IN THE UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA - LOS ANGELES DIVISION

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1 Main Document Page of 0 0 XAVIER BECERRA Attorney General of California TANIA M. IBANEZ Senior Assistant Attorney General ALICIA BERRY (SBN ) Deputy Attorney General 00 South Spring Street, Suite 0 Los Angeles, CA 00 Tel: () -0 / Fax: () -0 Alicia.Berry@doj.ca.gov Attorneys for Xavier Becerra, California Attorney General IN THE UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA - LOS ANGELES DIVISION In re, VERITY HEALTH SYSTEMS OF CALIFORNIA, INC., et al., Debtor and Debtor In Possession. Affects All Debtors Affects Verity Health System of California, Inc. Affects O Connor Hospital Affects Saint Louise Regional Hospital Affects St. Francis Medical Center Affects St. Vincent Medical Center Affects Seton Medical Center Affects O Connor Hospital Foundation Affects Saint Louise Regional Hospital Foundation Affects St. Francis Medical Center of Lynwood Medical Foundation Affects St. Vincent Foundation Affects St. Vincent Dialysis Center, Inc. Affects Seton Medical Center Foundation Affects Verity Business Services Affects Verity Medical Foundation Affects Verity Holdings, LLC Affects De Paul Ventures, LLC Affects De Paul Ventures - San Jose Dialysis, LLC Debtors and Debtors In Possession. VERITY HEALTH SYSTEM OF CALIFORNIA, INC., et al., Debtors and Debtors In Possession, Plaintiffs, v. OLD REPUBLIC INSURANCE COMPANY and CITY NATIONAL BANK, Defendants. Lead Case No. :-bk-0-er Jointly Administered With: Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-0-er Case No. :-bk-00-er Case No. :-bk-0-er Chapter Cases Honorable Judge Ernest M. Robles RESPONSE TO DEBTORS MOTION FOR ENTRY OF (I) AN ORDER () APPROVING FORM OF ASSET PURCHASE AGREEMENT FOR STALKING HORSE BIDDER, AND (II) AN ORDER (A) AUTHORIZING THE SALE OF PROPERTY FREE AND CLEAR OF ALL CLAIMS, LIENS AND ENCUMBRANCES; MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT THEREOF Adv. Proc. No. :-ap-0-er Continued Hearing: Date: October, 0 Time: 0:00 am (PDT) Location: United States Bankruptcy Court Courtroom East Temple Street Los Angeles, CA 00

2 Main Document Page of 0 0 TABLE OF CONTENTS Page INTRODUCTION... STATEMENT OF FACTS... MEMORANDUM OF POINTS AND AUTHORITIES... I. The California Attorney General Has Broad Powers to Protect the Public... II. III. IV. A. California Law Provides that the California Attorney General Has a Statutory Duty to Protect the Health and Safety of the Public... B. California Law Allows for the Modification of Conditions... The Bankruptcy Code Does Not Preempt State Statutes Designed to Protect the Public Health or Safety... The California Attorney General Objects to the Approval of the Form of the Asset Purchase Agreement, as the Schedules Have Not Yet Been Provided... The Parties to the Asset Purchase Agreement Appear to Agree that the Agreement is Subject to the Existing Conditions of the California Attorney General... V. While such Relief is Not Requested in the Motion, It is Noted that the Attorney General s Conditions are not a Claim, Interest, or Lien that Can Be Extinguished by the Sale of Property... 0 VI. The California Attorney General Requests an Automatic Stay of Any Sale Order for Days Pursuant to Section CONCLUSION... i

