Plan Committee of Heritage Associates II, LLC v. Department of Health and Mental Hygiene

1
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF MARYLAND
at Baltimore
In re: *
*
HERITAGE ASSOCIATES, II, L.L.C., * Case No. 03-58882-SD
* Chapter 11
Debtor. *
*
* * * * * * *
*
HERITAGE ASSOCIATES, II, L.L.C., *
*
Plaintiff, *
v. *
* Adversary No. 05-1547-SD
STATE OF MARYLAND, DEPARTMENT *
OF HEALTH AND MENTAL *
HYGIENE, ET AL., *
*
Defendants. *
*
MEMORANDUM DISMISSING COMPLAINT
Plaintiff, the Plan Committee of the Debtor, filed an adversary complaint against
Defendant, the Department of Health and Mental Hygiene of the State of Maryland, seeking to
Date signed January 10, 2006
Entered: January 11, 2006 Case 05-01547 Doc 13 Filed 01/12/06 Page 1 of 9

2
avoid and recover an allegedly fraudulent transfer. Defendant moved to dismiss on the grounds
that the Eleventh Amendment barred the suit. For the reasons set forth hereafter, the complaint
will be dismissed.
Background
It is alleged in the complaint that Heritage Associates II, L.L.C. (hereinafter, “Heritage”),
the Debtor, was formed in May, 2001 to purchase a nursing home facility from 1300 Windlass
Corporation. At that time, Ivy Hall Rehabilitation Center Inc. was operating the nursing home.
Ivy Hall was an independent party, unrelated to Heritage or Windlass. The sale never closed, but
Heritage began operating the nursing home on September 1, 2001, pursuant to a lease with
Windlass that expired on November 30, 2002. In order to qualify as a service provider under the
state funded medical assistance program, Heritage executed a provider agreement with the
Department of Health and Mental Hygiene of the State of Maryland (hereinafter, "Department").
The following allegations were made in the Complaint and are accepted as true for
purposes of the Department's Motion to Dismiss.
16. On or about November 8, 2001, Heritage signed a “Certificate of
Assurance Pursuant to COMAR 10.09.10.15A(2)” (the “Guaranty”), by
which Heritage purported to “accept liability for the financial obligations
of Ivy Hall Rehabilitation Center, Inc. to the Medical Assistance Program
(“Program”).”
17. Ivy Hall Rehabilitation Center, Inc. (“Ivy Hall”) was the prior operator of
the Nursing Home. Ivy Hall was not affiliated with Heritage or Windlass.
18. The Guaranty further permitted the [Department] to “withhold the amount
owed [to Heritage] from its provider payments.”
19. DHMH has invoked the Guaranty in support of DHMH's refusal to pay to
the Plan Committee moneys determined to be owed to Heritage following
an audit of Heritage's 2002 operations.
Case 05-01547 Doc 13 Filed 01/12/06 Page 2 of 9

3
(Pl. Complaint) (Emphasis supplied). From these allegations, as confirmed by the factual
assumptions contained in the arguments of counsel (Mem. in Opp., p. 2; Mem. in Support, p. 6),
the Department had already exercised its claim to recoupment when the instant complaint was
filed.
On May 29, 2003, five months after expiration of its lease with Windlass, an involuntary
Chapter 11 petition was filed against Heritage. On August 15, 2003 Heritage consented to an
order for relief under Chapter 11. Subsequently, a joint plan of liquidation was proposed by
Heritage and its creditors’ committee, and the joint plan was confirmed. The Plan vests all
property owned by Heritage in a Plan Committee (hereinafter, “Committee”) and empowers the
Committee to exercise all powers of a Trustee under the Bankruptcy Code.
The Committee filed this complaint against the Department seeking to avoid the
Guaranty under 11 U.S.C. § 544 because it allegedly constitutes a fraudulent conveyance
pursuant to Md. Code Ann. Com. § 15-209. The Committee argues that Heritage's estate is
entitled to funds earned by Heritage in 2002 that are being withheld by the Department to recoup
past overpayments made to Ivy Hall. Particularly, the Committee avers the Guaranty, which
entitles the Department to undertake the recoupment, constitutes a constructively fraudulent
transfer to the Department because Heritage was insolvent at the time it executed the Guaranty.
The Department filed a motion to dismiss pursuant to Fed. R. Civ. P. 12(b)(1), made
applicable by Fed. R. Bankr. P. 7012, alleging that this Court lacks subject matter jurisdiction to
hear the case because the Department is immunized from suit in federal court under the Eleventh
Amendment. Alternatively, the Department contends that avoiding the Guaranty disqualifies
Heritage as a provider under applicable regulations, resulting in Heritage not being entitled to
any of the payments the Committee seeks to recover.
Case 05-01547 Doc 13 Filed 01/12/06 Page 3 of 9

