In Re Valley Health System

Citation429 B.R. 692
Decision Date08 April 2010
Docket NumberAdversary No. 6:09-ap-01708-PC.,Bankruptcy No. 6:07-bk-18293-PC.
PartiesIn re VALLEY HEALTH SYSTEM, a California Local Health Care District, Debtor.Prime Healthcare Management, Inc., a California corporation, et al., Plaintiffs,v.Valley Health System, a California Local Health Care District, et al., Defendants.
CourtUnited States Bankruptcy Courts. Ninth Circuit. U.S. Bankruptcy Court — Central District of California

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Marc W. Rappel, Esq., Robert A. Klyman, Esq., Nathan M. Smith, Esq., Latham & Watkins LLP, Los Angeles, CA, for Plaintiffs, Prime Healthcare Management, Inc., et al.

Gary E. Klausner, Esq., Stutman, Treister & Glatt, P.C., Los Angeles, CA, Daniel K. Spradlin, Esq., M. Lois Bobak, Esq., Woodruff, Spradlin & Smart, APC, Costa Mesa, CA, for Debtor and Defendant, Valley Health System.

R.D. Kirwan, Esq., Carlyle W. Hall, Jr., Esq., Akin Gump Strauss Hauer & Feld LLP, Los Angeles, CA, for Defendant, Physicians for Healthy Hospitals.

Samuel R. Maizel, Esq., Pachulski Stang Ziehl & Jones LLP, Los Angeles, CA, for the Official Committee of Unsecured Creditors.

Peter J. Mort, Murrieta, CA, for Kali P. Chaudhuri.

Jay N. Hartz, Esq., Robert A. Davis, Jr., Esq., Hooper Lundy & Bookman, Inc., Los Angeles, CA, for Hemet Community Medical Group, Inc.

MEMORANDUM DECISION RE: CONFIRMATION OF FIRST AMENDED PLAN OF ADJUSTMENT OF DEBTS OF VALLEY HEALTH SYSTEM DATED DECEMBER 17, 2009, AS MODIFIED ON FEBRUARY 19, 2010, AND ADJUDICATION OF THE CHALLENGE ACTIONS

PETER H. CARROLL, Bankruptcy Judge.

Valley Health System, a California Local Health Care District (VHS) seeks confirmation of its First Amended Plan for the Adjustment of Debts of Valley Health System Dated December 17, 2009, as modified on February 19, 2010 (the “Modified First Amended Plan”) pursuant to § 943(b) of the Bankruptcy Code,1 dismissal of the complaint in the above referenced adversary proceeding, and adjudication of other causes of action alleged by Save the Hospitals, Inc.,2 Prime Healthcare Services, Inc.,3 Prime Healthcare Management, Inc.,4 Albert L. Lewis, Jr. (“Lewis”), John Lloyd (“Lloyd”), and Edward J. Fazekas (“Fazekas”) 5 that arise under state law and impact the feasibility of VHS's Modified First Amended Plan. At the hearing, Gary E. Klausner, Daniel K. Spradlin, and M. Lois Bobak appeared for VHS; R.D. Kirwan and Carlyle W. Hall, Jr. appeared for Physicians for Healthy Hospitals, Inc. (“PHH”); 6 Marc W. Rappel, Robert A. Klyman, Nathan M. Smith, and Daniel P. Brunton appeared for Save the Hospitals, Inc., Prime Healthcare Services, Inc. and Prime Healthcare Management, Inc. (collectively, Prime), Lewis, Lloyd, & Fazekas; 7 Samuel R. Maizel appeared for the Official Committee of Unsecured Creditors (the “Committee”); 8 Peter J. Mort appeared for Kali P. Chaudhuri, M.D. (“Chaudhuri”); Nathan F. Coco appeared for U.S. Bank, as Indenture Trustee for the holders of the Valley Health System Certificates of Participation (1993 Refunding Project) and the Valley Health System District Revenue Bonds (Refunding and Improvements Project) 1996 Series A (“U.S. Bank”); and Jay N. Hartz and Robert A. Davis, Jr. appeared for Hemet Community Medical Group, Inc. (“HCMG”). The court, having considered VHS's Modified First Amended Plan, the petitioners' objections thereto,9 the petitioners' claims against VHS under state law,10 the evidentiary record, and arguments of counsel, makes the following findings of fact and conclusions of law 11 pursuant to F.R.Civ.P. 52(a)(1), as incorporated into FRBP 7052 and applied to contested matters by FRBP 9014(c).

