Debtors Not Entitled to Automatic Stay Under the Bankruptcy Code in False Claims Act Litigation

By Michael D. Brofman, Esq. & Seth A. Nadel, Esq., Weiss Zarett Brofman Sonnenklar & Levy, P.C.
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On March 13, 2017, the United States District Court for the Middle District of Tennessee issued a ruling that the defendants in a pending civil action brought by the government under the False Claims Act (“FCA”) were not entitled to an automatic stay of proceedings as provided for in the U.S. Bankruptcy Code.[i] The case is captioned at United States vs. Vanguard, et al., case no. 3:16-cv-2380 (M.D. Tenn. 2016).

In September 2016, the United States and the State of Tennessee filed an FCA action against Vanguard Healthcare, LLC and six of its nursing homes and related entities (the “Defendants”). The lawsuit alleged that the defendants submitted false claims to Medicare and TennCare (Tennessee’s Medicaid) for nursing home services that were either substandard or had never been performed in the first place. Among the allegations in the complaint were that the nursing homes were habitually short-staffed, chronically undersupplied, failed to provide adequate infection controls, and failed to administer prescribed medications.

Prior to the commencement of the lawsuit, both the Tennessee Bureau of Investigation and the United States Department of Health and Human Services contacted counsel for most of the Defendants with respect to the suspected fraudulent activities alleged in the lawsuit. In response to the inquiry, the corporate defendants filed petitions for relief under Chapter 11 of the Bankruptcy Code. Under Bankruptcy Code provisions, an automatic stay of most litigation and actions to collect debts and enforce agreements is imposed by the filing of the bankruptcy petition However, the United States and Tennessee filed a joint motion for an order finding that the pending FCA action was legally excepted from the automatic stay in bankruptcy as an exercise of the State’s regulatory authority.

While recognizing that the filing of a petition for bankruptcy typically stays the continuation of other judicial proceedings against a debtor to allow them to reorganize their financial affairs free from the looming specter of pre-existing debt, the Court also noted that there were a number of both statutory and non-statutory exceptions to the automatic stay.  Most pertinently, the Bankruptcy Code contains a provision excepting from the stay any proceeding by a governmental unit to enforce the government’s “police or regulatory power.”

To determine whether the FCA action against the Defendants fell under the definition of a proceeding pursuant to the government’s police or regulatory power, the Court employed two tests used by the Sixth Circuit: the “pecuniary purpose test” and the “public policy test.”

Under the pecuniary interest test, the inquiry is whether the enforcement of government law or regulations would grant the government a monetary advantage to the detriment of other creditors in the bankruptcy proceeding. Here, the Court found that a victory in the FCA claim would only fix the amount owed to the government, which would remain an unsecured creditor, rather than giving it priority or a secured-creditor status. The government, therefore, would gain no advantage over other creditors in the bankruptcy proceeding.

Under the public policy test, the Court is required to analyze whether the government lawsuit seeks primarily to effectuate public policy or, in fact, to adjudicate private rights. The Court noted that the primary purpose of the FCA was to deter fraudulent billing and the submission of fraudulent claims to the government for payment As a result, the Court found that the government did not seek to adjudicate any private rights through the lawsuit. Hence, the suit passed muster for an exception to the stay under the public policy test. Therefore, despite arguments made by the defendants, the Court found that the United States and Tennessee’s FCA suit was a valid exercise of policy and regulatory authority and Defendants were denied the protection of the automatic stay under the Bankruptcy Code for the FCA suit.

While the Court characterized the automatic-stay exception in FCA suits as “well settled,” it is extremely important to note that this characterization was limited to actions by the government, and not by a private citizen in a qui tam action in which the government has not intervened. Though the Court’s language might seem to bode well for qui tam actions where the government has chosen to intervene, the analysis could change if the claims of the relator are interspersed with common law claims seeking to adjudicate individual rights. It should also be noted that the two tests employed by the court are limited to the Sixth Circuit, and that the analysis might likewise be altered in the event an FCA case was being pursued in a different jurisdiction.

Weiss Zarett Brofman Sonnenklar & Levy, P.C. is a Long Island law firm providing a wide array of legal services to the members of the health care industry, including corporate and transactional matters, civil and administrative litigation, healthcare regulatory issues, bankruptcy and creditors' rights, and commercial real estate transactions.

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[i] Section 362(a) of the Bankruptcy Code provides that the filing of a case under the Bankruptcy Code stays all actions against the debtor. The exceptions to the automatic stay are listed in Section 362(b).