UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
ST. LUKE’S HOSPITAL, :
:
Plaintiff, :
:
v. : Civil Action No. 08-0883 (JR)
:
KATHLEEN SEBELIUS, Secretary, :
Health and Human Services, :
:
Defendant. :
MEMORANDUM
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.
Background
Before merging with St. Luke’s, Allentown was a non-
profit 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.1 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
1
St. Luke’s takes issue with the use of these assets by the
Administrator, but because neither St. Luke’s nor Allentown made
any effort to appraise Allentown’s assets before the transaction,
the Administrator had no other numbers to use –- and neither does
this Court. St. Luke’s argues that Allentown’s contingent
liabilities should have been added into the mix of consideration,
but it has failed to provide any evidence of what those
contingent liabilities are or what they are worth, and in any
event Allentown warranted as part of the merger that it had no
contingent liabilities. A.R. 1120-21.
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[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-
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related difference between the value realized in the disposition
and the net book value.2 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
2
Recognizing the endless potential for gamesmanship of the
kind at issue here, Congress eliminated reimbursement of losses
as of December 1, 1997. See Balanced Budget Act of 1997, Pub. L.
No. 105-33, § 4404 (A.R. 1713-14). CMMS then amended Medicare
regulations to eliminate reimbursement of losses. 63 Fed. Reg.
1379, 1380-82 (Jan. 9, 1998).
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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.
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§ 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.
Analysis
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
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[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
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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 statutory merger between
unrelated parties, because the regulations themselves say that
realization of gains and losses from such a merger are subject to
that section.
At the time of the merger, 42 C.F.R. § 413.134(f)
provided that “[d]epreciable assets may be disposed of through
sale, scrapping, trade-in, exchange, demolition, abandonment,
condemnation, fire, theft, or other casualty,” and “[t]he
treatment of the gain or loss depends upon the manner of
disposition of the asset.” Of the types of disposal specified,
the only one that could arguably apply to a merger is a sale.
But section 413.134(f)(2) allows for the realization of gains or
losses only upon a “bona fide sale.” The reason for this
requirement is obvious –- only an arm’s length transaction for
reasonable consideration ensures that the purchase price is a
better reflection of actual value than the net book value. If
the sale is not a bona fide, free-market exchange, the purchase
price may be only an illusion, designed to make the asset appear
to have lost more value than it really has. As the Ninth Circuit
recently explained:
Providers are entitled to reimbursement only for
the “cost actually incurred” in servicing Medicare
patients. 42 U.S.C. § 1395x(v)(1)(A). As the
Secretary noted when promulgating 42 C.F.R.
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§ 413.134(f), “if a gain or loss is realized from
[a] disposition, reimbursement for depreciation
must be adjusted so that Medicare pays the actual
cost the provider incurred.” See Principles of
Reimbursement for Provider Costs and for Services
by Hospital-based Physicians, 44 Fed. Reg. 3980
(Jan. 19, 1979) (emphasis added). The Secretary's
requirements of “reasonable consideration” and
“fair market value” ensure that Medicare reimburses
actual costs, instead of providing a windfall to
providers.
Robert F. Kennedy, 526 F.3d at 562; see also Albert Einstein, 566
F.3d at 376-77; Via Christi Reg’l, 509 F.3d at 1274-77 (“Even if
a consolidation or statutory merger is not a ‘sale’ per se,
treating it as a sale pursuant to § 413.134(f)(2) ensures that
any depreciation adjustment will represent economic reality,
rather than mere ‘paper losses.’”). Thus, the Secretary’s policy
is far more reasonable than St. Luke’s proposal -- i.e., that
depreciation be recalculated every time there is a merger even
when the amount of assumed liabilities and other consideration
bears no recognizable relationship to the actual depreciation
incurred. A.R. 944-47.
St. Luke’s argues that the Secretary’s bona fide sale
requirement makes it impossible for St. Luke’s to have realized a
loss or a gain as a result of the merger –- that there would have
no point in paying a market price for Allentown’s depreciable
assets because, as the surviving entity, St. Luke’s would merely
have reabsorbed that payment after the merger. That may be true.
