CROFTON CONVALESCENT v. DEPT. OF HEALTH

• Decision Date: 08 April 2010
• Parties: CROFTON CONVALESCENT CENTER, INC. v. DEPARTMENT OF HEALTH & MENTAL HYGIENE, NURSING HOME APPEAL BOARD.
• Court: Maryland Court of Appeals

991 A.2d 1257

413 Md. 201

CROFTON CONVALESCENT CENTER, INC. v. DEPARTMENT OF HEALTH & MENTAL HYGIENE, NURSING HOME APPEAL BOARD.

No. 32 September Term, 2008.

Court of Appeals of Maryland.

April 8, 2010.

COPYRIGHT MATERIAL OMITTED

Howard L. Sollins (Diane Festino Schmitt of Ober, Kaler, Grimes & Shriver, Baltimore, MD), on brief, for Petitioner.

Mark J. Davis, Asst. Atty. Gen. (Douglas F. Gansler, Atty. Gen. of Maryland, Baltimore, MD), on brief, for Respondent.

ARGUED BEFORE BELL, C.J., HARRELL, BATTAGLIA, GREENE, ADKINS, BARBERA, and JOHN C. ELDRIDGE (Retired, specially assigned), JJ.

BARBERA, Judge.

In this case we decide whether, under the Code of Maryland Regulations ("COMAR") 10.09.10.10,¹ a Medicaid provider that made payments pursuant to an interest rate swap agreement can claim reimbursement of those payments as mortgage interest.

The petitioner, Crofton Convalescent Center ("Crofton"), is a nursing facility certified to provide medical care through the Maryland Medical Assistance Program ("Medicaid"). In 1998, Crofton entered into a financing arrangement that, through the use of an interest rate swap agreement, exchanged the variable interest rate on Crofton's mortgage for a fixed rate. Crofton then submitted the interest payments made according to the swap agreement ("swap payments") as mortgage interest payments for reimbursement from the respondent Department of Health and Mental Hygiene ("DHMH"). DHMH, however, disallowed Crofton's claim that interest paid under its swap agreement was a reimbursable expense under COMAR.

Crofton appealed DHMH's decision to the Nursing Home Appeal Board ("the Board"), which hears appeals from providers participating in Maryland's Medicaid program, and which ultimately affirmed DHMH's decision. Crofton then petitioned for judicial review in the Circuit Court for Baltimore City, which reversed the Board's decision. On appeal, a divided panel of the Court of Special Appeals held, in an unreported opinion, that the swap payments were not reimbursable.

Crofton argues that, because the financing arrangement that included the swap agreement was incidental to refinancing Crofton's mortgage, the Court of Special Appeals erred when it determined that the swap payments were not mortgage interest payments. For the reasons that follow, we hold that the Board applied the proper definition of mortgage interest and that Crofton's swap payments do not qualify as mortgage interest under that definition. We therefore affirm the judgment of the Court of Special Appeals.

I.

Crofton provides nursing and other medical services, in part, through Maryland's Medical Assistance Program ("Medicaid"), which is a state program partially funded by the federal government. Liberty Nursing Center, Inc. v. Dep't of Health and Mental Hygiene, 330 Md. 433, 438, 624 A.2d 941, 943 (1993). "When a state elects to participate in the federal medicaid program, it prepares and submits for approval by the federal Health Care Financing Administration . . . a state medicaid plan for the provision of medical assistance that complies with the federal Medicaid Act." Jackson v. Millstone, 369 Md. 575, 580, 801 A.2d 1034, 1037 (2002). "If the federal agency approves the state plan, then the state qualifies for federal funding, whereby the federal government will reimburse the state up to 50% of the cost of the medicaid program." Id. at 580, 801 A.2d at 1037.

Maryland's Medicaid program is administered by DHMH. Id. at 581, 801 A.2d at 1037. Pursuant to federal and state law, the Maryland Medicaid program reimburses nursing homes for patient-related costs of medical care, including interest payments on loans necessary for patient care. See Title XIX of the Social Security Act, 42 U.S.C.A. §§ 1396 et seq. (2006); 42 C.F.R. §§ 430-456 (2008); Md.Code (2009 Repl.Vol.), §§ 15-103, 15-105 of the Health General Article; COMAR 10.09.10 et seq. The Maryland Medicaid statutes charge DHMH with the promulgation of rules and regulations to govern the reimbursement of providers. See §§ 15-103, 15-105 of the Health General Article. Crofton's status as a Medicaid provider in Maryland entitles it to State reimbursements, which are issued by DHMH.

When DHMH denies reimbursement to a provider participating in Maryland's Medicaid Program, the Board considers the provider's appeal. The present case arises out of the Board's denial of Crofton's request that DHMH reimburse the swap payments Crofton made subsequent to refinancing its mortgage.

