Transtn Hosp Corp LA v. Shalala, Donna E.

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 24, 2000 Decided August 22, 2000

No. 99-5166

Transitional Hospitals Corporation of Louisiana,
Incorporated,
and
Transitional Hospitals Corporation of Texas, Incorporated,
Appellees

v.

Donna E. Shalala, Secretary,
Department of Health and Human Services,
Appellant

Appeal from the United States District Court
for the District of Columbia
(No. 97cv01351)

Anne M. Murphy, Attorney, U.S. Department of Justice,
argued the cause for appellant. With her on the brief were
David W. Ogden, Acting Assistant Attorney General, Antho-

ny J. Steinmeyer, Assistant Director, and Wilma A. Lewis,
U.S. Attorney.

Eugene Tillman argued the cause for appellees. With him
on the brief was Tamara V. Scoville.

Before: Williams, Rogers, and Garland, Circuit Judges.

Opinion for the Court filed by Circuit Judge Garland.

Garland, Circuit Judge: The Medicare program reim-
burses certain categories of hospitals on a "reasonable cost"
basis, rather than under the generally applicable, and less
remunerative, "Prospective Payment System." Long-term
care hospitals are one such category. Plaintiffs own two new
facilities for which they sought classification as long-term care
hospitals before they began admitting patients. The Depart-
ment of Health and Human Services (HHS) rejected plain-
tiffs' request, citing regulations that require new hospitals to
have six months of experience before they can qualify as
"long-term." In enacting those regulations, the Secretary of
HHS took the position that an initial data-collection period is
statutorily required. Plaintiffs, challenging the regulations in
the district court, took the opposite position: that the Medi-
care statute does not mandate an initial data-collection period
and in fact manifestly requires HHS to reimburse them as
long-term hospitals from the first day of operation. The
district court agreed with plaintiffs and declared HHS' regu-
lations invalid.

We do not find the statute as clear as either side suggests,
but rather conclude that Congress intended the Secretary to
exercise discretion in determining the manner in which a
hospital qualifies as a long-term care facility. We therefore
reverse the decision of the district court. However, because
the Secretary mistakenly believed that she lacked such dis-
cretion, we remand the case to permit her to determine
whether she wishes to retain the existing regulations knowing
that other options are permissible.

I

Medicare is a federal health insurance program for the
aged and disabled that is administered by the Health Care

Financing Administration (HCFA) of HHS. See 42 U.S.C.
ss 1395 et seq. Under Medicare Part A, institutional health
care providers are reimbursed for their services to eligible
patients. See id. ss 1395c to 1395i-5. From its inception
until 1983, Medicare reimbursed hospitals for the "reasonable
cost" of providing inpatient care, subject to certain limita-
tions. Id. s 1395f(b) (1982); see also id. s 1395x(v).

By 1983, Congress had become concerned that hospitals
reimbursed on a reasonable cost basis lacked incentives to
operate efficiently. This concern led to the revision of the
Medicare payment system in that year. See Social Security
Amendments of 1983, Pub. L. No. 98-21, s 601, 97 Stat. 65,
149. See generally County of Los Angeles v. Shalala, 192
F.3d 1005, 1008-09 (D.C. Cir. 1999). In place of the reason-
able cost method, Congress enacted the Prospective Payment
System (PPS) as the principal method of compensating hospi-
tals for inpatient care provided to eligible patients. Under
PPS, hospitals are reimbursed according to flat rates estab-
lished in advance for the various categories of patient diag-
noses (known as "diagnosis-related groups" or "DRGs"). 42
U.S.C. s 1395ww(d). The rates reflect the average cost
associated with treating a patient for a specific condition, and
encourage hospitals to keep costs within the anticipated reim-
bursement levels. For the care of patients whose hospitaliza-
tions are extraordinarily costly or lengthy, the statute autho-
rizes the Secretary to make "outlier payments" to supplement
the standard PPS disbursement. Id. s 1395ww(d)(5)(A)(i)-
(vi); see County of Los Angeles, 192 F.3d at 1009.

