Opinion
Case No. 07-28444-A-11, Docket Control No. WFH-2.
December 1, 2007
MEMORANDUM
OccMeds Billing Services, Inc., (OccMeds) seeks authority to use the cash collateral of Bridge Healthcare Finance, LLC, (Bridge) and Murphy Austin Adams Schoenfeld, LLP (Murphy Austin). Bridge, but not Murphy Austin, objects to the proposed use of cash collateral.
Since 1982, OccMeds has operated a medical billing company in Roseville, California. Its services are offered to doctors and clinics treating patients covered by workers' compensation insurance. Until recently, OccMeds arranged for the purchase of medicines by doctors or clinics who would dispense the medicines directly to their patients, eliminating the patient's need to take a prescription to a pharmacy.
Upon the dispensing of the medicine to a patient, a receivable would arise owed by the patient's worker's compensation insurer to OccMeds. OccMeds would, at the time of dispensing of the drug, advance a percentage of the invoice amount to the doctor or clinic dispensing the drug. OccMeds would handle all billing and collection procedures and would submit invoices to the various workers compensation insurers. Invoices would be paid directly to OccMeds. When the receivable was actually paid by the insurer, OccMeds would deduct the cost of the medicine dispensed and the amount of the advance previously paid to the doctor, and then would make a second payment to the dispensing doctor or clinic representing a percentage of the "profit." OccMeds would retain a percentage of the "profit" as its fee for processing invoices and advancing funds.
This business model required OccMeds to advance funds before OccMeds received payment from the insurance companies obligated to pay for the medicine. In some cases, OccMeds was also required to pay for the medicine dispensed before the cost was reimbursed by the insurance companies. This created cash flow difficulties that ultimately lead, in part, to the filing of this case. To avoid these difficulties, OccMeds is modifying its business model.
Under its modified business model, OccMeds will continue to pay for medicines delivered to doctors and clinics, but OccMeds will no longer advance funds to these doctors or clinics upon their sale of medicine to patients. Instead, the receivables will be owned by the doctors and clinics and OccMeds will collect the receivable as agent for the doctors and clinics. OccMeds will deduct the cost of medicine and a service fee, and will remit the remainder to its doctor and clinic clients. It is hoped that this modification will reduce OccMeds' capital outlay for ongoing operations.
OccMeds' primary asset is its accounts receivable and payment rights. When the petition was filed, its accounts receivable totaled $2,471,983. However, OccMeds estimates that only 60%, or approximately $1,247,130, is collectible.
The low rate of anticipated collection leads the court to conclude that a sizeable amount of these receivables are past due and will require litigation to collect.
This conclusion is buttressed by the fact that Exhibit C to the original motion indicates that of the $2,471,983, $2,400,429 is owed by four clients who also owe $1,304,725 of the $1,324,021 in over-advances made by OccMeds. These over-advances are discussed below.
OccMeds also claims that it is owed monies arising from transactions in which OccMeds paid for medicine, and advanced monies to doctor groups or pharmacies, based on receivables that were later rejected by the underlying insurance companies. OccMeds is owed $1,324,021 for these over-advances, and predicts that only 20-30% of them, a maximum of $397,206, will be collectible.
OccMeds' original motion gave the 20-30% estimate but indicated this estimate would produce a $417,013 recovery. This is actually 31.5% of the total amount. The amount given above is 30% of the total.
OccMeds further maintains that it is entitled to recover the cost of the medicine from the individual patients when a claim is disallowed by an insurer. OccMeds has a gross amount of $3,482,540 in claims against patients, and has assigned these claims to a collection agency. OccMeds estimates that only 20%, or $487,555, is collectible.
Thus, when the petition was filed, OccMeds had total receivables and rights to payment of $7,278,544, but of this amount, it judged that only $2,151,699 was collectible. OccMeds acknowledged at an earlier cash collateral hearing that substantial litigation and collection expense would be incurred to make these collections.
After the $19,807 adjustment made in footnote 2, this total is reduced further to $2,131,891.
