Distressed SNF Takeovers Can Pay Off, But Risks Abound

Struggling skilled nursing facilities present a minefield of potential risks for new owners and operators, but there are ways to mitigate them, even when the current operator is facing serious financial distress.

That’s according to Louis Robichaux, senior managing director at the consulting firm Ankura who focuses on health care restructuring, and George Mesires, leader of the senior housing and care practice at the law firm of Faegre Baker Daniels.  Focusing on staff and implementing good operational processes are crucial for success in a turnaround situation, but before a new owner or operator sets foot through the door, they should do extensive digging, both experts said.

“For a prospective purchaser, the most important element of the acquisition is due diligence — doing a deep dive into the distressed operator’s books and records, which are often in disarray, to assess the variety of potential liabilities related to the facility,” Mesires explained to Skilled Nursing News. “Once the liabilities are known, ideally the known unknowns, then a purchaser can begin to structure a deal that hopefully contains the liabilities that presumably it does not want to assume in the transaction.”

CMS speed bumps

The regulatory exposure will be hard to contain no matter what, Robichaux told SNN. When buying a health care business, there are generally two options for the purchaser: Assume the Medicare provider agreement, or cancel it and apply for a new one. Getting approved for the latter can take six months to a year, and the Centers for Medicare & Medicaid Services (CMS) makes it very difficult to bridge the gap in revenue that that would represent, he explained.

In addition, regulators are increasingly scrutinizing efforts to limit buyers’ liability, Mesires noted. This was highlighted in the case of Orianna Health Systems, in which the Department of Health and Human Services (HHS) filed an objection to the nursing home operator’s bankruptcy plan, arguing that HHS and CMS have ultimate control over the legal issues around the transfer of Medicare provider agreements. Under the proposal, 23 of Orianna’s 42 properties leased to Omega Healthcare Investors (NYSE: OHI) would be transferred to new operators, but those operators would not have been on the hook for any liabilities accrued by the facilities.

U.S. Attorney Erin Nealy Cox and the government argued that the deal was impossible under law regarding the transfer of Medicare agreements. Orianna, in response, filed a revised proposed order that clarified any new operators would agree to assume Medicare liabilities associated with the buildings as part of the deal.

“When you assume the Medicare provider agreement, you assume the obligations and the potential past liabilities that occurred under the prior owners and operators,” Robichaux said. “There are some exceptions for fraud, but generally in the ordinary course of things, obligations such as overpayments and claims adjustments and stuff like that, they all fall to whoever is the current operator at the time that those are identified. Medicare does not go back and say, ‘Oh, this did not occur on your watch.’ ”

Orianna received approval to transition the 23 facilities in May.

Indemnity issues

One of the best ways to avert issues on the indemnity front is to review the seller’s cost reports, get all correspondence between Medicare and the selling provider, and assess the potential danger, Robichaux said. An incoming operator could then put an indemnification clause in the contract, where the seller needs to indemnify the purchaser for any liabilities.

But if the seller is financially distressed, those provisions aren’t worth much.

“A buyer may seek protection through the use of fulsome seller representation and warranties, coupled with indemnification provisions, but such sale provisions are usually worthless when made by a financially distressed seller,” Mesires wrote.

In that case, the buyer can set aside a certain amount of the purchase price in escrow for any potential costs from Medicare liabilities, with rules that the money goes to the seller if nothing happens in a certain time frame, Robichaux said. But his preference for buying distressed properties is purchase themfrom bankruptcy, he noted.

“It makes it really clear the the new operator is not responsible for any preclosing liabilities and obligations other than those that you have to assume, like the Medicare provider agreement,” he explained. “[Things like] vendor invoices that are unpaid. It generally provides a measure of protection against state law successor liability issues, medical malpractice tort claims, they generally get what we call cut off … they remain in the bankruptcy estate and don’t transfer to the new operator.”

Operational obstacles

Takeovers on short notice, such as those of the properties operated by Skyline Healthcare, which had to be placed in receivership in several states, are a different matter. An incoming operator could find all sorts of problems walking in, ranging from employees not having the right credentials, inadequate food or medical supply inventory, equipment that’s rented and on the brink of being repossessed, or ongoing enforcement actions, Robichaux said. The last is particularly common in receivership, he noted.

And in situations that dire, the only solvent property is usually the landlord, which means the incoming operator should negotiate with them to cover any surprises.

“You’ve got to find out in whose best interest it’s in for the facility to continue to to operate,” Robichaux said. “And those are the parties you go to to seek funding.”

But all of the risks do have significant upside — if the incoming operator can pull off the turnaround.

“The upside is taking over a property where the value is depressed,” he explained. “The strategy would be stabilize operations, stabilize the staffing, get the census up, get revenue up and then either turn it into a positive cash flow operation and essentially reap the rewards … or turn around and sell it for a profit.”

Written by Maggie Flynn