Because PPS was "developed for short-term acute care
general hospitals," Congress acknowledged that it did not
"adequately take into account special circumstances of diag-
noses requiring long stays." S. Rep. No. 98-23, at 54 (1983).
Thus, Congress altogether excluded from PPS certain types
of hospitals that treat atypical patient populations. These
hospitals instead receive reimbursement for inpatient care
under the reasonable cost system. See 42 U.S.C.
s 1395ww(d)(1)(B). One type of hospital subject to the statu-
tory exclusion is a long-term care hospital, which the statute

describes as "a hospital which has an average inpatient length
of stay (as determined by the Secretary) of greater than 25
days." Id. s 1395ww(d)(1)(B)(iv)(I).1 The availability of this
exclusion is the central issue in the case before us.

A

HHS implemented the new PPS reimbursement scheme by
enacting regulations in 1984. In issuing its final rule, al-
though not in the rule itself, HHS announced that it intended
to apply the statutory exclusions prospectively only: any
change in a hospital's status (i.e., whether it was subject to or
excluded from PPS) that occurred during one cost reporting
period would generally take effect only at the start of the
next period, with each period typically lasting one year. See
Medicare Program; Prospective Payment for Medicare In-
patient Hospital Services, 49 Fed. Reg. 234, 243 (1984).
Thus, a new hospital would not qualify for the exclusion at
least until the initial reporting period was over. To accom-
modate new hospitals, HHS permitted an abbreviated initial
cost reporting period of six months, rather than the usual one
year. See 42 C.F.R. s 405.471(c)(5)(i), (c)(5)(ii)(B) (1983),
__________
1 The statute lists the following types of excluded hospitals:

(i) a psychiatric hospital (as defined in section 1395x(f) of
this title),

(ii) a rehabilitation hospital (as defined by the Secretary),

(iii) a hospital whose inpatients are predominantly individu-
als under 18 years of age,

(iv)(I) a hospital which has an average inpatient length
of stay (as determined by the Secretary) of greater than 25
days ...

...

(v)(I) a hospital that the Secretary has classified ... for
purposes of applying exceptions and adjustments to payment
amounts under this subsection, as a hospital involved extensive-
ly in treatment for or research on cancer....

42 U.S.C. s 1395ww(d)(1)(B).

now codified at 42 C.F.R. s 412.23(e)(1), (e)(3)(ii).2

In 1992, HHS formalized its prospective approach to exclu-
sions by proposing and then adopting the following rule:

For purposes of exclusion from the prospective payment
systems ..., the status of each currently participating
hospital ... is determined at the beginning of each cost
reporting period and is effective for the entire cost
reporting period. Any changes in the status of the
hospital are made only at the start of a cost reporting
period.

42 C.F.R. s 412.22(d). Thus, a hospital that qualifies for the
exclusion in the middle of a reporting period will not benefit
until the next reporting period. By the same token, a
hospital that ceases to qualify in the midst of a cost reporting
period will nevertheless be compensated as though it were
exempt for the entire period. See Medicare Program;
Changes to the Hospital Inpatient Prospective Payment Sys-
tems and Fiscal Year 1993 Rates, 57 Fed. Reg. 23,618, 23,657
(1992). For a new hospital, HHS' rule confirmed that the
exclusion does not begin until the first six months of data
collection have passed.

In response to the notice of proposed rulemaking, the
National Association of Long Term Hospitals (NALTH) sug-
gested that HHS permit new long-term care hospitals to self-
certify their average length of stay from the start. See
Letter from NALTH to HCFA at 2 (July 31, 1992) (J.A. at

__________
2 The regulations permit hospitals that experience a change in
their average length of stay to establish exclusion eligibility by
having an average length of stay greater than 25 days for the
immediately preceding six month period. See 42 C.F.R.
s 405.471(c)(5)(i), (c)(5)(ii)(B) (1983), now codified at 42 C.F.R.
s 412.23(e)(1), (e)(3)(ii). According to HHS, a new hospital that
treats patients with an average length of stay greater than 25 days
"will always experience [a] change in length of stay because its
initial length of stay is zero inpatient days." HHS Br. at 9 n.5.

53) [hereinafter NALTH Ltr.].3 HHS, however, concluded
that it did not have the discretion to permit self-certification
by long-term care hospitals. "We do not believe that the
statute permits us," the Department said, "to extend the
exclusion for long-term care hospitals to a hospital which has
not demonstrated actual compliance with the statutory re-
quirement." Medicare Program; Changes to the Hospital
Inpatient Prospective Payment Systems and Fiscal Year
1993 Rates, 57 Fed. Reg. 39,746, 39,800-01 (1992) [hereinafter
Final Rule]. The "criterion for exclusion as a long-term care
hospital (average inpatient length of stay greater than 25
days) can be assessed only over a period of time. Thus, a
hospital cannot qualify as a long-term care hospital until it
has been in operation for some period of time." Id. at 38,801.