OccMeds has three significant secured creditors with interests in these receivables and rights to payment.
Murphy Austin holds a judgment lien to secure a claim in the amount of approximately $131,000. Murphy Austin's judicial lien is in first priority position.
Bridge asserts a second priority blanket lien on all of OccMed's assets, including accounts receivable and payment rights, to secure a claim in the approximate amount of $1,351,000.
While Bridge is also secured by all of OccMeds' other assets, the motion concedes that its tangible assets have negligible value. The one other asset with material value is a proprietary billing system which is comprised of computer software. OccMeds believes that this software has a value of $250,000.
The court, however, doubts this valuation, particularly if the estate is liquidated and does not continue business operations. The record does not convince the court that this idiosyncratic piece of software will have a material value to a foreclosing creditor. For purposes of evaluating whether Bridge will be adequately protected if OccMeds uses its cash collateral, the court assigns this asset no value.
On August 27, 2007, Stan Leavitt and Gerald Ray filed a financing statement with the California Secretary of State. OccMeds acknowledges that Mr. Leavitt and Mr. Ray are owed approximately $128,320, and that their claim is secured by its accounts receivable and other assets. OccMeds believes, however, that their lien is junior to the liens of Murphy Austin and Bridge, and that their lien is not validly perfected.
Excluding the Leavitt-Ray lien, the secured claims total approximately $1,482,000, while the allegedly collectible receivables and rights to payment total $2,131,891. Given the surplus of receivables, and given OccMeds' willingness to give Bridge and Murphy Austin a replacement lien on post-petition receivables, OccMeds maintains that it has adequately protected their interests in its cash and therefore the court should permit it to use that cash for its operations.
11 U.S.C. § 363(c) authorizes the use of cash collateral as follows:
(2) The trustee may not use, sell, or lease cash collateral under paragraph (1) of this subsection unless —
(A) each entity that has an interest in such cash collateral consents; or
(B) the court, after notice and a hearing, authorizes such use, sale, or lease in accordance with the provisions of this section.
(3) Any hearing under paragraph (2)(B) of this subsection may be a preliminary hearing or may be consolidated with a hearing under subsection (e) of this section, but shall be scheduled in accordance with the needs of the debtor. If the hearing under paragraph (2)(B) of this subsection is a preliminary hearing, the court may authorize such use, sale, or lease only if there is a reasonable likelihood that the trustee will prevail at the final hearing under subsection (e) of this section. The court shall act promptly on any request for authorization under paragraph (2)(B) of this subsection.11 U.S.C. § 363(e) provides as follows:
(e) Notwithstanding any other provision of this section, at any time, on request of an entity that has an interest in property used, sold, or leased, or proposed to be used, sold, or leased, by the trustee, the court, with or without a hearing, shall prohibit or condition such use, sale, or lease as is necessary to provide adequate protection of such interest. This subsection also applies to property that is subject to any unexpired lease of personal property (to the exclusion of such property being subject to an order to grant relief from the stay under section 362.
The court concludes that OccMeds will be unable to adequately protect the interests of the secured creditors if it uses their cash collateral.
First, OccMeds' assertion that Bridge and Murphy Austin are over-secured is arguable at best. OccMeds finds itself in financial difficulty in large part because it advanced substantial sums to four clients in exchange for receivables (approximately $1,324,021) that have proven uncollectible. Further, these same clients owe most of the "open" receivables that were due on the petition date. It is incongruous to expect that, when litigation is commenced against these clients to collect $1,304,725 in over-advances, they will promptly and willingly pay the $2,400,429 in open receivables to OccMeds.
See footnote 1.
Viewed charitably, the receivables and rights to payment on hand when the petition was filed assure only one thing — a lot of litigation.
And, much of that litigation will be against the patients of OccMeds' clients. OccMeds asserts $3,482,540 in claims against patients. Given the modest amounts that individual patients undoubtedly owe for prescriptions, one wonders whether the expense associated with litigation (even if it takes place in small claims court) will be worth it.
