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Health Maintenance Organization Insolvency:
Bankruptcy Jurisdiction or State Proceedings
By: Lewis E. Hassett
Morris, Manning & Martin, LLP
leh@mmmlaw.com
and
Jessica F. Pardi
Morris, Manning & Martin, LLP
jfp@mmmlaw.com
This article was originally published in the Winter 1999 issue of The Receiver.
A. Introduction
The Constitution of the United States accords Congress the
authority to enact federal laws governing bankruptcies. U.S. Const. art. I,
§ 8, cl. 4. Because the Constitution does not accord exclusive bankruptcy authority
to the federal government, states are free to enact their own insolvency laws
unless Congress has enacted an applicable federal law. Brown v. Smart, 145 U.S.
454 (1892); Atlanta Flooring & Installation Co. v. Russell, 146 F.2d 884
(5th Cir.), cert. denied, 325 U.S. 862 (1945). In accordance with its Constitutional
mandate, Congress has enacted a federal bankruptcy law and has accorded exclusive
jurisdiction to federal courts. See 11 U.S.C. §§ 101 et seq.; 28 U.S.C. § 1334.
The Bankruptcy Code of 1978 expressly provides that "a
domestic insurance company" may not be the subject of a federal bankruptcy
proceeding. 11 U.S.C. § 109(b)(2). The provisions of the Bankruptcy Code of
1978 excluding insurance companies from the jurisdiction of the federal bankruptcy
courts was carried over from the prior Bankruptcy Act of 1898. See 11 U.S.C.
§ 4(a) (superseded). The exclusion of insurers from the federal bankruptcy court
process is consistent with pre-existing federal policy generally allowing states
to regulate the business of insurance. See 15 U.S.C. § 1012 (McCarran-Ferguson
Act).
In accordance with the exclusion of insurance companies from
the federal bankruptcy courts, states administered insurer insolvencies in their
own courts. In 1967, Wisconsin enacted the first comprehensive statutory scheme
exclusively covering insurer insolvencies. Shortly thereafter, the National
Association of Insurance Commissioners ("NAIC") promulgated the Model
Insurer Rehabilitation and Liquidation Act (the "Model Insolvency Act").
The Model Insolvency Act has been substantially amended since its creation.
Most states have now enacted some version of some part of the Model Insolvency
Act. In U.S. Department of the Treasury v. Fabe, 508 U.S. 491 (1993), the Supreme
Court recognized state regulation of insurer insolvencies and held that a state
statute according enhanced priority to policyholders trumped the general federal
statute according enhanced priority to claims of the federal government.
A health maintenance organization is an organization of health
providers wherein each member pays a premium in exchange for medical care. As
such, a health maintenance organization possesses some attributes of an insurer,
but in other ways is distinguishable. Like an insurer, a health maintenance
organization spreads risk, "both across patients and over time for any
given person." Anderson v. Humana, Inc., 24 F.3d 889 (7th Cir. 1994). Additionally,
in some states the rates that a health maintenance organization may charge are
determined by actuarial computations supervised by the state insurance commissioner.
Beacon Health, Inc., 105 B.R. 178, 183 (Bankr. D. N.H. 1989). Unlike an insurer,
a health maintenance organization provides actual medical care and does not
provide indemnification insurance. Estate of Medcare HMO, 998 F.2d 436, 445
(7th Cir. 1993). In most instances, a subscriber is not personally liable to
the providers, or at least to the participating providers, and such participating
providers do not have recourse against the subscribers. See Colette B. Resnik,
"Maxicare as a Guide for Health Maintenance Organizations in Bankruptcy."
8 Bankr. Dev. J. 271, 281 (1991) (hereafter "Resnik"). Not surprisingly,
a debate has arisen as to whether the insolvency of a health maintenance organization
is to be administered under the federal bankruptcy laws or under state laws
governing insurer insolvencies. Resnik, p. 271.
B. FEDERAL BANKRUPTCY JURISDICTION OVER HEALTH MAINTENANCE
ORGANIZATIONS
The NAIC has promulgated a Health Maintenance Organization
Model Act (the "Model HMO Act"), which expressly states that insolvency
proceedings of health maintenance organizations are to be administered in state
courts under the supervision of the commissioner of insurance. See Model HMO
Act, § 21(A). That section states as follows:
A rehabilitation, liquidation or conservation of a
health maintenance organization shall be deemed to be the rehabilitation,
liquidation or conservation of an insurance company and shall be conducted
under the supervision of the [commissioner] pursuant to the law governing
the rehabilitation, liquidation and conservation of insurance companies.