B

Plaintiffs Transitional Hospitals Corporation of Louisiana
and Transitional Hospitals Corporation of Texas (hereinafter
"the THC plaintiffs") opened two new hospitals at the end of
1992. Both were intended to treat patients with medically
complex conditions requiring extended inpatient stays, there-
by qualifying for the long-term care hospital exclusion from
PPS. Before commencing operations, the THC plaintiffs
wrote HCFA stating that they "only expect to admit patients
whose medical conditions will result in lengths of stay in
excess of 25 days." Letter from Counsel for THC to HCFA
at 2 (Nov. 12, 1992) (J.A. at 57) [hereinafter THC Ltr.]. They
asked HCFA to exclude them from PPS from the starting
date of their Medicare provider agreements, rather than
reimburse them under PPS during their first six months of
operation. See id. at 4 (J.A. at 59).

Kathleen Buto, the Director of HCFA's Bureau of Policy
Development, wrote back denying plaintiffs' request. Buto
said that the statute mandates exclusion only for "a hospital

__________
3 NALTH noted that HHS permits new rehabilitation hospitals
to self-certify that their inpatient populations meet the exclusion
criteria for that category. See NALTH Ltr. at 1-2 (J.A. at 52-53);
discussion infra Part III.

which has [emphasis added] an average length of stay (as
determined by the Secretary) of greater than 25 days."
Letter from HCFA to Counsel for THC at 2 (Dec. 24, 1992)
(J.A. at 63) (alteration and emphasis in original) [hereinafter
Buto Ltr.]. Noting that HHS regulations implement that
mandate by "examining [a hospital's] actual operating experi-
ence in a past period, rather than by relying on its admission
criteria or other formalized statements of how the hospital is
intended or expected to operate," Buto concluded that the
THC plaintiffs could not qualify for the exclusion in advance.
Id. at 2-3 (J.A. at 63-64).

Having had their request turned down, the THC plaintiffs
proceeded with the six-month cost reporting period. During
that time, they were reimbursed under PPS, supplemented by
outlier payments. At the end of the six-month period, both
hospitals demonstrated average inpatient lengths of stay ex-
ceeding 25 days, thereby qualifying for exclusion from PPS--
and entitling them to payment for "reasonable costs"--during
the next cost reporting period. See Linville Aff. pp 7, 8, 13
(J.A. at 35, 37). Plaintiffs estimate that their PPS reimburse-
ment during the initial six-month period was approximately
$1.2 million per hospital less than it would have been under
the reasonable cost standard. See id. pp 11, 12 (J.A. at 36).

The THC plaintiffs requested a hearing before the Provider
Reimbursement Review Board, which is authorized by statute
to hear the complaints of providers dissatisfied with the
compensation they have received. See 42 U.S.C. s 1395oo(a),
(d). Plaintiffs challenged the validity of the regulations that
denied them compensation for reasonable costs during their
first months of operation. The Board, however, concluded
that it lacked authority to determine the validity of HHS
regulations.

Plaintiffs then brought suit in the United States District
Court for the District of Columbia. Ruling on the parties'
cross motions for summary judgment, the court concluded
that the Medicare statute was neither silent nor ambiguous
on the question. Rather, the court concluded that the statute
unambiguously requires HHS to provide a PPS exclusion
from the beginning of a new long-term care hospital's partic-
ipation in the Medicare program. The court further held that
even if the statute were ambiguous, the Secretary's regula-

tions did not constitute a permissible interpretation of the
legislative language. The court therefore declared the regu-
lations invalid insofar as they preclude new long-term care
hospitals from securing immediate exclusion from PPS. See
Transitional Hosps. Corp. v. Shalala, 40 F. Supp. 2d 6, 15
(D.D.C. 1999). This appeal by the Secretary followed.

