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Penta State LLC – As Agreed at April 14th Hearing, and Absent Stipulation Filed by Debtors and Secured Lender Fifth Third, Court Issues Conversion Order for “End of Rope” Debtors with No Cash and Poor Sale Prospects in Post-COVID Market


April 18, 2023 – The Court hearing the Penta State cases has issued an order converting the Debtors Chapter 11 case into a case under Chapter 7 [Docket No. 159].

The order notes, “Pursuant to the process announced on the record during a hearing on [Friday] April 14, 2023, the Court notes that no notice of an agreement between the Debtors and the secured lender has been filed on the docket.”

At that hastily convened April 14th hearing, after an update provided by Debtors' counsel, Judge David R. Jones informed call participants that "unless there has been a written stipulation filed by noon on Monday by the Debtors and the bank I will on my own motion convert the cases to Chapter 7…I dont wan't you…or the employees…working for free."

In providing his update to the Court, the Debtors' counsel noted that the Debtors had arrived at "a very serious cash crunch" and was down, after making that Friday's payroll, to their last $250k….to the "end of the rope."

That cash crunch, counsel continue, was not going to be improved by operating income (in fact revenue form genetic testing reimbursements is being increasingly denied) or any possible revenue streams that might be opened up as a result of a positive result in the Debtors' ongoing adversary proceeding with CMS and Novitas (who the Debtors allege have wrongfully withheld payments). 

As to a possible sale, counsel noted that, coming out of COVID, the Debtors' laboratory testing business is "a really tough business to sell," with the market flooded with competitors closing and liquidating. That difficult sale market is made even worse in the present instance because the the Debtors are an "insider driven business," with the Debtors' CEO Dr. Saad Alsaab and his wife Sarah Carpenter key elements that would be difficult to part with in any going concern sale. As to an insider sale, or a sale where the couple remained, it was made abundantly clear at the hearing what has been known throughout the cases, that there is no love lost between the secured lender Fifth Third and Dr. Alsaab and that Dr. Alsaab did not otherwise seem likely to source third party/replacement financing.

Case Status

On October 11, 2022, privately held Penta State LLC and three affiliate debtors (dba Diax Labs, the “Debtors”) filed for Chapter 11 protection noting estimated assets between $10.0mn and $50.0mn; and estimated liabilities between $10.0mn and $50.0mn. At filing, the Debtors, operators of “two independent, high-complexity laboratories based near Houston, Texas,” noted that “these bankruptcy filings were necessitated because of both wrongful and illegal claims denials by Medicare and Fifth Third’s undue declarations of default and subsequent acceleration of the Loans.”

Events Leading to the Chapter 11 Filing

In a declaration in support of first day filings (the “Gupta Declaration”) [Docket No. 13], Amit Gupta, the Debtors' Chief Executive Officer, argues that Novitas, a Medicare administrative contractor (or "MAC") engaged by the CMS to process diagnostic claims filed by laboratories, has without legal basis since January 2022 rejected the Debtors' claims for reimbursement ($13.1mn worth of claims rejected with the Debtors holding back on filing an addition $6.1mn). The result has been a loss of 90% of its revenues with that opeartional deficit in turn triggering the decision of lender Fifth Third to accelerate borrowings under a recently entered $28.0mn financing facility. 

Gupta provides: "These bankruptcy filings were necessitated because of both wrongful and illegal claims denials by Medicare and Fifth Third’s undue declarations of default and subsequent acceleration of the Loans. 

…in January 2022, the Centers for Medicare & Medicaid Services (‘CMS’), through its contracted third-party Medicare administrative contractor, Novitas…began denying the Debtors’ claims for diagnostic-related ‘Current Procedural Terminology’ (‘CPT’) codes, which claims were the source of over 90% of the Debtors’ revenues at the time. Initially, these denials were blamed on a ‘software glitch.’ With the passage of time, CMS’s failure to correct this ‘glitch’ made it evident that CMS was, instead, denying the claims pursuant to inapplicable rules.

