N. Paul Coyle
Tracy L. Schovain
It is common for lenders to collateralize asset-based, cash flow and real estate loans with, among other items of collateral, commercial and governmental receivables. There are distinct variations of, and risks to the lenders in connection with perfecting liens on such receivables and the various accounts into which each such receivable is deposited. This article summarizes certain issues with respect to perfecting a security interest in both commercial receivables and governmental receivables (i.e., health care accounts receivable), provides an overview of the related “bifurcated” lockbox structure and identifies issues in connection with structuring and documenting such health care finance transactions.
Subsets of Health Care Accounts Receivable
Health care accounts receivable are usually classified in one of three categories: governmental collections, commercial collections and self-pay collections. Governmental collections include payments from Medicare, Medicaid, TRICARE and any other governmental health care program (each, a “Governmental Payor”). Commercial collections include payments from commercial health care insurers (i.e., Blue Cross/Blue Shield, etc.) (each, a “Commercial Payor”). Self-pay collections include payments from individual patients. A lender may have a perfected security interest in health care accounts receivable regardless of whether the payments are received from Governmental Payors, Commercial Payors or individuals.
Specific Types of Collateral under the Uniform Commercial Code and Related Perfection Issues
Under the Uniform Commercial Code (“UCC”), payments from Governmental Payors are considered “payment intangibles” [which is a subset of the term “general intangible” under Revised Article 9 of the UCC (“Revised Article 9”)] because such payments are disbursed from federal or state trust accounts and are not paid from insurance policies. Accordingly, lenders obtain a perfected security interest in such receivables the same way as such lenders would by perfecting a security interest in other payment intangibles. This is accomplished by filing a financing statement with the office of the Secretary of State from the state of the borrower’s jurisdiction of organization.
Revised Article 9 introduced “health care insurance receivables” as a new type of collateral—a subset of “accounts.” The term “health care insurance receivables” is defined in Revised Article 9 as “an interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for health care goods or services provided.” The defined term “accounts” in Revised Article 9 specifically includes health care insurance receivables. The term “health care insurance receivables” includes payments from Commercial Payors and individuals, but not payments from any Governmental Payor. As with perfection of liens on accounts and general intangibles, a lender may perfect a lien on health care insurance receivables (a subset of accounts) by filing a financing statement with the office of the Secretary of State from the state of the borrower’s jurisdiction of organization.
A lender’s security interest attaches to the cash proceeds of the health care insurance receivables and payment intangibles when the borrower receives payment. A borrower is deemed to have received payment from a Governmental Payor when such payment is deposited in a deposit account in the name, and under the control, of the borrower (i.e., any health care provider) (a “Governmental Deposit Account”) and a Commercial Payor when such payment is deposited in a deposit account that may be in either the name of the borrower or in the name of the lender (a “Commercial Deposit Account”).
Although a lender will have a perfected security interest in collections from the Governmental Payors, the Medicare anti-assignment rules—and related federal and state rules affecting Medicaid and other governmental health care programs (collectively, the “Anti- Assignment Rules”)—prohibit such lender from having control over the deposit account (and control over the disposition of funds on deposit in the Governmental Deposit Account) thereby preventing such lender from having a perfected security interest in a Governmental Deposit Account. Under Revised Article 9, a secured party must have “control” over a deposit account to be perfected in such account. Therefore, a lender cannot be perfected in any Governmental Deposit Account [recall, the lender is still perfected in the cash proceeds (payment intangibles) deposited into such account].
A lender is able to mitigate any risk from not having a perfected security interest on the Governmental Deposit Account by complying with the Anti-Assignment Rules and implementing a sweep mechanism (i.e., daily). At or shortly after closing of a financing transaction, a borrower will direct certain Governmental Payors to forward payments due to such borrower to a deposit account, which is subject to terms and provisions of a depository agreement by and among the borrower, the lender and the depository bank (the “Governmental Depository Agreement”). The Governmental Depository Agreement should specifically state that: the Governmental Deposit Account shall be subject only to the signing authority of the borrower, the borrower shall have exclusive control of the funds deposited in the Governmental Deposit Account and the depository bank shall be subject only to the borrower’s instructions regarding disposition of the funds in the Governmental Deposit Account. These minimum provisions will satisfy compliance with the Anti-Assignment Rules.