II

We review de novo the district court's ruling on the mo-
tions for summary judgment. See United Seniors Ass'n v.
Shalala, 182 F.3d 965, 969 (D.C. Cir. 1999). In judging the
validity of the Secretary's regulations, we apply the familiar
two-step framework of Chevron U.S.A. Inc. v. Natural Re-
sources Defense Council, Inc., 467 U.S. 837, 842-43 (1984).
We first ask "whether Congress has directly spoken to the
precise question at issue," in which case we "must give effect
to the unambiguously expressed intent of Congress." Id. If
the "statute is silent or ambiguous with respect to the specific
issue," we move to the second step and defer to the agency's
interpretation as long as it is "based on a permissible con-
struction of the statute." Id. at 843. However, deference is
"only appropriate when the agency has exercised its own
judgment." Phillips Petroleum Co. v. FERC, 792 F.2d 1165,
1169 (D.C. Cir. 1986). "When, instead, the agency's decision
is based on an erroneous view of the law, its decision cannot
stand." Id.

A

We begin with Chevron step one, and with the Secretary's
contention that Congress unambiguously expressed its intent
to bar the relief plaintiffs request.

The statutory provision at issue is quite brief. It excludes
from PPS any "hospital which has an average inpatient length
of stay (as determined by the Secretary) of greater than 25
days." 42 U.S.C. s 1395ww(d)(1)(B)(iv).4 When the Secre-

__________
4 Neither side makes an argument based on legislative history.
The PPS exclusion was passed as part of a large bill enacting

tary adopted her implementing regulations, she took the
position that the statute does not permit her to certify a
hospital as long-term in advance because the criterion for
exclusion, an average inpatient length of stay greater than 25
days, "can be assessed only over a period of time." Final
Rule, 57 Fed. Reg. at 39,801. "Thus," she said, "a hospital
cannot qualify as a long-term care hospital until it has been in
operation for some period of time." Id. Similarly, when
HCFA turned down plaintiffs' request for self-certification, it
stressed that, because under the statute only a hospital that
"has" the requisite length of stay is eligible, a hospital cannot
qualify until it makes the requisite showing that it "has" that
average length of stay. See Buto Ltr. at 2 (J.A. at 63).

The statute seems neither so clear, nor so dictatorial, to us.
Although it does establish a criterion based on average length
of stay, the statute is silent as to how and when that length
should be calculated. Nothing in the language precludes the
Secretary from determining length of stay based on a predic-
tion drawn, as plaintiffs suggest here, from a hospital's policy
of admitting only "patients whose medical conditions will
result in lengths of stay in excess of 25 days." THC Ltr. at 2
(J.A. at 57); cf. County of Los Angeles, 192 F.2d at 1013-15
(affirming HHS' use of predictions to determine statutorily-
mandated range of outlier payments).

Nor does the statute's use of the present tense verb "has"
definitively resolve the question. Although to qualify it must
be true that a hospital "has" the requisite length of stay, that
word does not tell us how to determine whether that state of
being exists. The agency has implicitly recognized as much
by adopting a policy of determining a hospital's status at the
beginning of a cost reporting period, and then permitting it to
retain that status for the entire period--even if conditions
change in the interim. See 42 C.F.R. s 412.22(d). Under

__________
wholesale changes in the Medicare program, and specific references
to the long-term care exclusion occur only in general passages
explaining the need for a reasonable costs alternative to PPS for
certain types of hospitals. See, e.g., H.R. Conf. Rep. No. 98-47, at
192-93 (1983); S. Rep. No. 98-23, at 53-55 (1983); H.R. Rep. No.
98-25, at 8-9, 141-42 (1983).

this policy, HHS excludes a hospital for the next period based
on data derived from the prior period, regardless of whether
the hospital actually "has" the requisite average on each day
of the next period. See id.

Moreover, nothing in the statutory language precludes an
alternative form of relief requested by plaintiffs: retroactive
reimbursement for reasonable costs incurred during the first
six months if, at the end of that period, the hospital shows
that it had a 25-day average during that period. Again, the
word "has" does not unambiguously decide this question.
Each of plaintiffs' hospitals could have accurately said on its
six-month anniversary that today it "has" a greater than 25-
day average--referring to the entire period from day one
through and including day 180. It would therefore have been
consistent with the literal language to reimburse the hospital
on that day for all of its reasonable costs incurred to date.

