Critical List – New Case of Interest to Health Care and Bankruptcy Attorneys
Ivan L. Kallick and James P. MentonManatt's Employer Alert
Health care and bankruptcy law used to have so little in common that legal practices in those areas were completely unrelated. Managed health care has changed that, however, and the convergence of bankruptcy and managed health care is presenting courts with new situations that are either healthy or unhealthy, depending on one's perspective.
Those involved in the health care industry and bankruptcy law need to be aware of Pardo v. PacificCare(In re APF Co.), 2001 WL 811685 (Bankr. D. Del. 2001), in which a health plan was sued to recover capitation payments that the plan withheld from a financially troubled health care provider that subsequently filed for Chapter 11 relief.
In this case of first impression, the Bankruptcy Court refused to grant the health plan's motion to dismiss for failure to state a claim. The court also refused to grant the health plan's motion to compel arbitration.
The dispute in Pardo involved medical management contracts between four entities of PacificCare(a health maintenance organization) and APF Co. and its affiliates. APF was a national physician practice-management company that entered into contracts with PacifiCare. The contracts required APF to make medical services available to enrollees of PacifiCare.
In return, PacificCareagreed to pay APF a monthly capitation fee. A capitation fee is a set monthly dollar amount paid by a health plan to a health care provider for services that may be rendered by a provider to a health-plan enrollee. The contracts required APF to pay medical service providers directly. PacificCarereduced its capitation payments when APF's financial troubles prevented APF from making direct payments to the medical-service providers.
In July 1998, APF filed for relief under Chapter 11 and confirmed a Chapter 11 plan. Then, the trustee of the creditor trust and the plan administrator filed an adversary proceeding (a lawsuit filed in the bankruptcy court) against PacificCareto recover withheld capitation payments, for an accounting of missed payments and to recover damages for willful violation of the automatic stay that went into effect upon the filing of the bankruptcy case.
In response, PacificCare filed a motion to dismiss for lack of standing under Federal Rule of Civil Procedure 12(b)(1) and failure to state a claim under Rule 12(b)(6) or, in the alternative, for a more definitive statement of the case under Rule 12(e).
Alternatively, PacificCare filed a motion to compel arbitration. The Bankruptcy Court, in a lengthy, published opinion, denied all of the motions.
The court held that the plaintiffs had standing to jointly assert the counts in the complaint. The court noted that the legal character of the capitation payments had not yet been determined but that "[t]he possibility that some recoveries may prove mutually exclusive ... does not prevent the Trustee or Plan Administrator from pleading all legal theories under which either or both may be entitled to recover."
The court subsequently found that the complaint adequately pleaded a factual basis to support the plaintiffs' standing to assert the counts, based on plan provisions that gave the plaintiffs rights to seek certain relief and pursue certain remedies and Bankruptcy Code Section 1123(b), which describes what may be provided for in a plan.
After deciding the standing issue, the court determined that PacifiCare's failure-to-state-a-claim argument lacked merit, thereby warranting denial of the motion to dismiss. The court refused to dismiss those claims seeking to avoid paying the capitation fees on the ground that they were invalid pre-petition setoffs under Bankruptcy Code Sections 553(b) and 550. Section 553(b) provides a creditor with certain rights of setoff under certain circumstances. Section 550 provides for the avoidance of certain transfers. The court reasoned that the allegations gave PacificCarefair notice of the nature of the claims asserted and established a colorable claim under Section 553(b).
The court also refused to dismiss those claims seeking turnover of the withheld capitation fees under Bankruptcy Code Section 542. The court rejected PacifiCare's argument that the plaintiffs had failed to plead claims for turnover because the claims were not fully mature and payable on demand and because the withheld funds were not estate property, as required by Section 542.
Given the complexity of the contractual relationships and the absence of relevant contracts or other evidence before it, the court determined that the plaintiffs would be entitled to offer evidence to establish these requirements, thereby making dismissal unwarranted.
Dismissal was also inappropriate for those claims seeking avoidance and recovery of the withheld capitation fees as preferential transfers under Bankruptcy Code Sections 547 and 550. Section 547, dealing with recovery of preferences, and Section 550, dealing with avoidance, were put forth as means to recover the unpaid capitation fees. PacificCareargued that setoffs cannot be preferences as a matter of law and that, as a result, the complaint fails to state a cause of action because it alleges both setoff and preference claims.