3 Main Document Page of 0 0 FEDERAL CASES TABLE OF AUTHORITIES Page Baker & Drake, Inc. v. Public Serv. Comm. of Nevada F.d (th Cir. )... In re Leckie Smokeless Coal Co. F.d (th Cir. )... 0, Midlantic National Bank v. New Jersey Department of Environmental Protection U.S. (), 0 S.Ct.... Zerand-Bernal, Inc. v. Cox F.d (th Cir. )... CALIFORNIA CASES D Amico v. Board of Medical Examiners Cal.d (Ca. Sup. Ct. )... Ojavan Investors, Inc. v. California Coastal Com. Cal.App.th ()... FEDERAL STATUTES U.S.C. (d)()... U.S.C. (f)... 0 U.S.C. (f)... U.S.C , U.S.C CALIFORNIA STATUTES California Code of Regulatons Title,., subd. (e), (f)()... Title,., subd. (g)()... Title,., subd. (h)()... ii

4 Main Document Page of 0 0 California Corporation Code TABLE OF AUTHORITIES (continued) Page -0...,, subd. (h) (a)() California Goverment Code... CONSTITUTIONAL PROVISIONS United States Constitution Eleventh Amendment... California Constitution, Article V,... iii

5 Main Document Page of 0 0 INTRODUCTION Xavier Becerra, Attorney General of the State of California, (California Attorney General) respectfully submits this Response to Debtors Motion for the Entry of (I) an Order () Approving Form of Asset Purchase Agreement for Stalking Horse Bidder and for Prospective Overbidders to Use, () Approving Auction Sale Format, Bidding Procedures and Stalking Horse Bid Protections () Approving Form of Notice to be Provided to Interested Parties, () Scheduling a Court Hearing to Consider Approval of the Sale to the Highest Bidder and () Approving Procedures Related to the Assumption of Certain Executory Contracts and Unexpired Leases; and (II) an Order (A) Authorizing the Sale of Property Free and Clear of All Claims, Liens, and Encumbrances; and Memorandum of Points and Authorities in Support Thereof filed October, 0 ( Motion for Sale ), filed October, 0 [Dkt No. ].) As it appears that the Debtor acknowledges that the conditions set forth in the California Attorney General s December, 0 Decision will be binding on any purchaser, the California Attorney General does not generally object to the transaction contemplated in the Motion for Sale, provided that certain clarifications and additional disclosures are made. The California Attorney General s response is limited to requesting: () certain modifications and clarifications with respect to the form of the Asset Purchase Agreement for stalking horse bidder and for prospective overbidders to use, () clarification that the sale of the property is not free and clear of the conditions set forth in the California Attorney General s December, 0 Decision, and () to the extent these requests and objections are overruled, the California Attorney General objects to the waiver of the -day stay pursuant to U.S.C By filing this Limited Response, the State of California does not waive its immunity under the Eleventh Amendment of the United States Constitution.

6 Main Document Page of 0 0 STATEMENT OF FACTS. In July 0, Daughters of Charity Health System and Daughters of Charity Ministry Services Corporation (collectively, Daughters ) entered into the System Restructuring and Support Agreement with BlueMountain Capital Management, LLC ( BlueMountain ), pertaining to the change in governance and control of Daughters, its affiliated entities, five acute care hospitals and skilled nursing facility; those facilities include but are not limited to: St. Vincent Medical Center in Los Angeles, St. Francis Medical Center in Lynwood, O Connor Hospital in San Jose, Saint Louise Regional Hospital in Gilroy, Seton Medical Center in Daly City, and Seton Coastside in Moss Beach.. On July, 0, Daughters submitted written notice of the transaction to the California Attorney General for review and approval pursuant to California Corporations Code section -0.. As required by state law, the California Attorney General retained a healthcare expert to evaluate the potential impact of the transaction on the availability and accessibility of healthcare services to each of the communities served by the five hospitals and skilled nursing facility. The expert prepared a written healthcare impact report for each hospital.. On December, 0, the California Attorney General issued a decision to consent with conditions ( Decision ), to the change in governance and control of Daughters of Charity Health System (now known as Verity Health Systems of California, Inc.). The Decision contained five sets of conditions, one for each of the hospitals, as well as a copy of the healthcare impact reports for each of the hospitals. (Decision, filed September, 0 [Dkt No. -].). Following the closing date, Verity Health Systems of California, Inc. (Verity), has continued to operate the five acute care hospitals and skilled nursing facility. According to the Richard Adcock, Verity s CEO, Verity provides approximately,0 inpatient beds, six active emergency rooms, a trauma center,

