Case KRH Doc 341 Filed 08/04/15 Entered 08/04/15 11:31:40 Desc Main Document Page 1 of 5

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1 Document Page 1 of 5 IN THE UNITED STATES BANKRUPTCY COURT FOR THE EASTERN DISTRICT OF VIRGINIA RICHMOND DIVISION In re: HEALTH DIAGNOSTIC LABORATORY, INC., et al., Chapter 11 Case No (KRH) (Jointly Administered) Debtors. UNITED STATES LIMITED OBJECTION TO DIP FINANCING MOTION The United States, on behalf of the Centers for Medicare & Medicaid Services ( CMS ), the Office of Inspector General of the Department of Health and Human Services, the Department of Defense s Defense Health Agency on behalf of the TRICARE program, and the United States Office of Personnel Management which administers the Federal Employees Health Benefits Program (collectively, the Federal Agencies ), hereby objects to the Motion of the Debtors and Debtors In Possession for Entry of Interim and Final Orders (i) Authorizing the Debtors to Obtain Post-Petition Financing; (ii) Authorizing the Use of Cash Collateral; (iii) Granting Liens and Superpriority Claims; (iv) Granting Adequate Protection; (v) Modifying the BENJAMIN C. MIZER RUTH A. HARVEY TRACY J. WHITAKER MARY A. SCHMERGEL Civil Division United States Department of Justice P.O. Box 875 Ben Franklin Station Washington D.C Tel. (202) Fax (202) mary.schmergel@usdoj.gov Attorneys for the Federal Agencies

2 Document Page 2 of 5 Automatic Stay; (vi) Scheduling a Final Hearing and (vii) Granting Related Relief filed on August 2, 2015 [Docket No. 327] (the DIP Financing Motion ), and respectfully states as follows: 1. The DIP Financing Motion requests entry of the DIP Orders 1 approving, among other things, the DIP Facility and the granting of post-petition senior secured, superpriority DIP Liens to the DIP Lender. 2. Although the proposed DIP Orders and DIP Facility appears to carve out an exception for USA Settlement Order, these documents do not incorporate, and in some places contradict, the rights and adequate protection secured by the United States under the USA Settlement Order. 3. Specifically, paragraph 9 of the Interim DIP Order and the definition of Permitted Liens in the DIP Facility provide, in relevant part, that the United States is (i) entitled to an allowed secured claim of no more than $2.6 million dollars which is (ii) secured by a lien on Medicare and Medicaid receivables. This is incorrect. Under the USA Settlement Order, the United States is entitled to setoff prepetition and postpetition receivables due to the Debtors from CMS against prepetition amounts owed to the United States. To the extent the United States does not exercise its setoff rights, it has an allowed secured claim in an amount equal to any payments made on or after the Petition Date by CMS to the Debtors on account of Medicare claims submitted by the Debtors for prepetition services. This amount has no cap and, as the Debtors acknowledged in their motion to approve the USA Settlement Order, because 1 Capitalized terms not otherwise defined herein shall have the same meanings ascribed to them in the DIP Financing Motion. 2

3 Document Page 3 of 5 of how claims get filed, the exact amount of the Prepetition Payments is not known at this time.... Docket No. 76 at fn.2. The Interim DIP Order and DIP Facility must be revised to reflect the true and correct terms of the USA Settlement Agreement. 4. Paragraph 9 of the Interim DIP Order also contains broad language that could be misconstrued to limit CMS regulatory and administrative powers, i.e., the last sentence of the paragraph provides: Notwithstanding any other provision of this Order or any other order of this Court, BB&T, CMS, PNC Equipment Finance, LLC, and the Bank of the West shall not be entitled to require the marshaling of any assets of the Debtors or otherwise exercise any control over a sale or liquidation of the Debtors or the Collateral which may otherwise arise under contract or applicable law. (emphasis added). CMS administers and enforces the Medicare Program, including any attempts to assign, sell or otherwise transfer Medicare provider or supplier agreements in violation of the Anti-Assignment Act, 41 U.S.C. 15. Accordingly, CMS should be stricken from this sentence. 5. Additionally, paragraph 10 of the Interim DIP Order attempts to limit the United States setoff rights to soley the right to setoff and recoup against CMS Medicare receivables by providing that, DIP Superpriority Claims shall be senior in priority to, and senior in right of payment to, any secured claim or right of setoff or recoupment of BB&T and the USA (including CMS), other than the [USA Settlement Order] However, the United States has a general common law and statutory right to setoff. United States v. Munsey Trust Co., 332 U.S. 234 (1947) (citing Gratiot v. United States, 1 Similar language is found in paragraph 9 of the Interim DIP Order and should be stricken or amended. 3

