Chelsea Community Hospital v. Michigan Blue Cross Ass'n

• Decision Date: 03 June 1977
• Docket Number: Civ. A. No. 75-71379.
• Citation: 436 F. Supp. 1050
• Parties: CHELSEA COMMUNITY HOSPITAL, SNF, and Chelsea Community Hospital, a Michigan nonprofit Corporation, Plaintiffs, v. MICHIGAN BLUE CROSS ASSOCIATION, Blue Cross Association and F. David Matthew, Secretary of Health, Education and Welfare, Defendants.
• Court: U.S. District Court — Western District of Michigan

436 F. Supp. 1050

CHELSEA COMMUNITY HOSPITAL, SNF, and Chelsea Community Hospital, a Michigan nonprofit Corporation, Plaintiffs, v. MICHIGAN BLUE CROSS ASSOCIATION, Blue Cross Association and F. David Matthew, Secretary of Health, Education and Welfare, Defendants.

Civ. A. No. 75-71379.

United States District Court, E. D. Michigan, S. D.

June 3, 1977.

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Gilbert M. Frimet, Alan G. Gilchrist, Frimet, Goren, & Bellamy, Southfield, Mich., William J. Rademacher, Chelsea, Mich., for plaintiffs.

William Z. Elliott, Civil Division, Dept. of Justice, Washington, D.C., Thomas M. Woods, Asst. U. S. Atty., Detroit, Mich., for defendants.

OPINION AND ORDER GRANTING DEFENDANTS' MOTION FOR SUMMARY JUDGMENT AND DENYING PLAINTIFFS' MOTION FOR SUMMARY JUDGMENT

CORNELIA G. KENNEDY, District Judge.

In this action plaintiffs, providers of services furnished to patients covered by the Health Insurance for the Aged Act (Medicare), 42 U.S.C. § 1395, et seq., seek judicial review of defendants' decision disallowing as reimbursable costs the rental payments during the period 1970 through 1972, made by the providers to their lessor, and substituting the lessor's costs of ownership. The plaintiffs, Chelsea Community Hospital, SNF (a skilled nursing facility) and Chelsea Community Hospital are closely related non-profit organizations operating a nursing home and hospital, respectively, in Chelsea, Michigan. The nursing home and hospital were constructed by a Michigan co-partnership, Chelsea Medical Center, on land purchased by it for this purpose. On June 22, 1970, the partnership signed a lease agreement with plaintiff Chelsea Community Hospital, SNF, which in turn entered into a sublease agreement with plaintiff Chelsea Community Hospital on September 29, 1970. The sublease incorporated the basic terms of the lease. Thereafter, the lease was amended retroactively to January 1, 1970, to substitute a fixed rental payment per bed for the previous sliding scale based on actual occupancy; this change was made on the advice of the Internal Revenue Service in order to permit the plaintiffs to qualify for tax-exempt status under § 501(c)(3) of the Internal Revenue Code, 26 U.S.C. § 501(c)(3).

Under the Medicare Act periodic payments to providers of services to insured patients may be made either directly by the Secretary of Health, Education and Welfare or through a "fiscal intermediary" — a public or private organization which has contracted with the Secretary to determine the proper amount of payments and to make such payments. Each provider of services may elect to be reimbursed either by such an intermediary or by the Secretary himself. 42 U.S.C. §§ 1395g and 1395h. In the instant case, plaintiffs nominated defendant Blue Cross Association (BCA) to serve as such a fiscal intermediary; BCA had previously entered into an agreement with the Secretary to perform such a function. BCA and defendant Michigan Blue Cross Association (MBCA) were parties to an agreement under which MBCA undertook to perform audits of various providers and determine the amount of payments to be made, with actual payment being made by BCA with funds advanced by the Secretary. MBCA began such an audit of plaintiffs in the spring of 1972 (the actual audits were conducted by employees of Blue Cross of Illinois, apparently on "loan" to MBCA).

42 U.S.C. § 1395x(v)(1)(A) provides in part as follows:

The reasonable cost of any services shall be the cost actually incurred, excluding therefrom any part of incurred cost found to be unnecessary in the efficient delivery of needed health services, and shall be determined in accordance with regulations establishing the method or methods to be used, and the items to be included, in determining such costs . ..

The amount paid to a provider is the lesser of "reasonable cost" so defined and the customary charges for such services. 42 U.S.C. § 1395f(b)(1). Pursuant to statutory authority, the Secretary has established an extensive code of regulations, including the following:

(a) Principal. Costs applicable to services, facilities, and supplies furnished to the provider by organizations related to the provider by common ownership or control are includable in the allowable cost of the provider at the cost to the related organization. However, such cost must not exceed the price of comparable services, facilities, or supplies that could be purchased elsewhere.

