How will sale of Saint Michael’s Hospital transform healthcare in Newark?

Governor Chris Christie’s administration has put off for nearly three years deciding what it should do about the future of healthcare in Newark. But the scheduled sale of the bankrupt Saint Michael’s Medical Center, one of five Newark hospitals, should force a decision.

The outcome of the sale will likely help shape the quality of healthcare that Newark residents receive, according to industry attorneys and analysts. It could also affect the financial stability of all of the city’s hospitals.

State involvement in hospital bankruptcies normally is limited to issues related to operating licenses. But not in this case, for three reasons:

First, the New Jersey Health Care Facilities Financing Authority, which is chaired by Acting Commissioner of Health Cathleen Bennett, issued tax-exempt bonds for Saint Michael’s that currently total roughly $230 million.

Second, the state also owns another troubled Newark facility — University Hospital, which is facing millions of dollars in annual operating losses for the foreseeable future.

Third, if the state allows the sale of Saint Michael’s it should get a short-term financial shot in the arm. But if were to decide to take over the facility, it could realize a greater payback over a longer period.

For nearly three years, California-based for-profit hospital chain Prime Healthcare has sought to buy Saint Michael’s for $49 million. But the sale has been delayed as the state Department of Health considered whether to approve the transfer of the hospital’s license. It can do this through the certificate of need, or CN, process, which allows the state to determine whether changes in hospital operation or ownership serve residents.

Saint Michael’s executives tried to force the state’s hand and push through the sale to Prime by pursuing Chapter 11 bankruptcy. The deadline to submit bids to buy the hospital is November 3. If there’s more than one bid, there will be an auction, scheduled for November 5, with the bidding opening at Prime’s offer of $49 million. The hospital board would then meet to choose what best offer and notify U.S. Bankruptcy Court Judge Vincent F. Papalia of its decision.

But the state could pursue ownership of the hospital and ask another hospital chain to operate it.

Robert Malone, a corporate-restructuring lawyer who’s not involved in the Saint Michael’s case, noted that the bankruptcy code includes a provision that could allow a bidder that doesn’t submit the highest offer to win.

“The judge has to look at not the highest but what is the best offer,” said Malone, a partner in Drinker Biddle & Reath’s Florham Park office.

The outcome is important for the financing authority. If the hospital were to be sold, then the authority would be able to use the money to pay off a portion of the remaining $233 million in debt – or $49 million if Prime wins.

But the benefits of this cash infusion would be short-lived. The state would still be responsible for paying the remainder of the bonds. If Prime wins with its current offer, the bond payments would be roughly $16.75 million annually beginning in roughly three years, until the approximately $184 million to $190 million remaining is paid off in 2039.

The Public Option

Observers say that the state has another option. It could take control of Saint Michael’s itself, ask another hospital system to operate the facility, and use revenue from that operator to pay off the outstanding bonds. The legal grounds for such an action is that the hospital building is essentially the collateral on the debt that the state issued for Saint Michael’s benefit.

There are risks to such a move, since it’s not clear how much revenue the hospital would generate. But it’s possible that it would provide much more revenue over a longer period of time than a sale.

There is a precedent for such a move right next door, where the Dormitory Authority of the State of New York took over the assets of Interfaith Hospital last year when it was in bankruptcy. It then leased the hospital building.

As expensive as Saint Michael’s bonds could be to the state, they pale in comparison to the potential annual losses related to University Hospital.

Consider this: If no changes are made to Newark hospitals, their annual operating losses are projected to reach to $191 million by 2019, according to a report from Chicago-based Navigant Consulting that was commissioned by the financing authority.

If no changes are made, the losses could fall particularly hard on University, which the state has a long-standing commitment to operate. This would be particularly true if both Saint Michael’s and East Orange General Hospital are operated by for-profit companies, not likely to incur annual operating losses, according to Renee Steinhagen, executive director of New Jersey Appleseed Public Interest Law Center.

But Navigant recommended an alternative scenario, in which Saint Michael’s, Newark Beth Israel Medical Center, and East Orange General Hospital are converted into outpatient facilities — essentially closing as full-service, acute-care hospitals. In-patient services would be consolidated in an expanded University Hospital. This would translate into a $64 million profit in 2019.

The state could pave the way for such a scenario by taking control of Saint Michael’s, according to Steinhagen. Once it did so, it could issue a request for proposals to lease the facility to another hospital operator, such as one of the several nonprofit systems that operate in North Jersey.

Steinhagen is concerned that Christie might decide against intervening, since the heaviest financial losses from the bonds and to University Hospital would occur after his term ends in January 2018.

