COURT OF APPEALS OF VIRGINIA
Present: Judges Benton, Annunziata and Senior Judge Duff
Argued at Alexandria, Virginia
LIFE CARE CENTER OF
NEW MARKET
OPINION BY
v. Record No. 2022-96-4 JUDGE JAMES W. BENTON, JR.
SEPTEMBER 2, 1997
DEPARTMENT OF MEDICAL
ASSISTANCE SERVICES
FROM THE CIRCUIT COURT OF SHENANDOAH COUNTY
Perry W. Sarver, Judge Designate
Laura G. Aaron (Mezzullo & McCandlish, on
briefs), for appellant.
E. Paige Selden, Assistant Attorney General
(James S. Gilmore, III, Attorney General;
William H. Hurd, Deputy Attorney General;
Siran S. Faulders, Senior Assistant Attorney
General, on brief), for appellee.
This is an appeal from a circuit court's order affirming a
decision of the Department of Medical Assistance Services (DMAS),
which denied reimbursement for certain expenses incurred by Life
Care Center of New Market. New Market argues that the trial
judge erred in affirming DMAS's decision to deny reimbursement
for (1) overhead expenses incurred by Life Care Construction in
building an addition to the New Market facility, and (2) certain
interest expenses incurred to finance a loan borrowed to fund the
construction project. For the reasons that follow, we affirm, in
part, and reverse, in part, the trial judge's order.
I.
New Market is a nursing facility in Virginia that is owned
and operated by Life Care Centers of America. New Market
participates in the Medicaid program, which is administered by
DMAS. As a Medicaid participant, New Market is entitled to file
a cost report with DMAS and obtain reimbursement for expenses
incurred in providing health care services to Medicaid
recipients. Expenses properly incurred in constructing an
addition to an existing facility may be reimbursed by DMAS. See
Fralin v. Kozlowski, 18 Va. App. 697, 699-700, 447 S.E.2d 238,
239-40 (1994).
In March 1987, New Market obtained a certificate of need to
construct a forty-two bed addition to its facility. New Market
received a loan commitment in 1987 and constructed the addition
in 1988 and 1989. After a field auditor for DMAS denied
reimbursement for certain overhead and interest expenses incurred
in the construction project, New Market appealed.
During the informal fact finding conference, New Market
argued that the $73,572 paid to Life Care Construction was
primarily for overhead expenses. When DMAS questioned New
Market's methodology for computing overhead and its lack of
supporting documentation, New Market requested and was granted
additional time to submit documentation to support its claim for
overhead costs. Although New Market supplied a summary chart of
Life Care Construction's fees and expenses for the two years the
project was under construction, it provided no documentation to
support the data in the chart. The record indicates that DMAS
"was concerned that . . . the overhead that was allocated to New
2
Market would have been disproportionate to the overhead that
would be allocated to other projects that were overseen by Life
Care Construction." Although James Branham, DMAS's audit
supervisor, offered to assist New Market in arriving at a
methodology that would be acceptable to DMAS, New Market did not
pursue that offer. Instead, New Market prepared a second
analysis based on revenues because it believed "that was the best
available information."
New Market also argued at the informal fact finding
conference that because the partnership distributions were a
customary and legitimate business practice, DMAS erroneously
disallowed reimbursement for interest on a portion of the loan
equivalent to those distributions. DMAS asserted that the
records established that New Market made distributions to the
partnership accounts from the construction loan proceeds and that
those loan funds therefore were not reasonably related to the
delivery of patient care. Following the informal fact finding
conference, the Director of the Division of Cost Settlement and
Audit affirmed the original decision. New Market again appealed.
A formal hearing was held before a hearing officer appointed
by the Supreme Court. The primary facts proved at the hearing
are not in dispute. The testimony at the hearing proved that New
Market initially entered into a contract with a local
construction company to build the contemplated addition to New
Market's facility. Before construction began, however, the
3
principal owner of the construction company died. Life Care
Centers of America, New Market's owner, then decided to build the
addition itself and formed for that purpose a new company, Life
Care Construction. New Market hired Life Care Construction to
build the addition. DMAS and New Market agree that Life Care
Construction is a "related party," i.e., that it was under common
ownership or control with New Market.