4
In its opposition the Committee maintains that its suit does not implicate the Eleventh
Amendment because the complaint is premised on the in rem jurisdiction of the Bankruptcy
Court over the Debtor’s estate. Specifically, the Committee contends that the relief it is seeking
is only avoidance of the Guaranty, not recovery of the funds withheld pursuant to the same.
The Department counters that the essence of the Committee’s complaint is the recovery
of funds in the possession of the State. For the reasons set forth below, the Committee's
complaint will be dismissed for lack of jurisdiction.
Standard of Review
When deciding a motion to dismiss based on the pleadings, the Court must "accept the
factual allegations in the Plaintiffs' complaint and must construe those facts in the light most
favorable to the Plaintiffs." Estate Constr. Co. v. Miller & Smith Holding Co., 14 F.3d 213, 217-18
(4th Cir. 1994). Dismissing a complaint is not appropriate "unless it appears beyond doubt that the
plaintiff can prove no set of facts in support of his claim which would entitle him to relief."
Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
Discussion
The defense of sovereign immunity is available to a State that is sued in a bankruptcy
case. See Schlossberg v. Comptroller of the Treasury (In re Creative Goldsmiths), 119 F.3d
1140 (4th Cir. 1997); NVR Homes, Inc. v. Clerks of the Circuit Courts (In re NVR, L.P.), 189
F.3d 442 (4th Cir. 1999). Sovereign immunity, unless waived, protects the State from a suit to
recover money from State coffers. See Ford Motor Co. v. Department of Treasury, 323 U.S.
459, 464 (1945); See Hess v. Port Authority Trans-Hudson Corp., 513 U.S. 30, 48-49 (1994);
NVR, 189 F.3d at 442. It does not protect the State from action that involves a bankruptcy
court's exercise of its in rem jurisdiction. See Tennessee Student Assistance Corp. v. Hood, 541
Case 05-01547 Doc 13 Filed 01/12/06 Page 4 of 9

