Insolvent Nonprofit Hospital’s 363(f) Sale Was Free of a $305 Million Cost Imposed by CA AG


The sale of the assets of a nonprofit hospital in California requires the permission of the state’s attorney general.

The deal

This deal involves the Bankruptcy Code Section 363(f) sale of four California nonprofit hospitals in bankruptcy for $610 million. I talked about this deal already in connection with the bankruptcy court’s ruling that the sale would be free of $50 million of seller’s Medi-Cal liabilities. See Buyer’s Section 363 Purchase of Bankrupt Hospital Assets Is Free of Medi-Cal Liabilities;

The lawsuit

Under California law, nonprofit hospitals can’t be sold without the approval of the state of California; which can impose conditions to its consent. Here, California consented to the sale, subject to various conditions. In particular, two of the conditions imposed an additional financial burden upon the buyer of approximately $305 million. First, the conditions required that the buyer continue to operate one of the hospitals as a licensed general acute care hospital through December 2024. The buyer had agreed to maintain the hospital’s general acute care license only through December 2020. The buyer estimated that continuing to operate the hospital as a general acute care hospital for an additional four years would cost approximately $285 million.

Second, the conditions required another of the hospitals to provide annual charity care in an amount of $13 million for six fiscal years. The required charity care amount is approximately $6.4 million more than the charity care that this hospital provided in fiscal year 2019. The charity care requirement imposed an additional incremental cost of approximately $20 million.

The buyer would not close the sale absent an order finding by the bankruptcy court that the hospitals can be sold free and clear of these conditions pursuant to § 363(f) of the Bankruptcy Code.

The seller was facing very significant liquidity constraints. Recently, California began withholding certain Medi-Cal fee-for-service payments owed to the seller, for the purposing of recovering alleged Medi-Cal overpayments. As of the beginning of October 2019, California had withheld approximately $4.5 million. The seller did not have the ability to borrow under any debtor-in-possession financing facility. At this time, the seller was financed by a by agreement between the seller and the principal secured creditors. Termination of the asset purchase agreement with the buyer would constitutes an event of default under this financing agreement. The court found that it was unclear whether the seller would be able to obtain alternative financing. Further, the seller must begin the expensive process of closing the hospitals while it still possesses a significant cash buffer. In short, the failure of this sale would probably necessitate the closure of three of the four hospitals.

Under these facts, the court permitted the sale of the hospitals free and clear of California’s $305 million worth of conditions under Bankruptcy Code 363(f).

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 No. 2:18-bk-20162-ER, 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 (October 23, 2019)  


The court noted another bankruptcy acquisition where section 363(f) was very useful in the context of seller liabilities to a state. That transaction involved Massachusetts unemployment taxes.

The taxes were computed based on the seller’s “experience rating,” which was determined by the number of employees it had terminated in the past. Because the bankrupt seller had terminated most of its employees prior to selling its assets, its experiencing rating, and corresponding unemployment insurance tax liabilities, were very high.  The court approved a section 363(f) sale to its buyer free of the seller’s very high unemployment insurance tax liabilities.

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



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Posted in bankruptcy sale, distressed business acquisitions, Section 363 sale, state approval of nonprofit hospital Tagged with: , ,

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