The Director’s Toolkit for Distressed Healthcare Management

The U.S. healthcare system stands at a precarious crossroads. For hospital and healthcare leaders, understanding the legal and strategic frameworks for managing financial distress has never been more critical. As the industry faces mounting pressures from regulatory changes and shifting payment models, healthcare directors and officers must be prepared to navigate complex restructuring scenarios while maintaining their fundamental mission: patient care.

The Current State of Healthcare Financial Distress

The healthcare industry has historically operated under significant financial strain, but recent developments have intensified these challenges. The passage of the One Big Beautiful Bill Act (OBBBA) that significantly reduced Medicaid coverage, coupled with increased insurance costs for consumers, creates substantial risk for providers facing unexpected shifts in payor mix and the types of services patients are seeking. As preventive care decreases due to reduced coverage, acute care visits under Emergency Medical Treatment and Labor Act (EMTALA) requirements increase, likely to result in greater financial losses, when operational margins are already razor thin.

Understanding Fiduciary Duties in Times of Distress

When a healthcare organization faces financial challenges, directors and officers must understand how their fiduciary responsibilities evolve. Corporate directors are held to higher standards of conduct, primarily through two fundamental duties: the duty of care and the duty of loyalty. For nonprofit organizations, an additional duty of obedience applies.

The Duty of Care

The duty of care requires that directors’ actions and conduct be informed and considered, with decisions made with “requisite care.” This doesn’t mean directors must personally possess expertise in every area affecting the organization. Rather, they are entitled to rely in good faith on reports prepared by company officers or outside experts, and officers themselves can rely upon outside experts to inform their decision-making.

Regardless of whether an organization is under financial distress, establishing and following a comprehensive decision-making process is essential. Equally important is maintaining detailed written records that demonstrate compliance with the duty of care. The board must ensure it obtains sufficient and detailed information from senior leadership to properly exercise its fiduciary duties.

Best practices for complying with the duty of care include asking questions and staying informed, meeting regularly as a board, requiring accurate and timely financial reporting along with other key operational information, requesting additional information when needed, proactively identifying issues and implementing plans to address them, engaging experts where necessary, and conducting scenario planning to consider alternatives.

What directors must avoid is equally clear: Never act as a “rubber stamp” for management decisions, and never ignore problems hoping they will resolve themselves.

The Duty of Loyalty

The duty of loyalty requires directors to act in the best interests of the company. Directors must be disinterested and independent in their decision making, and they cannot act solely for personal or non-corporate purposes, such as preserving their own positions or compensation. This represents the opposite of constituency-based decision making.

Identifying and avoiding conflicts of interest is critical to meeting this duty. Directors must constantly evaluate whether their personal interests might influence their judgment regarding what’s best for the organization and its stakeholders.

The Duty of Obedience (Nonprofit Organizations)

For nonprofit healthcare organizations, the duty of obedience requires directors to operate the organization in alignment with its mission and in compliance with its governing documents. This duty can create tension when an insolvent nonprofit faces the competing imperative to maximize creditor returns — a conflict that requires careful navigation and expert legal guidance.

Restructuring Options for Distressed Healthcare Organizations

Healthcare and senior living restructurings generally fall into three primary categories: sale, “true” reorganization, or liquidation. The appropriate restructuring strategy depends on numerous factors including existing cash needs, creditor cooperation, pending litigation, and other circumstances specific to each case.

Out-of-Court Solutions

Several options exist for organizations seeking to avoid formal bankruptcy proceedings. These include forbearance agreements with creditors, refinancing existing debt, sale or leaseback arrangements, recapitalization, and strategic affiliations with stronger healthcare systems.

Chapter 11 Bankruptcy

Chapter 11 provides powerful tools unavailable outside of bankruptcy. The automatic stay under 11 USC § 362 immediately halts all creditor collection efforts, lawsuits, and foreclosures upon filing. This breathing room allows organizations to stabilize operations while developing a long-term solution.

Chapter 11 also enables asset sales free and clear of liens, claims, and encumbrances, and provides the ability to assume favorable contracts and leases while rejecting burdensome ones. Directors must remember, however, their duty to maximize creditor returns when operating in bankruptcy.

Operational Stabilization During Transitions

Care providers face unique challenges in any restructuring process due to the imperative to preserve continuity of patient care. Managing transitions through a sale or other restructuring requires focused attention to operational continuity, financial triage and prioritizing, workforce stabilization, and clinical quality assurance.

These elements are not merely operational concerns — they represent legal obligations that boards must address to meet their fiduciary duties while protecting patient welfare.

Key Takeaways

As healthcare organizations face unprecedented financial pressures, directors and officers should remember several critical principles:

First, be alert for symptoms of distress — just as in patient care, early intervention is key to better outcomes. Second, adhering to corporate formalities provides greater legal protection when decisions are later scrutinized. Third, conflicts of interest represent the number one litigation risk for directors and must be rigorously identified and managed.

Regulatory compliance remains paramount even during financial distress. Disciplined communications practices offer greater protection, as statements made during crisis periods often become evidence in subsequent disputes. When properly executed with a deliberate plan, restructuring processes can salvage and preserve value rather than destroy it.

Finally, directors must understand their directors and officers (D&O) insurance coverage, confirm its sufficiency for potential risks, and understand tail funding requirements that may apply when the organization’s status changes.

Conclusion

The convergence of regulatory changes, payment model shifts, and increasing patient acuity creates a perfect storm for healthcare financial distress. Healthcare leaders must understand both their fiduciary obligations and the restructuring tools available to navigate these challenges successfully.

No matter the form of a healthcare restructuring process, the goal remains constant: preserving healthcare services for communities while meeting legal obligations to all stakeholders. By understanding these principles and seeking expert guidance early, healthcare directors and officers can fulfill their duties even in the most challenging circumstances.

If you have questions about how this may affect your business, we encourage you to connect with a member of LP’s Financial Services & Restructuring Group.