4 Document Page 4 of 5 40 U.S. 336, 370 (1841)); see also 31 U.S.C. 3728(a) ( The Secretary of the Treasury shall withhold paying that part of a judgment against the United States Government presented to the Secretary that is equal to a debt the plaintiff owes the Government. ). Although claims subject to setoff are treated as a secured claim under the Bankruptcy Code, 11 U.S.C. 506(a), the right of setoff is not a lien or security interest in another s property but, rather, is a right not to part with one s own funds. Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 21 (1995). Setoff is allowed as a defense to a claim brought by a debtor. See id. at 20; Durham v. SMI Industries Corp., 882 F.2d 881, 883 (4 th Cir. 1989). 7. Further, the stipulation approved by the USA Settlement Order explicitly states that the stipulation does not affect the rights and claims of any other federal entity other than CMS, including, but not limited to, the OIG-HHS, and the Department of Justice. See USA Settlement Order, Exhibit A, 10. Based on this language and applicable non-bankruptcy law, the Debtors and DIP Lender may not compromise other federal agencies right to assert their setoff and recoupment defenses through the DIP Orders. Accordingly paragraph 10 of the Interim DIP Order must be revised to reflect the United States common law and statutory right to setoff and recoup as preserved by the USA Settlement Order. WHEREFORE, the Federal Agencies respectfully request that the Court sustain its limited objection and have the Debtors incorporate the suggested changes attached hereto as Exhibit A, or language substantially similar thereto, to the DIP Orders and DIP Facility. [REMAINDER OF THE PAGE LEFT INTENTIONALLY BLANK] 4

5 Document Page 5 of 5 Dated: August 4, 2015 Respectfully submitted, BENJAMIN C. MIZER Principal Deputy Assistant Attorney General RUTH A. HARVEY Director TRACY J. WHITAKER Assistant Director /s/ Mary A. Schmergel MARY A. SCHMERGEL Civil Division United States Department of Justice P.O. Box 875 Ben Franklin Station Washington D.C Tel. (202) Fax (202) mary.schmergel@usdoj.gov Attorneys for the Federal Agencies 5