The [commissioner] may apply for an order directing the [commissioner]
to rehabilitate, liquidate or conserve a health maintenance organization
upon any one or more grounds set out in [cite rehabilitation law], or
when in the [commissioner’s] opinion the continued operation of the
health maintenance organization would be hazardous either to the enrollees
or to the people of this state. Enrollees shall have the same priority
in the event of liquidation or rehabilitation as the law provides to
policyholders of an insurer.
Similarly, the Model Insolvency Act expressly states that "prepaid
health care delivery plans" are subject to state-mandated insolvency proceedings.
Model Insolvency Act, § 2(G). Some states, such as Georgia, have clarified the
Model Insolvency Act by expressly stating "health maintenance organizations"
are covered by state insolvency proceedings. See Ga. Code Ann. § 33-37-2(7).
Accordingly, at least those states that have adopted the above
provisions of the Model HMO Act and the Model Insolvency Act intend to preclude
federal bankruptcy court jurisdiction over health maintenance organizations.
The question is whether the federal bankruptcy courts will respect that assertion
of jurisdiction. Upon the filing of a petition for relief under the federal
Bankruptcy Code, an automatic stay is issued, which effectively prevents a parallel
state proceeding. See 11 U.S.C. § 362. As a result, the federal courts will
determine ultimately whether a health maintenance organization’s insolvency
is administered in the federal bankruptcy court or the state court.
Federal courts have promulgated three different tests for determining
whether an entity is one of those excluded from bankruptcy court jurisdiction
under 11 U.S.C. § 109(b). See Estate of Medcare HMO, 998 F.2d 436 (7th Cir.
1993). The first, known as the "state classification test," looks
to the classification of the entity under state law. Cash Currency Exchange
Inc. v. Shine, 762 F.2d 542 (7th Cir. 1985). Under that test, the threshold
inquiry is whether state law classifies the entity as one specifically excluded
from being a debtor in bankruptcy under section 109(b)(2) of the Bankruptcy
Code. Estate of Medcare HMO, 998 F.2d at 438. If a state does so classify the
entity, the inquiry ends, and the insolvency will be handled at the state court
level. Id. If state law does not make such an express classification, the court
must examine whether, under state law, the entity is substantially equivalent
to those excluded from bankruptcy. Portland Metro Health, Inc. v. Driscoll,
15 B.R. 102 (Bankr. D. Or. 1981).
The second test, known as the "independent classification
test," requires the court to examine the language of Section 109 and to
use the techniques of statutory construction to determine whether, as a matter
of federal statutory construction, the entity at issue is excluded from being
a debtor in bankruptcy. Cash Currency Exchange, 762 F.2d at 551-552. Whereas
the state classification test focuses on state law, the independent classification
test focuses upon the meaning of a federal statute, that is, Section 109(b)
of the Bankruptcy Code.
Under the third test, known as the "alternative relief
test," the court examines Congressional intent, public policy and practicality
to determine whether federal bankruptcy relief is a satisfactory alternative
to the established state procedure for handling the insolvency. In re Republic
Trust and Savings Co., 59 B.R. 606, 614 (Bankr. N.D. Okla. 1986). Thus, the
court is called upon to consider whether a bankruptcy proceeding is a satisfactory
method, when compared with available state and federal non-bankruptcy methods,
of reorganizing or liquidating an entity. Id. at 614. Factors such as time and
expense may be considered. Id.
The state law to be analyzed under these tests is that in effect
on the date of filing of the bankruptcy petition. In re Michigan Master Health
Plan, Inc., 90 B.R. 274 (Bankr. E.D. Mich. 1985). Thus, subsequent amendments
to state law cannot divest a bankruptcy court of jurisdiction existing on the
dates of the petition. Id. at 276.
In a series of cases known as the "Maxicare cases,"
the United States Bankruptcy Court for the Central District of California repeatedly
held that a health maintenance organization is not a "domestic insurance
company" and, therefore, is eligible to be a bankruptcy debtor under section
109 of the Bankruptcy Code. In those cases, the court applied all three of the
jurisdictional tests.
In In re Maxicare Health Insurance Co., 104 B.R. 279 (Bankr.
C.D. Cal. 1989), the bankruptcy court found the state classification test to
be inconclusive. The court reasoned that, although Wisconsin law expressly classified
health maintenance organizations as domestic insurers, a functional analysis
of the health maintenance organization at issue did not lead to classifying
such entity as a domestic insurer. Id. at 283. The court then applied both the
independent classification test and the alternative relief test and found that
both of these tests weighed in favor of bankruptcy court jurisdiction. Id. at
288. Thus, the court’s final determination was that the health maintenance organization
at issue qualified as a bankruptcy debtor under section 109 of the Bankruptcy
Code. Id.
