                                                                FILED
                                                                MAR 12 2018
 1                         NOT FOR PUBLICATION
                                                           SUSAN M. SPRAUL, CLERK
                                                               U.S. BKCY. APP. PANEL
 2                                                             OF THE NINTH CIRCUIT

 3                  UNITED STATES BANKRUPTCY APPELLATE PANEL
                              OF THE NINTH CIRCUIT
 4
 5   In re:                        )      BAP No. CC-17-1198-LKuF
                                   )
 6   GARDENS REGIONAL HOSPITAL     )      Bk. No. 2:16-bk-17463-ER
     AND MEDICAL CENTER, INC.,     )
 7                                 )
                    Debtor.        )
 8   ______________________________)
                                   )
 9   GARDENS REGIONAL HOSPITAL     )
     AND MEDICAL CENTER, INC.,     )
10                                 )
                    Appellant,     )
11                                 )
     v.                            )      M E M O R A N D U M*
12                                 )
     STATE OF CALIFORNIA, and its )
13   Department of Health Care     )
     Services,                     )
14                                 )
                    Appellee.      )
15   ______________________________)
16                  Argued and Submitted on January 25, 2018
                             at Pasadena, California
17
                             Filed - March 12, 2018
18
              Appeal from the United States Bankruptcy Court
19                for the Central District of California
20        Honorable Ernest M. Robles, Bankruptcy Judge, Presiding
                         _________________________
21
     Appearances:     Samuel Maizel of Dentons US LLP argued for
22                    Appellant; Kenneth K. Wang, Deputy Attorney
                      General for the State of California, argued for
23                    Appellee.
                           _________________________
24
     Before: LAFFERTY, KURTZ, and FARIS, Bankruptcy Judges.
25
26        *
           This disposition is not appropriate for publication.
27   Although it may be cited for whatever persuasive value it may
     have (see Fed. R. App. P. 32.1), it has no precedential value.
28   See 9th Cir. BAP Rule 8024-1.
 1        The bankruptcy court ruled that the State of California
 2   Department of Healthcare Service’s (“DHCS”) postpetition
 3   withholding of Medi-Cal and supplemental hospital quality
 4   assurance (“HQA”) payments from the Debtor to recover unpaid HQA
 5   fees constituted equitable recoupment of unpaid HQA fees and thus
 6   did not violate the automatic stay.
 7        We AFFIRM.
 8                                   FACTS1
 9        Chapter 112 debtor Gardens Regional Hospital and Medical
10   Center, Inc. formerly operated a hospital in Hawaiian Gardens,
11   California.   Debtor had a Medi-Cal Provider Agreement with DHCS
12   and provided healthcare services to Medi-Cal beneficiaries.
13   A.   The Medi-Cal Program
14        Medi-Cal refers to the California Medical Assistance
15   Program, through which federal Medicaid benefits are
16   administered.     Under the Medicaid program, the cost of providing
17   healthcare to low-income people is shared between the state and
18   federal government, with states administering the Medicaid
19   program through their own specific plans.    Medi-Cal is
20   California’s Medicaid plan, and DHCS administers it.
21        California is generally entitled to be reimbursed by the
22   federal government for 50 percent of Medi-Cal costs.    42 U.S.C.
23   § 1396b(a).   To help cover its share of Medi-Cal costs,
24
          1
           For this factual recitation, we borrow heavily from the
25   bankruptcy court’s published opinion, In re Gardens Regional
26   Hospital and Medical Center, Inc., 569 B.R. 788 (Bankr. C.D. Cal.
     2017).
27
          2
           Unless specified otherwise, all chapter and section
28   references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532.