But it is true only because the actual sale “price” in this
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merger –- the assumption of a non-profit’s current liabilities in
order to keep it operating –- had nothing to do with the
reasonable value of the non-profit’s long-term assets. The
Secretary’s interpretation does not mean that no statutory merger
can ever result in revaluation of depreciable assets. If a
merger involved the assumption of liabilities that closely
mirrored the true value of depreciable assets, or involved
competitive bidding for those assets, it might satisfy the bona
fide sale requirements, even if it involved a non-profit entity
like Allentown. But where, as here, even the plaintiff agrees
that the “price” provides no reasonable estimate of market value,
see Pl. MSJ 17-18 (“[I]t would be mere happenstance if the fair
market value of the merged entity’s assets was equal to its known
liabilities for which the surviving entity would become
responsible.”), it would be odd indeed for Medicare to treat the
liabilities assumed as a better estimation of market price than
the assets’ net book value.
A large part of St. Luke’s argument is that the
Secretary’s interpretation is a post hoc rationalization -- that
the Secretary changed signals in this case, departing from a
previous policy that all statutory mergers automatically trigger
the reassessment of depreciable assets. St. Luke’s purports to
find that old policy in “informal agency interpretations,” Pl.
MSJ at 21 n.5, reflected in two letters and a portion the
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Medicare Intermediary Manual in effect at the time of the merger.
A.R. 531, 1500-01. Even if those informal sources do stand for
the proposition that CMMS did not previously subject statutory
mergers to any bona fide sale requirement –- and the issue is at
least unclear, see, e.g., Albert Einstein, 566 F.3d at 376 –- St.
Luke’s claim of error founders on the principle that agencies may
change their informal interpretations at any time, so long as
their new position is adequately explained. See, e.g., FCC v.
Fox Television Stations, Inc., 129 S. Ct. 1800, 1811 (2009)
(“[T]he agency must show that there are good reasons for the new
policy. But it need not demonstrate to a court’s satisfaction
that the reasons for the new policy are better than the reasons
for the old one; it suffices that the new policy is permissible
under the statute, that there are good reasons for it, and that
the agency believes it to be better, which the conscious change
of course adequately indicates.”). The Program Memorandum
explains that applying the bona fide sales requirement to
statutory mergers is necessary because many mergers are not
“driven by the ownership equity interests to seek fair market
value for the assets involved in the transaction” and so will not
reflect the fair market value of assets any better than the net
book value. A.R. 945-46. That rationale is sufficient –- post-
hoc or not –- to support the interpretation at issue here.
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St. Luke’s also argues that the Secretary’s change of
course required a new rulemaking, subject to notice and comment.
But interpretative clarifications do not require notice and
comment. 5 U.S.C. § 553(b)(A). Nor can there be any doubt that
the policy at issue here is properly an informal interpretation.
See Albert Einstein, 566 F.3d at 381 (finding this change only an
interpretive clarification); Via Christi Reg’l, 509 F.3d at 1271
n.11 (same). The materials identified by St. Luke’s to
substantiate the existence of a prior policy are themselves
informal interpretations, and the bona fide sales requirement
comes straight from the text of the existing rule itself. See 42
C.F.R. § 413.132(f)(2).
St. Luke’s makes three sundry arguments that may be
quickly disposed of. Its argument that the Deficit Reduction Act
of 1984 precluded the Secretary from interpreting his regulations
after that date is unsupported by the text of that act or any
case law in its motion. Its argument that Secretary failed to
timely list the Program Memorandum in the Federal Register fails
because St. Luke’s has failed to show prejudice from this error.
See 5. U.S.C. § 706. And its argument that the Secretary failed
to submit its interpretation to the House and Senate is precluded
from judicial review. Montanans for Multiple Use v. Barbouletos,
568 F.3d 225, 229 (D.C. Cir. 2009).
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The only question left, then, is whether the
Secretary’s finding that the St. Luke’s merger was not a bona
fide sale was supported by substantial evidence. It clearly was.
The sizable gap between the “purchase price” and the value of
Allentown’s assets and the other circumstances surrounding the
merger are sufficient to support the Administrator’s ruling. At
the time of the merger, Allentown’s current and monetary assets
alone were nearly double the value of the liabilities assumed;
its total assets were more than five times the “price”. The
Administrator’s finding is thus supported by more than
substantial evidence, and in fact well demonstrates why a bona
fide sales requirement is necessary to prevent Medicare from
making payments that bear no relation to actual costs. See
Albert Einstein, 566 F.3d 368; Robert F. Kennedy, 526 F.3d 557,
560-61; Via Christi Reg'l, 509 F.3d at 1277.
JAMES ROBERTSON
United States District Judge
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