Buying Distressed Operations in the Skilled Nursing Facility Space

Long Term Care & Senior Housing Update

Client Alert

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The “Nursing Home Covid-19 Data Dashboard” maintained by the Centers for Disease Control and Prevention (CDC) shows that COVID-19 had an unusually intense impact on the long term care community. Cases among nursing home residents first peaked during the end of December 2020, at a rate of 31 cases per 1,000 residents, and then took a steady decline for several months. Cases started to rise again in the summer of 2021, and then peaked again in the winter of 2021-2022, this time at a rate of 43.5 cases per 1,000 residents, before settling into a range not exceeding 17 cases per 1,000 residents for nearly a year. The Covid-19 death rate peaked near the end of December 2020, at a rate of 5.5 deaths per 1,000 residents, but as with cases, deaths soon started to decline, and have not exceeded a rate of 0.3 deaths per 1,000 residents for almost a year (since February 2022). 

The high toll on nursing facility residents caused by COVID-19 led to efforts by state and federal agencies to provide financial assistance for providers through a variety of tools, including the “alphabet soup mix” of stimulus funds such as CARES, PPPHCEA, and CRRSA. While those funds helped many facilities survive financially, many still find themselves struggling for a variety of other reasons, including staffing issues and costs, general inflation, regulatory issues, and other operational problems.

These struggles have led to numerous financially distressed facilities being offered for sale. The purpose of this article is to briefly note a few important items that a party considering buying a financially distressed facility should keep in mind, both from a diligence and a contracting standpoint. The first question that a buyer will always need to ask itself is whether its organization currently has the ability to quickly fix census or operational issues that are challenging the current owner. If not, it might be best to keep your conversations, and diligence actions, brief and to be prepared to move on in search of another opportunity.

Having a full understanding of the facility’s financial situation under consideration is always a key issue. Potential recoupments from payors has always been a “top of the list” question when acquiring a skilled nursing facility, but in addition to the usual Medicare, Medicaid, Managed Care Organization (MCO), commercial insurance, and other third-party payor programs, potential buyers should determine if there are federal stimulus funds received by the facility that might still need to be repaid. Additionally, a few states have developed programs for nursing homes in severe financial distress to apply for special funding (e.g., New York’s Vital Access Provider Assurance Program (VAPAP)), which could require repayments in certain circumstances.

Seller indemnification obligations and hold-back escrows are often a part of a purchase transaction. But for a distressed facility, how can you determine the meaningfulness of those indemnifications and escrows? An indemnification from a distressed ownership entity may be virtually worthless, so buyers need to determine if there are other entities or individuals “up the chain” who might provide a guarantee of certain indemnifications. Can the hold-back escrow be structured in a way that, even if there has not been anything discovered that would allow you to receive a distribution from the escrow, you might still be able to temporarily borrow from the escrow to deal with an issue neither buyer nor seller anticipated? 

Talk to your lender as early on in the process as you are able. If you have not financed a facility in the past few years, you may be surprised to learn that the long term care lending market has changed in many significant ways beyond just the interest rate increases that have been occurring regularly for the past several months. The loan-to-value ratio requirements, as well as the requirements for pledges of other assets or personal guarantees, especially for the acquisition of a facility that has struggled financially in recent years, may complicate your financing plans. If the seller has debt that you are contemplating assuming, remember that possible prior defaults of operational covenants may have been triggered due to the distressed situation, and the lender may have waived those defaults or entered into a “standstill agreement” with the operator. Those waivers and standstill provisions need to be carefully reviewed to determine if they might still apply to a new operator.

Finally, be creative as you consider the circumstances. Can you “buy the loan” from an existing lender who might be willing to offer a discount? Perhaps a lease with an option to purchase, with all or most of the lease payment going directly to the lender so the loan stays current, is a better option than purchasing the facility outright. If your lender will not offer the loan-to-value ratio you were hoping for, would the seller be willing to hold a second mortgage for some period of time, especially if that would enable the seller to stop the monthly operational losses currently being incurred (assuming you are confident your organization has the ability to quickly stop those losses)?