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Provena Hospitals v. Sebelius

October 13, 2009


The opinion of the court was delivered by: William M. Nickerson Senior United States District Judge for the District of Maryland


This action arises out of the November 30, 1997, consolidation of three Illinois hospital systems. Plaintiff Provena Hospitals (Provena), the entity into which the three systems consolidated, brings this action as the successor-in-interest to Mercy Center for Health Care Services (Mercy Center), one of the consolidating entities. Provena challenges the decision of the Secretary of Health and Human Services (the Secretary) denying Mercy Center's reimbursement claims for approximately $4.5 million in depreciation-related losses that Provena asserts resulted from the consolidation. The Secretary denied Provena's claim for reimbursement on two grounds: (1) that the consolidation was not between "unrelated parties" as required under 42 C.F.R. § 413.134(k); and (2) that no "bona fide sale" occurred as required under 42 C.F.R. § 413.134(f).

Provena argues that the "related party" and "bona fide sale" policies used to deny Mercy Center's claim were adopted only after the 1997 consolidation and that it was impermissible for the Secretary to apply them retroactively. In the alternative, Provena argues that, even if those policies were in place when Provena was formed, the consolidation satisfied the requisite conditions. The parties have filed cross motions for summary judgment, Paper Nos. 15 (Provena's) and 16 (the Secretary's), and the motions are fully briefed and supplemented. Upon review of the pleadings and the applicable case law, the Court finds that the Secretary properly interpreted and applied the policy disqualifying from depreciation reimbursement consolidations that were not bona fide sales.*fn1 Accordingly, the decision of the Secretary will be affirmed.*fn2


Title XVIII of the Social Security Act, 42 U.S.C. §§ 1395 et seq. (the Medicare Act) establishes a federally funded health insurance program for the aged and disabled. The Centers for Medicare and Medicaid Services (CMS)*fn3 administers the Medicare program on behalf of the Secretary, but the Secretary also contracts with private fiscal intermediaries to make the initial determination as to how much a Medicare provider should be reimbursed for services. See id. § 1395h. If the provider disagrees with the intermediary's reimbursement determination, it can appeal that decision to the Provider Reimbursement Review Board (PRRB). Id. § 1395oo(a). After sixty days, the decision of the PRRB becomes the final decision of the Secretary unless the Secretary, through the CMS Administrator, elects to review it within that time period. Id. § 1395oo(f)(1). A Medicare provider can seek judicial review of a final decision of the PRRB or the CMS Administrator in a federal district court. Id.

Under the Medicare Act, providers of Medicare services are entitled to be reimbursed for the "reasonable cost of [Medicare] services." Id. § 1395f(b)(1). The statute defines the "reasonable cost" of a service to be "the cost actually incurred, excluding therefore any part of incurred cost found to be unnecessary in the efficient delivery of needed health services." 42 U.S.C. § 1395x(v)(1)(A) (emphasis added). Furthermore, the reasonable cost is to be "determined in accordance with regulations establishing the method or methods to be used," as promulgated by the Secretary. Id. In addition to promulgating regulations, the Secretary also issues manuals, such as the Provider Reimbursement Manual (PRM) and the Medicare Intermediary Manual (MIM), to assist Medicare providers and fiscal intermediaries in administering the reimbursement system.

Of particular relevance here, the regulations in effect at the time of the 1997 consolidation stated that a provider could claim reimbursement for "[a]n appropriate allowance for depreciation on buildings and equipment used in the provision of patient care." 42 C.F.R. § 413.134(a). This allowance for depreciation was calculated by prorating "the cost incurred by the present owner in acquiring the asset" (its "historical cost") over the asset's "estimated useful life," and then estimating the percentage of the depreciation attributable to providing services to Medicare patients. Id. § 413.134(a)(3) and (b)(1). Providers were then reimbursed annually based upon this depreciation calculation.

In recognition of the fact that these annual payments might overstate or understate the true depreciation of the asset, Medicare regulations provided, under certain circumstances, for an adjustment to reconcile the previous annual depreciation payments with the asset's actual value upon the disposal of the depreciable asset. The principal Medicare regulation that addressed the depreciation of assets, 42 C.F.R. § 413.134, stated that the treatment of the gains or losses from a disposal of those assets "depends on the manner of disposition of the asset, as specified in paragraphs (f)(2) through (6) of this section." Id. § 413.134(f)(1). Subsection (f)(2), entitled "Bona fide sale or scrapping," provided that gains and losses realized from the bona fide sale of depreciable assets could be considered in calculating allowable costs.*fn4

When allowable, this adjustment under paragraph (f) was based upon the difference between the "net book value" (i.e., its initial depreciable basis minus subsequently recognized annual depreciation) and the consideration received for the asset at its disposal. If the consideration received was greater than the asset's net book value, then the provider realized a gain and was required to remit that difference to Medicare on the assumption that the annual allowances overstated the actual depreciation. If the consideration received was less than the asset's net book value, then the provider was deemed to have incurred a loss and received an additional depreciation reimbursement as a result of the disposition of the asset. If the Medicare provider sells multiple assets for a "lump sum sales price," the provider must allocate the price received among the assets sold, "in accordance with the fair market value of each asset." Id. § 413.134(f)(2)(iv). It must be remembered that the purpose of this adjustment upon disposal of an asset was to assure that "Medicare pays the actual cost incurred in using the asset for patient care." Via Christi Reg'l Med. Ctr. v. Leavitt, 509 F.3d 1259, 1262 (10th Cir. 2007).

