1 st Circuit Permits Recoupment of Medicare Overpayments David A. - - PDF document

NYI-2168912v1 RecoupmentBRRArticleOctNov2004 JP003318 079983 - 041016

1st Circuit Permits Recoupment of Medicare Overpayments David A. Beck The Bankruptcy Code's automatic stay is often thought of as an absolute bar to the collection of a pre-bankruptcy debt from a debtor outside of the bankruptcy process. However, while the scope

• f the automatic stay is broad, it does not preclude creditor collection efforts in all cases. One of

the most important exclusions from the reach of automatic stay is the common law doctrine of "recoupment." The 1st Circuit Court of Appeals recently reaffirmed the continuing vitality of this doctrine in In re Holyoke Nursing Home, Inc.. In doing so, the Court joined the majority of jurisdictions ruling that the doctrine of recoupment permits the Health Care Financing Administration (the "HCFA") to collect pre-petition debts of a chapter 11 debtor by withholding post-petition payments. Recoupment Versus Setoff in Bankruptcy The decision of the 1st Circuit rests on the distinction between the related doctrines of setoff and

• recoupment. Both remedies are a means of settling debts between parties who hold mutual
• bligations. Outside of bankruptcy, there is usually little reason to distinguish between the two
• doctrines. However, if the debtor files for bankruptcy, much may hinge on whether a creditor

initiative amounts to setoff or recoupment. The right of setoff “allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding ‘the absurdity of making A pay B when B owes A.’" The Bankruptcy Code does not create a right of setoff — it merely preserves whatever right existed under applicable non-bankruptcy law. Exercising that right requires three things: mutuality, temporal coincidence and relief from the automatic stay. The mutuality requirement demands

NYI-2168912v1 RecoupmentBRRArticleOctNov2004 JP003318 079983 - 041016

that each party owns its claim, with the right to collect in its own name. The claims need (and indeed can) not arise out of the same contract or transaction, nor must they be of the same

• character. Temporal coincidence means that the countervailing claims must have arisen prior to

the debtor’s bankruptcy filing. Finally, the right is not unfettered ― a party wishing to exercise its setoff rights must seek approval of the Bankruptcy Court and an order lifting the automatic

• stay. It is within the court's discretion when and under what circumstances to permit the

exercise of setoff rights. Generally, there is a judicial presumption favoring setoff if the previously discussed conditions are satisfied. However, because setoff undermines a basic premise of bankruptcy — equality among creditors — courts must weigh the right to setoff against the resulting prejudice to other creditors. A right to recoupment arises when one party to a contract or transaction overpays the

• ther such that the first party holds a credit balance that can be applied to reduce future payments

due under the contract. It is distinguishable from setoff in that the recoupment claim and the debtor's claim for future payment arise from a single transaction or contract. The distinction is an important one, given the inapplicability of the automatic stay to a creditor’s recoupment

• remedies. Also, some courts find that recoupment claims are not subject to the temporal

coincidence requirement governing setoff claims, such that a creditor can recoup pre-bankruptcy

• verpayments against post-petition obligations.

The First Circuit's Decision in Holyoke Nursing Home In Holyoke, the Court of Appeals confronted the issue of what constitutes a "single transaction" in the context of the relationship between the HCFA and a Medicare provider. Under the Medicare Reimbursement Program, the HCFA reimburses providers for the estimated cost of

NYI-2168912v1 RecoupmentBRRArticleOctNov2004 JP003318 079983 - 041016

services provided to Medicare patients. The HCFA then periodically audits the provider's books to determine the reasonableness of the provider's charges. The HCFA then has the statutory power to adjust future payments to the provider to collect any overpayment or to make the provider whole for previous underpayments that are discovered in the audits. If the HCFA discovers that a provider has received significant overpayments, it has the statutory right to withhold Medicare payments until the discrepancy has been remedied. Holyoke Nursing Home, Inc. became a part of the Medicare Reimbursement Program in

• 1990. In 2000, HCFA determined that it had overpaid Holyoke $373,639 for services rendered

in cost years 1999 and 1998. In accordance with its statutory authorization to recover

• verpayments by payment withholding, HCFA started to withhold funds from Holyoke in 2000.