The Governmental Depository Agreement should also contain provisions directing the depository bank to sweep on a periodic basis (i.e., daily) the proceeds on deposit in the Governmental Deposit Account to another account over which the lender has control (i.e., lender’s account). Because the borrower remains in control of the Governmental Deposit Account, the borrower can rescind any sweep order at any time, and the depository bank must comply with any such order. By reducing the balance in the Governmental Deposit Account to zero each day, any risk of the borrower’s redirecting or diverting funds is minimized. Typically, depository banks have their forms of Governmental Depository Agreements, which include most of the foregoing provisions. In the case of a Commercial Deposit Account, control may be achieved through the execution of a traditional deposit account control agreement (the “Commercial Depository Agreement”) by and among the borrower, the lender and the depository bank. Because these payments are from health care insurance receivables and not payments from Governmental Payors, the borrower and the lender are not subject to the Anti-Assignment Rules, and the lender may have control over the Commercial Deposit Account. As a result of not having to comply with the Anti-Assignment Rules, the Commercial Depository Agreement should provide that: payments from the health care insurance receivables are deposited into the Commercial Deposit Account, which may be in the name of the borrower or the lender; and the lender is in control of the Commercial Deposit Account. As stated above, the lender has a perfected security interest in all funds deposited into the Commercial Deposit Account. In addition, the key element of control exists (even though the borrower may have access to the funds in the Commercial Deposit Account); thus, the lender also has a perfected security interest in the Commercial Deposit Account. Having the Commercial Deposit Account in the name of the lender may also mitigate any risk in any bankruptcy proceeding of any borrower as the account is not property of the borrower—thus, not subject to any stay order of the bankruptcy court.
Regulatory Issues with Various Providers and Related Structuring Issues
In connection with structuring health care finance transactions, particular focus should be on the type of health care provider (i.e., the borrower). With asset-based loans, a lender’s focus is with respect to the ownership of the receivable because that receivable will be included in the borrowing base pursuant to which lender will provide loans. These issues arise when considering financing to management services organizations and health care providers subject to the corporate practices of medicine rules in effect in various states. For example, with management services organizations, it is vital to understand whether the receivable included in the borrowing base is the management fee or the underlying receivable from a Governmental Payor. Confirming whether the health care provider actually owns the receivable can be accomplished by reviewing such health care provider’s provider agreement. If the health care provider is a professional corporation owned by physicians and that provider generates the receivable, as long as such physicians assigned all of their rights to such payments and the health care provider generated those receivables using such provider’s provider number, those receivables are considered owned by such provider. Thus, to the extent a lender has a security interest in such receivables, such lender has the right to step into the borrower’s shoes and realize the full value of the receivable, as opposed to a receivable that constitutes a management fee where the lender is only able to realize the value of such management fee.
Similar issues arise in connection with operations transfer agreements and whether the new operator (i.e., the borrower) is using such new operator’s provider number to bill and collect the receivables generated at such facility, or whether such new operator is using the old operator’s (the seller’s) provider number to bill and collect such receivables. If the new operator is using the old operator’s provider number, any and all receivables generated using such old operator’s provider number are the property of the old operator. As stated above, in compliance with the Anti-Assignment Rules, Governmental Payors make payments only into accounts in the name of and under the control of the health care provider (here, the old operator). While there may be provisions in an operations transfer agreement to require the old operator to forward such payments to the new operator (the borrower), there are ways to potentially mitigate risks to the new operator.
In order to protect the lender and the new operator in a downside scenario, the operations transfer agreement should provide that in order to secure the old operator’s obligation to forward such payments from Governmental Payors to the new operator (i.e., daily), the old operator grants a security interest to the new operator in such receivables generated using the old operator’s provider number. The new operator perfects this security interest by filing a financing statement with the office of the Secretary of State from the state of the old operator’s jurisdiction of organization. The lender, in turn, has this financing statement assigned to the lender. Thus, the lender has an indirect security interest in the receivables generated at the facility using the old operator’s provider number and, to the extent necessary (i.e., court order), can direct payment to the lender.
When structuring health care finance transactions, it is essential for the lender to understand the regulatory issues specific to the health care provider, the facts surrounding ownership of certain receivables and how to perfect such lender’s security interest in the various buckets of collateral. As stated above, while lenders may be restricted with respect to certain types of collateral, there are ways to potentially mitigate lender’s risks and avoid being “naked” with respect to certain collateral.
About Duane Morris
Duane Morris has one of the most experienced and respected health law practices in the United States. Our lawyers counsel leading organizations in every major sector of the industry on the business and regulatory aspects of transactions involving healthcare companies, including M&A; connect clients with sources of capital and potential buyers and sellers of businesses; and provide full- service portfolio company representation, including employment and labor, litigation and other areas. As today’s healthcare providers focus on cost-effective ways to deliver healthcare services, Duane Morris develops innovative and creative ways to help healthcare clients increase their profitability and protect their assets. We tailor our services to specific segments of the industry, including hospitals; physicians; post-acute care, long-term care and senior services; information technology; and mHealth, telemedicine and health information technology.
About the Authors
N. Paul Coyle is a partner in the Chicago office of Duane Morris. Mr. Coyle practices in the area of corporate law with a focus on banking and finance issues, concentrating on commercial finance, banks and work for other institutional lenders, primarily in the health care industry. He negotiates and documents asset-based, cash-flow and real estate financing transactions, including health care receivable financings.
Tracy L. Schovain is an associate in the Chicago office of Duane Morris LLP. Ms. Schovain practices in the area of corporate law with a focus on finance transactions. She represents banks, commercial finance companies and borrowers in a wide variety of transactions, including single-lender and multi-lender commercial finance transactions, senior and mezzanine financing, health care financing and bankruptcy-related workout matters.