Richey Manor, Inc. v. Schweiker

• Decision Date: 30 July 1982
• Docket Number: No. 81-1045,81-1045
• Citation: 684 F.2d 130
• Parties: RICHEY MANOR, INC., d/b/a Richey Manor Nursing Home, Appellant, v. Richard SCHWEIKER, Secretary of Health and Human Services, Appellee.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 130

684 F.2d 130

221 U.S.App.D.C. 356

RICHEY MANOR, INC., d/b/a Richey Manor Nursing Home, Appellant, v. Richard SCHWEIKER, Secretary of Health and Human Services, Appellee.

No. 81-1045.

United States Court of Appeals, District of Columbia Circuit.

Argued April 27, 1982.

Decided July 30, 1982.

Appeal from the United States District Court for the District of Columbia (D.C. Civil Action No. 78-0865).

Leonard C. Homer, Washington, D. C., with whom Pamela J. White, Baltimore, Md., was on the brief, for appellant.

David B. Palmer, Dept. of Health and Human Services, of the bar of the District of Columbia Court of Appeals, pro hac vice by special leave of the Court, with whom Charles F. C. Ruff, U. S. Atty., Washington, D. C., at the time the brief was filed, was on the brief, for appellee. Nathan Dodell, Royce C. Lamberth and Kenneth M. Raisler, Asst. U. S. Attys., Washington, D. C., also entered appearances for appellee.

Before EDWARDS and BORK, Circuit Judges, and BONSAL, ^* Senior District Judge for the Southern District of New York.

Opinion for the Court filed by Circuit Judge BORK.

BORK, Circuit Judge:

Petitioner, Richey Manor, Inc., appeals from a judgment of the district court disallowing Medicare reimbursement for certain costs incurred in the purchase and operation of a health care facility (referred to as a "provider" of health services). Petitioner, which is the provider, apparently agrees that reimbursement of the types sought are not called for when 100% of the stock of a provider is purchased and no further transaction occurs. Petitioner contends, however, that when such a stock purchase is followed by a transfer of the facility's assets to a newly created not-for-profit corporation owned by the purchaser, the Medicare regulations entitle the provider to reimbursement for (1) depreciation costs calculated on a basis equal to the purchase price of the stock and (2) interest expense incurred by the purchaser in financing the purchase. We hold to the contrary. Both the language of the regulations and underlying Medicare policies make clear that a provider is not entitled to such reimbursement, and we therefore affirm the judgment of the district court.

I. BACKGROUND

A. Facts

Petitioner, Richey Manor, Inc., a not-for-profit corporation, operates a skilled nursing care facility. All of Richey Manor, Inc.'s stock is owned by Volunteers of America Care Facilities, Inc. ("VOA Care"), a not-for-profit corporation established by a religious organization to provide health care to the sick and infirm. The way in which the relationship between petitioner and VOA Care came into being is largely determinative of the outcome of this case.

In early 1974, VOA Care began negotiations with the shareholders of the predecessor, for-profit Richey Manor, Inc., to purchase the assets of that corporation. These assets consisted of the nursing care facility now owned by petitioner. The price asked and agreed to was $10,000 per bed for the 119 bed facility. But early in the discussions the Richey Manor shareholders stated that for tax reasons they would sell only stock and not assets. Petitioner's brief states that "(t)o induce VOA Care to purchase stock rather than assets, the selling shareholders agreed to assist VOA Care in the financing of the transaction." Appellant's Brief at 6. That inducement was, of course, effectively a reduction of the real cost to VOA Care.

On April 1, 1974, VOA Care purchased 100% of the stock of Richey Manor, Inc., paying $10,000 per bed. Approximately nine months later, VOA Care converted Richey Manor, Inc. to a not-for-profit corporation. The new Richey Manor, petitioner here, continued to do business with the Medicare program under the original provider agreement.

In September 1974, VOA Care revalued the assets of Richey Manor, Inc. to reflect the purchase price of the stock. Consequently, in its cost report for the fiscal year ending March 31, 1975, Richey Manor claimed depreciation costs based on the purchase price of the stock rather than the depreciated historical cost of the assets at the time of the sale. In addition, Richey Manor sought reimbursement for interest expenses incurred by VOA Care in financing the transaction.