Life Care Construction employed a local contractor, Paul
Thompson, who had a general contractor's license, to act as an
"on-site daily superintendent" for the project. Life Care
Construction "acted as owner's representative; it acted as
developer." According to the testimony, Life Care Construction
"studied [the project], listened to the operators of Life Care
Centers of America on the needs of the addition; . . . worked
with the architect; . . . designed with the architect the
blueprints, helped design the specifications for the project,
deciding the equipment, the finishes, [and] worked through the
process of the blueprints being drawn by the architect firm."
Life Care Construction also "prepared the liens for all the
subcontractors, paid the bills, coordinated with equipment
suppliers, the decorator and operations as it got near the end,
and then turned the building over to operations when it was
finished." Most of the contracts with the subcontractors were
executed by Life Care Construction.
New Market's analyst, Randy Martin, who is a certified
4
public accountant and an employee of Life Care Centers of
America, testified that New Market sought reimbursement for the
overhead costs (or "indirect costs") of the project that were
billed by Life Care Construction. 1 He testified that the
indirect costs of Life Care Construction were not separately
incurred in relation to individual projects and that they had to
be allocated among all of Life Care Construction's building
projects. To support New Market's claim for reimbursement,
Martin proposed two analyses that attempted to isolate the
indirect costs Life Care Construction incurred in relation to the
New Market construction project. In those analyses, which were
based on revenues that Life Care Construction received, Martin
attempted to eliminate any profits from the analysis because DMAS
will not permit reimbursement for profits earned by a related
party.
In the first calculation, Martin determined that two percent
of Life Care Construction's total revenues for the year
represented profits. Martin then determined the amount of
profits earned on the New Market project by multiplying by two
percent the total revenues received from New Market. After
1
"[O]verhead costs are those that are expended for the
benefit of the whole business, which by their nature cannot be
attributed or charged to any particular contract." Altmayer v.
Johnson, 79 F.3d 1129, 1132 (Fed. Cir. 1996); see also Alvey
Conveyor Mfg. Co. v. Kansas City Terminal Ry. Co., 203 S.W.2d
606, 609 (Mo. 1947) ("Overhead . . . includes the continuous
expense of a business irrespective of the direct costs on
particular contracts."); Neumiller Farms, Inc. v. Cornett, 368
So. 2d 272, 276-77 (Ala. 1979).
5
eliminating that amount of profit from the revenues, Martin
concluded that the resulting figure represented both direct and
indirect costs. Martin testified that overhead costs represented
approximately eight percent of the total cost of the New Market
project. The record does not reveal Martin's methodology for
arriving at the eight percent figure.
Martin testified that this method of computing overhead
costs has been accepted by Medicare in the past. In addition, he
testified that DMAS accepted this methodology when used by Total
Designs, the company that provided furnishings and decorations to
New Market for the same project.
Glen Walker, a certified public accountant licensed in
Virginia, testified as New Market's expert witness that Martin's
overhead figure of eight percent was unusually low. He indicated
that ten percent is a more typical overhead amount on commercial
construction projects. Walker also testified that the technique
Martin used to calculate overhead expenses has been used in
Virginia in the Medicaid program and is generally used 90% of the
time.
In the second calculation, Martin determined the total
amount of overhead costs billed by Life Care Construction for all
of its projects that year. Martin then "took the percentage of
. . . New Market's overhead billings to the total overhead
billings for those two years and applied that percentage to the
total [actual] overhead costs to identify . . . approximately
6
$79,000 of overhead that should be allocated to . . . New
Market." That amount "actually exceed[ed] the billings that . .
. Life Care Construction made to . . . New Market." Martin
testified that this method "had been used for Medicare and . . .
