The economic downturn has significantly impacted continuing care retirement communities (CCRCs), which provide elderly retirees and other residents with an alternative to conventional assisted living facilities and nursing homes. CCRCs allow residents to live independently while they are in good health, and then to receive increasing levels of care as needed, up to and including levels of care provided in traditional nursing homes. Residents of CCRCs prefer this type of care because they can stay in one facility that they choose as their health deteriorates.1 As consideration for a promise of lifetime care, many CCRCs require residents to pay large entrance fees (in the six-figure range) and additional monthly payments. The initial entrance fee deposits provide cash flow to operate the CCRC, and are used to pay for a range of care services, meal plans and a variety of on-site amenities and activities. In addition, most resident agreement contracts with the CCRC permit the entrance fee deposits to be used to pay for debt service and to pay for the costs of construction of the CCRC. The resident typically retains a right to receive a refund of the deposit from the CCRC when the resident dies and/or the resident’s unit is sold to another incoming resident who pays a new entrance fee deposit and then reoccupies the unit.2 If, however, a CCRC sells unoccupied units, rents units to a new resident, cannot sell new units and/or is insolvent, the CCRC may not have sufficient funds or a legal obligation to refund entrance fees to residents that wish to leave the CCRC.
The CCRC model is particularly at risk during economic downturns. Many residents of CCRCs sell their homes to pay for the large entrance fees that must be paid at the time that a resident occupies a CCRC unit. Declining sales prices and a stagnant real estate market have resulted in lower occupancy levels in independent living units, which serve as a CCRC’s primary source of profit and cash flow. In addition, many CCRCs fail to set aside sufficient funds for the future. During the early years of a CCRC, the costs associated with resident care are usually at their lowest because residents in the independent living facility are in good health at the time that they enter the CCRC. As residents age and begin to require assisted living services and/or skilled care nursing services, the costs of operating the CCRC significantly increase. When a CCRC underestimates month-to-month operating costs and fails to have access to additional liquidity, the CCRC faces unsustainable losses. In most cases, current residents are not able to afford increased monthly premiums or assessments to offset such losses. This lack of liquidity results in the triggering of defaults under the CCRC’s secured loans, which leads to traditional workouts and contingency planning.
Managing liquidity and restructuring the business model of a financially distressed CCRC can be a challenge. If a CCRC cannot keep its current residents and continue to attract new residents, it will lose its primary source of revenue. In addition, if residents who have paid significant entrance fees begin to realize that the CCRC is in financial distress, residents may decide to leave. In these out-of-court restructurings and workouts, the CCRC attempts to renegotiate the terms of the underlying secured debt and to provide the CCRC with sufficient time to address operational problems and find additional liquidity. Many non-profit CCRCs are financed through low-interest tax-exempt bond debt. This type of financing may present a financially distressed CCRC with limited options in a workout or out-of-court restructuring. The bond indenture trustee has the power to enforce a CCRC’s repayment obligations on behalf of the bondholders who are typically a variety of institutional investors and individuals. A CCRC’s repayment obligations are usually secured by liens on the CCRC’s assets, revenues and entrance fee deposits paid by the residents. In addition, the bond documents generally require the indenture trustee to hold certain of the CCRC’s funds in a bond reserve account that is used to pay the bondholders’ principal redemption payments, interest, costs, and fees. The bond documents usually restrict the indenture trustee’s use of the reserved funds and do not permit the funds to be used to fund the working capital needs of the CCRC. In addition, the bond documents typically contain consent requirements of the bondholders, which can present significant problems in obtaining bondholder consent to an out-of-court restructuring of the secured debt. Furthermore, in many instances, the CCRC’s payment obligations under the bond documents are back-stopped by a letter of credit. If the CCRC fails to make a required payment under the bond documents, the indenture trustee will make a draw under the letter of credit. The cumulative affect of these factors lead certain financially distressed CCRCs to the conclusion that a Chapter 11 bankruptcy is necessary to continue operations pending a restructuring or sale.
Over the last few years, various CCRCs have filed for protection under Chapter 11 of the Bankruptcy Code.3 When elderly residents enter into a CCRC residency agreement, they expect that they are paying for lifetime care and the opportunity to live in an independent care facility prior to needing skilled nursing care or assisted living care services. Once a CCRC enters bankruptcy, however, the CCRC residents are vulnerable to having their CCRC residency agreements being rejected as executory contracts under section 365 of the Bankruptcy Code.4 In addition, residents of a CCRC are usually unsecured creditors and, therefore, junior in priority to the allowed claims of the CCRC’s secured creditors. If the CCRC’s secured creditors are undersecured, residents of the CCRC may not receive a distribution in the bankruptcy case, thereby wiping out their life savings that were used to enter and stay at the CCRC.
McDonald Hopkins is counsel to the unsecured creditors’/residents’ committee in the Franciscan Communities St. Mary of the Woods, Inc. bankruptcy case filed in the U.S. Bankruptcy Court for the Northern District of Ohio (the Bankruptcy Court) on November 21, 2011, case number 11-19865 (the SMOW Case). In the SMOW Case, the debtor and its counsel, the committee and its counsel, McDonald Hopkins, and counsel for the bondholders and letter of credit issuer, were able to negotiate a sale process that addressed most of the concerns of the residents. Entrance fee deposits of new residents were escrowed after the petition date in a separate account. The final debtor-in-possession financing order (the Final Financing Order) excluded new entrance fee deposits paid on a post-petition basis from the liens and superpriority claims of the debtor-in-possession lender and the prepetition bondholders. With respect to existing residents, procedures were put in place to protect the identity of the residents, and each of the Final Financing Order and the order approving the bidding and sale procedures required that for any bid to be considered a “Qualified Bid” (as such term was defined in the bid procedures order) the bidder must assume all residency agreements of existing residents and all related obligations under the residency agreements without modification, including, without limitation, the right of each existing resident to a refund of their entrance fee deposit in accordance with the terms of their residency agreement. Ultimately, the debtor sold substantially all of its assets as part of a 363 sale process and the buyer assumed all of the obligations owing to residents under their applicable residency agreements. The sale was approved by the Bankruptcy Court on April 19, 2012.
The earlier a board and its professional advisors can admit that there is problem and formulate a restructuring plan to address the liquidity and operational issues, the better off the CCRC and its residents will be. The success of the restructuring will depend on timely action, current resident support and the ability to attract new residents to the CCRC.
1Nancy A. Peterman et al., Protecting residents of Continuing Care Retirement Communities, AM. Bankr. Inst. J., March 2003.
2U.S. Government Accountability Office, GAO-10-611, Older Americans: Continuing Care Retirement Communities Can Provide Benefits, But Not Without Some Risk. United States Senate Special Committee on Aging, Summary of Committee Investigation Report, July, 21, 2010.
3The Covenant at South Hills, Inc.; Erickson Retirement Communities, LLC; Lincolnshire Campus LLC and Naperville Campus, LLC (affiliates of Erickson Retirement Communities); Fairview Ministries and VibrantLiving Communities; The Clare at Water Tower; Fransiscan Communities St. Mary of the Woods, Inc.; and others not listed.
4See 11 U.S.C. § 365. See also, In re Brethren’s Home, 24 B.R. 336, 338-339 (Bankr. S.D. Ohio 1982) (Rejection of life care contracts of the residents of a CCRC, subject to an award of rejection damages).
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