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 1   California enacted the Medi-Cal Hospital Reimbursement
 2   Improvement Act of 2013 (the “RIA”), codified at California
 3   Welfare and Institutions Code §§ 14169.50–14169.76.    The RIA
 4   requires most general acute care hospitals to pay a quarterly
 5   Hospital Quality Assurance Fee (“HQA Fee”), which is assessed
 6   regardless of whether the hospital participates in the Medi-Cal
 7   program.   Cal. Welf. & Inst. Code § 14169.52(a).   The HQA Fee
 8   allows California to obtain more healthcare funds from the
 9   federal government, which generally matches state Medi-Cal
10   contributions dollar for dollar.
11        The HQA Fee is calculated using a complex formula based
12   primarily upon a hospital’s “patient days.”   For example, “one
13   Medi-Cal day” means that a hospital treated one patient under the
14   Medi-Cal program for one day; “two Medi-Cal days” means either
15   that a hospital treated two patients under the Medi-Cal program
16   for one day each, or treated one patient under the Medi-Cal
17   program for two days.   The formula for calculating the HQA Fee
18   takes into consideration a hospital’s annual fee-for-service
19   days, annual managed care days, and annual Medi-Cal days.    Id. at
20   § 14169.51(as).
21        After the HQA Fees are collected and augmented by federal
22   matching funds, DHCS redistributes them to the hospitals through
23   various types of quality assurance payments, including:
24        1) direct grants to public hospitals in support of health
25   care expenditures, id. at § 14169.58(a)(1);
26        2) supplemental quality assurance payments to private
27   hospitals, id. at § 14169.54–55;
28

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 1        3) increased capitation payments3 to hospitals providing
 2   treatment pursuant to Medi-Cal managed health care plans, id. at
 3   § 14169.56; and
 4        4) payments for children’s health care, id. at
 5   § 14169.53(b)(1)(B).
 6        The formulas under which the HQA Fees are assessed differ
 7   from the formulas under which the HQA Fees and associated federal
 8   matching funds are distributed.    As a result, some hospitals
 9   receive more money on account of their HQA Fee payments than
10   others.   Therefore, in addition to allowing California to receive
11   more federal matching funds, the RIA performs a redistributive
12   function.
13        The RIA is only one component of a complex statutory scheme
14   governing Medi-Cal’s funding and administration.      In addition to
15   receiving various types of payments under the RIA, hospitals are
16   also reimbursed for providing Medi-Cal services primarily through
17   two systems: a fee-for-service system and a managed care system.
18   In the fee-for-service system, DHCS enters into contracts with
19   hospitals to provide services to Medi-Cal beneficiaries and makes
20   direct payments to the hospitals.       See generally id. at § 14132
21   et seq. (delineating the types of Medi-Cal benefits provided
22   through the fee-for-service system).      In the managed care system,
23   DHCS contracts with managed care plans to provide healthcare
24   services to Medi-Cal beneficiaries.      See generally id. at
25   § 14087.3 et seq. (setting forth standards governing contracts
26
          3
27         A capitation payment is a per-month, per-person
     reimbursement on account of treatment provided to patients
28   enrolled in managed care plans.

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 1   between DHCS and managed care providers).    The fee-for-service
 2   and managed care systems allow hospitals to receive a baseline
 3   reimbursement on account of the Medi-Cal services they provide.
 4   The RIA supplements that baseline reimbursement for hospitals
 5   that are eligible to receive payments under the Act.
 6   B.   Debtor’s Relationship with DHCS
 7        Paragraph 2 of the provider agreement entered into between
 8   Debtor and DHCS in November 2014 requires, as a condition for
 9   participation as a provider in the Medi-Cal program, that Debtor
10   comply with all applicable provisions of California Welfare and
11   Institutions Code §§ 14000-14499.77.    Among those provisions is
12   the requirement to pay HQA Fees.    Cal. Welf. & Inst. Code
13   § 14169.52(a).    Because Debtor provided healthcare to Medi-Cal
14   beneficiaries on a fee-for-service basis, it was entitled to
15   receive Medi-Cal fee-for-service payments (“Medi-Cal Payments”).
16   Debtor was also entitled to receive supplemental quality
17   assurance payments (“Supplemental HQA Payments”), calculated
18   under formulas contained in the RIA, on account of certain
19   services provided to Medi-Cal beneficiaries.
20        Debtor stopped paying quarterly HQA Fees in March of 2015;
21   by the petition date of June 6, 2016, it owed $699,173.15 in HQA
22   Fees.    Postpetition, DCHS began withholding 20 percent of Medi-
23   Cal payments owed to Debtor and an unspecified percentage of the
24   Supplemental HQA payments owed to Debtor.4   By July 18, 2016,
25   DHCS had recovered the prepetition amount owing but continued the
26
          4
27         The record does not reflect how much of the withheld
     amounts represent Medi-Cal Payments and how much represents
28   Supplemental HQA Payments.

