• Can Medicaid Receivables Secure a Credit Facility?
  • May 31, 2004 | Author: David G. Smith
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • Borrowing to provide working capital and cash flow to health care organizations and other providers of medical services is often secured by, among other assets, accounts receivable. Providers and their lenders must understand the underlying restrictions on the use of amounts owing under Medicaid as security for credit facilities.

    Under the terms of a typical revolving credit facility secured by accounts receivable, the loan agreement, the security agreement and other documents related to the credit facility often require that the borrower set up one or more "lockbox" or "blocked" accounts, into which all of the payments related to the accounts receivable pledged as collateral are to be deposited.

    These accounts may be established with the lender, or held at third-party institutions under a tri-party control agreement or lockbox agreement among the lender, the borrower and the third-party institution. These arrangements perfect the lender's security interest in the lockbox accounts and give the lender further rights to the lockbox account in the exercise of the lender's discretion.

    Accounts held at third party institutions are normally periodically "swept" to a concentration account established at the lender. The lender also is authorized to periodically apply funds, whether deposited by the account debtors directly with the lender or swept in a concentration account, to the outstanding loan balances. Upon a default, the "self-help" provisions of the Uniform Commercial Code and the terms of the loan documents allow the lender to require that the account debtors forward payments on the receivables directly to the lender.

    States which participate in Medicaid programs must have plans in place that meet specified federal requirements. One of those requirements is a provision added in 1972 restricting the assignment of receivables owed to providers under a Medicaid program. Accordingly, a state Medicaid program must provide, with certain limited exceptions, that payments made with respect to Medicaid receivables must go directly to the provider. When a borrower/provider intends to use Medicaid receivables as collateral for a credit facility, the traditional structure must be modified.

    From the inception of the anti-assignment provision in 1972 through the mid-1980s, it was taken to be a complete prohibition on the use of Medicaid receivables as collateral for any credit facility. This changed in 1986, when the U.S. Court of Appeals for the Fifth Circuit, in the case of Wilson v. First National Bank of Lubbock, Texas (In re Missionary Baptist Foundation of America, Inc.), held that while the assignment of Medicaid receivables to a non-provider was prohibited, the granting of a security interest in such receivables should be allowed.

    The court reviewed the legislative history of the anti-assignment provision and found that Congress's main concern was that the direct payment of funds to "factoring" agencies (who purchase Medicaid receivables at a discount and then serve as collection agents for the accounts) was resulting in fraudulent billing practices and "incorrect and inflated claims." The court further found that it was not the intent of Congress to cut off a valid form of financing to entities who may need it the most (those providing health care services to the needy).

    The court decided that while the anti-assignment provision is valid, the grant of a security interest in a Medicaid receivable is not the same as an assignment of such receivable, and does not run afoul of the anti-assignment provision. Relying in part on Missionary Baptist and in part on their own analysis, other courts have subsequently held that the granting of a security interest in Medicaid receivables is allowed.

    A memorandum issued to all associate regional administrators for Medicaid from Christine Nye, then the director of the Medicaid Bureau of the Centers for Medicare and Medicaid Services (CMS), offers further guidance. The memorandum conditions the validity of any financing arrangement on whether the Medicaid payments go directly to the provider. Such payments may go directly to a bank or other account of the provider (so long as such bank is not the lender) and still be considered as going directly to the provider.

    Section 3488 of the CMS Intermediary Manual states that Medicaid payments to the provider may be sent directly to a bank (or similar financial institution) for deposit in the provider's account so long as (a) the check (or other form of payment) names the provider as payee; (b) the bank is neither providing financing to the provider nor acting on behalf of another party in connection with the provision of such financing; (c) the provider has sole control of the account; and (d) the bank is subject only to the provider's standing instructions regarding the account. At some point in the payment stream, the provider must have "full and effective, not merely purported, control" over the Medicaid monies it receives. The memorandum notes that while CMS allows such financing arrangements, Medicaid is administered by the states, so state law must also be considered in determining the validity of a financing arrangement.

    These restrictions make a traditional lockbox arrangement unworkable, because the lender has control over the initial account into which the payments are deposited, either through an account control agreement or lockbox agreement with a third party or because the payments are deposited directly into an account with the lender. At no point in the payment stream does the borrower/provider have full control over the monies in any account.

    However, an arrangement where the lockboxes are swept to a concentration account would be acceptable, so long as the initial lockboxes where the Medicaid payments are first sent are at an institution other than the lender bank, and the lender bank has no control over such lockboxes (i.e., no account control agreement or other type of lockbox agreement).

    Standing instructions by the borrower to such a third-party institution to periodically transfer cash held in lockbox accounts to an account with the lender would be allowed, but such instructions have to be revocable by the borrower. The lender would not be able to have control and a perfected security interest at the level of the initial lockboxes where the Medicaid receivables are deposited, and though only momentary, there is a point in the payment stream where the borrower/provider will have control over the monies owed as Medicaid receivables. No case law specifically addresses an arrangement like the foregoing, but case law, the memorandum and the manual suggest that it would be acceptable.

    In the traditional structure, after default by the borrower, the accounts receivable may be assigned to the lender under the UCC "self-help" provisions, and the terms of the loan documents and the lender then may collect receivables directly from the account debtors. The anti-assignment provision specifically disallows the assignment of Medicaid receivables to non-providers, so they cannot be assigned to the lender automatically. For such an assignment to occur, a lender must obtain a court order for the assignment of the receivables to the lender. Once the lender receives such an order, it may then directly collect any Medicaid receivables.

    No courts have discussed the standards for determining whether or not to order the assignment of Medicaid receivables to the lender. Courts have said that any court with jurisdiction over the subject matter and the parties may issue the order. In Credit Recovery Systems, the court discussed the issuance of an order for the assignment of Medicaid receivables to a lender, but only stated (a) that such an order may be issued by any court with jurisdiction over the subject matter and the parties involved and (b) that the assignment cannot occur before the court has issued its order.

    A lender apparently need only bring an action upon the debt owed (as it would do if all of the self-help remedies available to lenders were exhausted) and, if requested, a court will then order the assignment of the Medicaid receivables to the lender. Of course, this may cause a delay in the collection of the receivables by the lender.

    Medicaid is a state-administered federal program, and while 42 U.S.C. §1396(a)(32) requires state plans to have an anti-assignment provision, it does not prescribe exactly how the state plan must implement the provision. A state plan could be more restrictive than the federal anti-assignment provision. The Missionary Baptist court disapproved of one more restrictive state law provision. Under Missionary Baptist overly broad state provisions should be held to be invalid. Nonetheless, it is necessary to consult the laws governing each state's Medicaid program to check for any other restrictions that may apply to a security interest in Medicaid receivables.

    Since it may not be possible to obtain a perfected security interest in all deposit accounts into which Medicaid receivables are paid, or to completely cut-off a borrower/provider's control over Medicaid payments before and after default, certain lenders may be reluctant to extend credit to a borrower/provider against Medicaid receivables. Lenders willing to extend credit in such a situation will often charge a higher interest rate or higher fees related to the credit facility.