Slater Health Center, Inc. v. United States (In Re Slater Health Center, Inc.)

United States Court of Appeals
For the First Circuit

No. 04-1349

IN RE: SLATER HEALTH CENTER, INC.,

Debtor.

SLATER HEALTH CENTER, INC.,

Plaintiff, Appellant,

v.

UNITED STATES; BLUE CROSS & BLUE SHIELD OF RHODE ISLAND,

Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND

[Hon. Ernest C. Torres, U.S. District Judge]

Before

Torruella, Circuit Judge,
Campbell, Senior Circuit Judge,
and Lynch, Circuit Judge.

Matthew J. McGowan, with whom Salter McGowan Sylvia & Leonard,
Inc. was on brief, for appellant.
Joseph M. DiOrio, with whom R. Daniel Prentiss, Robert J.
Crohan, Jr., and Holland & Knight, LLP were on brief, for appellee
Blue Cross & Blue Shield of Rhode Island.
Michael P. Iannotti, Assistant U.S. Attorney, with whom Robert
Clark Corrente, U.S. Attorney, was on brief, for appellee United
States.

February 16, 2005
 LYNCH, Circuit Judge. Slater Health Center ("Slater"),

a nursing home which is currently in Chapter 11 bankruptcy, was

overpaid by Medicare because it took Medicare money for the

expenses of third party-provided services but then did not pay

those third parties as required. 42 U.S.C. § 1395g(a); 42 C.F.R.

§ 413.100(c). The government sought to recover these overpayments

by reducing Medicare reimbursements due to the bankrupt but still

operational Slater. Slater responded by instituting an adversary

proceeding in the bankruptcy court, alleging that this was an

improper setoff within the context of bankruptcy. At issue,

effectively, is whether the government may recover the overpayments

to Slater to put them back into Medicare or whether Slater's estate

gets the funds to be distributed to its many creditors.

This court recently held in In re Holyoke Nursing Home,

Inc., 372 F.3d 1, 4 (1st Cir. 2004), that a government adjustment

for a Medicare overpayment constitutes a recoupment, and not a

setoff, and therefore that such an adjustment is permissible and

unaffected by the bankruptcy context. The reasoning of that case

controls here, where the overpayment was due to Slater's taking

money from Medicare and contracting with third parties for services

that were provided but for which Slater did not pay the third-party

providers in a timely manner. 42 C.F.R. § 413.100(c). We affirm

the district court's decision, which allowed Medicare to recoup the

funds at issue.

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 I.

Under the federal Medicare program, the federal

government makes estimated payments at least once a month to

participating health centers for reasonable costs incurred in

treating Medicare patients, subject to subsequent audits and

"necessary adjustments on account of previously made overpayments

or underpayments." 42 U.S.C. § 1395g(a); see 42 U.S.C. §

1395x(v)(1)(A); Good Samaritan Hosp. v. Shalala, 508 U.S. 402, 406-

07 (1993). The purpose for making estimated payments, often before

a provider has actually rendered a service, is to protect the

liquidity of providers. See Fischer v. United States, 529 U.S.

667, 674 (2000). By statute, the Secretary of Health and Human

Services is empowered to administer this cost reimbursement scheme

and make regulations in this area. See 42 U.S.C. § 1395x(v)(1)(A);

Thomas Jefferson Univ. v. Shalala, 512 U.S. 504, 506-07 (1994)

("Subject to a few exceptions, Congress authorized the [Secretary]

to issue regulations defining reimbursable costs and otherwise

giving content to the broad outlines of the Medicare statute.").

Using his power to promulgate regulations, the Secretary

has defined the statutory term "overpayment." By regulation, an

overpayment includes the situation where a provider is given money

by Medicare to pay for certain health care services, and the

provider contracts with a third party who, in turn, provides those

services, but the provider fails to liquidate the liability by

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paying the third party within a designated period of time. 42

C.F.R. § 413.100(c). The regulation reads, in part, as follows:

Although Medicare recognizes, in the year of
accrual, the accrual of costs for which a
provider has not actually expended funds
during the current cost reporting period, for
purposes of payment Medicare does not
recognize the accrual of costs unless the
related liabilities are liquidated timely.

