose. The court granted Medicare’s motion to lift the automatic stay, and set off the Medicare payments. This is an important issue for lenders to the healthcare industry because it establishes that CMS’s right of setoff is in existence under the applicable statutes so any lending relationship established in the future would be subject to CMS’s setoff rights.
A creditor’s right to setoff may be waived if it takes an action inconsistent with the assertion of a right to setoff. However, whether those rules apply equally to the U.S. is subject to controversy. In McCarty v. Nat’l Bank of Alaska (In re United Marine Shipbuilding),10 the court held that the U.S. Department of Transportation (DOT) did not lose its setoff rights when the IRS mistakenly sent a debtor a check without a setoff deduction, after DOT had commenced an adversary proceeding for determination of setoff rights and notified the IRS to freeze the funds subject to setoff. The court stated that absent evidence that the disbursement of the tax refund was intended to be a voluntary or intentional relinquishment of the setoff right, the alleged waiver was not effective against the Medicare program. This ruling suggests trial even payment by CMS or other government entities might not be a waiver of that agency’s right to recoup or setoff monies owed, and that the agency can reach into a lender’s pocket and recover funds.
Another unique aspect of payments under Medicare is how long it might take; Medicare can decide it overpaid a healthcare entity years after a bill was initially paid. For example, Medicare may take years to audit the annual cost reports submitted by a hospital, resulting in a significant unliquidated and unmatured repayment risk if Medicare determines it overpaid the provider for a substantial period of time after the initial payment of a claim. Additionally, courts have generally held that even if a statute of limitations bars a creditor’s suit to collect an amount due, this does not bar the creditor from invoking its remedies to set off or recoup the debt against other claims by the debtor against the creditor. In other words, a stale claim that could not be asserted by a federal agency because it was barred by a statute of limitations could still be recovered by Medicare through offset of payments otherwise owed to a provider or supplier. Thus, a lender must be aware of potential overpayment or other liabilities that occurred years before it entered into the lending relationship with the borrower.
In conclusion, although there are a number of complexities with lending in the healthcare market, a secured lender can effectively lend against Medicare receivables, but should be aware of and have a team experienced with the unique issues involved in such lending.
- Health expenditure, total (% of GDP), available at http://data. worldbank.org/indicator/SH.XPD TOTL 25/ (Last accessed March 23, 2015).
- Medicare has four parts: Part A, which provides hospital and limited nursing home care; Part B which covers physician services; Part C, commonly called “Medicare-Advantage,” which allows beneficiaries to join Medicare-managed care plans, and Part D which is the Medicare prescription drug program.
- The Anti-Assignment Act is a federal statute prohibiting the assignment or transfer of claims against the U.S. Although referred to as the “Anti-Assignment Act,” it is really two statutory provisions: 41 U.S.C. §15, The Assignment of Contracts Act, and 31 U.S.C. §3727, The Assignment of Claims Act. The former involves executory contracts and is more concerned with continuing obligations, while the latter pertains to claims for work already done.
- There are numerous ways in which a healthcare provider of goods or services can owe money to the federal government in general and to Medicare in particular. For example, the Medicare provider may owe taxes to the IRS. These unpaid taxes may be subject to set off by the Medicare Program. Violations of various federal laws related to the Medicare Program can also create liability, including violations of Medicare Statutes and Regulations, the False Claims Act, the Anti-Kickback Laws, Stark Laws and other legislation.
- See, e.g., In re Worldcom Inc., 304 B. R. 611, 620 n.6 (Bankr S.D.N.Y. 2006) (under Texas law setoff in a form of counterclaim). In bankruptcy, however, the distinction can be important. For example, section 553 of the Bankruptcy Code codifies and governs setoff but is silent as to recoupment. Most significantly, setoff is available in bankruptcy only when both the opposing claims arise on the same side of the time line described by the petition’s filing, i.e., both must be prepetition claims or both must be postpetition claims. Recoupment is not so limited. In re McMahon, 129 F 3d 93 (2d Cir. 1997).
- 42 U.S.C. § 1395g(a).
- Because most states have enacted a form of the UCC, parties should look at the UCC for guidance as to whether a party has a setoff right. For example, UCC section 2-717 indicates that a party may not setoff a contractual claim against a debt on a separate contract. Moreover, section 2-717 preempts any equitable setoff rights under common law. Amerisourcebergen Corp. v. Dialysist West, Inc., 465 F 3d 946,951-52 (9th Cir. 2006). Article 9 of the UCC expressly states that it does not apply to any right of setoff, so its substantive rules (e.g., creation, perfection and other filing requirements) are irrelevant to a creditor asserting setoff rights. Thus, CMS is not required to take any steps other than publish its statutes and regulations in order for it to have priority over a lender asserting a security interest in accounts receivables.
