Lenders making secured loans to health care providers with Medicare and Medicaid receivables should be aware of limitations on their ability to perfect security interests in such borrowers’ deposit accounts. Secured lenders may perfect security interests in their borrowers’ accounts receivable (and identifiable cash proceeds therefrom) by filing UCC financing statements, but when proceeds of those accounts receivable are received by borrowers and deposited into borrowers’ deposit accounts, security interests in the deposit accounts themselves can be perfected only by obtaining "control" over the deposit accounts pursuant to § 9-104(2) of the UCC. In order to perfect such security interests in deposit accounts, revolving credit facilities are, therefore, typically subject to deposit account control agreements. In a deposit account control agreement, the borrower, the secured lender and the depository bank agree that the depository bank will comply with instructions from the secured lender directing disposition of the funds in the deposit account, without further consent by the borrower. This arrangement enables the secured lender to obtain control over the deposit account, thereby perfecting its security interest in the deposit account pursuant to UCC §9-312(b).
Loans to health care providers who receive Medicare and Medicaid payments, however, pose special problems for secured lenders seeking to perfect their security interests in deposit accounts. Medicare/ Medicaid anti-assignment regulations provide that no payment to be made to a provider of services under Medicare may be made to any other person under assignment (42 U.S.C. 1395g(c)) and no payment for any care or service provided under Medicaid to an individual may be made to anyone under assignment other than such individual or the person or institution providing such care or service (42 U.S.C. 1396a (32)). According to the Centers for Medicare and Medicaid Services (CMS) Intermediary Manual §3488.2, payments due to a provider of services may be sent to a bank for deposit in the provider’s account, but only if the check is in the name of the provider and the provider certifies that: (i) "the bank is neither providing financing to the provider nor acting on behalf of another party in connection with the provision of such financing," and (ii) "the provider has sole control of the account, and the bank is subject only to the provider’s instructions regarding the account." This means that any instruction given by a borrower who is a health care provider to its depository bank to transfer funds from the borrower’s deposit account, in which Medicare and Medicaid payments are deposited, to the account of its secured lender must be revocable by the borrower. Because the depository bank must be subject only to the borrower’s instructions regarding the deposit account, it cannot also be subject to instructions from the secured lender, and an arrangement satisfying the Medicare/Medicaid anti-assignment regulations, therefore, cannot give a secured lender "control" of the provider’s deposit account under UCC §9-104.
Many secured lenders find a partial solution to this perfection problem through the use of an arrangement commonly referred to as a "Double Lockbox." In a Double Lockbox arrangement, the health care provider borrower, secured lender, and depository bank enter into a revocable control agreement in which the borrower gives revocable instructions to the depository bank to transfer funds received in the borrower’s Medicare/Medicaid deposit account to an account held by the secured lender on a daily basis. Because the borrower’s instructions are revocable, a Double Lockbox arrangement is permissible under the Medicare/Medicaid anti-assignment regulations. Although it does not perfect the secured lender’s security interest in the borrower’s Medicare/Medicaid deposit account, the daily transfer of funds allows the secured lender to diligently monitor the deposit account and become aware if no funds are being swept, providing the best outcome available without violating the anti-assignment regulations.
Depository banks must be subject only to health care providers’ instructions regarding deposit accounts containing Medicaid/Medicare receivables, so any deposit accounts of health care provider borrowers that contain only receivables from commercial insurers or other non-Medicare/Medicaid sources may be subject to traditional deposit account control agreements. If a borrower maintains such a non-Medicare/Medicaid deposit account, its revocable control agreement may provide that the depository bank transfer the funds received in the borrower’s Medicare/Medicaid deposit account to its non-Medicare/Medicaid deposit account, which is subject to a control agreement perfecting the secured lender’s security interest, rather than to an account held by the secured lender.
Healthcare Insurance Receivables and Accounts as Collateral — A Plain English Explanation for Lenders
With certain precautions, a secured lender can include healthcare insurance receivables and accounts as collateral for a loan. In general, private healthcare insurance receivables are treated in the same manner as other accounts under the UCC while collateralizing government healthcare accounts is more risky due to federal anti-assignment provisions. With the aid of plain English, three Winstead attorneys shed light on the issues and differences.
Lenders that extend credit to healthcare companies and providers often include healthcare insurance receivables and healthcare-related accounts in the borrowing base that determines a lending amount. As with all collateral, the lender wants to be secured, perfected and first in priority on these healthcare insurance receivables. Additionally, should the borrower default, the lender wants to be able to foreclose on the collateral and realize its value as payment for the loan.
This article reviews the issues related to extending credit secured by a lien on healthcare insurance receivables and the differences between an account, where the account debtor is the government (i.e., on behalf of the Medicare program), and an account where the account debtor is a private party.
