“Conduct” Test Now the Rule in the Seventh Circuit – But We Still Don’t Know How the Seventh Circuit Will Deal With Due Process Concerns

Contributed by Debra A. Dandeneau.
It’s hard to believe, but until now, the Seventh Circuit has never weighed in on the issue of when a claim arises in a bankruptcy case.  As a result, the Seventh Circuit has had the luxury of sitting back, watching the Third Circuit go from Frenville to Grossman’s and letting other courts decide among the “conduct” test, “fair contemplation” standard, or “prepetition relationship” rule.  The Seventh Circuit finally had the opportunity to side with one of these tests in St. Catherine Hospital of Indiana, LLC v. Indiana Family and Social Services Administration.  Adopting the “conduct” test, the Seventh Circuit concluded that a state’s collection of a fee assessed prepetition but not payable until the debtor hospital’s postpetition fiscal year constituted an act to collect a prepetition claim and, therefore, violated the automatic stay imposed by section 362(a) of the Bankruptcy Code.  The Seventh Circuit, however, expressly did not decide how it would characterize a claim in the future if the claimant lacked the kind of prepetition relationship that existed between the debtor hospital and the state. 
In St. Catherine, the State of Indiana assessed a fee against certain hospitals for a period covering two fiscal years.  The amount of the fee owed for both years, however, was based upon financial information on file with the state about halfway through the first fiscal year.  The hospital debtor filed for chapter 11 protection after the collection of the fee had been approved by the federal Centers for Medicare & Medicaid Services, the state had calculated the assessment, and the state already had begun withholding Medicaid reimbursements to collect the fee for the first fiscal year.  The debtor hospital’s second fiscal year began about two weeks after its chapter 11 filing.  After the second fiscal year began, the state issued the debtor a bill for the fee owed for the second fiscal year and started withholding Medicaid reimbursements to collect that fee.
The Seventh Circuit Endorses the “Conduct” Test
In determining that the state held a prepetition claim that was subject to the automatic stay, the Seventh Circuit unequivocally adopted the “conduct” test – the date a claim arises is determined by the date of the conduct by the debtor that gave rise to the claim.  In so holding, it noted that the conduct test is broad enough to include contingent and unmatured claims and, therefore, is in accordance with the broad definitions of “debt” and “claim” in sections 101(12) and 101(5) of the Bankruptcy Code.  Indeed, the court went so far as to add that “under most circumstances, finding that a claim arose ‘at the earliest point possible’ will best serve the policy goals underlying the bankruptcy process.”
What Is the “Conduct” That Gives Rise to the Claim, Though?
What was the actual “conduct” that gave rise to the claim?  That actually was the focus of the parties’ dispute because both parties agreed that the conduct test applied to the state’s claims.  The state, however, characterized the relevant “conduct” as the hospital’s continued operation in the second fiscal year, arguing that, if the hospital had ceased operating before the commencement of its second fiscal year, the hospital would not have had any liability for the second year’s fee.  The state likened the fee to a tax that is levied annually on hospitals.  The debtor, on the other hand, argued that the fee was tantamount to a contractual liability that arose on the date that the statute authorized assessment of the fee (or, at the latest, when CMS approved the imposition of the fee).
The Seventh Circuit did not find either analogy persuasive.  It noted that the fee clearly was not a contract because the hospital played no role in the process that gave rise to the fee.  It also found, though, that the fee clearly was not a tax because the fee was not calculated on an annual basis, and the fee was not a “fundraising device” for the state.  Instead, it was a one-time fee imposed for the purpose of increasing Medicaid reimbursements to hospitals.  That the fee was payable in installments – one due prepetition and one due postpetition – was no different from a prepetition loan that is payable over time.  The court found that all the relevant acts occurred prepetition – adoption of the fee by the legislature, CMS’s approval of the fee, and calculation of the entire fee.  Moreover, the contingency of the hospital’s continued operation was just that – an event that made the claim a “contingent” claim, a type of claim expressly contemplated by section 101(5)(A) of the Bankruptcy Code.
What About Tort Claims?
The Seventh Circuit acknowledged that the additional requirement of a prepetition relationship addresses the issue of whether a creditor has been afforded due process, but it stated that it need not decide in the context of St. Catherine whether to adopt such a test or some other standard that layers on due process principles to the issue of when a claim arises.  That is because the debtor hospital and the state clearly had a relationship, so any formulation of the test would have been satisfied in the case before it.  Accordingly, the court left the door open for other situations, such as tort claims, in which a straightforward application of the conduct test may lead to the forfeiture of rights by unknown creditors.  Indeed, the Seventh Circuit acknowledged that “where the claimant is the victim of pre-petition tortious conduct, but does not realize he or she has been a victim until some harm manifests after the bankruptcy … a court may be less inclined to conclude that the party had a claim or contingent claim dischargeable in bankruptcy.”  At least in St. Catherine, however, the debtor’s prayers (for relief) were answered.