Pacific Coast Medical Enterprises v. Harris
| Decision Date | 28 March 1980 |
| Docket Number | Nos. 77-2914,77-3281,s. 77-2914 |
| Citation | 633 F.2d 123 |
| Parties | PACIFIC COAST MEDICAL ENTERPRISES, a California Corporation, Plaintiff- Appellant and Cross-Appellee, v. Patricia HARRIS, * Secretary of the United States Department of Health, Education and Welfare; et al., Defendants-Appellees and Cross-Appellants. Department of Benefit Payments of the State of California, Amicus Curiae. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Sherwin L. Memel, Los Angeles, Cal., on brief, for plaintiff-appellant and cross-appellee; Memel, Jacobs, Pierno & Gersh, Los Angeles, Cal., argued.
Arthur R. Chenen, Los Angeles, Cal., for Pacific Coast Medical.
Henry Eigles, Baltimore, Md., for H. E. W.
Appeal from the United States District Court for the Central District of California.
Before GOODWIN and TANG, Circuit Judges, and EAST, ** District Judge.
Pacific Coast Medical Enterprises (PCME), a California corporation and provider of Medicare services, 1 petitioned the District Court to review a final decision of the Secretary of Health, Education and Welfare denying reimbursement for certain amounts claimed by PCME to be compensable under Medicare. PCME had acquired the assets of a corporate Medicare provider by first purchasing 100 percent of the capital stock of that provider and shortly thereafter liquidating that corporation. The Secretary ruled, for purposes of recognizing a stepped-up basis in computing reimbursements, that this two-step transaction was not a purchase of assets under the Medicare regulations. The District Court reversed the Secretary's decision. The Court's order enjoined the Secretary from withholding Medicare reimbursements from PCME for not only the year under review, but all subsequent cost-reporting years as well, and directed the method for computation of goodwill. Pacific Coast Medical Enterprises v. Califano, 440 F.Supp. 296 (C.D.Cal.1977).
The Secretary appeals. 2 We note jurisdiction under 28 U.S.C. § 1291. We believe the Secretary erred in treating the transaction as two unrelated events, and that the regulations, when applied to a single acquisition, are not susceptible to the Secretary's interpretation. We affirm, with minor modification, the judgment of the District Court.
This case arises under Title XVIII of the Social Security Act, known as the Medicare program. 42 U.S.C. §§ 1395-1395rr. This legislation provides for federal reimbursement of medical care for the aged and certain disabled persons. 42 U.S.C. § 1395c. It accomplishes this, in part, 3 through contractual arrangements with medical facilities to be "providers" of such medical care. 42 U.S.C. § 1395cc. These providers afford certain covered medical services to the program's beneficiaries, for which they receive reimbursement from the Government. 4
A provider is reimbursed for the "reasonable cost" of the services provided, or, if lower, the customary charges for such services. 5 In its 1972 amendments to the Medicare statutes, Congress defined "reasonable cost" as "the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services." 42 U.S.C. § 1395x(v)(1)(A). Such actual costs include appropriate allowances for depreciation on buildings and equipment, 42 C.F.R. § 405.415(a) (1978), and a reasonable return on equity capital, 42 U.S.C. § 1395x(v)(1)(B); 42 C.F.R. § 405.429 (1978). Assets and equity capital are valued at their historical cost. 42 C.F.R. § 405.415(a), (b) (1978).
The actual reimbursement for these costs is usually effected through a "fiscal intermediary." These private non-government entities are frequently health and accident insurance companies such as "Blue Cross" organizations. 6 The intermediaries serve as HEW's agents in the day to day administration of the Medicare program, 42 U.S.C. § 1395h, making interim monthly payments to providers. At the end of a provider's fiscal year, the intermediary reviews the provider's reimbursement claims and makes a final decision on that year's reimbursable costs. 42 C.F.R. § 405.1803 (1978). If the provider is dissatisfied with the finding, it may request a hearing before the Provider Reimbursement Review Board (PRRB). 7 The decision of the Board, entered after a hearing, is final unless the Secretary, "on his own motion," reverses or modifies it. 42 U.S.C. § 1395oo (f). The provider has a right to judicial review from the Board's decision or from the Secretary's subsequent action. Id.