Finally, and perhaps most important, this is not a statute
as to which we can only infer, from Congress' silence, an
implicit intent to delegate to the Secretary the authority to
reasonably interpret the statutory terms. See Chevron, 467
U.S. at 844. Rather, in this case the statute excludes a
hospital that has an average length of stay of greater than 25
days, "as determined by the Secretary." 42 U.S.C.
s 1395ww(d)(1)(B)(iv). Thus, Congress has provided "an ex-
press delegation of authority to the agency to elucidate a
specific provision of the statute by regulation." Chevron, 467
U.S. at 843-44; see also 42 U.S.C. ss 1302(a), 1395hh(a)
(granting HHS authority to issue regulations to administer
Medicare program). This means that the Secretary has
discretion to determine how to calculate the qualifying length
of stay, and that we are bound to uphold her determination as
long as she exercises that discretion in a reasonable way. See
Chevron, 467 U.S. at 843-44.

B

The THC plaintiffs also see the statute as clear and unam-
biguous--although in precisely the opposite way as that per-
ceived by HHS. In their view, and in the view of the district
court, the use of the present tense "has" requires that if

during any given period the hospital "has" a 25-day average,
it must be considered exempt for the entire period. See THC
Br. at 22-23. The use of the present tense, plaintiffs contend,
requires that the exclusion "be applied on a current basis,"
and "allows no alternative temporal reading." Id. Or, as the
district court put it, "the plain language of the statute indi-
cates that a long-term care hospital may obtain an exemption
from the Prospective Payment System whenever it 'has' an
average inpatient length of stay greater than 25 days."
Transitional Hosps., 40 F. Supp. 2d at 10.5

Again we disagree, this time for the mirror image of our
reasoning with respect to HHS' interpretation. Because the
statute does not tell us how to determine whether a hospital
"has" the required average length of stay, it cannot be read
as requiring the agency to make that determination constant-
ly and instantaneously--any more than it can be read (as
HHS would have it) as requiring the agency to make that
determination prospectively only. In Methodist Hospital v.
Shalala, 38 F.3d 1225 (D.C. Cir. 1994), we considered a
similar argument regarding the wage index used to determine
reimbursement rates under PPS. In that case, the plaintiff
hospitals contended that the Medicare statute required retro-
active application of corrections made to the index to ensure
that the Secretary was not employing an incorrect index in
the period prior to the next correction. We rejected that
claim, noting that it "would require the Secretary to make
virtually continuous adjustments in the wage index." Id. at
1230. "The statute," we said, "does not specify how the
Secretary should construct the index, nor how often she must
revise it.... Congress through its silence delegated these
decisions to the Secretary." Id. The same is true here.

__________
5 Plaintiffs also proffer an argument they describe as based on
statutory purpose, contending that they are entitled to an exemp-
tion from their first day of operation because Congress' exclusion of
long-term care hospitals from PPS demonstrates its recognition
that PPS is an inadequate method for reimbursing such hospitals.
But this simply begs the question discussed in the text: were
plaintiffs' hospitals "long-term," within the meaning of the statute,
from that first day?

 But, plaintiffs argue, if Congress had intended the exclu-
sion to apply prospectively, it could have drafted the statute
to provide a PPS exclusion for a hospital that "had" an
average inpatient length of stay greater than 25 days "during
its most recent cost reporting period." Transitional Hosps.,
40 F. Supp. 2d at 11 (quoting Pls.' Mot. for Summ. J. at 15)
(emphasis omitted). Frankly, we do not see such a revised
statute as particularly less ambiguous. Indeed, we do not see
why HHS could not have proffered the same editorial sugges-
tion and then made the opposite argument: If Congress had
intended hospitals to receive retroactive reimbursement as
plaintiffs contend, wouldn't it have defined the exclusion as
covering hospitals that "had" the requisite average during
their "most recent cost reporting period"? In any event,
while positing a "clearer" way to write a statute may suggest
that an existing statute is ambiguous, it surely does not
establish that it is unambiguous. And if the statute is not
unambiguous, Chevron requires us to defer to a reasonable
reading by the Secretary.