7 Main Document Page of 0 0 and a host of medical specialties, including tertiary and quaternary care. (Declaration of Richard G. Adcock in Support of Emergency First-Day Motions, at,, filed August, 0 [Dkt No. ].). Condition I of the California Attorney General s Decision provides that the conditions shall be legally binding on the parties to the transaction, including the hospital facilities, and any other subsidiary, parent, general partner, limited partner, member, affiliate, successor, successor in interest, assignee, or person or entity serving in a similar capacity, and any entity succeeding thereto as a result of consolidation, affiliation, merger, or acquisition of all of substantially all of the real property or operating assets of the hospitals, or the real property on which the hospital is located, any and all current and future owners, lessees, licensees, or operators of the hospital, and any and all current and future lessees and owners of the real property on which the hospital is located. (Decision, at,, filed September, 0 [Dkt No. -].). Following Verity s acceptance of the California Attorney General s Decision, the transaction closed December, 0. The terms in the Decision remain in effect for fifteen years from the closing date of the System Restructuring and Support Agreement. (Decision, at,, filed September, 0 [Dkt. No. -].). On October, 0, Verity filed a Motion for Sale related to two of the hospitals in Santa Clara County: O Connor Hospital in San Jose, and Saint Louise Regional Hospital in Gilroy. It appears that the parties to the Asset Purchase Agreement agree that the California Attorney General s conditions remain in place. Section. of the Asset Purchase Agreement indicates that Purchaser agrees that promptly after the Signing Date, and in any event prior to the date of the Auction, it will use its commercially reasonable efforts to negotiate any issues with the California Attorney General over approval of the transactions contemplated by this Agreement. Sellers agree to cooperate in good faith as permitted under the

8 Main Document Page of 0 0 Bankruptcy Code to assist in this endeavor. (Asset Purchase Agreement, Section., at. [Dkt No. -].). Verity further appears to agree, as the seller in the Asset Purchase Agreement, that the conditions set forth in the Decision are binding on Verity. Section. of the Asset Purchase Agreement states in part, For so long as Purchaser owns or operates any Hospital, Purchaser intends to maintain essential clinical services at such Hospital as more specifically set forth on Schedule. in a manner that is consistent with the objectives of the current conditions of approval from the California Attorney General that are binding upon Sellers with respect to each such Hospital. (Asset Purchase Agreement, section., at 0, [Dkt No. -].) 0. The Asset Purchase Agreement between certain of the Verity entities and the County of Santa Clara for the sale of O Connor Hospital and Saint Louise Regional Hospital appear to agree that the California Attorney General s conditions related to the provision of charity care also remain in place. Section. of the Asset Purchase Agreement states in part, [a]s of the Effective Time, and for so long as Purchaser owns and operates any Hospital, but subject to the conditions, if any, placed on any Hospital by the California Attorney General as of the Effective Time, (a) Purchaser s charity care policies, which are broad in scope, will apply to each Hospital, and (b) Purchaser will continue to provide care through communitybased health programs at each Hospital, including cooperation with local organizations that sponsor health care initiatives to address identified community needs and improve the health status of the elderly, poor, and other at-risk populations in the community. (Asset Purchase Agreement, section., at 0, [Dkt No. -].). On October, 0, the California Attorney General requested a copy of the schedules referenced in the proposed Asset Purchase Agreement, and was informed by Debtors Counsel, Samuel Maizel that [t]he schedules to the APA are