Holyoke filed for bankruptcy later that year. After the bankruptcy filing, HCFA continued to withhold payments due to Holyoke. In response to the withholding of a major part of its revenue, Holyoke filed an adversary proceeding alleging that HCFA's pre-petition retention of payments constituted an invalid preferential transfer and that HCFA's post-petition withholding

• f Medicare payments violated the automatic stay.

After discussing the difference between recoupment and setoff, the 1st Circuit proceeded to consider what constituted a single transaction within the Medicare Reimbursement Program so as to permit the application of the recoupment doctrine. The Court observed that "[n]either the Medicare statute, the Bankruptcy Code nor their respective legislative histories treats the issue before us." The Court further noted that its sister circuits have split on what constitutes a single transaction under the Medicare Reimbursement Program. Under one view, which was adopted by the 3d Circuit in In re University Medical Center, only activity within a given cost year constitutes a single transaction. Debts owed with

NYI-2168912v1 RecoupmentBRRArticleOctNov2004 JP003318 079983 - 041016

respect to different years do not arise out of the same transaction. Thus, in the 3d Circuit's view, when the HCFA withholds payments in one cost year to recover overpayments in an earlier cost year, it impermissibly sets off those obligations in violation of section 362(a)(7). The District of Columbia Circuit, the 9th Circuit and the majority of lower courts take the contrary position that debts arising in different cost years arise out of a single transaction for purposes of recoupment. The First Circuit adopted the view of the majority of courts which have examined the question of what constitutes a single transaction by finding that activity in multiple cost years can constitute a single transaction for purposes of the recoupment doctrine. According to the Court of Appeals, the Medicare statute seems to contemplate that payments and withholdings under it constitute a single flow rather than separate transactions for each individual cost year. For instance, the First Circuit explained, both the Medicare statute and the provider agreement between HCFA and Holyoke contemplated a system where payment is made for estimated costs, with later corrective audits and retroactive adjustments. This and other aspects of the contractual relationship between Holyoke and HCFA led the Court to conclude that the payments and credits were not a series of discrete transactions for individual cost years, but instead, a single ongoing integrated transaction. It found that the continuous method of adjusting payments under the Medicare Reimbursement Program means that debts in different cost years still arise out of the same transaction. The First Circuit accordingly ruled that HCFA could recoup Holyoke's

• bligation to repay pre-petition overpayments from amounts due to Holyoke after it filed for

bankruptcy. In doing so, it rejected Holyoke's argument that equitable concerns justify barring recoupment because allowing it would deprive Holyoke of cash flow necessary to the success of its reorganization effort. According to the Court of Appeals, "public policy would be ill-served

NYI-2168912v1 RecoupmentBRRArticleOctNov2004 JP003318 079983 - 041016

by permitting insolvent providers ― like Holyoke ― a windfall at the expense of other Medicare providers which have managed their facilities prudently to avoid chapter 11." Analysis The First Circuit's decision in Holyoke is significant both inside and outside of the healthcare

• industry. For the health care industry, Holyoke provides further caution that debtors outside the

3d Circuit are unlikely to be able to claim the protection of the automatic stay to stop HCFA from recovering pre-petition overpayments by withholding post-petition payments. These debtors will instead have to try to reach a consensual resolution regarding the overpayments to prevent HCFA from unilaterally exercising recoupment rights in a way that could destroy any prospects for the provider to reorganize. The ruling is also important in other contexts. It illustrates that courts may be more willing to interpret liberally the "same transaction" requirement pivotal to determining whether a creditor's remedy amounts to setoff or recoupment. As contractual relationships and transactions become increasingly sophisticated and complicated, an expansive definition of "same transaction" may be a welcome development for creditors intent upon minimizing exposure

• ccasioned by a bankruptcy filing.

____________________________ Holyoke Nursing Home, Inc. v. Health Care Financing Administration (In re Holyoke Nursing Home, Inc.), 372 F.3d 1 (1st Cir. 2004). In re University Medical Center, 973 F.2d 1065 (3d Cir. 1992). United States v. Consumer Health Services of America, Inc., 108 F.3d 390 (D.C. Cir. 1997) In re TLC Hospitals, Inc., 224 F.3d 1008 (9th Cir. 2000).