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 1   withholding because Debtor failed to pay postpetition HQA Fees.
 2        On May 2, 2017, Debtor filed a Motion for Order Granting
 3   Relief Against the State of California and Its Department of
 4   Health Care Services for Violating the Automatic Stay (the
 5   “Motion”).   Debtor argued that DHCS’s withholding of Medi-Cal and
 6   Supplemental HQA payments was an impermissible setoff that did
 7   not meet the standards for equitable recoupment and thus violated
 8   the automatic stay.   Debtor requested that the court find DHCS in
 9   civil contempt and order it to pay Debtor $4,131,147.64 of
10   withheld payments.    DHCS opposed, arguing that its withholding of
11   both types of payments satisfied the Ninth Circuit’s “logical
12   relationship test” for recoupment.
13        After hearing argument, the bankruptcy court issued written
14   findings and conclusions, concluding that the doctrine of
15   equitable recoupment allowed DHCS to withhold a percentage of the
16   Medi-Cal and Supplemental HQA Payments it owed Debtor for the
17   purpose of recovering unpaid HQA Fees.     In re Gardens Reg. Hosp.,
18   569 B.R. at 800.   The bankruptcy court entered an order denying
19   Debtor’s motion to compel DHCS to turn over the withheld funds.
20   Debtor timely appealed.
21                               JURISDICTION
22        The bankruptcy court had jurisdiction pursuant to 28 U.S.C.
23   §§ 1334 and 157(b)(2)(O).   We have jurisdiction under 28 U.S.C.
24   § 158.
25                                   ISSUE
26        Whether the bankruptcy court erred in concluding that DHCS’s
27   withholding of a percentage of Medi-Cal Payments and Supplemental
28   HQA Payments owed to Debtor to recover unpaid HQA Fees was

                                      -6-
 1   permissible without relief from stay under the doctrine of
 2   equitable recoupment.
 3                            STANDARD OF REVIEW
 4        We review de novo the bankruptcy court’s application of
 5   undisputed facts to the law concerning equitable recoupment.
 6   Aetna U.S. Healthcare, Inc. v. Madigan (In re Madigan), 270 B.R.
 7   749, 753 (9th Cir. BAP 2001) (citing Sims v. U.S. Dept. of Health
 8   & Human Servs. (In re TLC Hosps., Inc.), 224 F.3d 1008, 1011 n.7
 9   (9th Cir. 2000)).
10                                DISCUSSION
11   A.   Equitable Recoupment
12        Equitable recoupment is similar to setoff.   Recoupment and
13   setoff each permit a creditor to deduct amounts owed to it by a
14   debtor from amounts it owes to the debtor.    Nevertheless, “they
15   have differences with important consequences in the bankruptcy
16   context.”   In re TLC Hosps., Inc., 224 F.3d at 1011.   Section 553
17   of the Bankruptcy Code preserves the right of a creditor to
18   offset a prepetition debt it owes to the debtor against that
19   creditor’s prepetition claim.   Before exercising its right of
20   setoff, the creditor must obtain relief from the automatic stay.
21   See Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 19 (1995);
22   § 362(a)(7).   Section 553 does not permit setoff across the
23   petition date; pre- and postpetition claims may not be offset.
24        Recoupment, on the other hand, is not mentioned in the
25   Bankruptcy Code.    Rather, it is a common law equitable doctrine
26   which has been defined as “the setting up of a demand arising
27   from the same transaction as the plaintiff’s claim or cause of
28   action, strictly for the purpose of abatement or reduction of