9 Main Document Page of 0 0 still being created. I am HOPEFUL that we will have them prepared by the hearing on October th. They will be public at that point. ( from Samuel Maizel, dated October, 0 attached as Exhibit A.). The California Attorney General has not received a request for modification of the Decision aside from the notice of Verity s intent to terminate its Management Agreement with Integrity. (Debtors Notice of Motion and Motion to Reject Health System Management Agreement with Integrity Healthcare, LLC, filed September, 0 [Dkt No. ].) MEMORANDUM OF POINTS AND AUTHORITIES I. THE CALIFORNIA ATTORNEY GENERAL HAS BROAD POWERS TO PROTECT THE PUBLIC Xavier Becerra is the duly elected Attorney General of the State of California and is the chief law officer of the State. Cal. Const., art. V,. The California Attorney General has broad constitutional, common law and statutory powers under the state constitution to protect the public. Cal. Const., art. V, ; D 'Amico v. Board of Medical Examiners Cal.d, - (Ca. Sup. Ct. ); Cal.Rptr.. The California Attorney General is charged with the supervision and regulation of nonprofit corporations and other charitable trusts in this state. Cal. Gov t. Code (West 0). A. California Law Provides that the California Attorney General Has a Statutory Duty to Protect the Health and Safety of the Public Sales of nonprofit debtor corporation s assets are subject to applicable state law. See U.S.C. (d)() and (f).) California law requires nonprofit corporations to provide notice and obtain written consent from the California Attorney General in order to transfer, sell, or otherwise dispose of a material amount of their assets. Cal. Corp. Code - 0 (West 0). The California Attorney General s review of hospital transactions range from technical legal matters to the broad question of whether the

10 Main Document Page 0 of 0 0 transaction is in the public interest. The most significant question is whether the proposed transaction will adversely affect the availability and accessibility of health care services to the affected community. To that end, California law expressly authorizes the California Attorney General to retain a healthcare expert to evaluate the potential impact of a proposed transaction on the availability and accessibility of healthcare services to each of the communities served by the healthcare facility involved. Cal. Corp. Code (a)() (West 0). Here, the California Attorney General used his statutory powers to protect the public health and safety in issuing the December, 0 Decision. The primary purpose of the conditions is to ensure the availability and accessibility of health care services to the affected community. See, e.g., Cal. Corp. Code, subd. (h) (West 0); Cal. Code Regs., tit.,., subd. (e), (f)().) California law further requires the California Attorney General to monitor compliance with any terms or conditions of any agreement for which the California Attorney General conditionally consented and parties to the agreement are required to provide to the California Attorney General with information necessary for the California Attorney General to monitor compliance. Cal. Code Regs., tit.,., subd. (g)(). The California Attorney General retains broad authority to enforce the conditions and is entitled to specific performance, injunctive relief, and other equitable remedies a court deems appropriate for any breach of the conditions. Cal. Corp. Code (West 0). B. California Law Allows for the Modification of Conditions California law also allows either the selling or acquiring corporation or entity, or their successors in interest, to request that the California Attorney General approve an amendment to the terms and conditions, when unforeseen circumstances occur. Cal. Code Regs., tit.,., subd. (h)(). However, none of the parties to the Asset Purchase Agreement has requested a modification of the California Attorney General s December, 0 Decision. Nothing in the Debtors motion

