The opinion of the court was delivered by: James Robertson United States District Judge
Allentown Osteopathic Medical Center, a Medicare provider, merged with St. Luke's Hospital on January 1, 1997. St. Luke's, the surviving entity, sought to recover from Medicare a "loss" on Allentown's depreciable assets that it asserts was recognized in the merger. That claim was denied by the assigned Medicare intermediary on the ground that the merger was not a "bona fide sale." The Provider Reimbursement Review Board reversed that decision on appeal, but was itself overruled by the Administrator for the Centers for Medicare and Medicaid Services. Before the court are cross motions for summary judgment on St. Luke's challenge to that final determination.
Before merging with St. Luke's, Allentown was a nonprofit hospital in Allentown, Pennsylvania certified as a Medicare "provider of services." A.R. 2, 434. Allentown began to encounter economic difficulties, and lost about $1.3 million in the year before the merger. A.R. 248, 1339. Not only was Allentown losing money, but its facilities were also in need of an upgrade it could not afford. Pl. MSJ at 9-10.
Allentown thus began searching for potential "affiliation partners" and hired KPMG Peat Marwick LLP to help find them. Pl. MSJ at 10. St. Luke's promised to upgrade Allentown's facilities and made qualified promises to keep Allentown an in-patient, acute-care hospital, and so a deal was struck. A.R. 245-46; 253; 676-78. The merger occurred on January 1, 1997 with St. Luke's as the surviving entity. A.R. 260-63; 564-65. Title to all of Allentown's assets passed to St. Luke's, and St. Luke's became responsible for Allentown's $4.8 million in known liabilities. A.R. 447. At the time of the merger, Allentown's financial statements valued its assets at $25.1 million, including $8.5 million in current and monetary assets.*fn1 A.R. 448; 573.
Medicare functions (believe it or not) by paying providers based on the cost of procedures --- incentivizing the use of as many procedures as possible. Providers are compensated, not for results, but for "the reasonable cost of [Medicare] services," 42 U.S.C. § 1395(b)(1), i.e., "the cost actually incurred... [as] determined in accordance with regulations" promulgated by the Secretary, 42 U.S.C. § 1395x(v)(1)(A). One such cost is the "depreciation on buildings and equipment used in the provision of patient care." 42 C.F.R. § 413.134(a). Depreciation allowances are paid annually by taking "the cost incurred by the present owner in acquiring the asset," id. § 413.134(b)(1), dividing that purchase price by the asset's estimated useful life, id. § 413.134(a)(3), and dividing again by the percentage of the asset's use devoted to Medicare services. Thus, a million dollar machine estimated to last ten years that is used on Medicare patients 50 percent of the time would depreciate at $100,000 per year, and would receive an allowance from Medicare of $50,000 per year. At the end of any given year, the asset has a "net book value," which is the purchase price minus depreciation from previous years. Thus, after three years of use, our hypothetical million dollar machine would have a net book value of $700,000. In theory, that net book value represents the fair-market price that asset could yet fetch if sold or treated as an asset in a merger.
The Medicare regulations in effect at the time of the Allentown merger recognized that this was only theory, however, and thus provided that when a capital asset was actually disposed of, either Medicare or the provider could recoup the Medicare- related difference between the value realized in the disposition and the net book value.*fn2 According to those regulations, when two unrelated entities combine pursuant to a statutory merger --which was the manner in which Allentown and St. Luke's combined -- any "realization of gains and losses" is "subject to the provisions of [42 C.F.R. § 413.134(f)]." 42. C.F.R. § 413.134(k) (formerly 42 C.F.R. § 413.134(l)). Under section 413.134(f), gains and losses from the disposition of depreciable assets are treated differently depending on the manner of the disposition. At issue here is whether the Allentown merger accomplished a "bona fide sale," which may result in a gain or loss for Medicare purposes depending on whether the purchase price actually paid was greater or less than the net book value.