I. STATEMENT OF FACTS
A VHS-The District

VHS is a public agency formed in 1946 under the State of California Local Health Care District Law (“LHCDL”).12 VHS serves a district that encompasses 882 square miles in the San Jacinto Valley in Riverside County, California, with a population within the district of nearly 360,000. At its inception, VHS operated only an 18-bed hospital purchased from the city of Hemet, California. On the petition date, VHS owned and operated the Hemet Valley HealthCare Center (the “Skilled Nursing Facility”), a 113-bed skilled nursing facility in Hemet, California, together with three acute hospitals-Hemet Valley Medical Center (“Hemet Hospital”), a 340-bed facility in Hemet, California; Menifee Valley Medical Center (“Menifee Hospital”), an 84-bed facility in Sun City, California; and Moreno Valley Community Hospital (“Moreno Valley Hospital”), a 95-bed facility in Moreno Valley, California. The Moreno Valley Hospital and its primary service area were situated outside VHS's boundaries. Each of the hospitals provided comprehensive health services and 24-hour emergency medical services.13

The cost of VHS's comprehensive health care system was financed, in large part, by two series of bonds issued by VHS (collectively, the “Bonds”): (1) the $61,650,000 Valley Health System Certificates of Participation (1993 Refunding Project); and (2) the $47,335,000 Valley Health System District Revenue Bonds (Refunding and Improvements Project) 1996 Series A. U.S. Bank, VHS's largest creditor, was owed approximately $84 million in principal and interest on the Bonds as of the date of the petition.

B. Events Leading to Bankruptcy

Before filing its petition, VHS communicated with its major creditors, including U.S. Bank, and the two labor unions that had been certified as the bargaining representatives for certain VHS employees-SEIU and the California Nurses Association (“CNA”). VHS advised its creditors and the unions of its intention to seek relief under chapter 9, and assured them that it would negotiate a plan of adjustment consistent with the requirements of chapter 9 once it developed a viable business plan. VHS's Board of Directors approved the chapter 9 filing only after a public meeting, noticed in accordance with state law, at which attendees were advised of VHS's intention to file a chapter 9 petition and given the opportunity to question the board of directors and its professionals and to be heard on the issue. VHS's decision “was made only after a careful review of all options and strategies and with the input and guidance of consultants with expertise in healthcare restructuring, corporate counsel, bond counsel, and bankruptcy counsel.” 14

VHS sought relief under chapter 9 only after exhausting its efforts to solve its financial problems through an out-of court restructuring of debt or the sale of its assets. Two years earlier, VHS had attempted to restructure its debt through Riverside County Measure I (“Measure I”) which contemplated the issuance of $485 million in general obligation bonds, secured by property tax revenues, to retire VHS's special revenue bond debt, finance necessary capital improvements, and provide VHS the time and capital required to return to profitability. Measure I was rejected by the voters on September 16, 2005. VHS then attempted to improve its liquidity through the sale of assets.

On August 8, 2007, VHS approved a sale of substantially all of its assets to Select HealthCare Solutions (“Select”), subject to voter approval in accordance with California law. Select and VHS further agreed that, in the event the sale was not approved by the voters, then Select would have the opportunity to purchase the Moreno Valley Hospital from VHS for $47 million. Voters rejected Riverside County Measure G (“Measure G”), which sought approval of the asset sale to Select, on November 6, 2007-37 days before VHS filed its chapter 9 petition. The Moreno Valley Hospital was generating monthly losses of between $300,000 to $500,000, and Select had not pursued its opportunity to purchase the hospital from VHS prior to the petition date.

VHS's method for generating revenue exacerbated its operating losses. VHS derived its income from a complicated system of capitation and sub-capitation agreements. VHS was losing money under its capitation contracts, as well as the associated capitation risk pools formed with certain physician groups. The unpaid risk pool liability alone associated with these capitation contracts exceeded $16 million on the petition date, and VHS had not reserved funds for the payment of these liabilities.

QHR Consulting Services (“QHR”), a turnaround specialist, was retained by VHS on October 15, 2007 to analyze VHS's operations and complex contractual relationships, stabilize VHS's financial situation, and assist in formulating a business plan to return VHS to profitability. QHR examined VHS's $250 million annual budget before undertaking the task of framing a meaningful business plan. Based on its preliminary findings, QHR recommended operational changes to increase VHS's revenues by approximately $12 million without materially increasing expenses and to eliminate approximately $20 million in annual expenses with no degradation to the quality of VHS's operations. QHR determined that the key to returning VHS to profitability, however, hinged upon (1) negotiating fee for service agreements to replace its capitation contracts; and (2) consummating a sale of the Moreno Valley Hospital.

C. VHS's Chapter 9 Petition

On December 13, 2007, VHS filed a voluntary petition under chapter 9 in this case disclosing approximately 5,000 creditors holding claims in excess of $100 million. On January 11, 2008, the court denied the United States trustee's motion seeking appointment of a patient care ombudsman pursuant to § 333(a)(1). 15 On February 20, 2008, the court overruled the objections of U.S. Bank and SEIU to VHS's petition and denied U.S. Bank's motion to dismiss, holding that VHS had established that it was eligible for relief under chapter 9 and “was unable to negotiate with creditors prior to the filing of its chapter 9 petition ... because negotiation was impracticable within the meaning of § 109(c)(5)(C).” 16

D. Relevant Events During Bankruptcy

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