We also must take care to read the word "has" in the
context of the entire phrase of which it is a part. Two
elements of that context are important here. First, the
statutory exclusion is for a hospital that has "an average"
inpatient length of stay of greater than 25 days. The criteri-
on of "an average" strongly militates against plaintiffs' view
that a hospital's status must be measured at every moment in
time. As HHS correctly points out, an average is a criterion
that can only be assessed over a period of time. Moreover,
the statute refers not to an average "over" a period of 25
days, but to an average "of" 25 days--necessarily indicating
that the period of measurement must be more than 25 days in
order reasonably to determine whether the "average" during
that period was at least 25 days. Hence, the use of the word
"has" in conjunction with the word "average" would not
preclude waiting until six months have passed to determine
whether, at that point, the hospital "has" an average of 25
days over a 180-day period.

Indeed, were we to read the statute as literally as plaintiffs
and the district court suggest, plaintiffs' own contention--that

they "met the 25-day requirement at all times during their
operation" and so were entitled to payment from the first
day--would be plainly incorrect. THC Br. at 4. On day one,
the hospitals could not have had a 25-day average because 25
days had not yet passed. If a hospital must be, and may only
be, paid for days on which it "has" a 25-day average, plain-
tiffs could not have qualified earlier than the 25th day. Even
then, they could have done so only if every patient present on
day one were still at the hospital 25 days later.

The second element of context that is important here is the
statute's parenthetical phrase, "as determined by the Secre-
tary." As we have discussed above, by employing this phrase
Congress has made "an express delegation of authority to the
agency to elucidate [the] specific provision of the statute by
regulation." Chevron, 467 U.S. at 843-44. This further takes
the case out of the realm of Chevron step one's de novo
review, and into the realm of Chevron step two--which asks
only whether the agency's interpretation is reasonable. See
id. And that gives the agency considerable leeway to deter-
mine how "has" is to be defined, and whether to require
prospective, contemporaneous, or retrospective evaluation
and payment. See San Bernardino Mountains Community
Hosp. Dist. v. Secretary of Health & Human Servs., 63 F.3d
882, 886-87 (9th Cir. 1995) (holding that inclusion of phrase
"as determined by the Secretary" in Medicare Act's definition
of "sole community hospital" "make[s] clear that Congress
intended to delegate to the Secretary the task of outlining
and defining the criteria for attaining sole community hospital
status").

Plaintiffs resist the conclusion that Congress has delegated
definitional authority to HHS. They argue that the fact that
the parenthetical "as determined by the Secretary" follows
the phrase "an average inpatient length of stay," means that
Congress has only given the agency "discretion to determine
how the average length of stay will be calculated"--and not
whether the hospital "has" that average. THC Br. at 26.
This is far too sophistic a reading. First, the concession that
the agency has discretion to determine how to calculate the

average necessarily means it has discretion to determine
whether a hospital "has" that average--since a hospital can-
not have a qualifying average unless it satisfies the agency's
calculation methodology. Second, even if word placement
were decisive, it is as true that the delegating parenthetical
follows the phrase "has an average inpatient length of stay"
as that it follows the phrase "an average inpatient length of
stay." At most this renders the scope of Congress' delega-
tion ambiguous, which again moves us to Chevron's second
step. See Chevron, 467 U.S. at 844.6

C

In reaching the conclusion that the statute unambiguously
requires retroactive reimbursement for the hospitals' initial

__________
6 Plaintiffs assert that Congress confirmed their reading of the
long-term care exclusion in its 1997 amendments to the Medicare
statute, which place payment limits on newly participating long-
term care hospitals. Those amendments provide that:

in the case of a hospital or unit that is within a class of hospital
described in subparagraph (B) which first receives payments
under this section on or after October 1, 1997--

(i) for each of the first 2 cost reporting periods for which the
hospital has a settled cost report, the amount of the payment
with respect to operating costs ... [shall be] equal to the
lesser of ... [the amount of operating costs or a national
limit.]

42 U.S.C. s 1395ww(b)(7)(A). Plaintiffs contend that this language
indicates that Congress intended newly participating long-term care
hospitals to receive reimbursement for reasonable costs from the
date of their first reporting period. But as the Secretary points
out, this provision does not materially advance the analysis. By its
terms, it applies only to a "subparagraph (B)" hospital. A subpara-
graph (B) hospital, in turn, is defined as including a hospital that
comes within subsection (d)(1)(B)(iv)--the precise subsection that is
in dispute in this case. See id. s 1395ww(b)(7)(B); cf. Methodist
Hosp., 38 F.3d at 1231 (noting, in the context of the Medicare
statute, that "the views of a subsequent Congress form a hazardous
basis for inferring the intent of an earlier one") (internal quotation
omitted).