On October 19, 2000, the Secretary of CMMS issued Program Memorandum A-00-76, which addressed the application of 42 C.F.R. § 413.134(k). A.R. 944. The Program Memorandum clarified the Secretary's interpretation of section 413.124(k), explaining that mergers would be subject to the "bona fide sale" requirement, and defining a "bona fide sale" as an arm's length transaction for reasonable consideration. A.R. 944; 947. The memorandum specifically noted that the interpretation was justified partly because non-profits may combine with other entities for reasons "that may differ from the traditional for-profit merger or consolidation" and that are not "driven by the ownership equity interests to seek fair market value for the assets involved in the transaction." A.R. 945-46. The Program Memorandum therefore emphasized that -- just like combinations of for-profit entities -- mergers that involve non-profits must be arm's length transactions for reasonable consideration if gains or losses on depreciable assets are to be realized for Medicare purposes. A.R. 947.
After the merger, St. Luke's submitted a cost claim to Medicare. The claim was for $2.9 million, representing depreciation on Allentown's assets that had never been booked or claimed in annual depreciation allowances. Because the only consideration St. Luke's gave for the assets it acquired in the merger was its assumption of some $4.8 million of Allentown's liabilities, and because this amount fell short of the net book value remaining on Allentown's assets, St. Luke's claimed that the transfer of these depreciated assets represented a "loss" to Allentown compensable by Medicare at $2.9 million. A.R. 63. And, because Allentown was now a part of St. Luke's, it was St. Luke's that could request reimbursement.
St. Luke's claim was first submitted to a paid contractor known as a Medicare fiscal intermediary, see 42 U.S.C. § 1395h, which denied the claim on the ground that the merger was not a bona fide sale. A.R. 1997. St. Luke's administratively appealed to the PRRM, which reversed the bona fide sale determination and remanded. A.R. 69. The Administrator of CMMS, relying in part on the Program Memorandum, reversed again. A.R. 2-22. The Administrator held that Allentown did not receive reasonable consideration for its assets, that the merger was not an arm's length transaction, and that the merger therefore failed to qualify as a bona fide sale from which Allentown had suffered any compensable costs. A.R. 20-22. St. Luke's challenges that final determination in this action.
Review of CMMS's determination is governed by 42 U.S.C. § 1396oo(f)(1), which incorporates the Administrative Procedure Act, 5 U.S.C. § 706: final agency action may be set aside only when "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law" or when "unsupported by substantial evidence." And under familiar principles of agency review, an agency's interpretation of its own rule is entitled to the utmost deference. See Ballard v. C.I.R., 544 U.S. 40, 70 (2005) ("An agency's interpretation of its own rule or regulation is entitled to "controlling weight unless it is plainly erroneous or inconsistent with the regulation." (internal quotations omitted)). "This 'broad deference' is especially warranted [here] because Medicare regulations are 'complex and highly technical' and determinations in this area 'necessarily require significant expertise and entail the exercise of judgment grounded in policy concerns.'" Robert F. Kennedy Med. Ctr. v. Leavitt, 526 F.3d 557, 562 (9th Cir. 2008) (quoting Thomas Jefferson University v. Shalala, 512 U.S. 504, 512 (1994)).
St. Luke's primary argument for overturning the Administrator's decision is that the Secretary's interpretation making statutory mergers subject to the bona fide sale requirement is plainly contrary to the regulations. Three courts of appeal have already disagreed with this argument. See Albert Einstein Med. Ctr. v. Sebelius, 566 F.3d 368, 376-77 (3rd Cir. 2009); Robert F. Kennedy, 526 F.3d 557, 560-61; Via Christi Reg'l Med. Ctr. v. Leavitt, 509 F.3d 1259 (10th Cir. 2007). That consensus is not surprising: the Secretary's interpretation is supported by the text of the regulations and by common sense.
At the time of the merger, 42 C.F.R. § 413.134(k)(2)(I) provided that "the realization of gains and loses" from a statutory merger between unrelated entities is "subject to the provisions of [42 C.F.R. § 413.134(f)]." Section 413.134(k)(2)(ii) provided that no revaluation of assets was allowed for mergers between related parties. St. Luke's position is that, because it was unrelated to Allentown, no other impediment stood between it and the realization of a gain or loss from the merger --- including section 413.134(f). But it is plainly consistent with the text of the regulation to apply the requirements of section 413.134(f) to a ...