5
U.S. 440 (2004); Maryland v. Antonelli Creditors' Liquidating Trust, 123 F.3d 777 (4th Cir.
1997); Virginia v. Collins (In re Collins), 173 F.3d 924, (4th Cir. 1999). The dispositive issue
raised by the Department's motion to dismiss is whether the complaint seeks in substance to
recover money from the State, as Defendant contends, or whether it merely involves exercise of
the bankruptcy court's in rem jurisdiction, as Plaintiff contends. For the reasons set forth below,
the complaint in substance seeks to recover money from the Department and is thus barred by
the doctrine of sovereign immunity.
In NVR, supra, the Court found that an action brought against a state, whose essential
purpose was to recover funds from the state treasury, was impermissible under the Eleventh
Amendment. See NVR, 189 F.3d at 442. In that case, the bankruptcy court confirmed a plan
that exempted the Debtor from paying state recordation taxes. At the time of confirmation, the
Debtor had already paid recordation taxes to the state. Subsequently, the Debtor filed for a
refund and the state denied the request. Next, the Debtor brought a motion under Bankruptcy
Rule 9014 seeking a judgment declaring that the taxes were not owed to the state pursuant to the
reorganization plan. In response, the state argued that the bankruptcy court lacked jurisdiction to
hear the claim under the Doctrine of Sovereign Immunity. The Court agreed with the Defendant
and stated in pertinent part:
NVR is demanding payment from the Maryland and Pennsylvania
treasuries. Although federal law may reign supreme in the
bankruptcy context, the federal courts do not necessarily reign
supreme over an unconsenting state's treasury. (internal citations
omitted) As courts have recognized in similar contexts, a state is
closely identified with its treasury and an action leading to an
order forcing a payment to citizens is the quintessential "suit"
under the Eleventh Amendment. See Hess v. Port Authority Trans-
Hudson Corp., 513 U.S. 30, 48-49, 130 L. Ed. 2d 245, 115 S. Ct.
394 (1994) (noting the almost unanimous view that the primary
factor in determining whether a state is immune from a federal
Case 05-01547 Doc 13 Filed 01/12/06 Page 5 of 9

6
judicial proceeding depends upon whether the action directly
impacts the state treasury.)
Id. at 453. The Circuit Court made it clear that the procedural formality used to bring the action
against the state was not dispositive. Rather, the fact that the remedy sought by NVR required a
federal court to raid a state's treasury constituted an affront to state sovereignty that is
impermissible under the Eleventh Amendment.
While NVR predated the Supreme Court's decision in Hood, it is consistent with that
holding. In fact, Hood specifically distinguished the matter before it from one where a trustee is
seeking to recover funds from a state. See Hood, supra, at 454. The Supreme Court stated in
relevant part:
The court has in rem jurisdiction over the matter, and the court
here has not attempted to adjudicate any claims outside of that
jurisdiction. The case before us is thus unlike an adversary proceeding
by the bankruptcy trustee seeking to recover property in the hands of the
State on the grounds that the transfer was an avoidable transfer.
As in NVR, the Supreme Court in Hood made it clear that the procedures required to
bring an action do not dictate whether the action constitutes a suit against a state. Instead, the
Court found that the Bankruptcy Court had exclusive jurisdiction over the bankruptcy estate and
that discharging a debt owed to a state was within the purview of that jurisdiction. By contrast,
the relief sought in NVR was the recovery of money from the state, which the Fourth Circuit
concluded, regardless of the form by which it was brought, constituted a suit prosecuted against
a state to recover money. The holdings in Hood and NVR are consistent because both are
premised on the jurisdiction of the Bankruptcy Court. Hood articulates that the discharge of a
debt owed to a state is within the jurisdiction of the Bankruptcy Court, while NVR concludes
that ordering a state to pay money is outside that jurisdiction.
Case 05-01547 Doc 13 Filed 01/12/06 Page 6 of 9

7
The facts before the Court here mirror those in NVR. The Committee has filed an
adversary proceeding seeking to recover funds that were withheld by the Department. While the
procedure used to institute the action is not controlling, the remedy sought by the Committee
classifies the action as a suit against a state that is impermissible under the Eleventh
Amendment. The Committee seeks to recover property that is in the State’s possession. As
stated very clearly by the Court in NVR, a suit seeking to raid a state's treasury is the
quintessential suit contemplated by the Eleventh Amendment. The Committee attempts to argue
that the relief they request is not the turnover of property, but rather a declaration avoiding the
Guaranty signed by Heritage. Specifically, the Committee argues that the Guaranty creates an
obligation encumbering the estate that the Bankruptcy Court has jurisdiction to avoid. See
Hood, supra. While the Guaranty does create an obligation, the controlling fact in this case is
that the obligation has been fully satisfied as a result of the recoupment undertaken by the
Department. Consequently, as the Department correctly argues, a judgment avoiding the
Guaranty essentially requires the Department to pay moneys out of the state treasury. The Court
in NVR, faced a similar issue regarding the validity of a declaration by the bankruptcy court
exempting the debtor from recordation taxes that had already been paid. The Court stated, inter
alia:
The ultimate resolution of the dispute between NVR and the states
does require, however, that the federal courts exercise jurisdiction
over the states. The states persuasively framed this issue by noting
that if the federal court action could not result in ordering the
states to return the tax payments, then any opinion issued would be
advisory and improper. (internal citations omitted). "The real
value of the judicial pronouncement -- what makes it a proper
judicial resolution of a 'case or controversy' rather than an advisory
opinion -- is in the settling of some dispute which affects the
behavior of the defendant towards the plaintiff." The district court
attempted to tip-toe around the issue by stating, "Neither reached
nor decided here is the question whether the bankruptcy court's
Case 05-01547 Doc 13 Filed 01/12/06 Page 7 of 9