42 C.F.R. § 413.100(c)(1). Specifically, short-term liabilities

like those at issue in this case must be paid off within one year

after the end of the cost reporting period in which the liability

is incurred, although extensions of up to three years after the end

of the cost reporting year in which the liability is incurred may

be granted. 42 C.F.R. § 413.100(c)(2)(i).

Slater, a 150-bed nursing home located in Pawtucket,

Rhode Island, filed a Chapter 11 bankruptcy petition on January 26,

2001, and thereafter continued to operate as a debtor in

possession. Slater is a participant in the Medicare program. Blue

Cross & Blue Shield of Rhode Island ("Blue Cross"), a fiscal

intermediary for Medicare,1 notified Slater in December 2001 that

it had reopened Slater's 1997 cost report for analysis and that it

had found Medicare overpayments to Slater. In February 2002, Blue

1
Providers may choose to receive payment from such a fiscal
intermediary rather than directly from the Secretary. The
intermediary then makes an agreement with the Secretary to perform
various administrative responsibilities, such as performing audits
and calculating overpayments. See 42 U.S.C. § 1395h; Heckler v.
Cmty. Health Servs., 467 U.S. 51, 54 (1984).

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Cross notified Slater that it also had found Medicare overpayments

to Slater based on its 1998 cost report, which had likewise been

reopened. The total amount of these overpayments, plus interest,

was approximately $407,600. These sums were subject to recoupment.

All but one of the overpayments for these two years --

for $37,031 -- were overpayments under 42 C.F.R. § 413.100(c); that

is, $370,569 in overpayments arose because Slater contracted with

certain third-party providers for health care services to Medicare

patients and the services were provided by these third parties but

the third parties themselves were never paid by Slater. By the

time Blue Cross notified Slater of the Medicare overpayments,

Slater could not pay the third-party providers, because it was in

bankruptcy.

In response to Blue Cross's notice of overpayment,

Slater, beginning in January 2002, stopped billing Medicare for its

receivables for a period of time. Evidently, Slater's theory was

that Medicare could not recoup overpayments if Slater filed no

further requests for payment. Eventually, though, this strategy

became too costly for Slater; Slater filed an adversary proceeding

against Blue Cross and the federal government with a federal

bankruptcy court in Rhode Island on June 19, 2002, seeking

injunctive and declaratory relief preventing any recoupment due to

section 413.100(c) overpayments. In re Slater Health Ctr., Inc.,

294 B.R. 423, 426 (Bankr. D.R.I. 2003).

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 The bankruptcy court denied Slater's request for a

temporary restraining order on August 9, 2002, after an expedited

hearing. Id. Slater then filed claims for all of its backed-up

receivables, which were paid minus the total amount of the

overpayments, $407,600. Id. at 426-27. Slater next moved the

bankruptcy court for reconsideration of the denial of its motion

for a temporary restraining order; the court granted the motion on

June 20, 2003, and the bankruptcy court issued an order requiring

Medicare to return $370,569 to the bankruptcy estate (the $407,600

less the $37,031 of admitted overpayment due to an accounting

error).2 Id. at 432.

The bankruptcy court held that the automatic stay

provision in the bankruptcy code, 11 U.S.C. § 362(a)(7), had not

been violated because Medicare's attempt to recover all of the

overpayments constituted a recoupment, rather than a setoff. The

payments and subsequent adjustments for overpayments constituted a

single, integrated transaction. In re Slater Health Ctr., Inc.,

294 B.R. at 431.

However, the bankruptcy court then invoked equitable

principles against the Secretary's right of recoupment and refused

2
The bankruptcy court initially ordered the returned funds to
be held in a separate account pending further hearings involving
interested parties. In a later, September 23, 2003 order, the
bankruptcy court ruled that the funds would be held by Slater for
distribution with the general funds of the estate, rather than
being specifically set aside for the third-party providers that
Slater did not pay.

