For most bankruptcy practitioners, the sale of a debtor's assets under §363 of the Bankruptcy Code is a common occurrence. Very few would question whether a bankruptcy court has jurisdiction to order the debtor's assets sold to maximize the value of the estate for creditors. However, when the asset involved is a nonprofit acute care hospital, basic assumptions may not necessarily apply. In particular, various states have taken the position that so-called "conversion statutes," which regulate the sale of nonprofit hospitals to for-profit enterprises, apply even inside a bankruptcy case. This article suggests one line of attack that may be successful in working around such objections. Although this article focuses on the Georgia conversion statute, the discussion herein should be applicable to other states, as most conversion statutes are fairly similar in scope and purpose.

The Georgia Hospital Acquisition Act

Section 363 authorizes a trustee to sell assets of the estate. Moreover, §363(f) authorizes the sale of assets free and clear of interests under certain circumstances. In Georgia, as in many states,¹ the legislature has adopted a statute governing the sale of nonprofit hospitals, known as the Georgia Hospital Acquisition Act (GHAA). Under the GHAA, the seller of a nonprofit hospital and a potential purchaser thereof may not enter into any agreement to dispose of hospital assets without first providing the attorney general with at least 90 days' notice of the proposed transaction prior to its consummation. O.C.G.A. §31-7-407. Under the GHAA, the attorney general is required to conduct a public hearing to inquire into certain issues as more fully set forth in O.C.G.A. §31-7-406 and subsequently to issue a report of his/her findings. Finally, if the attorney general finds that any disposition or acquisition of assets violates the GHAA, then any such agreements shall be deemed "null and void," and each nonprofit entity and acquiring entity shall be subject to a fine of up to $50,000. O.C.G.A. §31-7-412. In Sparks v. Hospital Authority of the City of Bremen, 241 Ga. App. 485, 526 S.E.2d 593 (1999), the Georgia appeals court interpreted the scope of the GHAA and held, among other things, that under the GHAA, the attorney general is authorized to "approve or reject" any proposed sale of a nonprofit hospital.

No exception is made in the GHAA for hospitals owned by sellers in bankruptcy. Thus, the operation of the GHAA may directly interfere with the ability of the bankruptcy court to assure that the value of the assets of a debtor operating a nonprofit hospital will be maximized for the benefit of the creditors. As a result, a clear conflict exists between the operation of the Bankruptcy Code and the GHAA, as interpreted by the Georgia appeals court. This brings the Supremacy Clause of the U.S. Constitution into play.

Pre-emption

The acts of state legislatures that interfere with or are contrary to the laws of Congress are invalid under the Supremacy Clause. Gibbons v. Ogden, 22 U.S. 1 (1824). Courts have traditionally recognized three areas where federal law pre-empts state law: (1) express pre-emption, (2) field pre-emption or (3) conflict pre-emption. English v. General Elec. Co., 496 U.S. 72, 78-79 (1990). Under established case law, an actual conflict exists when compliance with both federal and state regulations is physically impossible, or if state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress. Hillsborough County v. Office Automated Med. Lab. Inc., 471 U.S. 707 (1985).

In Perez v. Campbell, 402 U.S. 637 (1971), the issue was the intersection of bankruptcy law and the state of Arizona's regulation of motor vehicles. Pursuant to Arizona law, the Motor Vehicle Division Superintendent had the duty to suspend the license and registration of each operator of a vehicle involved in an accident causing damage exceeding $100, unless the operator could prove financial responsibility by depositing appropriate security to cover the costs of any judgment or by owning liability insurance that would effectively cover those costs. Id. at 640. In the event of bankruptcy, the statute stated that a discharge following the rendering of any judgment resulting from an accident would not relieve the debtor from any of these requirements. Id. at 641.

In Perez, a debtor was ruled to be at fault in an accident with damages totaling $2,425. Id. at 638. Unable to pay the amount, the plaintiff filed for bankruptcy. Id. The court discharged the debtor from all debts, including the $2,425 judgment. Id. at 639. However, while the bankruptcy was pending, the state suspended the plaintiff's license and registration pursuant to the above-described statute. Id. The plaintiff argued that the Arizona statute was in direct conflict with the Bankruptcy Code, therefore violating the Supremacy Clause of the Constitution. Id. at 643. Thus, the issue before the Supreme Court was whether Arizona could include as part of its statutory scheme a section providing that a bankruptcy court's discharge of an automobile accident tort judgment has no effect on the debtor's obligation to repay the creditor. Id. at 643.

