Managing a struggling hospital: Legal duties and pitfalls

A Law Review Q&A

Revenue uncertainty and cost pressures continue to threaten hospital operating margins nationwide. While financial performance has rebounded for many providers across 2013, declining payment and lackluster inpatient volumes are expected to make it difficult to remain profitable in the future.

For struggling hospitals, proactively addressing financial woes early-on can prevent a host of operational and legal consequences. Yet, management is often slow to recognize and effectively address fiscal challenges until it’s already too late—potentially exposing leadership to personal liability.

We spoke with Michael P. Richman and Peter S. Partee, Sr. from the firm Hunton & Williams LLP to discuss strategies to successfully navigate financial woes, legal risks for management, and tactics to chart a sustainable path to solvency.

1. What are the principal legal responsibilities and duties of which management of a struggling hospital should be aware? 

The most important responsibility is to recognize and address financial distress—and to seek professional assistance—as early as possible. Denial and delay will inevitably lead to poorer outcomes. This is a practical responsibility, rather than a strictly legal one, but it assures that management is properly attuned to protecting the value and viability of the hospital, which is their main legal responsibility and duty.

2. Where do hospitals most often run into difficulties in responding to fiscal woes? When may the actions of leadership involve personal liability?

Over and over again, we find that management takes too long to recognize that there are financial issues to be addressed or appear to "bury their heads in the sand." We also have seen many instances where bankruptcy (and other) courts, with the benefit of hindsight, are critical of such management indifference.

The strongest and most protective response is to bring in outside professionals—financial advisors and turnaround specialists, as well as legal counsel—to work aggressively at managing the problems and providing solutions, and to do so at the first objective signs of distress.

That said, the human failure of delay does not necessarily lead to personal liability. Unless management appears to be acting in their self-interest or otherwise in a manner that serves interests other than protection of the hospital enterprise (or unlawfully), personal liability is rare. Management’s reasonable business judgment is generally accorded great deference in any subsequent legal dispute. Nonetheless, we think that the chances of personal liability may increase with the scale of the delay.


3. How can administrators proactively mitigate their legal risk during a financial crisis?  What steps can be taken to get an organization back on track?

There is no question that having outside legal counsel involved as early as possible presents the greatest mitigation of the legal risks to hospital management and administrators. Knowledgeable and experienced counsel will guide management, and in line with the deference ordinarily accorded to reasonable business judgment, it would be difficult for a court to find management liable for following the advice of experienced counsel.

Likewise, having outside financial assistance from any of the advisory firms who specialize in distressed hospital turnarounds is not only an excellent way to mitigate risk, but also, working with counsel, a great way to develop and implement plans to put the organization back on track. There is no one way this should be done; every hospital financial crisis is unique. There may be a wide variety of steps that would have to be implemented, running the gamut from cost cutting, personnel adjustments, claims management (and reimbursement management), capital improvements, financial and lending arrangements, and many associated matters.

4. At what time is bankruptcy an appropriate and effective option to restore the financial viability of a hospital? 

While we are experienced bankruptcy lawyers, we always counsel that bankruptcy should be the very last option when there is no reasonable likelihood of restructuring and putting the hospital back on track outside of court. There is one primary exception: Sometimes a bankruptcy is a useful restructuring tool when there is agreement among most of the important management and financial participants in a restructuring and bankruptcy can overcome dissenters. This is a process known as a "prepack," which indicates a bankruptcy plan is already prepared and largely agreed upon.

Additionally, there may be some situations (which are typically encountered when management has delayed too long in seeking outside professional assistance) where some particularly hostile or adverse action, like a foreclosure, is about to be launched by a lender or other party. In this case, bankruptcy is a prudent means of stopping such action because once filed, the bankruptcy petition triggers section 362 of the Bankruptcy Court which implements the "automatic stay," freezing all outside adverse actions against the hospital.

If bankruptcy becomes necessary under any scenario, there are many tools provided to enhance the chances of a successful restructuring.

Your legal counsel team should be well-versed in the bankruptcy options and strategies so that you are advised of those alternatives early, and these may be considered and used in the context of the out-of-court restructuring negotiations that will likely take place.

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