…after the Debtors incurred millions of dollars of additional fixed costs and reimbursement receivables, Novitas advised that its denials were based on newly identified LCDs and Articles. The cited LCDs for the denials, however, are facially inapplicable to the denied claims; and to the extent any Article facially may apply, such Articles are extraneous to any governing LCDs and thus insufficient and illegal authority upon which to base these particular claims denials. Upon learning that the denials were based on improper legal bases rather than the previously-asserted software excuse, the Debtors immediately complained to Novitas and CMS. 

But Novitas and CMS refused to take any action to right the wrongs they caused.

The consequences of Novitas’ actions have resulted in approximately $13.1 million in wrongfully denied claims.  The Debtors have held back from submitting an additional $6.1 million in reimbursement claims pending a correction of Novitas’ wrongful treatment of the CPT codes.

On July 7, 2022, having been ignored by Novitas and CMS for several months and their financial condition worsening as a result, two of the Debtors filed suit in the United States District Court for the Northern District of Texas….Despite the existential crisis facing the Debtors, on July 11, 2022, the District Court denied the Debtors’ Emergency Motion for Temporary Restraining Order, holding that the Debtors failed to demonstrate a substantial threat of irreparable harm that the issuance of a temporary restraining order would redress and that the Debtors failed to demonstrate a likelihood of success on the merits. Following the entry of the District Court’s order and the Debtors’ filing of their amended complaint, the government defendants filed a motion to dismiss, which remains pending. Subject to the outcome of the same, at present it appears that a trial on the merits is likely to occur no sooner than Fall 2023.

The Debtors simply cannot survive for that period of time without redress for CMS and Novitas’ wrongful actions. Accordingly, contemporaneously with their bankruptcy filings, the Debtors will file a new complaint initiating an adversary proceeding, which will include new causes of action based on operative bankruptcy law and substantially similar causes of action asserted in the to-be-dismissed Northern District action. 

As the Debtors became aware of CMS and Novitas’ wrongful acts, the Debtors proactively contacted Fifth Third to advise them of the impact on revenues. On multiple occasions through June and July 2022, the Debtors provided information and updates to Fifth Third, but despite the Debtors’ transparent and open dialogue with Fifth Third—and without the Debtors ever having defaulted on a financial obligations under the Loans—Fifth Third declared a “Material Adverse Effect” under the Loans on July 13, 2022. Fifth Third cited to the allegations in the Complaint for support. In the same correspondence, Fifth Third stated that it “believes” that other bases for default exist and goes on to make unsubstantiated, vague, and false accusations regarding unspecified misrepresentations.

….Following additional correspondence between counsel for the Debtors and Fifth Third, on September 21, 2022, Fifth Third accelerated the Loans, despite the Debtors never having defaulted on a payment obligation under the Loans. Following the same, the Debtors had no choice but to seek bankruptcy protection."

Prepetition Indebtedness

The Debtors only secured indebtedness exists under a March 2022 credit agreement entered into with Fifth Third Bank, National Association ("Fifth Third") and which is comprised of a $23.0mn and a $5.0mn revolver.

About the Debtors

According to the Debtors: “In 2015, Dr. Saad Alsaab started a toxicology laboratory in Tomball, Texas, with a vision to transform the face of healthcare diagnosis. That laboratory, which provided a wide array of toxicology diagnostic services, has evolved into DIAX Labs: a powerhouse for diagnostic testing, innovating new techniques and employing cutting-edge technology and state-of-the-art equipment to provide reliable, accurate, and comprehensive diagnostics testing with rapid turnaround times.

Today, DIAX Labs operates two independent, high-complexity laboratories based near Houston, Texas: Elite Medical Laboratory Solutions (“Elite”), which is accredited by the College of American Pathology (CAP), and Graham Tomball (“GT”), which is accredited by the Commission on Office Laboratory Accreditation (COLA). DIAX Labs offers a suite of services, principally including (a) toxicology, (b) molecular diagnostics, (c) genetics, and (d) blood and wellness testing for patients with commercial insurance and Medicare beneficiaries.”

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The post Penta State LLC – As Agreed at April 14th Hearing, and Absent Stipulation Filed by Debtors and Secured Lender Fifth Third, Court Issues Conversion Order for “End of Rope” Debtors with No Cash and Poor Sale Prospects in Post-COVID Market appeared first on Daily Bankrupt Company Updates | Bankrupt Company News.

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