Medicaid [in other] states and was a rather commonly accepted
method of determining the related party costs." However, he
added that he had "never had to do this type of [calculation] for
another DMAS audit" because New Market was Life Care Centers of
America's only facility in Virginia. Walker, the certified
public accountant, testified that methods similar to this second
analysis are used ten percent of the time.
Martin testified that he had offered to provide "back-up
documentation" to support his calculations. However, James
Branham, the audit supervisor for DMAS, testified that Life Care
Construction's documents were not made available to him for
review during the audit. He said that he had only received "some
compiled financial statements." Branham also testified, however,
that an analysis that is based upon revenues is "not an
acceptable basis of allocating costs." He stated that such an
analysis is inappropriate in related party cases because the
revenue is not determined in an arms length transaction. Branham
further testified that although Martin had initially agreed to
work with him to "develop this cost information" in a manner that
was "more in accordance with the Medicare and Medicaid
regulations," Martin did not contact him.
7
Wendall Gatlin, a senior officer for DMAS, testified that he
sought the additional documentation because he "wanted to
determine what services [New Market] received" from Life Care
Construction. He was concerned that there was a "duplication of
duties" between Life Care Construction and Thompson, the local
contractor.
On the issue of DMAS's denial of reimbursement for a portion
of the interest expense incurred in financing the construction
loan, Martin testified that New Market borrowed $1,200,000 to
finance the project and that the actual total cost of the project
was $1,075,474. Because the loan exceeded the actual cost, New
Market only sought reimbursement of the interest expense for the
portion of the loan that actually was needed, the $1,075,474
total cost of the project.
Martin testified that DMAS initially disallowed $104,461 of
the total costs and that a large portion of that amount was the
overhead cost disallowance. To avoid reimbursing the interest on
the portion of the loan attributable to an expense DMAS
disallowed, the total amount of the loan was adjusted to $971,013
for interest reimbursement purposes. The amount was adjusted
again to account for a portion of management fees that exceeded
amounts allowable under the Medicare regulations. DMAS
determined that the money used to pay the management fees "was
cash that the facility could have withheld and not paid to the
management company and used to fund the construction rather than
8
paying it to the management company." In addition, DMAS
determined that partnership distributions and loans had been made
in the amount of $263,266. DMAS determined that New Market
should have used those funds to reduce its need to borrow.
Finally, the amount of the loan was also adjusted to account for
expenditures of operating funds made during the construction
process. DMAS determined that because only $573,923 of the total
loan was necessary for the project, interest attributable only to
that portion of the loan would be reimbursed.
Based on this evidence, the hearing officer reversed the
decision to deny the reimbursements and ruled in favor of New
Market. DMAS then appealed. After review by DMAS's Director,
DMAS issued a final agency decision that rejected the hearing
officer's conclusions of law and denied the reimbursements New
Market sought. On appeal to the circuit court, the trial judge
affirmed DMAS's ruling as contained in the final agency decision.
New Market now appeals.
II.
STANDARD OF REVIEW
Recently, this Court specifically addressed the standard of
review applicable to similar cases.
In reviewing decisions by DMAS, an
appellate court accords great deference to
both the agency's factual findings and
interpretation of the laws applicable to "the
reimbursement due qualified providers for
their reasonable cost incurred while
delivering health care services." This Court
will overturn DMAS' "interpretations of the
statutes and regulations governing Medicaid
9
and Medicare principles of reimbursement
. . . only . . . when found to be arbitrary
and capricious."
Beverly Health and Rehab. Servs., Inc. v. Metcalf, 24 Va. App.
584, 592, 484 S.E.2d 156, 160 (1997) (citations omitted).
III.
CONSTRUCTION COSTS
New Market first argues that the trial judge erred in
affirming DMAS's decision to deny reimbursement of certain
construction costs. New Market contends that DMAS erroneously
arrived at its decision without first reviewing New Market's
supporting documentation. DMAS argues that New Market failed to
provide adequate supporting documentation and that, therefore,
the denial of reimbursement was supported by 12 VAC 30-90-110
(1990). DMAS also argues that New Market's methodology for
isolating the overhead costs applicable to the New Market project
was inadequate.