This Case

In 1998, the term on Crofton's $4.2 million mortgage was expiring, bringing due a balloon payment on the loan. To avoid making the balloon payment, Crofton sought to refinance the mortgage through a fixed rate loan. Crofton considered several bids, including a bid from M & T Bank ("the Bank") for a loan with a 6.55% fixed interest rate.² Seeking an even lower rate, Crofton entered negotiations with the Bank, which then produced a financing package that consisted of a $4.2 million term loan with an interest rate of LIBOR³ plus one percent, a $500,000 term loan at an interest rate of LIBOR plus one percent, and a "swap agreement" trading the variable interest rate on the two term loans for a fixed interest rate of 5.5% based on a $4.7 million "notional amount," both of which quoted terms we next explain.

A basic, "plain vanilla," swap agreement "is a contract between two parties, . . . to exchange or `swap' cash flows at specified intervals, calculated by reference to a particular rate or index." See S. Lawrence Polk & Bryan M. Ward, A Guide to the "Regulatory No Man's Land" of Over-The-Counter Interest Rate Swaps, 124 Banking L.J. 397, 399 (2007). The "most commonly employed interest rate swaps are fixed/floating rate swaps in which the first counterparty pays the second at designated intervals, a specific amount of interest based on a fixed interest rate multiplied" by an agreed principal amount called the "notional" amount. Stuart Somer, A Survey of Legal & Regulatory Issues Relevant to Interest Rate Swaps, 4 DePaul Bus. L.J. 385, 387 (1992). Concurrently, the second counterparty pays the first counterparty based on a floating interest rate, such as LIBOR, applied to the notional amount. Id. The notional amount is used solely to calculate the interest payments and is not exchanged between the parties. Thrifty Oil Co. v. Bank of America Nat'l Trust and Sav. Ass'n, 310 F.3d 1188, 1191 (9th Cir.2002) (adopting 249 B.R. 537 (S.D.Cal.2000)), modified, Thrifty Oil Co. v. Bank of America Nat'l Trust and Sav. Ass'n, 322 F.3d 1039, 1043 (9th Cir.2003) (addressing counsel fee issue). The swap enables a party to hedge against interest rate fluctuations by exchanging "interest payment streams of one debt instrument for those of another, where both debt obligations are the same amount." Somer, supra at 387.

In Thrifty Oil Co., a panel of the Ninth Circuit Court of Appeals explained a hypothetical five-year interest rate swap between Counterparties A and B:

(1) Counterparty A agrees to pay a floating interest rate equal to LIBOR. . .; (2) Counter-party sic B agrees to pay a 10% fixed interest rate; (3) both counterparties base their payments on a $1 million notional amount and agree to make payments semiannually. If LIBOR is 9% upon commencement of the first payment period, Counterparty B must pay A: (10%-9%) * $1 million * (.5) = $5,000. These net payments vary as LIBOR fluctuates and continue every six months for the term of the swap. If interest rates rise, the position of Counterparty B, the fixed-rate payor, improves because the payments it receives increase. For example, if LIBOR rises to 11% at the beginning of the next payment period, Counterparty B receives a net payment of $5,000 from A. Conversely, the position of Counterparty A, the floating-rate payor, improves when interest rates fall. The party whose position retains positive value under the swap is considered `in the money' while a party with negative value is considered `out of the money.'

310 F.3d at 1191-92.

Interest rate swaps are typically documented in a confirmation and a master agreement. Id. at 1192. The master agreement is often a standard form agreement prepared by the International Swaps and Derivatives Association ("ISDA"). Id. In this case, Crofton and the Bank memorialized the swap in an ISDA master agreement accompanied by a separate confirmation and amortization schedule.⁴ Pursuant to the financing package, Crofton agreed to refinance its mortgage with a term loan with a variable interest rate of LIBOR plus one percent and then to swap the variable rate with the Bank for a fixed rate of 5.5%. During the relevant time period, however, the variable interest rates were below 5.5%, and thus Crofton was required under the swap agreement to pay the difference to the Bank. If the LIBOR plus one percent rate had been above 5.5%, Crofton would have paid the variable rate loan amounts, and the Bank would have reimbursed Crofton for the difference, effectively bringing Crofton's interest payments back down to the 5.5% interest rate.

Under Crofton's accounting system, Crofton treated the swap payments as mortgage interest payments, which are reimbursable costs under COMAR 10.09.10.10.C. Crofton reports costs for which DHMH should reimburse providers ("allowed costs"), to DHMH each fiscal year. DHMH reviews the reports and adjusts the costs by disallowing costs that are not reimbursable under the applicable laws and regulations. In 2002, DHMH hired Clifton Gunderson, LLP, to review Crofton's 2002 cost report and to recommend adjustments. Based on its review, Clifton Gunderson determined that Crofton's swap payments were not eligible for reimbursement. Accordingly, DHMH disallowed the costs.

The Litigation

Crofton appealed the decision to the Board, which referred the appeal to the Office of Administrative Hearings for a contested evidentiary hearing before an Administrative Law Judge ("ALJ").⁵ The ALJ...