- 461 B.R. 648 (Bankr D.D.C. 2011).
- 260 B.R. 724, 740-44 (Bankr E. D. Pa. 2000).
- 198 B.R. 970, 978 (Bankr W.D. Wash 1996), aff’d, 146 F 3d 739 (9th Cir. 1998).
Lenders making secured loans to health care providers with Medicare and Medicaid receivables should be aware of limitations on their ability to perfect security interests in such borrowers’ deposit accounts. Secured lenders may perfect security interests in their borrowers’ accounts receivable (and identifiable cash proceeds therefrom) by filing UCC financing statements, but when proceeds of those accounts receivable are received by borrowers and deposited into borrowers’ deposit accounts, security interests in the deposit accounts themselves can be perfected only by obtaining "control" over the deposit accounts pursuant to § 9-104(2) of the UCC. In order to perfect such security interests in deposit accounts, revolving credit facilities are, therefore, typically subject to deposit account control agreements. In a deposit account control agreement, the borrower, the secured lender and the depository bank agree that the depository bank will comply with instructions from the secured lender directing disposition of the funds in the deposit account, without further consent by the borrower. This arrangement enables the secured lender to obtain control over the deposit account, thereby perfecting its security interest in the deposit account pursuant to UCC §9-312(b).
Loans to health care providers who receive Medicare and Medicaid payments, however, pose special problems for secured lenders seeking to perfect their security interests in deposit accounts. Medicare/ Medicaid anti-assignment regulations provide that no payment to be made to a provider of services under Medicare may be made to any other person under assignment (42 U.S.C. 1395g(c)) and no payment for any care or service provided under Medicaid to an individual may be made to anyone under assignment other than such individual or the person or institution providing such care or service (42 U.S.C. 1396a (32)). According to the Centers for Medicare and Medicaid Services (CMS) Intermediary Manual §3488.2, payments due to a provider of services may be sent to a bank for deposit in the provider’s account, but only if the check is in the name of the provider and the provider certifies that: (i) "the bank is neither providing financing to the provider nor acting on behalf of another party in connection with the provision of such financing," and (ii) "the provider has sole control of the account, and the bank is subject only to the provider’s instructions regarding the account." This means that any instruction given by a borrower who is a health care provider to its depository bank to transfer funds from the borrower’s deposit account, in which Medicare and Medicaid payments are deposited, to the account of its secured lender must be revocable by the borrower. Because the depository bank must be subject only to the borrower’s instructions regarding the deposit account, it cannot also be subject to instructions from the secured lender, and an arrangement satisfying the Medicare/Medicaid anti-assignment regulations, therefore, cannot give a secured lender "control" of the provider’s deposit account under UCC §9-104.
Many secured lenders find a partial solution to this perfection problem through the use of an arrangement commonly referred to as a "Double Lockbox." In a Double Lockbox arrangement, the health care provider borrower, secured lender, and depository bank enter into a revocable control agreement in which the borrower gives revocable instructions to the depository bank to transfer funds received in the borrower’s Medicare/Medicaid deposit account to an account held by the secured lender on a daily basis. Because the borrower’s instructions are revocable, a Double Lockbox arrangement is permissible under the Medicare/Medicaid anti-assignment regulations. Although it does not perfect the secured lender’s security interest in the borrower’s Medicare/Medicaid deposit account, the daily transfer of funds allows the secured lender to diligently monitor the deposit account and become aware if no funds are being swept, providing the best outcome available without violating the anti-assignment regulations.
Depository banks must be subject only to health care providers’ instructions regarding deposit accounts containing Medicaid/Medicare receivables, so any deposit accounts of health care provider borrowers that contain only receivables from commercial insurers or other non-Medicare/Medicaid sources may be subject to traditional deposit account control agreements. If a borrower maintains such a non-Medicare/Medicaid deposit account, its revocable control agreement may provide that the depository bank transfer the funds received in the borrower’s Medicare/Medicaid deposit account to its non-Medicare/Medicaid deposit account, which is subject to a control agreement perfecting the secured lender’s security interest, rather than to an account held by the secured lender.