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to allow Medicare to recoup the $370,569 that was due to section

413.100(c) overpayments. Over objections that equitable principles

could not overcome the Secretary's right of recoupment, the

bankruptcy court held that it was entitled to perform a "careful[]

weigh[ing]" of "the relative harm to both parties." Id. The court

stressed that the overpayment in this case was generated by

Slater's failure to pay certain third-party providers who provided

Medicare services to patients; since these third-party providers

were now creditors of the estate, any recoupment by Medicare would

hurt the third-party providers and other creditors by giving them

a reduced payout. Id. On the other hand, the court stated that

Medicare would merely be gaining a windfall if it were to recoup

these funds because all of the Medicare services had been provided,

and thus the money was actually earned by the third-party providers

and would not make up for any loss by Medicare. Id.

The bankruptcy court also determined several other,

related points of contention. The bankruptcy court allowed Slater

to assume the Medicare agreement and eventually confirmed Slater's

Chapter 11 plan, which contained a subordination of Medicare's

$370,569 overpayment claim. Id. at 432-35. The result was that

Medicare would receive none of this claim.

After the plan was confirmed, the Secretary appealed the

bankruptcy court's holding that it could not recoup the $370,569

overpayment (along with the subsidiary orders on the same topic) to

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the federal district court, which reversed the bankruptcy court.

In re Slater Health Ctr., Inc., 306 B.R. 20 (D.R.I. 2004). The

district court agreed with the bankruptcy court that the automatic

stay provision of 11 U.S.C. § 362(a)(7) did not apply to Medicare's

$370,569 claim because it was a recoupment, rather than a setoff.3

Id. at 25.

However, the district court held that the bankruptcy

court had erred in ranging so broadly to balance the equities in

order to nonetheless deny Medicare its right of recoupment and, at

any rate, the equities cut in Medicare's favor. Id. at 26-27. The

proper balancing was not between Medicare and the third-party

providers, but between Slater and Medicare, because the money could

not be set aside merely for the use of the unpaid creditors and its

return to the estate would only "somewhat improve[]" those unpaid

creditors' chances of being paid. Id. And this was money that

Slater was never entitled to, because Medicare agreed to reimburse

only reasonable expenses that were actually paid. This money

3
The district court also offered an alternative argument: it
did not even need to reach the recoupment versus setoff analysis
because Slater had no claim to the $370,569 at all. There was
merely a debt to Slater, in which Slater's entitlement was defined
as its reasonable costs less any prior overpayments. See In re
Slater Health Ctr., Inc., 306 B.R. at 25. We faced a similar
argument in In re Holyoke Nursing Home, Inc., 372 F.3d 1, 4 n.1
(1st Cir. 2004), where we did not address it because we resolved
the case using recoupment analysis. We likewise resolve this case
using recoupment analysis, and do not address this alternative
argument, which is not advanced by the Secretary on appeal.

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rightly belonged to Medicare, and, "if anything, allowing Slater to

retain funds advanced to it as reimbursement for sums that it never

paid would constitute a windfall to Slater." Id. at 27. This

resolution of the recoupment issue mooted the related issues in the

case, so the appeals of the related bankruptcy court orders were

dismissed. Id. at 27-28.

Neither the bankruptcy court nor the district court had

the benefit of our decision in In re Holyoke Nursing Home, Inc.,

372 F.3d 1 (1st Cir. 2004), which was issued later.

Slater appeals from the district court's allowance of

Medicare's $370,569 recoupment. It also argues that if the

recoupment is disallowed and the $370,569 is returned to the

bankruptcy estate, then it should still be allowed to assume the

Medicare agreement and its Chapter 11 plan should be confirmed

despite the subordination of Medicare's claims.

II.