Second, the new business model being instituted by OccMeds has fallen significantly short of producing the receivables it predicted at the beginning of this case. As noted in the declaration of Scott R. Mitchell, through the week of November 19, OccMeds projected the generation of $124,274 in post-petition accounts receivable, but actually generated only $44,371 in such receivables, a negative variance of $79,903. Moreover, none of these post-petition receivables came from new clients.
Third, Bridge is worse off now than at the beginning of the case.
Since the petition was filed, OccMeds has collected $197,985 of pre-petition accounts receivable. It began this case with $48,669 of cash. Thus, OccMeds has collected a total of $246,654 of Bridge's cash collateral.
OccMeds now has approximately $189,108 of cash on hand and $44,371 of new post-petition accounts receivable, for a total of $233,479.
Thus, Bridge is $13,175 ($246,654 minus $233,479) worse off than it was at the beginning of the case.
To the extent Bridge is holding $37,807.33 of cash that belongs to DSI as DSI maintains, Bridge will be that much more worse off.
Fourth, not only is OccMeds' new business model producing a reduced level of receivables, there is a substantial question as to whether it creates a receivable in OccMeds' favor.
OccMeds does not create an account receivable when it bills a client because payment of its 30-35% fee occurs only if the insurance company or the patient pays OccMed's client. This may be weeks or even months after the insurance company or patient is billed. Moreover, because the client owns the account receivable rather than OccMeds, OccMeds has no ability to collect from the patient or the insurance company on its own behalf.
Fifth, while OccMeds has a pending settlement with Murphy Austin that will eliminate one-half of its senior lien, the deal requires payment of the remaining $62,622 to Murphy Austin. This nominally benefits Bridge. However, payment of the $62,622 will further deplete Bridge's cash collateral.
Sixth, OccMeds is also seeking a surcharge against OccMeds pursuant to 11 U.S.C. § 506(c). If permitted, this will reimburse OccMeds, at the expense of Bridge, for costs associated with the collection of its pre-petition receivables and rights to payment.
Central Bank v. Cascade Hydraulics Utility Service, 815 F.2d 546 (9th Cir. 1987), provides the standard for evaluating a request to surcharge a secured creditor's collateral. A trustee or debtor in possession seeking to surcharge collateral must establish that the expenses incurred were (1) reasonable; (2) necessary; and (3) beneficial to the secured creditor. Id. at 548. As explained in In re Debbie Reynolds Hotel Casino, 255 F.3d 1061, 1068 (9th Cir. 2001):
"this is not an easy standard to meet. It is the party seeking the surcharge that has the burden of showing a `concrete' and `quantifiable' benefit. The § 506 recovery is limited to the amount of the benefit actually proven."
The court will not resolve the surcharge motion at this time. However, it agrees with Bridge's argument that the mere fact that a surcharge is being attempted corroborates Bridge's argument that it is not over-secured and adequately protected.
In its motion to use cash collateral, OccMeds has maintained that Bridge is over-secured. If so, the costs OccMeds incurs collecting pre-petition receivables do not benefit Bridge. Absent the bankruptcy petition, Bridge could direct OccMeds' receivables to itself and, pursuant to the terms of its agreement with OccMeds, add its collection expenses to its claim. As long as the receivables exceeded the amount owed plus its costs, Bridge would be paid.
Hence, in bankruptcy, Bridge is benefitted by OccMeds' collection efforts only if it is under-secured and OccMeds expends resources not subject to Bridge's lien in an effort to collect or preserve Bridge's collateral. See In re Compton Impressions, Ltd v. Queen City Bank (In re Compton Impressions, Ltd), 217 F.3d 1256, 1261 (9th Cir. 2000) (denying motion to surcharge because "the [b]anks could have fully recovered the unpaid balance of their loan if they had initially foreclosed on the property").
OccMeds has not carried its burden of establishing that it can use its cash while adequately protecting Bridge's interest in that cash.
A separate order shall be lodged by counsel for Bridge denying further use of cash collateral.