Developing a Game Plan for Healthcare Organizations Entering Chapter 11

January 25, 2021

By Michael Sandnes

This article originally appeared in ABF Journal.

COVID-19 forced hospitals, rural health clinics, health systems and other healthcare organizations to face unprecedented circumstances, some of which manifested in factors that lead to insolvency, such as extreme credit crises, competition, increased costs and cash shortfalls. The American Hospital Association predicted that 800 acute care hospitals either exhausted their revenue sources by the end of 2020 or will do so in Q1/21, forcing many into a Chapter 11 bankruptcy filing, reorganization or immediate sale of all assets.

During this unprecedented time, it is critical that CEOs demonstrate strong and decisive leadership to influence facility operations when facing the likelihood of closing. With the clock ticking and time running out, smart and savvy CEOs can make the difference between a facility that survives, possibly in a different form, or one that closes its doors, which will lead to job losses and a liquidation of all assets.

In most cases, when an out-of-court solution is no longer practical, healthcare operations file for Chapter 11 protection, whereby the company becomes a debtor-in-possession and the executive team continues to control the assets while managing the day-to-day business. Approvals from the bankruptcy court, of course, are required for certain actions, including financing through DIP loans, asset sales, employee incentives and fee payments to professionals.

A good game plan is essential for a CEO when preparing to file Chapter 11. That plan must demonstrate there will be flexibility afterward to address changing circumstances. This includes developing a comprehensive and unambiguous communication plan; informing various constituencies such as the board of directors, employees, medical staff, elected officials and the community; knowing and understanding the facility’s ever-changing status; and presenting operational recommendations to the board on an ongoing basis. To complicate matters further, creditor vendors will be organized into an official committee of unsecured creditors, which will attempt to influence the direction of the bankruptcy. Furthermore, appropriate notification to the Department of Health, Department of Human Services, other state agencies, and the families of patients in the hospital is critical. Leadership’s failure to achieve a turnaround could require the hiring of a chief restructuring officer/financial advisory consultant to oversee operations and remove authority from the CEO.

A Movement Toward Shallower Waters

Within the last few months, several major healthcare entities located on the Eastern Seaboard and in the central U.S. have filed for Chapter 11 bankruptcy protection. These have included acute care hospitals, physician organizations, imaging centers, nursing homes and assisted living centers. Simply put, any assistance provided by government stimulus programs have not been enough. Issues such as decreased reimbursements, holds on elective procedures, increasing costs related to COVID-19, increased cases of indigent care, aging facilities and expensive technology have all contributed to this deteriorating trend. Indications are that more bankruptcies are looming during 2021.

Many of these healthcare entities do not have the management resources, time or sophistication to determine if and/or when they may have passed the point of no return and entered the insolvency zone. This is the time when a strong financial advisory team with clear expertise in bankruptcy, restructuring, financial services and asset disposition services can be essential in moving an organization forward, specifically when applied to the following key areas.

Assessment and Implementation

In some cases, an organization requires assistance to perform an assessment and evaluation of the senior leadership. It also can require robust action plans to illuminate the causes of continuing losses in order to develop strategies designed to close cost gaps. This includes assessing an organization’s short- and long-range viability, business model, facilities and equipment, and contracts, as well as the compatibility of present leadership and how that will impact any future market downsizing plans. The tough steps — such as consolidation, employee layoffs, company downsizing, implementation of plans with definitive timelines — must occur immediately to stem losses and reposition the healthcare entity for its future. Additional mitigation may include closing unprofitable entities and liquidating assets. Most importantly, developing an inclusive action plan will allow employees and physicians to foster confidence and good will with the surrounding communities so they can work together for successful outcomes.

Short-Term Cash Flow

Preparing an initial 13-week cash flow is critical to properly develop a detailed action plan that reflects operations and how an institution can make ends meet. The team must analyze underperforming facilities/operations for cost reductions, validate cash collateral budgets and ensure lenders’ security interest in the debt. This must be done with an eye toward the organization’s mission, quality of care and community perception. The team also must determine if other sources of funding, such as a DIP financing, are needed.

Asset Valuation

The team needs to perform market valuations of the business, the equipment and the real estate properties, as well as test-market alternative uses of the property. A determination of asset values can help inform what management can hope to achieve and utilize in a reorganization.

Reorganization Alternatives

  • The advisory team must assess strategies that maximize a return to creditors and evaluate various reorganization plans, including:
  • Reorganization and whether to conduct asset sales vs. affiliations or conduct asset sales vs. liquidation
  • Assistance with the development/negotiation of a reorganization plan
  • Identification of potential affiliation partners and/or buyers with appropriate resources and cash infusion
  • Liquidation and sell off of all unproductive assets and evaluation of third-party bids
  • Other Sources of Recovery

Lastly, the team must assist in the identification of other potential sources of recovery, including preference and fraudulent conveyances, and provide expert testimony on matters such as the feasibility of a plan of reorganization.

It is incumbent upon each CEO to remain vigilant and identify five common signs that indicate an organization may be headed into trouble, including:

  1. Excessive debt
  2. Contingent liabilities
  3. Profitability and liquidity issues
  4. Continuous borrowing
  5. Inability to pay down current or impending debt

Many companies in bankruptcy will require radical restructuring, asset sales and employee layoffs. These tough and often painful decisions may be the only way for an organization to survive. The CEO or board must select the right people for the executive team and establish performance metrics to make sure plans proceed in the right direction while adhering to a strict timeline. In addition, leadership must show compassion toward employees to engender trust and support.

The implementation of a business turnaround plan must be monitored with intensity and accountability. The first goal is understood to be stabilizing cash flow and preventing it from diminishing. Sales and profit centers need to be analyzed, with decisions made based on which areas increase revenue and which need to be scaled down or eliminated.

In summary, it all comes down to the ability of a CEO to successfully lead the organization back toward solvency, notwithstanding the challenges of the position or the ever-changing financial landscape.

About Michael Sandnes

Michael Sandnes is a Director in the Financial Advisory Services Group, with over 15 years of expertise in the health care industry.