Filed 12/15/23 Case 23-10457 Doc 1212

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ROB BONTA
2 Attorney General of California
BENJAMIN G. DIEHL
3 Supervising Deputy Attorney General
KENNETH K. WANG
4 GRANT LIEN
Deputy Attorneys General
5 State Bar No. 187250
1300 I Street, Suite 125
6 P.O. Box 944255
Sacramento, CA 94244-2550
7 Telephone: (916) 210-7920
Fax: (916) 324-5567
8 E-mail: Grant.Lien@doj.ca.gov
Attorneys for Creditor California
9 Department of Health Care Services
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UNITED STATES BANKRUPTCY COURT
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EASTERN DISTRICT OF CALIFORNIA
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FRESNO DIVISION
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In re Case No. 23-10457-B-11
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MADERA COMMUNITY HOSPITAL, Chapter 11
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Debtor in Possession. DC No.: GL-1
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CREDITOR CALIFORNIA
17 DEPARTMENT OF HEALTH
CARE SERVICES’S OPPOSITION
18 TO MOTION FOR APPROVAL
OF CHAPTER 11 PLAN
19 DISCLOSURE STATEMENT
20 Date: January 9, 2024
Time: 9:30 a.m.
21 Place: 2500 Tulare Street
Courtroom 13
22 Fresno, California 93721
Judge: Hon. René Lastreto II
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Creditor DHCS’s Opp’n to Mot. to Approve Chapter 11 Plan Disclosure Statement (23-10457)
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1 INTRODUCTION
2 Creditor California Department of Health Care Services (the Department)
3 opposes the Official Committee of Unsecured Creditors’ Motion for an Order
4 Approving the Chapter 11 Plan Disclosure Statement [Docket Nos. 1121-1126] on
5 the grounds that the Disclosure Statement and Chapter 11 Plan, as currently written,
6 would permanently enjoin the Department from equitably recouping Medi-Cal
7 overpayments, in contravention of the controlling law of the Ninth Circuit. The
8 Department therefore requests that the Court modify the Disclosure Statement and
9 the Chapter 11 Plan to allow recoupment as permitted under the law.
10
ARGUMENT
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I. Ninth Circuit Law Authorizes the Department to Equitably Recoup
12 Medi-Cal Overpayments
13 The Department’s Medi-Cal reimbursement payment system involves making
14 interim payments out of segregated funds for health care services, auditing those
15 interim payments, making subsequent adjustments, and requiring the return of
16 overpayments to the segregated funds. Because Medi-Cal’s reimbursement
17 payment system is treated as a single transaction—with an indisputable
18 interconnected relationship—overpayments are recoverable under the doctrine of
19 equitable recoupment, and equitable recoupment of the overpayments is not subject
20 to the automatic stay.
21 Equitable recoupment is similar to setoff in that each permits a creditor to
22 deduct the amounts owed to it by a debtor from any amount that it owes to the
23 debtor. Nevertheless, the two doctrines “have differences with important
24 consequences in the bankruptcy context.” Sims v. U.S. Dep’t of Health & Human
25 Servs. (Sims), 224 F.3d 1008, 1011 (9th Cir. 2000). The defining characteristic of
26 setoff—as opposed to equitable recoupment—is that the debt and claim arise from
27 different transactions. Gardens Reg’l Hosp. & Med. Ctr. Liquidating Trust v.
28 California (Gardens) 975 F.3d 926, 933 (9th Cir. 2020).
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Creditor DHCS’s Opp’n to Mot. to Approve Chapter 11 Plan Disclosure Statement (23-10457)
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1 Unlike recoupment, a setoff requires that the creditor first obtain permission
2 from the Court. Specifically, section 553 of the Bankruptcy Code allows a creditor
3 to setoff a pre-petition debt it owes to the debtor against that creditor's pre-petition
4 claim, but only if the creditor first obtains relief from the automatic stay. See
5 Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 19 (1995); 11 U.S.C. § 362(a)(7).
6 And finally, section 553 does not permit setoff “across” the petition date; pre-
7 petition and post-petition claims may not be offset. 11 U.S.C. § 553.
8 Recoupment, on the other hand, is not provided for in the Bankruptcy Code.
9 Rather, it is a common law equitable doctrine that has been defined as “the setting
10 up of a demand arising from the same transaction as the plaintiff's claim or cause of
11 action, strictly for the purpose of abatement or reduction of such claim.” Newbery
12 Corp. v. Fireman's Fund Ins. Co., 95 F.3d 1392, 1399 (9th Cir. 1996) (citation
13 omitted) (emphasis in original). Unlike setoff, recoupment is not subject to the
14 automatic stay. Sims, 224 F.3d at 1011. Additionally, recoupment “is not limited
15 to prepetition claims and thus may be employed to recover across the petition date.”
16 Id. (citation omitted). Because recoupment is in the nature of a right to reduce the
17 amount of a claim and does not involve establishing the existence of independent
18 obligations, recoupment is not subject to the same restrictions in bankruptcy as
19 setoff. Gardens, 975 F.3d at 933.
