A principal reason for buying the assets of a distressed business out bankruptcy is to purchase the assets free and clear of liabilities under Bankruptcy Code Section 363.
In this case the buyer agreed to purchase the assets of 4 California hospitals for $610 million. Each of the hospitals received Medi-Cal reimbursement from California for providing health care services to the poor under provider agreements.
However, the seller provider agreements had liabilities to California in excess of $50 million.
The buyer asked the bankruptcy court to sell the provider agreements “free and clear of claims and interests” under Bankruptcy Code § 363, meaning that California would receive no payments in connection with the transfer. California resisted arguing that the provider agreements could not be sold free and clear of the liabilities because they are executory contracts; meaning that the buyer would have to assume the $50 liabilities in order to receive reimbursement under California’s Medi-Cal program.
The buyer argued that the provider agreements were not contracts but part of an entitlement program. The court agreed; saying that the provider agreements “lack a key feature found in all contracts—obligations imposed on both parties to the agreements.”
The court noted that the Medi-Cal provider agreements impose no obligations upon California. The only obligations spoken of in the Medi-Cal provider agreements pertain to the seller. Even these obligations do not constitute consideration for contract purposes, since they merely restate the seller’s pre-existing legal obligations.
The court found that the Medi-Cal provider agreements were akin to a license issued by a government agency, and therefore that the Medi-Cal provider agreements could be sold under § 363. The Medi-Cal provider agreements create a statutory entitlement to bill the Medi-Cal program for providing Medi-Cal services.
The court said that Bankruptcy Code § 363 provides that a sale Seller’s Medi-Cal provider agreements may be sold free and clear of any interest in the agreements, including the $50 million liabilities owed to California under the state’s Medi-Cal laws.
This case is referred to as In Re Verity Health System of California, Inc., Lead Case No. 2:18-bk-20151-ER, Jointly Administered With Case No. 2:18-bk-20162-ER, Case No. 2:18-bk-20163-ER., 2:18-bk-20164-ER, 2:18-bk-20165-ER, 2:18-bk-20167-ER, 2:18-bk-20168-ER, 2:18-bk-20169-ER, 2:18-bk-20171-ER, 2:18-bk-20172-ER, 2:18-bk-20173-ER, 2:18-bk-20175-ER, 2:18-bk-20176-ER, 2:18-bk-20178-ER, 2:18-bk-20179-ER, 2:18-bk-20180-ER, 2:18-bk-20181-ER, United States Bankruptcy Court, C.D. California, Los Angeles Division (September 26, 2019)
This case illustrates the value of purchasing the assets of a distressed business in bankruptcy. But it also demonstrates that not all assets can be purchased free and clear of all liabilities. For example, purchasing executory contract such as valuable lease may come with liabilities that the buyer can’t avoid.
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million
Telephone: 714 273-6291
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