In re Gardens Regional Hosp. & Med. Ctr., Inc., __ F.3d __, 2020 WL 5541387 (9th Cir., Sept. 16, 2020)
Gardens Regional Hospital and Medical Center was a private, nonprofit hospital participating in Medi-Cal. Gardens Regional received payments through Medi-Cal’s “fee-for-service” system, and supplemental payments through California’s Hospital Quality Assurance Fee (HQAF) program. HQAF is a broad-based healthcare tax on most non-public hospitals in the state. It is not a prohibited “circular-funding” practice because the collected taxes are deposited into a separate fund to be used for enumerated purposes, one of which is to make supplemental payments to Medi-Cal participants.
Gardens Regional stopped paying its HQAF assessments, filed for bankruptcy, and ceased operations. The State recovered Gardens Regional’s pre- and post-petition HQAF debt by withholding both Medi-Cal service payments and HQAF supplemental payments. Gardens Regional responded that the State’s withholding of post-petition funds violated the Bankruptcy Code’s automatic stay, which prohibits a setoff by a creditor of any debt after the debtor files a bankruptcy petition. The State argued it had properly claimed recoupments, which are exempt from the automatic stay. The bankruptcy court and the Ninth Circuit Bankruptcy Appellate Panel agreed with the State, and Gardens Regional appealed.
The Ninth Circuit affirmed in part and reversed in part, holding that some of the State’s deductions were proper recoupments, while others were improper setoffs. To qualify as a recoupment, “the rights being asserted against the debtor” must be closely and logically related to “the debtor’s countervailing obligations[,] such that they may be fairly said to constitute part of the same transaction.” Thus, the State’s recovery of unpaid HQAF assessments by withholding supplemental HQAF-funded supplemental payments was proper—there was an obvious connection between the two. However, no logical connection existed between unpaid HQAF assessments and the Medi-Cal fee-for-service payments that the State separately owed Gardens Regional, so the Sate’s deductions of those assessments were setoffs violating the bankruptcy stay.