20 In determining whether two events are part of the same transaction and
21 therefore eligible for equitable recoupment, courts in the Ninth Circuit apply the
22 “logical relationship” test, analogous to the test used to determine compulsory
23 counterclaims, i.e., whether the counterclaim arises from the same aggregate set of
24 operative facts as the initial claim. Aetna U.S. Healthcare, Inc. v. Madigan (In re
25 Madigan), 270 B.R. 749, 755 (9th Cir. BAP 2001); see also Newbery Corp., 95
26 F.3d at 1399 (noting that recoupment has been analogized to both compulsory
27 counterclaims and affirmative defenses). In this context, the word “transaction” is
28 given a “liberal and flexible construction.” In re Madigan, 270 B.R. at 755
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1 (citations omitted). A transaction may include “a series of many occurrences,

2 depending not so much upon the immediateness of their connection as upon their
3 logical relationship.” Sims, 224 F.3d at 1012 (quoting Moore v. N.Y. Cotton Exch.,
4 270 U.S. 593, 610 (1926)). In the final analysis, the obligations must be
5 “sufficiently interconnected so that it would be unjust to insist that one party fulfill
6 its obligation without requiring the same of the other party.” In re Madigan, 270
7 B.R. at 755.
8 In Sims, the Ninth Circuit held that Medicare’s compensation system to
9 providers—where the Medicare program makes payments to providers on an
10 estimated basis, Medicare then conducts a retroactive audit to determine the precise
11 amount of reimbursement due to the provider, and the provider returns
12 overpayments during subsequent fiscal years—qualified as a single transaction that
13 is subject to equitable recoupment. Gardens, 975 F.3d at 936 (citing Sims, 224
14 F.3d at 1012-14). The Ninth Circuit explained in Sims that the timing of the audit
15 had “little to do with how one conceptualizes the relation between past
16 overpayments and current compensation due.” Id.
17 Likewise, in Gardens, the Ninth Circuit applied the Sims analysis to uphold
18 equitable recoupment in the Medi-Cal program. Gardens, 975 F.3d at 938 (relying
19 on Sims, 224 F.3d at 1012-13 to affirm Medi-Cal’s equitable recoupment of
20 Hospital Quality Assurance Fees (HQAF).) The Ninth Circuit in Gardens held that
21 “[t]he test remains whether the relevant rights being asserted against the debtor are
22 sufficiently logically connected to the debtor’s countervailing obligations such that
23 they may be fairly said to constitute part of the same transaction.” Gardens, 975
24 F.3d at 934. A distinctive system of continuously managing segregated funds
25 against payments out of those same funds is properly treated as a single transaction
26 for purposes of recoupment. Id. at 938. The “overall linkage” between payment
27 streams into and out of a particular fund, even if they relate to different fiscal years,
28 “are sufficiently logically related to permit recoupment.” Id. Under such
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1 circumstances, it would be “inequitable for the debtor to enjoy the benefits of that
2 transaction without meeting its obligation,” and “allowing recoupment . . . would
3 not encroach upon, or undermine the policy judgments reflected in the Bankruptcy
4 Code’s limitations on setoffs.” Id.
5 Under the foregoing case law from the Ninth Circuit, the Department has a
6 right to equitably recoup Medi-Cal overpayments from the Debtor post-petition,
7 without violating the automatic stay.
8 II. The Disclosure Statement and Chapter 11 Plan as Written, Would
Permanently Enjoin the Department from Equitably Recoupment of
9 Medi-Cal Overpayments
10 Page 39, lines 25-27 and page 40, lines 7-8 of the Disclosure Statement, as
11 well as page 37, lines 5, 12-13, of the Chapter 11 Plan, state that creditors are
12 “permanently enjoined” from “asserting any right of setoff, subrogation, or
13 recoupment of any kind . . .” This provision, as written, is impermissible because it
14 would preclude the Department from equitably recoup Medi-Cal overpayments, in
15 complete contravention of binding Ninth Circuit authority.
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III. The Disclosure Statement and Chapter 11 Plan Language Should Be
17 Modified to Allow Recoupment as Permitted under Law
18 The Court should modify page 39, lines 25-27 and page 40, lines 7-8 of the
19 Disclosure Statement, as well as page 37, lines 5, 12-13 of the Chapter 11 Plan, to
20 state that creditors are “permanently enjoined” from “asserting any right of setoff,
21 subrogation, recoupment of any kind, unless permitted under law,…” Adding this
22 phrase is necessary to protect the Department’s recognized right to equitably recoup
23 Medi-Cal overpayments.
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Creditor DHCS’s Opp’n to Mot. to Approve Chapter 11 Plan Disclosure Statement (23-10457)
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1 CONCLUSION
2 The Disclosure Statement and Chapter 11 Plan, as currently written, would
3 permanently enjoin the Department from equitably recouping Medi-Cal
4 overpayments, in contravention of the controlling law of the Ninth Circuit. The
5 Department therefore requests that the Court modify the Disclosure Statement and
6 the Chapter 11 Plan to allow recoupment as permitted under the law.
7
Dated: December 15, 2023 Respectfully submitted,
8
ROB BONTA
9 Attorney General of California
BENJAMIN G. DIEHL
10 Supervising Deputy Attorney General
11 /s/ Grant Lien
12
GRANT LIEN
13 KENNETH K. WANG
Deputy Attorneys General
14 Attorneys for California Department
of Health Care Services
15 LA2023600940
37738136.docx
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Creditor DHCS’s Opp’n to Mot. to Approve Chapter 11 Plan Disclosure Statement (23-10457)