The dispositive issue in this case is simply whether

Medicare's adjustment to Slater's reimbursement claims for prior

overpayments constituted an invalid setoff that contravened the

bankruptcy code's automatic stay provision, 11 U.S.C. § 362(a)(7),

or instead a valid recoupment, which would not be affected by

bankruptcy but could simply be deducted from debts owed to Slater

as a matter of course. See Holyoke, 372 F.3d at 3. A setoff is

C's deduction from C's debt to B of an amount based on B's

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unrelated debt to C; a recoupment is C's deduction from C's debt to

B based on B's debt to C arising out of the same transaction. See,

e.g., id. at 3-4; United Structures of Am., Inc., v. G.R.G. Eng'g,

S.E., 9 F.3d 996, 998 (1st Cir. 1993); see also Collier on

Bankruptcy ¶ 553.10 (15th ed. rev. 2004).

The answer to this question is controlled by our recent

decision in In re Holyoke Nursing Home, Inc. In that case we held,

in conformity with the majority of other circuits to consider the

question, that Medicare's adjustment for an overpayment constitutes

a recoupment, not a setoff: "Both the Medicare statute and the

provider agreement -- by contemplating [Medicare's] payment of

estimated costs, corrective audits, and retroactive adjustments or

partial adjustments for overpayments and underpayments in

determining [Medicare's] net liability for current cost-year

services -- strongly indicate that the contractual relationship

between [Medicare] and Holyoke constitutes one, ongoing, integrated

transaction." Id. at 4. We further held that once adjustments for

Medicare overpayments had been determined to be recoupments,

further "equitable balancing" was improper. Id. at 5.

Slater attempts to distinguish Holyoke by arguing that

Holyoke did not deal with this particular kind of overpayment: an

overpayment due not to, for example, Slater's billing of services

that it did not provide, but instead to Slater's failure to pay

third-party providers for services that have already been provided.

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42 C.F.R. § 413.100(c). The Secretary is statutorily given power

to make regulations administering the reimbursement system,

including adjustments for under- and overpayments. Slater has

lodged no challenge to the Secretary's regulation, 42 C.F.R. §

413.100(c), which defines this sort of conduct as an overpayment.

Slater argues, however, that the "same transaction" test

for recoupment is not met here because the unpaid sums owed the

third-party therapy providers are wholly extrinsic to the

relationship between Slater and Medicare. This is incorrect. The

Medicare regulations define "overpayment" as including a provider's

failure to liquidate costs in a timely manner. 42 C.F.R. §

413.100(c).

The regulation's inclusion of this situation as an

overpayment is perfectly logical: Medicare's interest is not simply

in ensuring that patients are treated, but is also, under a cost

reimbursement system, in making sure that its money only reimburses

providers for reasonable Medicare-related expenses that providers

actually pay out as required. See, e.g., Good Samaritan Hosp., 508

U.S. at 405-06. Providers are advanced money based on costs with

the understanding that they will actually have to pay those costs;

if they do not, then adjustments for overpayments must be made

because providers have no entitlement to the extra money. See id.

at 406-07. If costs are not liquidated within a certain period of

time, then Medicare justifiably assumes that they will not be paid

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at all and therefore that providers are sitting on a windfall

profit. A different rule, as desired by Slater, would create

incentives for health care providers not to pay third-party

providers on a timely basis.

Slater did not use its Medicare money to pay its third-

party provider Medicare-related expenses in the past. In the

context of bankruptcy, where the funds in the estate will be used

to pay off a wide variety of creditors and other expenses, there is

no guarantee that all or most of the funds will be used to pay

third-party providers if the overpayment were returned to the

bankruptcy estate. See Holyoke, 372 F.3d at 5. The overpayment

claim under § 413.100(c), far from being wholly extrinsic to the

relationship between Medicare and Slater, is in fact integral to

it.4 The recoupment analysis in Holyoke, which treats Medicare

adjustments for over- and underpayments as part of an ongoing

stream to ensure that providers get only the money that they are

actually entitled to, is thus fully applicable here.