“The bill comes due after he’s out of office — but from the taxpayers’ perspective, the taxpayer is still bearing the brunt,” said Steinhagen, who said she intends to convey her concerns to the administration.

Saint Michael’s executives reject Navigant’s findings. They say that maintaining hospital competition actually keeps costs down and ensures more services than if a regional giant like Barnabas Health were operating nearly all Newark hospitals.

They also question the projections that Navigant made that went into the report, saying that it assumes steep declines in the need for inpatient beds that haven’t yet materialized.

Michael Sirota, a lawyer representing Saint Michael’s in bankruptcy court, said the very fact that Prime has pursued the hospital “completely undermines the integrity of that report,” since the for-profit company sees an opportunity in a city where Navigant projects heavy financial losses. He has said that the bankruptcy process is designed to lead to expedited sales, as the hospital treads a fine line between arguing for bankruptcy and that it has a positive economic future.

“You can get experts to write on any topic, but the market has spoken,” said Sirota, a member of the law firm Cole Schotz in its Hackensack office.

Sirota is deeply skeptical of any potential state attempt to assume control of the hospital.

“I’ve never seen the financing authority or the state of New Jersey bid and acquire for its own portfolio a hospital,” he said. “I don’t know where the state or a financing authority will get the financing to operate this hospital as an owner, so that’s a hypothetical that’s completely new to me.”

Prime has committed to investing $25 million into the hospital, keeping all 1,400 of its workers, and maintaining all of its services for five years. But critics question its long-term commitment to maintaining services that aren’t profitable, alleging that it could potentially offload them onto already financially ailing University Hospital.

While Steinhagen argues that it makes financial sense for the state to pursue control of Saint Michael’s, she feels that an even more important reason for state control is the potential benefits to the quality of care that patients receive.

“The more that these hospitals coordinate — which is not something you can do with everybody vying for services that produce revenue — the quality is not going to improve,” she said. “This is about financial viability of all of the hospital sand it’s about quality and improving access to care in the city of Newark.”

Another wild card in the outcome is the position of Barnabas, the largest hospital system in the state. It’s indicated an interest in pursuing a bid.

But Barnabas’s pursuit has its own complications. As the owner of Newark Beth Israel and nearby Clara Maass Medical Center in Belleville, a successful Barnabas bid could face a review by the Federal Trade Commission to ensure that it’s not creating an anticompetitive situation.

Robert McCann, another Drinker Biddle & Reath partner not involved in the case, said the many factors in the case complicate any decision by the FTC.

On the one hand, Barnabas’s market share would normally draw the interest of the FTC.

On the other hand, the commission normally stays out of consideration of bankrupt hospitals, since a hospital whose losses outstrip its revenue normally isn’t a factor in competition. But the regulators’ interest perks up when there’s an auction drawing multiple bidders — particularly if one bidder is seen as potentially seeking to close a hospital to block out the ownership of a rival.

In addition, if the state would make a strong statement about its interest in the case, “the federal government is typically going to be somewhat deferential to the interest of the state,” said McCann, who has extensive experience in hospital antitrust cases and is a partner in his firm’s Washington, D.C., office.

McCann said the case is unique, with the actions of a U.S. bankruptcy judge (“There’s really nobody more powerful in our judicial system than a bankruptcy judge,” McCann said) squaring off with a powerful federal agency.

“I’ve never seen a square intersection of a bankruptcy judge and the FTC, but I can’t imagine it would be without fireworks,” he said, summing it up: “It’s very messy it’s a fascinating case.”

Saint Michael’s board, with its history of preferring that Prime buy the hospital, could reject a Barnabas offer even if it was the highest bid. It could then ask Papalia to approve the sale to Prime even if it wasn’t the highest offer, based on the argument that a bid that doesn’t depend on FTC approval is the “best” offer.

While Sirota declined to speculate on the particular hypothetical scenario of Barnabas submitting the highest bid, he added that any bid contingent on making it through an FTC review would be met with skepticism by Saint Michael’s board. He said Prime’s bid has no such contingency.

“Imagine the officers and directors electing to go forward with a contingent bid and lose a contingency-free bid and for some reason the contingent bid doesn’t close — that would be you know an embarrassment,” he said.

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Regardless of the outcome of the bankruptcy process – and whether the state seeks control of Saint Michael’s – the administration would still have final say. That’s because of the CN process overseen by the Department of Health, as well as the responsibility of the attorney general to determine whether the conversion of a hospital from nonprofit to for-profit status is in the public interest.

If the state were to deny a license to Prime, that could spark a legal appeal, and the bankruptcy sale could be back at square one, with the possibility of the judge requiring a second auction, and a different buyer than the first time through the process.