Credit, Lease Defaults Send 14-SNF Cornerstone Healthcare into Bankruptcy

An operator with several skilled nursing facilities in the states of Washington, Oregon, and Idaho has filed for Chapter 11 bankruptcy protection, citing issues with its secured debt and — in chorus with other bankrupt operators across the country — problems with its leases.

Cornerstone Healthcare Services operates 14 SNFs in the states of Washington, Oregon, and Idaho, as well as one assisted living facility in Washington, according to a formal declaration from Cornerstone CEO Will Masterson. These facilities have approximately 1,182 residents and employ more than 1,200 in the local communities.

Bloomberg Law first reported the news.

“The Cornerstone Healthcare Debtors filed these cases primarily in order to address specific issues with their secured debt and leases,” Masterson asserted in his declaration. “Cornerstone Healthcare fully expects to confirm a plan of reorganization, emerge from Chapter 11 in a stronger position, and continue to provide the highest quality of care.”

Defaults lead to interest woes

The “major driving factor,” according to Masterson’s declaration, was a default notice from MidCap Financial Trust under its Department of Housing and Urban Development (HUD)-backed and non-HUD credit and security agreements, which provided Cornerstone with revolving credit up to $17 million.

Cornerstone had granted a lien and security interest in its assets to secure the agreements. Cornerstone owed MidCap approximately $9.09 million as of the petition date, under both the credit agreements and other pre-petition loan documents.

In addition, Cornerstone had about $20.9 million in unsecured debt, mostly consisting of trade debt, according to Masterson, though this was less of a factor in the bankruptcy filing. He did note that the Chapter 11 filing would provide an opportunity to restructure the debt.

On October 14, MidCap sent default notices to the debtors under both the HUD and non-HUD credit agreements that asserted prior and ongoing covenant defaults, “based on the fixed-charge coverage ratio under the credit agreements.”

Those default notices instituted default interest, at a rate of 5% above the standard contract rate, retroactively effective to February 1 of this year, according to Masterson’s declaration.

“This imposition of default interest has negatively impacted cash flow, and is a major driving factor being the bankruptcy filing,” he wrote in the declaration.

A request for comment from MidCap was not returned as of press time.

Masterson emphasized that overall, Cornerstone’s business was sound, with $94 million generated in revenue in the first three quarters of the year, with profitability in terms of both earnings before interest, tax, depreciation, and amortization, and net income.

The argument, Faegre Baker Daniels partner George Mesires explained to SNN, is that setting aside the debt obligations, the business is operationally viable.

“When that’s the case, you would characterize the company as having a balance sheet problem: there’s too much debt, basically,” he said. “As opposed to some companies in bankruptcy that have an operational problem.”

‘Catastrophic consequences’ from rent agreements

Cornerstone’s leases were also a factor in the decision to file for Chapter 11 bankruptcy, according to Masterson’s declaration.

The case includes 19 debtor entities, which includes 16 individual LLCs for each facility — each of which is a wholly owned subsidiary of PNW Healthcare Holdings, LLC.

“Cornerstone Healthcare” is the collective term for the debtors in the filing, which include the PNW Healthcare entity and PNW Master Tenant I, LLC and PNW Master Tenant II, LLC.

These last two entities hold the leases for each of the 16 facilities, but “the ultimate landlord” for the real property that each facility operates upon is the private equity firm Formation Capital, according to Masterson’s declaration.

Formation declined to comment for this story.

Specifically, each piece of real property is owned by a separate special purpose entity of Formation, with rights in each property assigned to one of two master landlords: Canyon nH, LLC and Canyon Z, LLC. Known as the Canyon landlords, those “unaffiliated non-debtor entities” lease the facilities’ real properties to the PNW Master Tenant entities — which in turn lease them to the individual facility entities, according to the Masterson declaration.

“[T]he Canyon Landlords have asserted that there are various defaults under the lease agreements,” he wrote in the November 24 filing. “The Canyon Landlords have not sent a formal notice of default. Nevertheless, the possibility of an attempt by the Canyon Landlords to terminate the leases based on these asserted defaults, with the catastrophic consequences that would result, was determined by the Debtors to be an unacceptable risk.”

Both the Canyon LLCs in the voluntary petitions for PNW Master Tenant I and PNW Master Tenant II are listed as being in the care of Cascade Capital Group of Skokie, Ill.

“The Canyon entities are the master tenant of Formation across a multiple asset portfolio,” Cascade general counsel Mordy Kaplan explained to Skilled Nursing News via e-mail. “The Canyon entities sublease the assets to multiple operators, of which Cornerstone is one. The Canyon entities do not operate the assets in question, and are not the party that filed the bankruptcy.”

That reasoning echoes several other operators that declared bankruptcy over the course of the past several months. Absolut Care in New York filed for Chapter 11 bankruptcy in September, citing a “crushing rent burden” of approximately $11 million a year to its landlords. Senior Care Centers cited “expensive leases” when it entered Chapter 11 bankruptcy late last year.

And though it did not declare bankruptcy, the CEO of one of the largest operators in the country, Genesis HealthCare (NYSE: GEN), argued that traditional nursing home arrangements with real estate investment trusts (REITs) have been a “failure,” given high rent escalators in an uncertain reimbursement environment.

In terms of rent, the Canyon nH LLC — which was the lessor for the nine PNW buildings without HUD loans — had an unsecured claim of $813,339.78. Canyon Z, which was the lessor for the seven HUD facilities, had an unsecured claim of $1.43 million, according to the petitions filed for PNW Master Tenant I and PNW Master Tenant II.

The bankruptcy declaration from Cornerstone came shortly after Formation Capital and three other major private equity firms received letters from a group of lawmakers demanding details about their ownership of SNFs.

Sens. Elizabeth Warren and Sherrod Brown — along with Rep. Mark Pocan — asked executives at The Carlyle Group, Formation Capital, Fillmore Capital Partners, and Warburg Pincus LLC to provide information on their SNF investments, citing quality concerns.