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 1   such claim.”    Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d
 2   1392, 1399 (9th Cir. 1996) (citation omitted) (emphasis in
 3   original).    Unlike setoff, recoupment is not subject to the
 4   automatic stay.    In re TLC Hosps., Inc., 224 F.3d at 1011.
 5   Additionally, recoupment “is not limited to prepetition claims
 6   and thus may be employed to recover across the petition date.”
 7   Id. (citation omitted).
 8        In determining whether two events are part of the same
 9   transaction, courts in the Ninth Circuit apply the “logical
10   relationship” test, analogous to the test used to determine
11   compulsory counterclaims, i.e., where the counterclaim arises
12   from the same aggregate set of operative facts as the initial
13   claim.   In re Madigan, 270 B.R. at 755; see also Newbery Corp.,
14   95 F.3d at 1399 (noting that recoupment has been analogized to
15   both compulsory counterclaims and affirmative defenses).      In this
16   context, the word “transaction” is given a “liberal and flexible
17   construction.”    In re Madigan, 270 B.R. at 755 (citations
18   omitted).    A transaction may include “a series of many
19   occurrences, depending not so much upon the immediateness of
20   their connection as upon their logical relationship.”      In re TLC
21   Hosps., Inc., 224 F.3d at 1012 (quoting Moore v. N.Y. Cotton
22   Exch., 270 U.S. 593, 610 (1926)).
23        In the final analysis, the obligations must be “sufficiently
24   interconnected so that it would be unjust to insist that one
25   party fulfill its obligation without requiring the same of the
26   other party.”    In re Madigan, 270 B.R. at 755.   As such, although
27   not required, courts often find that the “same transaction”
28   requirement is satisfied when corresponding liabilities arise

                                      -8-
 1   under a single contract.   Id. at 758.   “The rationale for
 2   allowing recoupment in contract cases is that it would be
 3   inequitable for the debtor to enjoy the benefits of a transaction
 4   without also meeting [its] obligations.”    Id. (citing Newbery
 5   Corp., 95 F.3d at 1403).
 6        In any event, as we explain in detail below, application of
 7   the “logical relationship” test does not require that the
 8   obligations of the counterparties be identical, or, particularly
 9   in the context of a contract with a governmental entity intended
10   to promote a public policy, that the class subject to an anterior
11   obligation to the governmental agency be exactly the same class
12   that would reap a benefit under the subject contract.    Rather, a
13   “logical relationship” may be found where there is an
14   interconnection between the obligations such that it is equitable
15   to treat them as the same transaction.
16   B.   The bankruptcy court did not err in concluding that DHCS was
          entitled, under the doctrine of recoupment, to withhold
17        Supplemental HQA Payments owed to Debtor.
18        A primary purpose of the RIA is to “improve funding for
19   hospitals and obtain all available federal funds to make
20   supplemental Medi-Cal payments to hospitals.”    Cal. Welf. & Inst.
21   Code § 14169.50(a).   The HQA Fees imposed under the RIA are to be
22   “used to increase federal financial participation in order to
23   make supplemental Medi-Cal payments to hospitals, and to help pay
24   for health care coverage for low-income children.”    Id. at
25   § 14169.50(d).
26        As noted by the bankruptcy court, the additional federal
27   matching funds generated by the HQA Fees enable DHCS to have
28   sufficient revenue to make Supplemental HQA Payments.    Put

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 1   another way, without the HQA Fees, DHCS could not perform its
 2   redistributive function, and Debtor would not receive any
 3   Supplemental HQA Payments.   Using a liberal and flexible
 4   construction of the word “transaction” thus leads to the
 5   conclusion that the HQA Fees are logically related to the
 6   Supplemental HQA Payments.
 7        On appeal, Debtor contends that there is no logical
 8   relationship between its obligation to pay HQA Fees and DHCS’s
 9   obligation to make Supplemental HQA Payments for three reasons.
10   First, the formulas used to calculate each parties’ liabilities
11   are different; second, licensed acute care hospitals are required
12   to pay HQA Fees even if they do not receive Supplemental HQA
13   Payments, i.e., the obligation to pay the HQA Fees is based
14   solely on licensure and not on any right to receive Supplemental
15   HQA Payments; and third, the amounts of the HQA Fees to be paid
16   bears no relationship to the amount of the Supplemental HQA
17   Payments a provider receives.
18        Debtor has not cited any authority to support these
19   arguments, and we agree with the bankruptcy court that Debtor’s
20   interpretation of the logical relationship test is too narrow.
21   The facts that (i) the fees and the reimbursements are calculated
22   using different formulas and (ii) the amounts paid and received
23   are not related do not change the fact that without the HQA Fees,
24   DCHS would have no resources with which to pay the Supplemental
25   HQA Payments.   And the fact that some hospitals are exempt from
26   the requirement to pay HQA Fees but still receive Supplemental
27   HQA Payments does not change the fundamental fact that the source
28   of the funding for the Supplemental HQA Payments is, at least