Security Interest in Accounts
Lenders routinely take a lien on accounts as part of the collateral package securing a loan. Pursuant to the Uniform Commercial Code (UCC), healthcare insurance receivables are a subset of accounts and considered the same as accounts with respect to the method by which a secured lender obtains a perfected security interest. The borrower or any other person whose property secures the loan will grant the lender a security interest in its accounts (which includes healthcare insurance receivables). This grant of a security interest, and the giving of value by the lender, makes the lender secured and gives it some rights in the collateral.
Additionally, the lender will want to perfect its security interest by filing a financing statement describing the collateral in the jurisdiction where the borrower, or other person granting the security interest (such as a guarantor), is located. The filing of the financing statement perfects the lender’s security interest in the account, and gives the lender priority over any unsecured creditors and any secured creditors that have not perfected.
Being a perfected secured creditor is only part of the battle for a lender. Equally important for a lender is its ability to collect the proceeds of any of the accounts, if necessary. In addition to a lien in the accounts, the lender will also take a lien on, among other things, the cash and deposit accounts where the cash proceeds are deposited when the accounts are paid.
The secured lender must have “control” of the deposit account in order to perfect a security interest in the deposit account and the money in the deposit account. Control exists if: i.) the secured lender is the depository bank at which the debtor maintains its deposit account; ii.) the secured lender becomes the depository bank’s customer with respect to the deposit account; or iii.) the secured lender enters into a deposit account control agreement with the depository bank. A deposit account control agreement is signed by the debtor, secured lender and the depository bank, and provides that the secured lender will have control of the account by virtue of the depository bank agreeing to take instructions from the lender without obtaining consent from the debtor.
Security Interest in Healthcare Insurance Receivables and Medicare Accounts
A security interest in a healthcare insurance receivable can be perfected through the filing of a financing statement. Deposit accounts, where proceeds from healthcare insurance receivables and accounts are deposited, can be perfected through control over such deposit accounts. However, federal laws require that government healthcare accounts, including Medicare and Medicaid, be treated differently from private healthcare insurance receivable accounts in certain ways. As a result, secured lenders must take certain additional steps to protect their collateral or consider limiting the amount of government healthcare accounts that are included in their borrowing base.
Private Health Insurance Accounts
A lender may perfect a security interest in non-government healthcare accounts (i.e., private pay insurance) and the applicable deposit account, where the account payments are deposited, in the same fashion as the process regarding the accounts and deposit accounts discussed previously. In the case of healthcare insurance receivables and accounts, the security interest of the lender attaches to the cash proceeds of such accounts, when the debtor receives the payment. The cash proceeds of the healthcare insurance receivables and accounts should not be commingled with other funds and should remain identifiable in order to perfect a security interest in such cash proceeds.
When a secured lender perfects a security interest in the healthcare insurance receivables and accounts, the secured lender has a right to notify the account debtors to directly make payments to the secured lender if the debtor defaults. Even if the provider agreement between the healthcare provider and the heath insurance company,as the account debtor, restricts assignment of the healthcare insurance receivables, the UCC provides that the grant, attachment and perfection of a security interest in the account does not result in a default under the provider agreement.
Exhibit 1 reflects the typical secured private pay account structure.
Medicare accounts, as well as the accounts of other government healthcare programs, are subject to anti-assignment rules. These anti-assignment rules prohibit a healthcare provider from assigning its right to payment for services to any person other than the provider. A violation of the anti-assignment rules could result in termination of the healthcare provider’s participation in Medicare or other government programs. Thus the lender may be secured and perfected in the account under the UCC, but it may have practical issues with collecting the cash proceeds, because the lender cannot be paid directly from the government.
In particular, the healthcare provider’s deposit account where Medicare payments are made can only be in the name of the provider, and only the provider is allowed to provide instructions with regard to the account. With Medicare accounts, the debtor will retain the ultimate right to direct the payments of funds into and out of the deposit account. Although a lender cannot have control over the debtor’s initial deposit account containing proceeds of Medicare accounts, the depository bank, secured lender and debtor may sign an agreement, pursuant to which the depository bank agrees to notify the lender if the debtor rescinds the sweep order.
However, if a secured lender perfects a security interest in the Medicare accounts themselves, then the secured lender is perfected in the identifiable cash proceeds of those receivables. As a result, once Medicare makes a payment to a provider, and that payment is deposited in the provider’s account, the secured lender’s security interest is perfected in the cash proceeds for 20 days, despite the fact that the secured lender cannot control the deposit account. It is recommended that the lender require a healthcare provider debtor to deposit its Medicare reimbursement proceeds into a deposit account separate from the non-government healthcare insurance receivables deposit account — in order for the proceeds to remain identifiable. Additionally, the loan documentation should contain covenants that prohibit commingling.