6 Case KRH Doc Filed 08/04/15 Entered 08/04/15 11:31:40 Desc Exhibit(s) A Page 1 of 2 EXHIBIT A 9. DIP Lien Priority. The DIP Liens securing the DIP Facility shall be senior to the liens of Branch Banking and Trust Company and BB&T Equipment Finance Corporation (collectively, BB&T ) and any other liens or assessments encumbering any DIP Collateral, and junior in priority only to the liens and rights of (i) CMS with respect to its Aallowed Ssecured Cclaim and rights to setoff and or recoup as preserved granted at paragraphs 6 and 7 ofin the Final Order Approving the Debtors Entry into Stipulation, Authorizing Use of Cash Collateral and Granting Adequate Protection to the United States of America (Doc. No. 217, the USA Settlement Order and Stipulation ). The United States Allowed Secured Claim shall not up to an aggregate amount of $2,600,000 exceed the amount of Prepetition Payments made on or after the Petition Date minus all amounts setoff by the United States against the Prepetition Payments or the Postpetition Payments as defined and described in the USA Settlement Order and Stipulation, all of which is secured solely by a lien in receivables from the Medicare and Medicaid programs (the Adequate Protection of the USA ); (ii) PNC Equipment Finance, LLC ( PNC ) and (iii) Bank of the West ( West ) ((i)-(iii), collectively, the Permitted Liens and CMS, PNC, and West being the Permitted Lienholders ) and further subject only to the Carve Out (as defined herein); provided, however, that the DIP Agent shall have the right to liquidate the Collateral immediately upon an Event of Default without notice to (other than any notice required under paragraph 24 hereof) or the consent of any other party, and any and all Collateral or proceeds from any sale or liquidation of any Collateral shall be indefeasibly paid to the DIP Agent ahead of any and all other claims of any other creditor or party, subject only to the Carve Out and the Permitted Liens. Other than as set forth herein, the DIP Liens shall not be made subject to or pari passu with any lien or security interest hereinafter granted in these Chapter 11 Cases or any Successor Cases. The DIP Liens shall be valid and enforceable against any trustee or other estate representative appointed in these Chapter 11 Cases or any Successor Cases, upon the conversion of any of these Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code (or in any other Successor Case), and/or upon the dismissal of any of these Chapter 11 Cases or Successor Cases. The DIP Liens shall not be subject to Sections 506(c), 510, 549, or 550 of the Bankruptcy Code. No lien or interest avoided and preserved for the benefit of any estate pursuant to Section 551 of the Bankruptcy Code shall be made pari passu with or senior to the DIP Liens. Notwithstanding any other provision of this Order or any other order of this Court, including the USA Settlement Order, the DIP Liens shall be senior in priority to, and senior in right of payment to, any secured claim or right of setoff or recoupment of BB&T and the USA (other than the Adequate Protection of the USA). It is the intent of this Order that the DIP Agent, on account of the DIP Liens, shall receive, on a final basis, the first dollars paid by any buyer for any asset of the Debtors or the first dollars from any liquidation of the Debtors or the Collateral until all DIP Obligations are indefeasibly extinguished, subject only to the Carve Out and the Permitted Liens. Notwithstanding any other provision of this Order or any other order of this Court, BB&T, CMS, PNC Equipment Finance, LLC, and the Bank of the West shall not be entitled to require the marshaling of any assets of the Debtors or otherwise

7 Case KRH Doc Filed 08/04/15 Entered 08/04/15 11:31:40 Desc Exhibit(s) A Page 2 of 2 exercise any control over a sale or liquidation of the Debtors or the Collateral which may otherwise arise under contract or applicable law. 10. DIP Superpriority Claims. Upon entry of this Interim Order, the DIP Agent ishereby granted, pursuant to Section 364(c)(1) of the Bankruptcy Code, an allowed superpriority administrative expense claim in each of these Chapter 11 Cases and any Successor Cases (collectively, the DIP Superpriority Claims ) for all DIP Obligations. The DIP Superpriority Claims shall be subordinate in priority only to the Carve Out, and shall (a) otherwise have priority over any and all administrative expenses and unsecured claims against the Debtors or their estates in any of these Chapter 11 Cases and any Successor Cases, at any time existing or arising, of any kind or nature whatsoever, including, without limitation, administrative expenses of the kinds specified in or ordered pursuant to Bankruptcy Code 105, 326, 328, 330, 331, 365, 503(a), 503(b), 506(c), 507(a), 507(b) (except as set forth herein), 546(c), 546(d), 726 (to the extent permitted by law), 1113 and 1114, and any other provision of the Bankruptcy Code, except as set forth herein, and (b) at all times be senior to the rights of the Debtors and their estates, and any successor trustee or other estate representative, to the extent permitted by law. Notwithstanding any other provision of this Order or any other order of this Court, including the USA Settlement Order, the DIP Superpriority Claims shall be senior in priority to, and senior in right of payment to, any secured claim or right of setoff or recoupment of BB&T and the USA (including CMS), other than the Adequate Protection of the USA; however, the DIP Superpriority Claims shall not be senior to nor have priority over the United States right to assert setoff or recoupment, including those rights included in the USA Settlement Order and Stipulation. It is the intent of this Order that the DIP Agent, on account of the DIP Superpriority Claims, shall receive, on a final basis, the first dollars paid by any buyer for any asset of the Debtors or the first dollars from any liquidation of the Debtors or the Collateral until all DIP Obligation