Bankruptcy Options for the Financially Distressed Nonprofit Hospital

Bankruptcy Options for the Financially Distressed Nonprofit Hospital

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It is well-known that many nonprofit hospitals in the United States are struggling financially. The Healthcare Association of the State of New York's most recent report1 on the financial health of New York hospitals is indicative of this trend. The report states that New York hospitals posted an aggregate operating margin of -1.3 percent in 2000, the third straight year that more than 60 percent of New York's hospitals lost money on operations. The preliminary financial information collected for 2001 is no better; the association reports that it is seeing another year of money-losing operations for New York hospitals, with an expected -1.4 percent operating margin.

One of the first options that a financially distressed health care provider may examine is filing a petition for relief under the Bankruptcy Code. Unlike most business enterprises that are organized as for-profit corporations, a hospital organized as a non-profit corporation does not have to be concerned with the threat of three unpaid creditors banding together to file an involuntary bankruptcy petition against it. The provisions of ยง303 of the Bankruptcy Code have been interpreted to preclude the filing of an involuntary petition against a nonprofit corporation. Approximately 80 percent of the non-governmental, acute care hospitals in the United States are organized as nonprofit corporations.2

Although a nonprofit hospital may have entered the zone of insolvency, many considerations suggest that a bankruptcy petition should not be its first choice. The nonprofit hospital is a charitable mission grounded in providing care for the sick and needy. Its federal tax-exempt status is dependent on its providing a community benefit while operating an emergency room that provides care to patients without regard to their ability to pay. Thus, the concerns of its creditors are not paramount.

The costs of a bankruptcy proceeding pose difficult choices for the distressed hospital. A chapter 11 petition initiates a costly round of professional fees. In a typical case, the hospital will be faced with retaining counsel and accountants with specialized expertise in bankruptcy. Paying the fees of these professionals as well as the fees of counsel and accountants for the creditors' committee will be costly. Unlike the hospital's other creditors who will share pro rata on their claims, these professionals often insist on being paid first as a condition for providing services.

A bankruptcy is a financially driven process where creditor concerns predominate. While the creditors have well-defined roles and well-established representation through the mechanism of the creditors' committee, the patients and the community the hospital serves do not. Unlike the shareholders of a for-profit corporation who have the opportunity to form an equity-holders' committee during a bankruptcy proceeding, the patients and members of the community, who are the "owners," if you will, of a nonprofit hospital, typically have no similar committee.

The nonprofit hospital is a charitable mission grounded in providing care for the sick and needy.... Thus, the concerns of its creditors are not paramount.

Difficult Decisions

A financially distressed hospital may face the prospects of shutting down and ceasing its patient care activities. This is not a decision that is always dictated by purely financial considerations. It is just as likely that it will depend on a complex mix of factors that include an assessment of the ability of the hospital to continue to provide the high level of care that the community expects and the availability of qualified health care personnel. As many a financially distressed hospital has learned, the rumors of financial problems can cause its critical care-givers to seek employment elsewhere. Inadequate staffing in key departments may leave little choice but to close selected departments, or in some cases, the entire hospital. While a bankruptcy court may be an adequate forum to examine the financial ramifications of this course of action, it is not well-equipped to evaluate and make decisions on the medical aspects of this problem.

Non-bankruptcy Options

What other options are available for the financially distressed nonprofit hospital facing the prospect of closure? A nonprofit hospital with a competent management team will better serve its charitable mission, its patients, the community and its creditors by first addressing its responsibilities for the current and continuing care of its patients and then turning to the issue of dealing with its creditors. Instead of using its dwindling cash flow and the limited resources of its management team to fund and participate in a bankruptcy proceeding, the patients and the community are better served if the nonprofit hospital uses its funds to pay the critical vendors whose services are needed over the 45-60 days. This can permit an orderly transfer of patients and patient care responsibilities to other health care providers and the ultimate cessation of patient care activities. The state department of health that licenses and regulates the hospital's health care activities is better equipped to supervise and achieve an optimal outcome for all concerned parties if it, rather than a bankruptcy court, has jurisdiction over the initiation, timing and critical decision-making that must occur in the closure of a hospital.

A recent example is the 2001 closure of the Genesee Hospital in Rochester, N.Y. The process required a tremendous amount of cooperation and almost daily interaction between hospital personnel and the Department of Health, not only to safely shut down the existing patient care activities, but to assure that the patients have alternative sources to provide for their care after the completion of the closure. It is difficult to envision how this process would have benefited by the time delay and expenditure of resources needed to seek court approval for the closure and justify to its creditors each decision that was made on the most effective method to shut down hospital operations from the standpoint of patient safety.

With the hospital safely closed, the nonprofit hospital can turn its attention to addressing the legitimate claims of its creditors. Again, a bankruptcy is not the only vehicle for accomplishing this. If the financial condition of the hospital or the outstanding claims make an out-of-court workout unfeasible, the hospital has the option of seeking a judicial dissolution under the nonprofit laws of its state. In New York, the court has the authority to appoint a receiver to oversee the judicial dissolution, collect and sell the hospital's remaining assets, adjudicate claims and distribute the proceeds to the hospital's creditors.

In conclusion, because a financially distressed nonprofit hospital does not face the prospect of being forced into bankruptcy through an involuntary petition, it has a greater ability to consider a broader range of options. Because of its charitable mission and primary responsibility to its patients and the community it serves, selecting a course of action that discharges these responsibilities first under the jurisdiction of the agency that licenses and regulates the hospital's health care activities, and then turning to resolution of the claims of its creditors in an out-of-court or state court proceeding, can provide a better outcome than resorting to a bankruptcy proceeding in the first instance.


1 Health Care Under Stress: A Financial Profile of Hospitals and Health Systems in New York State, April 2002, Healthcare Association of New York State. Return to article

2 Hospital Statistics, 2002 Ed., American Hospital Association. Return to article

Journal Date: 
Sunday, December 1, 2002