(b) Definitions — (1) Related to provider. Related to the provider means that the provider to a significant extent is associated or affiliated with or has control of or is controlled by the organization furnishing the services, facilities, or supplies.

(2) Common ownership. Common ownership exists when an individual or individuals possess significant ownership or equity in the provider and the institution or organization serving the provider.

(3) Control. Control exists where an individual or an organization has the power, directly or indirectly, significantly to influence or direct the actions or policies of an organization or institution.

(c) Application. (1) Individuals and organizations associate with others for various reasons and by various means. Some deem it appropriate to do so to assure a steady flow of supplies or services, to reduce competition, to gain a tax advantage, to extend influence, and for other reasons. These goals may be accomplished by means of ownership or control, by financial assistance, by management assistance, and other ways.

(2) Where the provider obtains items of services, facilities, or supplies from an organization, even though it is a separate legal entity, and the organization is owned or controlled by the owner(s) of the provider, in effect the items are obtained from itself. An example would be a corporation building a hospital or a nursing home and then leasing it to another corporation controlled by the owner. Therefore, reimbursable cost should include the costs for these items at the cost to the supplying organization. However, if the price in the open market for comparable services, facilities, or supplies is lower than the cost to the supplier, the allowable cost to the provider shall not exceed the market price.

20 C.F.R. § 405.427(a)(b)(c).

During the course of the aforementioned audit, the auditors determined that one Dr. Michael Papo, the principal partner of Chelsea Medical Center (the lessor), was also the medical director and administrator of both providers (lessee and sublessee). Dr. Papo owned a 2/3 interest in the partnership in 1970 (minor interests totalling 7% were later transferred by him to a relative and to his wife as trustee for his children). Administrative Record, Tab A, exhibit F. The auditors also found that Dr. Papo had signed promissory notes on behalf of plaintiff Chelsea Community Hospital, SNF (also known as Chelsea Medical Center, Inc.); had underwritten and guaranteed loans to both providers, pledging his own household goods as collateral; had paid property taxes for the providers (and was later reimbursed by the plaintiff nursing facility); had guaranteed a lease agreement between one of the providers and a third party; and, had, check-writing authority for both providers.

On the basis of these and other factors, MBCA determined that Dr. Papo was "in a position to have influence and enjoy effective control of the affairs of these providers regardless of his title." Administrative Record, Tab A, exhibit C. It, therefore, concluded that the lessor-partnership and the lessee-providers were related by common control, and that rental payments under the building lease were includable as allowable costs of the providers only to the extent of the lessor's costs of ownership. Accordingly, plaintiffs' rental costs were redetermined on this basis and allowed in an amount $202,152 less than that provided in the lease agreement. BCA payments to plaintiffs were adjusted to reflect this change.

In November of 1972, Dr. Papo resigned his position as Medical Director of both providers. Beginning with the calendar year 1973, therefore, defendants have found that the providers and the lessor-partnership were not related organizations, and have allowed the full amount of rental payments made by the providers as reimbursable costs.

On April 6, 1973, plaintiffs requested a provider appeal hearing of MBCA's determination as to rental payments during 1970-1972, in accordance with a procedure adopted by BCA to comply with 20 C.F.R. § 405.1809. The hearing was held on February 19, 1975, before a hearing officer of BCA. The hearing officer issued a written decision, finding that the facts determined by MBCA's auditors were basically correct; that these facts established a "presumption" of common control; that the providers had failed to rebut this "presumption"; and that the reduction in costs allowed was, therefore, proper. No statute or regulation provides for review by the Secretary of a fiscal intermediary's determination of reasonable cost for accounting periods prior to 1973.

Plaintiffs filed the instant case on July 23, 1975. Their complaint based the Court's jurisdiction on 28 U.S.C. § 1331 and the Administrative Procedure Act, 5 U.S.C. § 702, and set forth five separate "counts," including Count Three — Failure to Render a Decision Supported by Substantive Evidence. Plaintiffs filed an amended complaint, adding 42 U.S.C. § 405(g) and (h) as bases of jurisdiction, and adding a claim that the hearing officer's decision was "arbitrary," "capricious" and an "abuse of discretion" within the meaning of 5 U.S.C. § 706. The record of the administrative hearing has been filed, including a transcript, an extensive brief, and several exhibits. Plaintiffs have filed a motion for summary judgment, and defendants have filed a motion to dismiss or, in the alternative, motion for summary judgment. Both motions were argued by counsel at a hearing held on February 28, 1977,...