HEALTH CARE BASICS FOR BANKRUPTCY LAWYERS

III. ELIGIBILITY OF HEALTH CARE ENTITIES FOR BANKRUPTCY PROTECTION

A. Health Maintenance Organizations

A domestic insurance company may not be a debtor under any of the Chapters of Title 11. Insurance companies as well as banking institutions are ineligible for liquidation under the bankruptcy laws because alternative state and federal laws provide for their liquidation. In most states, health maintenance organizations (HMOs) are highly regulated and state laws provide for their liquidation. When state insurance regulators have challenged the eligibility of HMOs for federal bankruptcy protection, the bankruptcy courts have generally found that HMOs are domestic insurance companies and are ineligible for bankruptcy protection. In contrast, in cases where the state has expressed no interest in controlling an HMO's liquidation or reorganization, the courts have declared the HMO eligible for protection. Only in the Maxicare cases, which involved a national network of HMOs in 40 states, has the court responded to state insurance agency challenges with the finding that an HMO does not fall within the section 109(b) exclusion. The state insurance authorities appealed the bankruptcy court's decisions in the Maxicare cases. However, when the reorganization plan for Maxicare was confirmed, all states except Wisconsin dismissed their appeals. In Wisconsin's appeal, the district court reversed the bankruptcy court. Because HMOs had to be incorporated as insurance companies in Wisconsin, the district court ruled that Wisconsin law clearly classified and regulated its HMOs as insurance companies ineligible for bankruptcy. The Maxicare cases have questionable precedential value in light of the Seventh Circuit's conclusion that an HMO is a domestic insurance company in Matter of Estate of Medcare HMO, a case described at length below.

Prior to Medcare, bankruptcy courts typically followed an earlier Seventh Circuit opinion and applied two well-developed tests to determine whether a company falls within the group of entities prohibited from being a debtor. The first test, the state classification test, requires the court to look at the entity's status under the laws of the state where it is incorporated. If the state law classifies the company as one that is excluded under section 109(b)(2)

(e.g. a domestic insurance company), the analysis generally ends and the case is dismissed. Typically, however, the state classification scheme is not conclusive and the court must compare the powers state law confers upon or withholds from the entity with the powers conferred upon or withheld from entities excluded under section 109(b)(2). The court also determines whether the entity is subject to extensive state regulation, is subject to express statutory procedures for liquidation or rehabilitation, and conducts business of a public or quasi public nature. If the entity is highly regulated by state law, it is likely to be excluded from bankruptcy court protection.

The second test, the independent classification test, requires the court to construe the language of section 109(b)(2) itself using traditional rules of statutory construction.

Some bankruptcy courts have suggested a third test, the alternative relief test, which allows the bankruptcy court to determine whether a Chapter 11 proceeding is a satisfactory alternative to state statutory liquidation proceedings.

After reviewing the bankruptcy courts' erratic application of these tests to HMOs, the Seventh Circuit in Medcare concluded that there are not really three tests for determining whether an entity is ineligible for bankruptcy protection. "Rather, absent an express classification under section 109 or some 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."