The Supreme Court adopted a two-step process to decide whether a state statute conflicts with a federal statute. Id. at 644. Under this process, a court must (1) ascertain the construction of the two statutes and (2) determine whether they are in conflict. Id. Under the first prong of the test, the court focused on the purpose of the Arizona statute, finding it was "to protect the public who use the highways from financial hardship which may result from the use of automobiles by financially irresponsible persons." Id. Turning to the Bankruptcy Code, the court stated that its principal purpose is to give debtors "a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt." Id. at 648. The court determined, based on the construction of Arizona's statute, the purpose and effect of the statute frustrated the Bankruptcy Code by preventing debtors to be free and clear of pre-existing debt. Id. at 656. Accordingly, the court held that the state statute was pre-empted by the Bankruptcy Code. Id.

Lower courts interpreting Perez have held that despite a regulation's concern for protecting the public interest, this purpose does not prevent federal pre-emption of the regulation, if the public interest being protected is pecuniary in nature. See, e.g., Public Service Co. of New Hampshire v. State of New Hampshire (In re Public Service Co. of New Hampshire), 108 B.R. 854, 870 (Bankr. D. N.H. 1989) (noting that while "state police power enforcement of issues dealing with imminent threats to public health and safety are accorded overriding importance notwithstanding bankruptcy proceedings," nonetheless "federal pre-emption is more likely when the state police power involved is economic regulation rather than health or safety"). However, when a true public safety and welfare interest can be shown, pre-emption will not be ordered. See Midlantic National Bank v. New Jersey Department of Environmental Protection, 474 U.S. 494, 507 (1986) (holding that "a bankruptcy court does not have the power to authorize an abandonment [of contaminated property] without formulating conditions that will adequately protect the public's health and safety"); Baker & Drake v. Public Service Commission of Nevada, 35 F.3d 1348 (9th Cir. 1994) (laws regulating operation of taxicabs were held to be for public safety, and thus not subject to pre-emption).

Does the Bankruptcy Code Pre-empt a Conversion Statute?

The first step in determining whether conflict pre-emption is appropriate in the context of a conversion statute is to establish whether the state regulation is an obstacle to accomplishing and executing the full purposes and objectives of Congress, or if compliance with both federal and state regulations is a physical impossibility. See Hillsborough County Fla. v. Office Automated Med. Lab. Inc., 471 U.S. 707 (1985). With regard to the GHAA, the GHAA directly clashes with the Bankruptcy Code, making compliance with one law a violation of the other. According to the GHAA's statutory framework, the attorney general must approve or reject any proposed purchase of a nonprofit hospital by a for-profit corporation. However, §363 of the Bankruptcy Code places this approval power squarely in the hands of the bankruptcy court. If the bankruptcy court approves a proposed sale of a nonprofit hospital, this is a violation of the GHAA, and the attorney general can undo the sale. Thus, compliance with the provisions of the Bankruptcy Code and compliance with the provisions of the GHAA are mutually exclusive.

Once the threshold question of conflict has been resolved, the next step for the court is to decide whether the federal law will pre-empt the state law. As the Supreme Court has outlined in Perez and Midlantic National Bank, federal pre-emption is not appropriate if the statute is designed to protect public health and safety as opposed to public pecuniary interest. Yet with respect to the GHAA, it is difficult to determine the exact intent of the regulation. There is no language to indicate its express purpose. Therefore, the bankruptcy court will have to rely on the statutory construction of the regulation when making its determination.