The district court reversed that decision in In re Family Health
Services, Inc., 143 B.R. 232 (C.D. Cal. 1992). In that case, the court held
that it was "not appropriate to use a functional analysis . . . [when]
state law unequivocally does classify HMOs as insurance companies." Id.
at 232. The court clarified that it was not holding that all health maintenance
organizations are excluded from bankruptcy relief, only those health maintenance
organizations domiciled in states which classify and regulate health maintenance
organizations as insurance companies. Id.
The remaining Maxicare cases have been distinguished by other
courts, which have noted that the Maxicare cases involved a national network
of health maintenance organizations in over forty states. In re Beacon Health,
Inc., 105 B.R. 178 (Bankr. D. N.H. 1989) (holding that a New Hampshire health
maintenance organization is a domestic insurer and is therefore ineligible to
be a bankruptcy debtor). In such circumstances, it may be appropriate to weigh
the state classification test against federal bankruptcy policy.
In Medcare, 998 F.2d at 442, the court rejected the three-part
test, holding that the classification under state law controls, unless such
state law is found to frustrate the purposes of the Bankruptcy Code. The court
stated as follows:
In essence, then, there should not really be three
separate tests for ascertaining whether an entity is excluded from the
protection of the Bankruptcy Code. Rather, absent express classification
under section 109 or some other federal statute, the classification
of an entity should generally follow the law of the state of its incorporation,
so long as that classification does not frustrate the purposes of the
Code.
Id. at 442. Noting that Illinois law expressly classified health
maintenance organizations as insurers, the court concluded that an Illinois
health maintenance organization was not subject to a federal bankruptcy proceeding.
Id. at 447.
As state statutes have been amended to satisfy the "state classification
test," federal courts have become more likely to bar bankruptcy court jurisdiction
over health maintenance organizations. See Craig P. Druehl, "Note and Comment:
HMO and Insurance Insolvency: The Benefits and Detriments of a Federal System,"
23 Am. J. L. Med. 487, 494 (1997) (hereafter "Druehl"); Patrick Collins,
"HMO Eligibility for Bankruptcy and The Case for Federal Definitions of
109(b)(2) Entities," 2 Am. Bank. Inst. L. Rev. 425 (1994). Most recently,
in In re Master Health Plan, Inc., No. MC197-021, 1997 U.S. Dist. Lexis 22880
(S.D. Ga. June 18, 1997), the district court refused to stay the state insolvency
court from administering the insolvency of a health maintenance organization.
Adopting the Seventh Circuit's emphasis on the state classification test, the
court cited several provisions of Georgia law which appeared to classify health
maintenance organizations as insurers for most purposes. Specifically, the court
cited a Georgia statute, which was similar to Section 21(A) of the Model HMO
Act. The court also cited other provisions of the Georgia Insurance Code that
defined "insurer" to include health maintenance organizations. Specifically,
Official Code of Georgia Annotated Section 33-1-2(4), which defines "insurer,"
states that "health maintenance organizations are insurers within the meaning
of this title." A similar definition of "insurer" is set forth
in Georgia’s HMO Act, stating that "[h]ealth maintenance organizations
are included within such term." Ga. Code Ann. § 33-21-12(7).
One of the strongest arguments against classifying a health
maintenance organization as an insurer is that a health maintenance organization
does not indemnify against loss. In Master Health, the court found that argument
appealing, but not dispositive. Master Health at 6. The court held that the
absence of that essential feature of insurance, i.e. indemnification against
loss, did not mandate federal bankruptcy jurisdiction. Id. The court held that
the absence of an indemnity provision "is not enough to overcome Georgia’s
obvious intent to classify HMOs as insurance companies." Id. Essentially,
the court applied the state classification test and found that the intent of
Georgia law was clear, i.e. to avoid federal bankruptcy jurisdiction over health
maintenance organizations, thereby precluding any inquiry into whether health
maintenance organizations are in fact sufficiently akin to insurers to preclude
bankruptcy jurisdiction.
C. CONCLUSION
The trend appears to test bankruptcy court jurisdiction over
health maintenance organizations under the state classification test. Under
that test, courts look to state law to see if the state intended to preclude
federal bankruptcy court jurisdiction. As a result, state legislatures effectively
may be able to preclude federal bankruptcy court jurisdictions over health maintenance
organizations by adopting preclusive statutory language. The Model HMO Act and
the Model Insolvency Act contain language supporting state court jurisdiction.
The language added by Georgia certainly promoted state jurisdiction in the Master
Health case.
Notwithstanding the trend towards state court jurisdiction
over insolvencies of health maintenance organizations, health maintenance organizations
likely will continue to seek federal bankruptcy protection. Several commentators
advocate federal bankruptcy jurisdiction over health maintenance organizations.
See Resnik, pp. 273-289; Druehl, pp. 502-509. Accordingly, these issues will
continue to be subjects of litigation and legislative action.
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Morris, Manning & Martin, LLP.
All rights reserved.
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