11 Main Document Page of 0 0 suggests the parties intend to modify the Decision. II. THE BANKRUPTCY CODE DOES NOT PREEMPT STATE STATUTES DESIGNED TO PROTECT THE PUBLIC HEALTH OR SAFETY The United States Supreme Court has held that the Bankruptcy Act does not preempt a state statute or regulation that is reasonably designed to protect the public health or safety... Midlantic National Bank v. New Jersey Department of Environmental Protection, U.S., 0 (), 0 S.Ct.. The bankruptcy laws should not be used to place buyers in a position that they are above the law, leaving the public at risk without the protection of important public health and safety laws. Zerand-Bernal, Inc. v. Cox, F.d, (th Cir. ). [F]ederal bankruptcy preemption is more likely () where a state statute facially or purposefully carves an exception out of the Bankruptcy Code, or () where a state statute is concerned with economic regulation rather than with protecting the public health and safety." Baker & Drake, Inc. v. Public Serv. Comm. of Nevada, F.d, (th Cir. ) (holding that the Bankruptcy Code did not preempt Nevada's ban on taxi leasing, a regulation intended to secure the public convenience and safety). In enacting this legislation concerning health facilities owned by nonprofit corporations, the California Legislature made findings and declarations regarding the impact of such transactions to the public s access to healthcare: (c) Charitable, nonprofit health facilities have a substantial and beneficial effect on the provision of health care to the people of California, providing as part of their charitable mission uncompensated care to uninsured low-income families, and under-compensated care to the poor, elderly, and disabled. (d) Transfers of the assets of nonprofit, charitable health facilities to the for-profit sector, such as by sale, joint venture, or other sharing of assets, directly affect the charitable use of those assets and may affect the availability of community health care services. (Cal. Corp. Code, Ch., Note,, Stats ch 0.) III. THE CALIFORNIA ATTORNEY GENERAL OBJECTS TO THE APPROVAL OF THE FORM OF THE ASSET PURCHASE AGREEMENT, AS THE SCHEDULES HAVE NOT YET BEEN PROVIDED On October, 0, Verity entered into a proposed Asset Purchase Agreement with the County of Santa Clara for the purchase of two of Verity s

12 Main Document Page of 0 0 hospitals: O Connor Hospital in San Jose, and Saint Louise Regional Hospital in Gilroy, California. (Asset Purchase Agreement, filed October, 0 [Dkt No. -].) However, none of the numerous schedules referenced in the Asset Purchase Agreement have been provided and will apparently not be available until the hearing on the motion. The schedules relate to essential terms of the Asset Purchase Agreement including the specific clinical services the Purchaser agrees to maintain. As such, the California Attorney General objects to the approval of the Asset Purchase Agreement until his attorneys have had an opportunity to meaningfully review the schedules and consult with the healthcare expert on the impact of the schedules on the health and safety of the impacted communities. The California Attorney General requests an opportunity to provide further objections/responses to the motion for sale following the disclosure of the schedules. IV. THE PARTIES TO THE ASSET PURCHASE AGREEMENT APPEAR TO AGREE THAT THE AGREEMENT IS SUBJECT TO THE EXISTING CONDITIONS OF THE CALIFORNIA ATTORNEY GENERAL A seller cannot sell rights greater than what it has and a buyer obtains the interest with the same limitations and restrictions which bound their predecessors in interest. Ojavan Investors, Inc. v. California Coastal Com. Cal.App.th, (); Cal.Rptr.d 0. The conditions imposed by the California Attorney General s Decision for each of the five hospitals and one skilled nursing facility remain in effect for fifteen years from the closing date of the transaction. The conditions also make clear that they apply to all future owners, managers, lessees, licensees, or operators of the hospitals and skilled nursing facility. (Decision, at,, filed September, 0 [Dkt No. -]. It appears that Debtors agree that the Asset Purchase Agreement is subject to the existing conditions set forth by the California Attorney General s issued December, 0. The motion does not state that the conditions do not apply.

13 Main Document Page of 0 0 Section. indicates that the Purchaser will use its commercially reasonable efforts to negotiate any issues with the California Attorney General over approval of the transactions contemplated by this Agreement. (Asset Purchase Agreement, at [Dkt NO. -].) Section. of the agreement acknowledges that for so long as Purchaser owns and operates any Hospital, but subject to the conditions, if any, placed on any Hospital by the California Attorney General (a) Purchaser s charity care policies will apply to each Hospital, and (b) Purchaser will continue to provide care through community-based health programs at each Hospital Id. at 0. Section. of the agreement further acknowledges that Purchaser intends to maintain essential clinical services at such Hospital in a manner that is consistent with the objectives of the current conditions of approval from the California Attorney General that are binding upon Sellers with respect to each such Hospital. Id. at 0. Verity, as the seller in the Asset Purchase Agreement acknowledges that the conditions set forth in the Decision are binding on Verity. Section. of the Asset Purchase Agreement states in part, For so long as Purchaser owns or operates any Hospital, Purchaser intends to maintain essential clinical services at such Hospital as more specifically set forth on Schedule. in a manner that is consistent with the objectives of the current conditions of approval from the California Attorney General that are binding upon Sellers with respect to each such Hospital. ([Dkt No. -] Exhibit A, Section. Asset Purchase Agreement, at 0.) Here, the conditions accepted by Verity specifically contemplated a future sale of the hospital. (Decision, at,, filed September, 0 [Dkt No. -].) Under both California law and the express terms of the conditions, the County of Santa Clara as the proposed purchaser takes the assets subject to the existing conditions, regardless of whether additional California Attorney General review or approval is necessary.