As noted above, under the GHAA, the attorney general must conduct a public hearing to inquire into the nature of the transaction. O.C.G.A. §31-7-401. The attorney general is required to address certain issues as outlined in O.C.G.A. §31-7-406 that tend to indicate the design and purpose of the regulation. Therefore, the bankruptcy court will most likely rely on this language in making its determination. Under O.C.G.A. §31-7-406, the attorney general is required to address the following:

1. whether the disposition is permitted under the Georgia Nonprofit Corporation Code;
2. whether the disposition is consistent with the directives of major donors who have contributed more than $100,000;
3. whether the governing body of the nonprofit corporation exercised due diligence in deciding to dispose of hospital assets;
4. the procedures used by the nonprofit corporation in making its decision to dispose of its assets, including whether appropriate expert assistance was used;
5. whether any conflict of interest was disclosed, including but not limited to conflicts of interest related to directors or officers of the nonprofit corporation and experts retained by the parties;
6. whether the seller or lessor will receive fair value for its assets;
7. whether charitable assets are placed at unreasonable risk if the transaction is financed in part by the seller or lessor;
8. whether the terms of any management or services contract negotiated in conjunction with the transaction are reasonable;
9. whether any disposition proceeds will be used for appropriate charitable health care purposes;
10. whether a meaningful right of first refusal to repurchase the assets by a successor nonprofit corporation or foundation has been retained, if the acquiring entity subsequently proposes to sell, lease or transfer the hospital to yet another entity;
11. whether sufficient safeguards are included to assure the affected community continued access to affordable care and to the range of services historically provided by the nonprofit corporation; and
12. whether the acquiring entity has made an enforceable commitment to provide health care to the disadvantaged, the uninsured and the underinsured, and to provide benefits to the affected community to promote improved health care.

Based on the case law cited above, pre-emption will hinge on the court's interpretation of the GHAA. The critical factor is whether the regulation's purpose is to protect public pecuniary interest or public health and safety. While the conclusion to be drawn from a review of the above-listed factors is by no means clear, it does not seem that the GHAA has as its chief purpose the protection of public health and safety. That is, whether a nonprofit or a for-profit entity operates a particular health care facility would not seem to implicate public health concerns. Rather, the main purpose of the statute, as evidenced by the factors set forth above, seems to be for the protection of the public's pecuniary interest in ensuring that health care facilities owned by non-profit entities, which have received favorable tax and other benefits by virtue of their nonprofit status generally in exchange for an increased commitment to charity care, continue the same mission for which the state's taxpayers have at least partially paid. This would seem to be pecuniary in nature. Nonetheless, it is a difficult question.

The pre-emption argument was successfully tested in the case of Georgia International Health Alliance Inc., et al., Case No. 00-66092 (Bankr. N.D. Ga.). In Georgia International, the Georgia attorney general ultimately did not oppose entry of a judgment in an adversary proceeding granting declaratory judgment that the GHAA was pre-empted by federal bankruptcy law. The compromise reached with the attorney general was to provide for a public hearing of the type contemplated by the GHAA, with the attorney general given standing to file a report regarding the proposed transaction and to make a recommendation to the bankruptcy court subsequent to such public hearing. However, the attorney general agreed to allow the bankruptcy court to make the final decision regarding the proposed sale of the nonprofit hospital to a for-profit entity (Tenet Healthcare), and to be bound by such decision. Ultimately, the bankruptcy court approved the sale. The result was that the bankruptcy court was able to accommodate at least some of the concerns that led to the passage of the GHAA without surrendering control over the bankruptcy process. This ruling is similar to one reached in 1998 in the case of In re Allegheny Health, Education and Research Foundation, No. 98-25773 (Bankr. W.D. Pa.).

Conclusion

When a nonprofit health care entity files for bankruptcy relief, and where the reorganization strategy might include a sale of assets, attention must be paid to non-bankruptcy laws such as conversion statutes, and a strategy developed for dealing with such statutes. In some cases, a return to core constitutional principles such as the Supremacy Clause and pre-emption may prove beneficial.

Footnotes

¹ Arizona, California, Colorado, Connecticut, Georgia, Hawaii, Idaho, Indiana, Louisiana, Maryland, Nebraska, New Hampshire, New Jersey, Ohio, Oregon, Pennsylvania, Rhode Island, South Dakota and Virginia have all adopted conversion statutes. In addition, in many states, common law allows the state attorney general to exercise such oversight even in the absence of a specific state statute. Return to article