8
[order declaring NVR exempt from the transfer and recordation
taxes] is binding in any way on the [state] taxing authorities."
(internal citations omitted). It is apparent, however, that absent the
ability of the bankruptcy court to exercise jurisdiction over the
states and compel the turnover of the tax payments, no remedy
effectively could be granted. This case is indeed one in which
"adjudication . . . depends on the court's jurisdiction over the
state." This finding alone is enough to determine that the action, if
it is to meet the requirements of Article III, is a suit against the
states.
NVR, 189 F.3d at 453.
In the instant case the facts are even more persuasive. A judgment avoiding the
Guaranty would require that the Department disgorge property in its possession as that is the
only relief available to the Committee. Consequently, if the Committee was to prevail with
respect to the narrow relief it has requested, namely, to avoid the Debtor's Guaranty, it could
have one of two results. First, the Debtor's Guaranty would be avoided. The Guaranty is a
material term of the provider agreement and a Debtor may not avoid part of an agreement
without avoiding the entire agreement. With the Guaranty avoided, there would be a failure to
comply with COMAR 10.09.10.15(A) of the Medicaid regulations, thus resulting “in all
unsettled fiscal periods to be immediately settled at 90 percent of the rates used for the most
recently settled fiscal period, and amounts due shall be paid immediately.” COMAR
10.09.10.15(D) (emphasis added). Second, in the alternative, the basis for the recoupment that
the Department has already effected would be avoided retroactively. The avoided Guaranty does
not change the fact that the Department is still in possession of the funds. As a result, the
essential nature of the Committee’s suit is to recover money from a state agency regardless of
the cause of action it chose to frame the issue. As the Court in NVR so eloquently stated, “it is
best to avoid such judicial gerrymandering” in order to force a state agency into bankruptcy
court. NVR, 189 F.3d at 454.
Case 05-01547 Doc 13 Filed 01/12/06 Page 8 of 9

9
Under either result, based on the facts alleged in this complaint, the Department, an
agency of the State of Maryland, would be required to pay money to the Committee. Such a
result is prohibited by the doctrine of sovereign immunity. See NVR, 189 F.3d at 457.
Moreover, the Committee does not appear to have been left without any opportunity for a
remedy under State law, since there opportunity to appeal is provided under COMAR
10.09.10.28.
For the reasons set forth above, the Committee's complaint will be dismissed for lack of
jurisdiction.
ORDER ACCORDINGLY.
cc: James C. Olson, Esquire
10451 Mill Run Circle
Suite 400
Owings Mills, MD 21117
Lori S. Simpson, Esquire
Bishop, Daneman, et al.
2 North Charles Street, Suite 500
Baltimore, MD 21201
Brett Bierer, Assistant Attorney General
300 West Preston Street, Suite 302
Baltimore, MD 21201
Office of the U.S. Trustee
300 West Pratt Street
Suite 375
Baltimore, MD 21201
End of Memorandum.
Case 05-01547 Doc 13 Filed 01/12/06 Page 9 of 9