14 Main Document Page of 0 0 V. WHILE SUCH RELIEF IS NOT REQUESTED IN THE MOTION, IT IS NOTED THAT THE ATTORNEY GENERAL S CONDITIONS ARE NOT A CLAIM, INTEREST, OR LIEN THAT CAN BE EXTINGUISHED BY THE SALE OF PROPERTY U.S.C. (f) states in pertinent part: The trustee may sell property under subsection (b) or (c) of this section free and clear of any interest in such property of an entity other than the estate, only if-- () applicable nonbankruptcy law permits sale of such property free and clear of such interest; () such entity consents; () such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; () such interest is in bona fide dispute; or () such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. However, The California Attorney General s Conditions are not a claim, interest, or lien that can be extinguished by a sale of the assets. Debtors cite In re Leckie Smokeless Coal Co.) F.d, (th Cir. ), for the proposition that debtors could sell their assets under (f) free and clear of successor liability that otherwise would have arisen under federal statute. (Motion at :-, emphasis added.) Leckie involved a determination of whether the purchaser of debtors assets could be liable as a successor in interest under the federal Coal Industry Retiree Health Benefit Act of. U.S.C. 0-; In re Leckie Smokeless Coal Co. F.d,, (th Cir. ). The court initially noted that a claim was limited to a right to payment. Id. at p. 0. The court specifically held that the right to collect future premium payments constituted an interest in the assets. Id. at p.. Contrary to Leckie, the Attorney General s conditions were imposed pursuant to California law. Cal. Gov. Code, and do not consist of either a claim nor an interest in the property within the meaning of section (f). The court also noted that under, subdivision (f)(), a trustee may sell property free and clear of another entity's interest in that property if such entity 0

15 Main Document Page of 0 0 could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. (Id. at p..) It is undisputed that the Attorney General could not be compelled to accept money satisfaction in lieu of condition imposed to ensure that the community retains access to it hospital services. The California Attorney General s police and regulatory powers to protect the health and safety of the public cannot be valued or monetized pursuant to section (f)() and (). VI. THE CALIFORNIA ATTORNEY GENERAL REQUESTS AN AUTOMATIC STAY OF ANY SALE ORDER FOR DAYS PURSUANT TO SECTION 00. U.S.C. 00. provides for an automatic stay of any order authorizing the use, sale or lease of property automatically stayed for days after the entry of the order. The proposed sale will have a large impact on the health and safety of the surrounding communities, and the California Attorney General requests that the - day stay not be waived. The California Attorney General objects to the waiver of the -day stay unless these requests and objections are satisfied.

16 Main Document Page of 0 0 CONCLUSION While it appears that both Verity and the County of Santa Clara acknowledge that the conditions imposed by the Attorney General are in effect, this should be expressly stated in the Asset Purchase Agreement entered into with any successful bidder and in the sale order. Further, the sale motion should not be approved unless and until all interested parties have had a meaningful opportunity to review and comment on the schedules referenced in the motion. Dated: October 0, 0 LA00 00.docx Respectfully submitted, XAVIER BECERRA Attorney General of California TANIA M. IBANEZ Senior Assistant Attorney General /s/ Alicia Berry ALICIA BERRY Deputy Attorney General California Office of the Attorney General

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