cost reporting period, the district court relied on another
district court opinion, County of Los Angeles v. Shalala, 992
F. Supp. 26 (D.D.C. 1998), which held that a provision of the
Medicare statute required HHS to make retroactive adjust-
ments to outlier payments.7 County of Los Angeles held that
the provision, which set a range for the "total amount of the
additional payments made," 42 U.S.C. s 1395ww(d)(5)(A)(iv)
(emphasis added), unambiguously required the Secretary to
adjust the additional payments retroactively to ensure that
the total fell within the range. See County of Los Angeles,
992 F. Supp. at 36. It thus rejected the Secretary's interpre-
tation of the provision as merely instructing her as to where
to set outlier thresholds for the coming year. The district
court in the instant case followed that line of reasoning, and
held that HHS could not use prior-period experience merely
to determine how to reimburse the plaintiff hospitals in the
future, but rather had to reimburse the hospitals for their
reasonable costs from the first date of their operation. See
Transitional Hosps., 40 F. Supp. 2d at 12.

Although the district court's reliance on the opinion in
County of Los Angeles cannot be faulted, this court reversed
that decision seven months later. See County of Los Angeles
v. Shalala, 192 F.3d 1005 (D.C. Cir. 1999). Rejecting an
argument based on verb tense, we held that "instead of
embodying a retrospective inquiry into the amount of outlier
payments that have been made," "the phrase 'payments made
under this subparagraph' might just as plausibly reflect a
prospective command to the Secretary about how to structure
outlier thresholds for payments to be made in advance of each
fiscal year." Id. at 1013. In so holding, we cited the Su-
preme Court's decision in Regions Hospital v. Shalala, 118
S. Ct. 909 (1998). There, the Court held that the statutory
phrase, "recognized as reasonable," "by itself[ ] does not tell
us whether Congress means to refer the Secretary to action
already taken or to give directions on actions about to be

__________
7 As discussed in Part I above, outlier payments are a supple-
ment to PPS reimbursement for hospitals with patients that stay
for unusually long periods. See 42 C.F.R. ss 412.80 et seq.

taken." Id. at 916 (quoting Administrators of the Tulane
Educ. Fund v. Shalala, 987 F.2d 790, 796 (D.C. Cir. 1993)).
"In other words," the Court said, "the phrase 'recognized as
reasonable' might mean costs the Secretary (1) has recog-
nized as reasonable for [prior reimbursement] purposes, or
(2) will recognize as reasonable as a base for future ...
calculations." Id. By the same token, we conclude that the
phrase at issue here--"has an average inpatient length of
stay (as determined by the Secretary) of greater than 25
days"--is ambiguous and may refer to the hospital's status at
the beginning of, during, or at the close of a cost reporting
period. Cf. United States Dep't of the Treasury v. FLRA, 960
F.2d 1068, 1072 (D.C. Cir. 1992) (holding that statutory
phrase "adversely affected" is ambiguous and permits "alter-
native temporal readings").

III

Having concluded that the analysis of Chevron step one
does not resolve the case, we would ordinarily move to step
two and ask whether the Secretary's interpretation of the
meaning of the statute is reasonable. Plaintiffs argue that
the Secretary's interpretation is not reasonable, contending
that HHS has no justification for not permitting self-
certification, for not utilizing the alternative of retroactive
reimbursement, and for denying both options to long-term
care hospitals while making them available to another catego-
ry of PPS-excluded institutions: rehabilitation hospitals. See
42 C.F.R. s 412.23(b)(8), (b)(9).

HHS replies that it is perfectly reasonable to rely on actual
data regarding length of stay rather than on a hospital's self-
interested prediction. The Department explains that it per-
mits self-certification by rehabilitation hospitals because the
criteria for qualification of such hospitals are based on the
"characteristics of the patients and the types of services that
the facility furnishes," Final Rule, 57 Fed. Reg. at 39,801,8