The trial judge made the following rulings:
It was New Market's responsibility to
furnish evidence in support of its claim for
reimbursement for management fees and
overhead costs. . . . DMAS insisted that New
Market furnish information on a cost and not
a revenue basis. After the Informal Fact
Finding Conference, there was a general
agreement that the parties would meet for the
purpose of developing procedures for
providing cost information and the supporting
data for such costs. The time for
accomplishing this was extended by DMAS, and
New Market's response has been to insist on
reimbursement on a revenue basis.
The evidence supports that ruling.
10
To facilitate the process of auditing health care providers,
DMAS requires providers to keep and make accessible adequate
documentation to support their claims for reimbursement. See 12
VAC 30-90-110 (1990). In relevant part, 12 VAC 30-90-110
provides as follows:
II. Types of records to be maintained.
Information which must be maintained for the
duration of the provider's participation in
the DMAS includes, but is not limited to:
* * * * * * *
D. Copies of all cost reports filed with
the DMAS together with supporting financial
statements.
III. Record Availability. The records must
be available for audits by DMAS staff. Where
such records are not available, costs shall
be disallowed.
(Emphasis added). As pertinent to this case, DMAS would have
grounds to deny New Market's claim if New Market failed to make
available its cost reports or supporting financial statements.
See 12 VAC 30-90-110 (II)(D).
The evidence reveals that DMAS sought to audit the financial
documents that would support New Market's request for
reimbursement. Branham, the audit supervisor for DMAS who
oversaw the audit of New Market, testified that "[w]hen [they]
requested [the documentation], what was furnished were some
financial statements." Branham stated that he sought more
detailed information than the "compiled financial statements"
provided by New Market; he sought documents demonstrating "the
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various components of [the] . . . costs and the revenue."
Gatlin, a senior officer for DMAS, testified that the auditors
"were after the detail of the services" that Life Care
Construction provided to New Market. Gatlin stated that DMAS
initially "wanted to determine what services . . . [New Market]
received" from Life Care Construction.
Branham testified that when New Market initially sought
reimbursement for money paid to Life Care Construction, DMAS
"questioned the need" for the payment "because they had a general
contractor, . . . Thompson, who was on-site and was doing . . . a
lot of the subcontracting." DMAS also questioned "the
methodology" that New Market used. New Market had only submitted
a "profit computation" as justification for the fees charged by
Life Care Construction. DMAS informed New Market that it
required additional financial documents because New Market had
merely submitted statements using a "revenue basis" for
calculating the payment it made to Life Care Construction.
Branham testified that the Medicaid regulations require that
providers be reimbursed only for actual costs incurred by related
parties. He testified that revenue based methodologies are not
acceptable because related party transactions are "not . . .
arms-length transaction[s]" and, thus, "revenue[s] can be set at
whatever the related parties agree." Branham testified that when
the DMAS auditors requested supporting financial statements for
the requested reimbursement they only received "compiled
12
financial statements" that did not provide adequate "back-up"
financial documentation to support New Market's methodology.
Branham further testified that at the informal conference
DMAS informed New Market "that the more appropriate method would
be to identify all of the various project costs and use that
basis for allocating the indirect costs or the overhead
components." Although DMAS believed that it had reached an
agreement with New Market to develop the cost information, New
Market did not follow through. Instead, it submitted another
revenue based proposal. New Market also did not submit financial
documentation to support the second proposal.
Accordingly, we hold that the evidence supports the trial
judge's finding that New Market failed to meet its burden, under
12 VAC 30-90-110, to provide documentary evidence to support its
claim for reimbursement. "Because the trial [judge's] decision
upholding DMAS's denial of payment to [New Market] is consistent
with Medicare principles of reimbursement, [the] decision was not
arbitrary or capricious and must be affirmed." Fralin, 18 Va.
App. at 705, 447 S.E.2d at 243.
IV.
INTEREST EXPENSE
New Market sought reimbursement for interest expenses it
incurred to finance the construction loan. DMAS found that
portions of the loan were unnecessary and denied reimbursement
for the interest that accrued on those portions of the loan.