The court rejected this argument, finding that the plaintiffs could allege both improper setoff and preference claims. The court reasoned that a pre-petition setoff is a defense to a preference action, but the possibility of such a defense does not warrant dismissal.
One claim in the complaint alleged that PacificCarewillfully violated the automatic stay by withholding capitation fees post-petition without Bankruptcy Court approval. The court held that the plaintiffs had adequately pled a claim for violation of the automatic stay, noting that it had entered an order expressly prohibiting PacificCareand like creditors from withholding and offsetting monthly capitation payments due APF.
The court also determined that the automatic stay applied to corporate debtors, not just to individuals, thereby allowing recovery of damages. The court also held that even if that were not the case, recovery of damages could be fashioned as appropriate relief under Bankruptcy Code Section 105, which provides a court with the discretion to provide relief necessary and appropriate to carry out the provisions of Title 11.
In addition, PacifiCare's alternative motion for a more definitive statement as to all counts under Rule 12(e) was denied on the basis that the complaint was not ambiguous and provided fair notice of the nature and basis for each claim asserted and a general indication of the type of litigation involved. Any of the purported deficiencies in the complaint were factual and could be resolved through discovery.
As an alternative to dismissal, PacificCaresought to stay the adversary proceeding pending arbitration because of purported arbitration clauses contained in the contracts between PacificCare and APF, which PacificCarealleged must be enforced under the Federal Arbitration Act.
Relying on Hays and Co. v. Merrill Lynch, Pierce, Fenner & Smith Inc., 885 F.2d 1149 (3rd. Cir. 1989), PacificCareargued that the arbitration clauses must be enforced because the plaintiffs' claims are derivative of APF's rights under the pre-petition contracts and, therefore, arbitrating the claims cannot seriously jeopardize the objectives of the Bankruptcy Code as a matter of law. The claims are derivative, PacificCareargued, based on the plan, which assigns the plaintiffs the claims.
The court rejected PacifiCare's argument, holding that the plaintiffs' claims are not subject to mandatory arbitration. The court reasoned that the plaintiffs were asserting the claims on behalf of creditors; therefore, the claims derive from the Bankruptcy Code rather than from the debtors. As a result, the claims are not subject to mandatory arbitration, because their pursuit is on behalf of creditors, not parties to the arbitration agreement.
The court also refused to exercise its discretion to compel arbitration. The court noted that the motion to arbitrate seemed premature because it sought to stay the entire adversary proceeding, even though PacificCareadmitted that not all of the contracts have arbitration clauses and some of the contracts had not even been located. "Arbitrarily staying the adversary proceeding to resolve only those claims which are based on contracts that happen to contain arbitration clauses," wrote the court, "will result in piecemeal litigation and unnecessary expense for both parties."
Moreover, the court reasoned, staying the adversary proceeding would seriously jeopardize the objectives of the Bankruptcy Code, which include preservation of the estate by not wasting limited resources on litigation of similar cases in different geographical areas, centralized resolution of purely bankruptcy issues and application of established bankruptcy procedures. A stay for arbitration would also disrupt equality of distribution, because "it would give any aggrieved party who could cite to an arbitration clause in its contract an exalted status over all other creditors."
Although aware of the strong federal policy favoring arbitration, the court concluded that Bankruptcy Court was the most efficient and effective forum in which to resolve "these fundamental Bankruptcy Code issues," particularly when the parties had not requested arbitration outside of bankruptcy.
The result of this lengthy opinion by Judge Peter Walsh has yet to be determined. An appeal is likely, and the ultimate outcome of the litigation, if allowed to proceed, is unpredictable.
What is evident, however, is that it will be worthwhile for practitioners to continue to check on the health and condition of Pardo. The ruling is one of first impression that other Bankruptcy Courts may find persuasive.
Ivan L. Kallick, a partner in the Los Angeles office of Manatt, Phelps & Phillips, has a practice that includes health care and bankruptcy law. James P. Menton, an associate in the Los Angeles office, practices in the firm's litigation unit.
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© 2013 Manatt, Phelps & Phillips, LLP. All rights reserved.