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8 The statute excludes from PPS "a rehabilitation hospital (as
defined by the Secretary)." 42 U.S.C. s 1395ww(d)(1)(B)(ii). The
Secretary's implementing regulation defines such a hospital as one

criteria which--unlike length of stay--a hospital can "virtual-
ly guarantee[ ]" from the first day of operations, HHS Reply
Br. at 12. With respect to the alternative of retroactive
adjustment, HHS points out that no one suggested such an
option until after the district court litigation began in this
case.9 Moreover, HHS argues that retroactive adjustments
are as likely to hurt hospitals that slip below the average
during a period for which they have been prospectively
qualified, as it is to help them by providing reimbursement
for a prior period in which they became qualified along the
way. By setting reimbursement rates "that are not later
subject to retroactive correction," HHS contends, "the Secre-
tary promotes certainty and predictability of payment for not
only hospitals but the federal government." HHS Br. at 41
(quoting County of Los Angeles, 192 F.3d at 1019).

Although we ordinarily would now proceed to evaluate
these various arguments under the standards of Chevron's
second step, we cannot do so in this case. While the Secre-
tary has discretion to establish a reasonable mechanism for
determining whether a hospital has the requisite average
length of inpatient stay, that discretion must be exercised
through the eyes of one who realizes she possesses it. At
several points, the Department's briefs suggest that the
Secretary did realize that she had such discretion.10 At other
points, the briefs suggest quite the opposite.11 Most relevant,

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that, inter alia, serves an inpatient population of whom at least 75
percent require intensive rehabilitative services for the treatment of
specified conditions including stroke, spinal cord or brain injury,
major multiple trauma, and amputation. See 42 C.F.R.
s 412.23(b)(2).

9 Neither NALTH in its comments on the 1992 proposed rule,
nor the THC plaintiffs themselves in their 1992 request to HCFA,
proposed retroactive reimbursement. See HHS Reply Br. at 14 n.7.

10 See, e.g., HHS Br. at 25, 28.

11 See, e.g., HHS Br. at 12 (stating that in promulgating 1992
regulations, "HHS concluded that a self-certification procedure for
long-term care hospitals would violate its statutory mandate"); id.
at 15 (stating that in rejecting THC plaintiffs' request for self-

however, is that the notice issued at the time the final rule
was promulgated makes it quite clear the Secretary did not
believe that she had the discretion to do what the plaintiffs
request. See, e.g., Final Rule, 57 Fed. Reg. at 39,800-01
("We do not believe that the statute permits us to extend the
exclusion for long-term care hospitals to a hospital which has
not demonstrated actual compliance with the statutory re-
quirement.") (emphasis added); id. at 39,800 (declaring the
Secretary's doubt that "the law would support such a policy");
id. at 39,801 ("[T]he [statutory] criterion for exclusion ... can
be assessed only over a period of time. Thus, a hospital
cannot qualify as a long-term care hospital until it has been
in operation for some period of time.") (emphasis added).12

As the Supreme Court has instructed, an agency "order
may not stand if the agency has misconceived the law." SEC
v. Chenery Corp., 318 U.S. 80, 94 (1943); see Phillips Petrole-
um, 792 F.2d at 1169-70. Applying that principle, this court
has held that "an agency regulation must be declared invalid,
even though the agency might be able to adopt the regulation
in the exercise of its discretion, if it was not based on the
[agency's] own judgment but rather on the unjustified as-
sumption that it was Congress' judgment that such [a regula-
tion is] desirable" or required. Prill v. NLRB, 755 F.2d 941,
948 (D.C. Cir. 1985) (internal quotations omitted) (alterations
in original). Because the Secretary evaluated the various
reimbursement alternatives on the assumption that "a hospi-
tal cannot qualify as a long-term care hospital until it has
been in operation for some period of time," Final Rule, 57
Fed. Reg. at 39,801, and because that assumption is incorrect,

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certification, HCFA explained "that nothing in the statute or regu-
lations would allow it to grant the hospitals an immediate exclusion
from the PPS").

12 The Buto letter, although somewhat more equivocal, reflects
a similar understanding. See Buto Ltr. at 2 (J.A. at 63) (denying
plaintiffs' request because statute mandates exclusion only for "a
hospital which has [emphasis added] an average length of stay (as
determined by the Secretary) of greater than 25 days") (alteration
and emphasis in original).

the Secretary must make a fresh determination as to whether
she wishes to adopt the self-certification or retroactive adjust-
ment options.

IV

For the foregoing reasons, the judgment of the district
court is reversed. The case is remanded to that court with
instructions to remand it to HHS for further consideration
consistent with this opinion.