13
Under the Nursing Home Payment System, "cost shall include
actual allowable . . . interest." NHPS § 2.1 (A) (1989-1991).
All costs, including interest, must be necessary and reasonable.
See NHPS App. I, § 1.1 (A) (1989-1991). As the NHPS does not
define "necessary" and "reasonable," we must look to the Medicare
principles of reimbursement as set forth in the Provider
Reimbursement Manual for guidance. See Beverly, 24 Va. App. at
594, 484 S.E.2d at 161. "Necessary and proper interest on both
current and capital indebtedness is an allowable cost." Prov.
Reimb. Man., Part 1, § 200 (1968). "To be allowable under the
Medicare program, interest must be . . . necessary and proper for
the operation, maintenance, or acquisition of the provider's
facilities." Prov. Reimb. Man., Part 1, § 202.1 (1968).
"Necessary means that the interest [must] be incurred on a loan
made to satisfy a financial need of the provider . . . ." Prov.
2
Reimb. Man., Part 1, § 202.2 (1983).
Interest Incurred to Pay Management Fees
The record reveals that DMAS reduced the amount of the loan
for which it would pay the interest expense in part to account
for management expenses New Market incurred. No authority
supports that reduction. DMAS made the adjustment on the ground
that because related party management fees are not reimbursable,
the management fees should not have been incurred; rather, New
2
§ 202.2 has been amended since 1983; however, the 1983
version is applicable to the cost reports for 1989, 1990, and
1991 involved in this case.
14
Market should have used those funds to reduce its need to borrow.
DMAS misapplies the law. To determine whether interest for
a loan is reimbursable, the relevant inquiry is the necessity for
the loan. See Prov. Reimb. Man., Part 1, § 202.1 (1968).
Whether DMAS will reimburse a given expenditure is a different
question than whether an expenditure is necessary. DMAS does not
reimburse all expenditures made by providers that are necessary
for the ongoing operation of their facilities. Thus, regardless
of whether DMAS would reimburse New Market for related party
management fees, the interest on the loan is reimbursable so long
as the management fees were a necessary expense incurred in
operating New Market's health care facility.
At the evidentiary hearing, Martin described the management
services as "accounting services, data processing services, risk
management services, [and] . . . general overall supervision."
No evidence was offered at the hearing that would tend to show
that the management services were not a necessary expense of the
health care facility. Accordingly, we hold that the trial judge
erred in affirming DMAS's decision to deny reimbursement for
interest on the portion of the loan that was equivalent to the
amount of management fees paid by New Market.
Partnership Distributions
DMAS determined that the amount of the loan necessary for
New Market's project should be reduced by $263,266, the amount of
the partnership distributions made between 1987 and 1989. DMAS
15
reasoned that New Market had those funds available and could have
used them to reduce its need to borrow. Thus, DMAS found that
$263,266 of the loan was not "necessary."
New Market argues that under Pioneer Hosp. v. The Travelers
Ins. Co., 1983-1 Medicare & Medicaid Guide, New Developments
(CCH) Para. 32,400 (PRRB Jan. 7, 1983), DMAS's consideration of
the partnership distributions was erroneous. We agree. In
Pioneer, the Provider Reimbursement Review Board held that when
determining whether a loan was "necessary" for interest
reimbursement purposes, the availability of funds and
distributions to partners after the loan was made are not
relevant. Rather, a reviewing tribunal should only consider the
provider's financial condition as it existed at the time the loan
was made. Therefore, we hold that DMAS erred in using the
partnership distributions made after the loan commitment as a
basis for reducing the amount of interest it would reimburse.
Accordingly, we affirm the trial judge's decision to uphold
DMAS's denial of reimbursement for the related party overhead
expenses. However, we reverse the remainder of the decision and
remand the case to the trial judge. The trial judge shall remand
the case to DMAS to remove the interest deductions it imposed on
account of the management fees and partnership distributions.
Affirmed in part, reversed in part,
and remanded.
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