Paragraph (k)*fn5 of § 413.134, which is at the center of this controversy, addressed three particular types of transactions:

(1) the acquisition of a provider's capital stock; (2) a statutory merger; and (3) a consolidation. Although paragraph (k) was denominated as a provision related to "[t]ransactions involving a provider's capital stock," the Secretary has always interpreted it as applying in the non-profit sector as well, Via Christi, 509 F.3d at 1263 n.4 and 1272 n.12, and neither party disputes that the Secretary was correct in so doing. Under this paragraph, a consolidation was defined as a "combination of two or more corporations resulting in the creation of a new corporate entity." Id. § 413.134(k)(3). There is no dispute in this litigation that the formation of Provena was a consolidation within the meaning of this provision.

The portion of paragraph (k) addressing consolidations where at least one of the original entities was a Medicare provider, § 413.134(k)(3), draws a distinction between the treatment of consolidations involving "related" parties and those involving parties that are "unrelated." If the parties to the consolidation were unrelated, the regulation permitted the assets of the provider corporation(s) to be revalued. Id. § 413.134(k)(3)(i). If the consolidation was between two or more related corporations, no revaluation of provider assets was permitted. Id. § 413.134(k)(3)(ii).*fn6

The portion of paragraph (k) related to statutory mergers contains a similar distinction between related and non-related entities. § 413.134(k)(2). As in the consolidation provision, no revaluation of assets was permitted if the merging entities were related. Unlike the provision addressing consolidations, however, the statutory merger provision goes on to state that "[i]f the merged corporation was a provider before the merger, then it is subject to the provisions of paragraphs (d)(3) and (f) of this section concerning recovery of accelerated depreciation and the realization of gains and losses." § 413.134(k)(2)(i). As discussed above, paragraph (f) provides that a depreciation adjustment is only allowed if a sale was a "bona fide sale." Although the consolidation provision, § 413.134(k)(3), does not contain a parallel reference to paragraph (f), the Secretary has interpreted it as containing a similar provision. See infra. The propriety of that interpretation is one of the central issues in this litigation.

One additional provision in the regulations is potentially relevant here. Under the "general rules" section of 42 C.F.R. § 413.134, the term "fair market value" is defined in terms of a "bona fide sale:"

Fair market value is the price that the asset would bring by bona fide bargaining between well-informed buyers and sellers at the date of acquisition. Usually the fair market price is the price that bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition.

42 C.F.R. § 413.134(b)(2). Here, the Secretary relies on this provision to incorporate a "fair market value" or "reasonable consideration" element into the requirement of a bona fide sale. This interpretation of the regulations is also a major issue in this litigation.

To understand the arguments put forth by Provena, some discussion of the historical development of Medicare policy related to depreciation and adjustments allowable on the disposal of depreciable assets is helpful. Medicare regulations issued in November 1966 first designated depreciation as an "allowable cost," and required that gains and losses from disposal of assets be included in the allowable cost determination. 31 Fed. Reg. 14,808, 14,810-11 (Nov. 22, 1966).

The regulations, however, did not specify the procedures for calculating the gain or loss on disposal.

On January 19, 1979, the regulations were amended to address certain types of disposal of assets, including by "bona fide sale." 44 Fed. Reg. 3980, 3982-83 (Jan. 19, 1979). This amendment added what is now § 413.134(f), discussed above. Included in this amendment was the provision that, in the case of "lump sum sales," the sales price would be allocated to each asset according to its fair market value. 44 Fed. Reg. 3980, 3983. In issuing these amended regulations, the agency stated that they "are intended to assure that the depreciation allowed under Medicare accurately reflects providers' costs of using assets for patient care." 44 Fed. Reg. 3980.

On February 5, 1979, the regulations were amended again to add what is now paragraph (k) of § 413.134, including the consolidation provision discussed above. 44 Fed. Reg. 6912, 6915 (Feb. 5, 1979). When these amendments to the regulations were first proposed in 1977, the Secretary clarified that they were simply to describe the intention of existing programs regulations and principles when applied to "complex financial transactions." 42 Fed. Reg. 17485 (Apr. 1, 1977). "The proposed amendments are a specific interpretation of existing program policy based on previously promulgated regulations." Id.

The next development related to the recognition of gains or losses upon the disposal of a depreciable asset came not from the Secretary, but from Congress. On July 18, 1984, Congress enacted Section 2314(a)(ii) of the Deficit Reduction Act of 1984 ("DEFRA") (Pub. L. No. 98-369), which required Medicare regulations to "provide for recapture of depreciation in the same manner as provided under the regulations in effect on June 1, 1984." Although the language in DEFRA referred to "recapture of depreciation," courts, as well as the Secretary, have recognized that this provision applied both to transactions that result in a gain and to transactions that result in a loss. See Lake Med. Center v. Thompson, 243 F.3d 568 (D.C. Cir. 2001); 57 Fed. Reg. 43,906, 43,907 (Sept. 23, 1992).

In 1987, the Secretary issued two pronouncements relevant to the consolidation provision in § 413.134. In April 1987, the Secretary included an explanation in the MIM that "Medicare program policy permits a revaluation of assets affected by corporate consolidations between unrelated parties." AR at 4197-98, MIM, 04-87, § 4502.7. On May 11, 1987, William Goeller, Director of HCFA's Division of Payment and Reporting Policy of the Office of Reimbursement Policy, Bureau of Eligibility, Reimbursement and Coverage, responded to ...

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