Under Holyoke, the bankruptcy court erred in performing

further equitable balancing once the recoupment versus setoff

analysis had been completed. Holyoke, 372 F.3d at 5. Both

4
We therefore do not accept Slater's argument that § 413.100(c)
is merely a penalty that gives providers an incentive to liquidate
Medicare expenses in a timely manner, rather than a true type of
overpayment. Section 413.100(c) has an incentive effect, but it is
also an additional way to ensure that Medicare payments are
reimbursements for actual expenses paid out, and not windfall
profits for phantom provider costs.

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rationales present in Holyoke are applicable here. First, the

"same transaction" analysis itself inherently embodies competing

issues of equity, for the simple reason that "it would be

inequitable for [a debtor] to enjoy the benefits of the same

transaction without also meeting its obligations." Id. (quoting In

re Univ. Med. Ctr., 973 F.2d 1065, 1081 (3d Cir. 1992) (internal

quotation marks omitted)) (emphasis and alteration in Holyoke). In

at least most cases, analysis of the recoupment issue should both

begin and end with the same transaction question without discussing

other equitable issues. See, e.g., United Structures of Am., 9

F.3d at 999 ("[W]hen a debtor in bankruptcy seeks to recover from

a creditor whose claim against the debtor arises out of the same

transaction, allowing the creditor to recoup damages simply allows

the debtor precisely what it is due when viewing the transaction

'as a whole.' . . . [A] debtor has, in a sense, no right to funds

subject to recoupment."); Collier on Bankruptcy ¶ 553.10 (15th ed.

rev. 2004) ("[T]he key question in most recoupment cases is whether

the relevant obligations constitute part of the 'same

transaction.'"). Since we have already determined that the same

transaction test is met in this case, we need not go further.

As well, the Holyoke court noted that a bankruptcy

court's inherent equitable powers cannot be used in a way that

alters substantive rights defined under applicable nonbankruptcy

law. See Holyoke, 372 F.3d at 5; see also In re Ludlow Hosp.

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Soc'y, 124 F.3d 22, 27 (1st Cir. 1997). Here, Congress intended,

in the Medicare statutes, for the Medicare payment adjustment

system to operate as one continuous stream, including adjustments

for "overpayments" (a term that the Secretary has power to define).

42 U.S.C. § 1395g(a); 42 U.S.C. § 1395x(v)(1)(A); Holyoke, 372 F.3d

at 5; United States v. Consumer Health Servs. of Am., Inc., 108

F.3d 390, 394 (D.C. Cir. 1997). Equitable powers should not be

used to interfere with this Congressional policy choice.5 Holyoke,

372 F.3d at 5.

We therefore hold that the $370,569 can be recouped by

Medicare as an overpayment adjustment, and need not be returned to

Slater's bankruptcy estate. We need go no further. Since the

$370,569 overpayment to Slater will be recouped, Slater is

unquestionably permitted to assume the Medicare agreement under 11

U.S.C. § 365. The question of whether Slater must cure by paying

$370,569 to Medicare as a condition of assuming the contract under

11 U.S.C. § 365(b) never arises, and we need not discuss the issue

of whether such assumption of an executory contract would have been

permitted even if the $370,569 had instead been returned to

5
At any rate, as the district court noted, the equities do not
favor Slater. Slater never used the Medicare money for reasonable
Medicare costs, but now wants to make it available for distribution
to all of its creditors. Medicare ought to be able to reasonably
expect that its money, which is part of the public fisc, will go
only to reimbursements for actual Medicare costs and will not be
used for other purposes. See In re Slater Health Ctr., Inc., 306
B.R. at 27.

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Slater's estate. The Secretary's objections to the confirmation of

Slater's plan are now likewise moot, because the Medicare

overpayments, having been recouped by Medicare, are no longer part

of the plan.

III.

The decision of the district court allowing Medicare's

recoupment of the $370,569 is affirmed, and the case is remanded to

the bankruptcy court for proceedings consistent with this opinion.

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