The facts of this case are not in dispute. 8 In 1969, Community Hospital of Los Angeles, a California corporation, was a duly authorized Medicare provider. At that time, PCME was also a provider, but was totally independent of Community Hospital. On May 21, 1969, the stockholders of Community Hospital and PCME entered an agreement under which PCME would acquire 100 percent of the stock of Community Hospital in exchange for approximately $7,000,000 worth of PCME stock. Immediately upon the closing of this exchange of stock, on May 30, 1969, PCME made numerous changes in the operation of Community Hospital, including changes of administrator, accountant, attorneys, bank accounts, and directors. Nine months later, on February 25, 1970, PCME liquidated Community Hospital as a corporation, and Community Hospital's assets were distributed to PCME.
It was at all times the intent of PCME to acquire the assets of Community Hospital, and the stock acquisition was a preliminary step to the dissolution of the corporation. This two-step method of acquisition was chosen to accommodate the tax planning desires of the former shareholders of Community Hospital, and to avoid an acceleration provision in a mortgage on Community Hospital property. Further, it is stipulated that the exchange of stock was undertaken between unrelated parties in an arm's length bona fide transaction. There is no dispute over the value of the consideration paid by PCME to the former shareholders of Community Hospital corporation.
In submitting its cost reports for cost reporting years ended June 30, 1970 9 and thereafter, PCME treated the transaction as an acquisition of assets. Such treatment allows PCME to increase (step-up), for Medicare accounting purposes, the value (basis) of the Community Hospital assets to the cost of those assets (including goodwill) to PCME. The basis is stepped up from Community Hospital's basis the cost of the assets to it. Reimbursement claims for depreciation and return on invested capital are calculated using this basis value. As a result of this increased cost basis, PCME may submit higher reimbursement claims for depreciation and return on invested capital than it would if forced to use as a cost basis the original cost of the assets to Community Hospital. The Secretary refused to recognize this form of acquisition as an arm's length purchase of assets for purposes of Medicare reimbursements, and disallowed PCME's claims for each of its cost reporting years. The IRS, the SEC, and California's Commissioner of Corporations, however, did each approve the transaction as such a purchase of assets.
On April 28, 1975, PCME appealed the decision concerning its 1973 cost year to the PRRB. 10 On August 19, 1975, the PRRB rendered a decision favorable to PCME's claim. The Secretary, however, chose to review this decision of the PRRB. On October 17, 1975, the Commissioner of Social Security, duly acting for the Secretary, 11 reversed the PRRB and denied PCME's claim.
PCME filed for judicial review in the District Court pursuant to 42 U.S.C. § 1395oo (f), under which the Court accepted jurisdiction. 12 The District Court, reversing the Secretary, held that his 13 refusal to allow a step-up in basis or recognition of goodwill following the two-step transaction was unreasonable, arbitrary, and capricious. 14 The District Court remanded the matter to the fiscal intermediary for computation of amounts due PCME, in accordance with the findings of fact and conclusions of law, effectively requiring that the computation be made using the stepped-up basis. One such finding was that goodwill be recognized as the entire difference between the consideration paid for Community Hospital and the value of the Hospital's tangible assets. The District Court also ordered that PCME was entitled to use the stepped-up basis in post-1973 reporting years.
On August 22, 1977, the District Court entered a supplemental order granting PCME's motion for injunction pending appeal. 440 F.Supp. at 310. It enjoined the defendants from withholding further Medicare reimbursements under the terms of its order, for cost reporting years ended June 30, 1973 and thereafter. This order was conditioned upon PCME posting a bond for security equal to 100 percent of the amount to be paid. The Government appeals from the judgment and orders of the District Court.
The Secretary denied PCME's reimbursement claims based upon his interpretation and application of certain HEW Medicare regulations. We will preface our analysis with an overview of these regulations.
Among the many regulations the Secretary has promulgated to administer the Medicare program are provisions addressing reimbursement, valuation of assets, and change of ownership of a provider. The Secretary here has applied these regulations so as to deny PCME a stepped-up basis after its two-step acquisition of Community Hospital.
In outlining what is reimbursable, the regulations include costs attributable to long-term assets and capital. See 42 C.F.R. § 405.401-.402 (1978). They provide allowances for depreciation, id. at § 405.415(a), and reasonable return on invested equity capital, id. at § 405.429, (including goodwill 15). The amount of such reimbursement depends on the value of the assets, which for these purposes is to be fixed at...
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