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May 23, 1991

LOUIS W. SULLIVAN, M.D., Secretary, Department of Health and Human Services, Defendant

The opinion of the court was delivered by: LAMBERTH


 This case comes before the court on the parties' cross-motions for summary judgment.

 The controversy here involves plaintiff hospital's 1984 claim for Medicare reimbursement for interest incurred as a result of borrowing $ 14,675,000.00 for a capital project without using the $ 3,480,575.00 fund designated for spending on capital projects. The court finds that the hospital must forfeit most of its claim for interest expense reimbursement for 1984 since it failed to use the designated capital fund account first.

 I. Background

 A. The 1982 ICU/CCU construction plan

 Plaintiff Sentara-Hampton General Hospital ("Hampton") is a non-profit acute care hospital in coastal Virginia. The hospital enjoys certification to participate in the Medicare program. *fn1" Defendant's Statement of Material Facts ("Def. Stmt.") at para. 1 (Jan. 16, 1990); see 42 U.S.C. § 1395cc (1988) (certified hospitals must agree to charge Medicare patients only for services rendered and notify HHS Secretary of administrative changes).

 In 1979-80 Hampton's Board of Trustees approved a long-term capital improvement plan, which included construction of an intensive care unit and a critical care facility. Plaintiff's Statement of Material Facts ("Pltf. Stmt.") at 4, para. 14 (Nov. 27, 1989). When the Board was ready to begin construction in April 1982, it expected the project to cost $ 15,681,002.00. Pltf. Stmt. at 15.

 Like any consumer planning a large purchase, the Hampton Board needed to minimize its interest costs while keeping installment payments manageably low. Hampton here could plan its construction to maximize Medicare reimbursement for all of their "necessary and proper expenses incurred in furnishing services, such as administrative costs, maintenance costs, and premium payments" that they incur in serving Medicare patients. 42 C.F.R. § 413.13(c)(3) (1989). See also 42 U.S.C. § 1395ww(a) (1988). Since Congress requires the Health Care Financing Administration ("HCFA") *fn2" to avoid both subsidization of expenses that non-Medicare patients incur and non-Medicare patient shouldering of Medicare expenses, HCFA will reimburse the cost of new construction to the extent that Medicare patients will occupy the new building just as it will pay traditional medical bills. *fn3"

 Since hospitals like Hampton frequently must renovate their old buildings and buy new equipment simply to maintain their state accreditation, the Medicare program includes special construction financing incentives. Among them is a regulation permitting hospitals to create funded depreciation accounts ("FDAs"), which are savings accounts that a hospital must spend exclusively for replacement and renovation of capital assets. 42 C.F.R. § 413.143(e). *fn4" In return for the hospital spending the FDA exclusively upon capital projects, HCFA omits the interest that the funds accumulate from the hospital's annual earnings since the earnings reduce the hospital's total annual cost which then reduces Medicare reimbursement, as follows:

 Total cost of routine services x Medicare = Annual

 Total number of inpatient days inpatient days reimbursement

 St. Mary of Nazareth Hospital Center v. Heckler, 760 F.2d 1311, 1314 (D.C. Cir. 1985) (Interest earned on all accounts but FDAs reduce the fraction's numerator - "cost of routine services" - which in turn reduces annual reimbursement).

 Not only must the hospital spend the FDA exclusively upon capital projects, but, to minimize the Medicare program's liability for interest expense reimbursement, the hospital also must use the fund to reduce borrowing for capital projects. HCFA executes the plan by:

 1) noting the project cost

 2) looking to see the amount of FDA available at the time the hospital makes its borrowing decision

 3) noting how much the hospital borrows, and

 4) deeming the borrowing unnecessary to the extent that the hospital has FDA monies available which it does not spend upon the project.

 When HCFA determines the necessity of borrowing (step #4), Medicare regulations require that the interest expense be both "proper" - incurred in giving patient care, 42 C.F.R. § 413.153(a)(1), and necessary:

 "(i) Incurred on a loan made to satisfy a financial need of the provider. Loans that result in excess funds or investments would not be considered necessary;

 (ii) Incurred on a loan made for a purpose reasonably related to patient care; and

 (iii) Reduced by investment income except if such income is from gifts or grants, whether restricted or unrestricted, and that are held separate and not commingled with other funds. Income from funded depreciation or a provider's qualified pension fund is not used to reduce interest expense."

 42 C.F.R. § 413.153(b)(2).

 Controversy and confusion arise in applying this "financial need/necessary" provision because even the hospitals that have created FDAs often need to borrow by issuing bonds when they commence major construction projects. True to that pattern, Hampton has claimed that it needed to borrow the entire cost of the ICU/CCU construction by issuing $ 14,675,000.00 in tax exempt bonds to satisfy a "financial need," while HCFA countered argue that Hampton did not have a financial need that included the $ 3,480,575.00 in its FDA. Pltf. Stmt. at para. 16. However, since the hospital's Certificate of Need required completion of the project during 1984, the Board voted to use $ 500,000.00 from the FDA to create a contingency account which it could use should the ICU project expenses exceed the $ 403,000.00 from the borrowed funds already set aside. Id. at para. 8.

 To buttress its reimbursement claim, the plaintiff has added that the Board in 1982 expected to satisfy the following obligations by 1985 in addition to completion of the ICU/CCU:

 1) a $ 1.5 million balloon payment due in 1985 on a 1975 bond issue

 2) the cost of renovating the hospital's third floor

 3) Purchase of new CAT scanner

  4) Other capital expenditures discussed in long term plan between 1982 and 1985. Pltf. Stmt. at para. 17. Yet even when the Board created the $ 500,000.00 contingency account and bought miscellaneous capital goods, the FDA still grew from 1982 through 1985: Fiscal Year FDA Balance 1982 $ 4,918,449 1983 $ 5,296,000 1984 $ 6,158,000 1985 $ 6,927,063


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