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 1   indirectly, the revenue generated by the HQA Fees.   Even
 2   conceding that the relationship between the Supplemental HQA
 3   Payments and the HQA Fees is not linear, the relationship is
 4   “sufficiently interconnected so that it would be unjust to insist
 5   that one party fulfill its obligation without requiring the same
 6   of the other party.”   In re Madigan, 270 B.R. at 755.   From this
 7   standard, it follows that a “logical relationship” may exist even
 8   when the transactions at issue do not correspond exactly.
 9   C.   The bankruptcy court did not err in concluding that DHCS was
          entitled, under the doctrine of recoupment, to withhold
10        Medi-Cal Payments owed to Debtor.
11        As noted, the provider agreement between Debtor and DHCS
12   requires, as a condition of being a Medi-Cal provider, that
13   Debtor comply with all applicable provisions of California
14   Welfare and Institutions Code §§ 14000-14499.77.   Among those
15   provisions is the requirement to pay HQA Fees; if fees are not
16   timely paid, DCHS may immediately begin to deduct the unpaid
17   assessment and interest from Medi-Cal Payments owed to the
18   hospital.   Cal. Welf. & Inst. Code § 14169.52(a) and (h).
19   Accordingly, when it executed the provider agreement, Debtor
20   agreed that DHCS could withhold unpaid HQA Fees from Medi-Cal
21   Payments.   Based on this agreement, we conclude that the logical
22   relationship test is satisfied.
23        Despite this agreement, Debtor contends that no logical
24   relationship exists between the HQA Fees and the Medi-Cal
25   Payments for the same reasons Debtor disputes a logical
26   relationship between HQA Fees and Supplemental HQA Payments:
27   (i) DHCS’s obligation to make Medi-Cal Payments arises from the
28   fact that Debtor is a Medi-Cal participant, while Debtor’s

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 1   obligation to pay HQA Fees is based solely on licensure; (ii) the
 2   respective amounts are calculated using different formulas;
 3   (iii) there is no express reference in the provider agreement to
 4   recoupment or offset or the HQA program; (iv) the bankruptcy
 5   court’s analysis was too superficial because it lacked a detailed
 6   analysis of the obligations between the parties; and (v) the
 7   Medi-Cal provider agreement cannot create a logical relationship
 8   because it is a form document, citing Saint Joseph’s Hospital v.
 9   Dep’t of Public Welfare of Pennsylvania (In re Saint Joseph’s
10   Hospital), 103 B.R. 643, 656 (Bankr. E.D. Pa. 1989); Kings
11   Terrace Nursing Home & Health Related Facility v. New York State
12   Dep’t of Social Services (In re Kings Terrace Nursing Home &
13   Health Related Facility), No. 91 B 11478 (FGC), 1995 WL 65531
14   (Bankr. S.D.N.Y. Jan. 27, 1995), aff’d, 184 B.R. 200, (S.D.N.Y.
15   1995); and Hollander v. Brezenoff, 787 F.2d 834 (2d Cir. 1986).
16        We do not find these arguments persuasive.   While true that
17   Debtor would have to pay HQA Fees even if it did not participate
18   in the Medi-Cal program, Debtor could not have become a Medi-Cal
19   provider without agreeing that unpaid HQA Fees could be withheld
20   from Medi-Cal Payments.   And Debtor does not explain how the fact
21   that the amounts are calculated using different formulas impacts
22   its agreement to the withholding of Medi-Cal Payments to recover
23   unpaid HQA Fees.   Similarly, Debtor does not explain why
24   incorporating statutory requirements into the terms of the
25   provider agreement negated Debtor’s consent to those terms or
26   severs the logical relationship between the HQA Fees and the
27   Medi-Cal Payments.
28        As for the bankruptcy court’s analysis, we find no fault