The secured lender will want to obtain control over those Medicare payments by, as quickly as possible, moving the payments into a deposit account subject to the lender’s control. In order to do this, the funds should be swept regularly from the debtor’s deposit account into a deposit account subject to the lender’s control. This is referred to as a “double lockbox arrangement.”
In the double lockbox arrangement, there are some circumstances to keep in mind. The debtor continues to control the initial deposit account and can rescind the sweep order and withdraw money from the initial deposit account at any time. In addition, if the debtor files bankruptcy, the funds may become trapped in the initial account, as the sweeping mechanism may be stayed. As a result, the secured lender should require that the account be swept on at least a daily basis in order to avoid cash proceeds accumulating.
Exhibit 2 reflects the typical Medicare or government pay account structure.
Case Law Interpretation of Anti-Assignment Rules
If the debtor defaults on a loan, federal law preempts non-judicial enforcement of a security interest in government healthcare accounts. However, the Medicare statutes provide for a judicial remedy in order to obtain assignment of the Medicare payments. A secured lender must file suit to enforce its security agreement, and a judge may issue an order assigning the right to Medicare payments to a third party. Such court order, when filed with Medicare, is not a violation of the anti-assignment rules. However, the courts have inconsistently interpreted the Medicare anti-assignment provisions. Some courts provide a flexible interpretation of the anti-assignment provisions and others are stricter.
In Missionary Baptist v. First National Bank, the Fifth Circuit upheld an arrangement where the bank took a security interest in Medicare and Medicaid accounts and, by agreement, received direct payment of the accounts. The Fifth Circuit held that this did not violate the anti-assignment rules. Missionary Baptist is the foundation for several cases, which conclude that the anti-assignment rules were not intended to invalidate security interests in Medicare and Medicaid receivables, so long as the provider has control over the initial payment from the government.
In DFS Secured Healthcare Receivables Trust v. Caregivers Great Lakes, Inc., the Seventh Circuit discussed the history behind the anti-assignment rules, finding that “nothing suggests that Congress intended to prevent healthcare providers from assigning receivables to a non-provider.” In fact, the court noted that in this case, Medicare was aware of the assignment of healthcare accounts between the provider and a non-provider third party, and that there was no evidence of any disapproval of the assignment.
In the case, In reNuclear Imaging, the court discussed the double-lockbox arrangement, but stressed that the secured lender has no legal right on its own to demand payment from the government. Once a default situation arises, the secured lender cannot directly obtain payment from the government and will only have a security interest in the payments that have already been swept into the deposit account it controls.
However, in Credit Recovery Systems, LLC v. Hieke, the District Court for the Eastern District of Virginia struck down an agreement assigning the right to file Medicare and Medicaid claims for direct payment from the government. In that case, a clinic pledged its Medicare and Medicaid accounts as collateral and, when the clinic defaulted on the loan, the lender took possession of the assets and sold the accounts to Credit Recovery Systems.
The clinic later entered a settlement agreement with the government, whereby it agreed to abandon its rights to unpaid Medicare and Medicaid claims. Credit Recovery Systems filed an action seeking declaratory judgment that the assignment was valid, so it could file a claim with the government for the Medicare and Medicaid claims. The court held that the right to receive direct payments from the government cannot be assigned. This ruling effectively prevents a secured lender from exercising its remedies without a court order.
With certain precautions, a secured lender can include healthcare insurance receivables and accounts as collateral for a loan. In general, private healthcare insurance receivables are treated in the same manner as other accounts under the UCC. The process of collateralizing government healthcare accounts is more risky due to federal anti-assignment provisions. This risk can be mitigated with i.) a double lockbox arrangement with a daily sweep feature, ii.) a deposit account control agreement, iii.) a reduction of available credit, and/or iv.) exclusion of such receivables from the borrowing base.
Cheryl Camin is a shareholder in Winstead’s Healthcare Industry Group as well as the Corporate Securities/Mergers & Acquisitions Practice Group. Her practice focuses on healthcare matters, advising providers and businesses on entity formation and structural, contractual and regulatory healthcare issues. She can be reached by e-mail at: ccamin [at] winstead [dot] com.
John Holman Jr. is a member of Winstead’s Finance & Banking Practice Group. He represents lenders and administrative agents in secured and unsecured debt financings and purchasers of debt. His transactions have included credit facilities for insurance holding companies, oil and gas companies, and commercial and residential construction and art-secured loans. He can be reached by e-mail at: jholman [at] winstead [dot] com.
Elaine Flores is an associate in Finance & Banking Practice Group. She can be reached by e-mail at: eflores [at] winstead [dot] com.
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