B. The Medicare Statutory and Regulatory Scheme

This case arises under the Medicare Act, Title XVIII of the Social Security Act, 42 U.S.C. §§ 1395 et seq. (1976), which created a comprehensive program of health insurance for the aged and disabled. This program is administered, in part, through contractual arrangements with providers of health services. 42 U.S.C. § 1395cc. Under these arrangements, the federal government reimburses providers for the "reasonable cost" of the services provided. The provider usually arranges reimbursements by appointing a qualified public or private agency as a "fiscal intermediary." The intermediary acts as the Secretary's agent for reviewing claims and making payments. A provider dissatisfied with the fiscal intermediary's disposition of a claim for costs may seek a hearing before the Provider Reimbursement Review Board (PRRB). 42 U.S.C. § 1395oo. The Board's decision is the final step of agency review unless the Secretary, sua sponte and within 60 days after the provider is notified of the PRRB's decision, reverses or modifies the decision of the PRRB. In practice, this determination is made by the Administrator of the Health Care Financing Administration, to whom the Secretary has delegated his authority.

As noted, the touchstone for determining reimbursement is the concept of "reasonable cost." In the 1972 amendments to the Medicare Act, 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). The Department of Health and Human Services ("HHS") has promulgated numerous regulations to give further meaning to the term "reasonable cost."

The governing regulations are found in 42 C.F.R. §§ 405.401 et seq. (1981). ¹ Under § 405.415(a)(2), the Medicare program reimburses providers for depreciation of assets based on the historical cost of the assets. "Historical cost" is in turn defined in § 405.415(b)(1) as "the cost incurred by the present owner in acquiring the asset." This cost is the original "basis" upon which depreciation is computed. The basis declines as depreciation is taken. Section 405.415(g) provides that

the price paid by the purchaser shall be the cost basis where the purchaser can demonstrate that the sale was a bona fide sale and the price did not exceed the fair market value of the facility at the time of the sale. The cost basis for depreciable assets shall not exceed the fair market value of those assets at the time of sale....

20 C.F.R. § 405.415(g) (1977) (emphasis added). ² Thus, the Medicare regulations make clear that a purchase of "depreciable assets" for a price greater than its existing basis entitles the purchaser to a stepped-up basis and therefore to a greater depreciation reimbursement. ³ It is undisputed that a simple purchase of stock does not entitle the purchaser to a stepped-up basis. ⁴ Many transactions, however, are hybrid in nature and are not easily characterized as either a purchase of assets or a purchase of stock.

The most common hybrid is a 100% stock purchase plus a second step, such as a subsequent merger or liquidation of the acquired corporation. Such transactions are problematic because while the form of the transaction is a stock purchase, in substance the transaction may resemble a purchase of assets. For that reason, such transactions have sometimes been accorded a stepped-up basis for depreciation purposes.

In this case, characterization of the transaction (VOA Care's purchase of all the stock of the for-profit Richey Manor and the latter's conversion into a not-for-profit corporation) will determine the outcome. If this transaction constitutes a stock purchase, Richey Manor will receive the seller's basis in the facility; if, on the other hand, the transaction is deemed an asset acquisition, Richey Manor will receive reimbursement based on the much higher purchase price of the stock.

Reimbursement of interest expense is generally governed by 42 C.F.R. § 405.419(a) (1981) which permits only such interest as is "necessary and proper." This is in turn defined in § 405.419(b)(2)(i) and (ii) which require that the interest "(b)e incurred on a loan made to satisfy a financial need of the provider" and "for a purpose reasonably related to patient care." In addition, loans which result in investments are not considered "necessary." Id. The loans here were made to VOA Care to finance the purchase of the for-profit Richey Manor, Inc.'s stock. The question is whether that transaction meets the criteria of the regulations.

C. The Decisions Below

This litigation began with a decision by the fiscal intermediary not to allow Richey Manor reimbursement for 1975 cost report claims of depreciation based on revalued assets and of the interest costs incurred by VOA Care. Richey Manor appealed to the PRRB which reversed the fiscal intermediary and allowed the claims. The Administrator for the Health Care Financing Administration, acting for the Secretary, reviewed the decision of the PRRB and again reversed. Petitioner appealed the Administrator's decision to the district court, which affirmed. This appeal followed.

II. Decision

A. Depreciation

We note at the outset that review of the Secretary's decision is conducted under 42 U.S.C. § 1395oo (f)(1) which in turn incorporates the Administrative Procedure Act's standard of review. Under this standard, the decision of the Secretary may be set aside only if it is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law." 5 U.S.C. § 706(2)(A) (1976). It is well established that Congress granted the Secretary broad discretion to...