                                    -12-
 1   with it.   The court examined in detail the obligations of the
 2   parties.   Although its analysis may not have matched the analysis
 3   done by the Ninth Circuit in TLC Hospitals, that case did not set
 4   out a bright-line standard or list of factors for analyzing
 5   recoupment scenarios.   Ultimately, the analysis is an equitable
 6   one in which the court must determine, under the facts presented,
 7   whether the obligations at issue are “sufficiently interconnected
 8   so that it would be unjust to insist that one party fulfill its
 9   obligation without requiring the same of the other party.”
10   In re Madigan, 270 B.R. at 755.
11        The argument that the Medi-Cal provider agreement could not
12   be the basis for a logical relationship because it is a form
13   document does not appear to have been made in the bankruptcy
14   court; thus, we need not consider it.   See O’Rourke v. Seaboard
15   Surety Co. (In re E.R. Fegert, Inc.), 887 F.2d 955, 957 (9th Cir.
16   1989).   In any event, none of the cases Debtor cites involve the
17   application of the logical relationship test.
18        Debtor also urges the Panel to consider Indiana Family and
19   Social Services Administration v. Saint Catherine Hospital of
20   Indiana, LLC, (In re Saint Catherine Hospital of Indiana, LLC),
21   511 B.R. 117 (S.D. Ind. 2014), rev’d on other grounds, 800 F.3d
22   312 (7th Cir. 2015).    The facts of that case are similar to those
23   here, but with some important differences.   The debtor in that
24   case was an acute care hospital that treated Medicare and
25   Medicaid patients.   Like California, the State of Indiana had
26   imposed a “hospital assessment fee” or “HAF” to facilitate
27   increased reimbursement for hospital care to Medicaid patients.
28   Prepetition, the Indiana Family and Social Services

                                     -13-
 1   Administration (“FSSA”) withheld Medicaid payments to the debtor
 2   to recover unpaid HAFs and continued the withholding
 3   postpetition.    On appeal from the bankruptcy court, the district
 4   court held that the withholding was not permissible as a
 5   recoupment because (i) the statute that authorized the HAF was
 6   separate from the regular pay-for-service arrangement; (ii) the
 7   obligation to pay the HAF was triggered solely by the hospital’s
 8   status as an acute care facility; and (iii) the initial
 9   assessment was “frontloaded” in a way that rendered it akin to a
10   tax.    The court thus concluded that the obligations did not arise
11   from the same contract or transaction.    The case is
12   distinguishable from our facts, however, in that there was no
13   contract or statute that permitted FSSA to withhold Medicaid
14   payments to the hospital to recover the HAF debt.    Accordingly,
15   Saint Catherine Hospital is not persuasive.
16          One final point.   Throughout its argument, Debtor seems to
17   contend that it would be unfair to permit one party to a contract
18   unilaterally to dictate terms that essentially authorize
19   equitable recoupment – such as, here, requiring (i) an
20   acknowledgment of and an agreement to abide by obligations
21   arising under statutes and regulations, and (ii) an agreement
22   that violations of those statutes and regulations would lead not
23   merely to a breach of the subject contract, but would also permit
24   the governmental entity to exercise the contract remedy of
25   recoupment.    Were the provider contracts between private,
26   independent, economic actors, we might find this argument worthy
27   of consideration.    Here, however, as a government entity, the
28   State is guided by public policy considerations rather than

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 1   solely economic ones.   Indeed, it is abundantly clear from a
 2   review of the governmental programs that are the subject of this
 3   dispute that DHCS’s purpose in entering into these agreements is
 4   not to create a profit center related to the provision of
 5   critical medical services, but to create and fund programs that
 6   will adequately serve the needs of its citizens, and will incent
 7   participants in these programs to provide the revenue that funds
 8   these necessary programs.   As such, we see nothing inequitable or
 9   unfair in holding Debtor to its obligations under the provider
10   agreement and applicable state law.
11                               CONCLUSION
12        The bankruptcy court did not err in ruling that DHCS’s
13   withholding of a percentage of Medi-Cal Payments and Supplemental
14   HQA Payments owed to Debtor to recover unpaid HQA Fees was
15   permissible under the doctrine of equitable recoupment and was
16   thus not a violation of the automatic stay.
17        Accordingly, we AFFIRM.
18
19
20
21
22
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28

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