The controversy stems from the limits written into the federal Bankruptcy Code on what entities can be debtors in a bankruptcy case. Courts applying Louisiana, Arizona, Pennsylvania, Texas and Michigan law have held that HMOs are not insurance companies and therefore are eligible for bankruptcy relief. However, courts applying Wisconsin, New Jersey, Illinois and Oregon law have found HMOs to be domestic insurance companies and therefore ineligible for federal bankruptcy protection. The issue of whether an HMO can file a bankruptcy petition or must proceed under state insurance law is important in several aspects. Providers also generally have fewer rights under state liquidation proceedings because the general goal of such proceedings is to continue coverage for the enrollees.
Providers therefore prefer to have insolvent HMOs liquidate or reorganize under the Bankruptcy Code.
The largest case to date of an HMO seeking bankruptcy protection occurred in Los Angeles in the late 1980s, when the Maxicare network filed. The Maxicare cases involved 48 affiliates of its national network. The bankruptcy court initially decided that the affiliates were eligible to reorganize under the Bankruptcy Code. Three years later, in 1992, however, the federal district court reversed the decision relating to Maxicare's Wisconsin affiliate. In 1993, the U.S. Court of Appeals for the 7th Circuit issued the only federal appeals court opinion on this issue when it held that Medcare was an insurance company under Illinois state law and could not be a debtor under the Bankruptcy Code.