Hospital Affiliates Intern., Inc. v. Schweiker

• Decision Date: 30 July 1982
• Docket Number: No. CIV-1-81-107.,CIV-1-81-107.
• Court: U.S. District Court — Eastern District of Tennessee
• Parties: HOSPITAL AFFILIATES INTERNATIONAL, INC. v. Richard SCHWEIKER, in his official capacity as Secretary of Health & Human Services.

543 F. Supp. 1380

HOSPITAL AFFILIATES INTERNATIONAL, INC. v. Richard SCHWEIKER, in his official capacity as Secretary of Health & Human Services.

No. CIV-1-81-107.

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

July 30, 1982.

COPYRIGHT MATERIAL OMITTED

Thomas, Mann & Gossett, Chattanooga, Tenn., for plaintiff.

W. Thomas Dillard, U. S. Atty., Chattanooga, Tenn., for defendant.

MEMORANDUM

FRANK W. WILSON, Chief Judge.

This is an action under the Medicare Act, 42 U.S.C. §§ 1395 et seq. (1976) as amended. The plaintiff alleges that it suffered a capital loss when it sold a capital asset to Downtown Hospital Association (DHA) in 1975 (¶ 11, Court File # 1). It is alleged that this loss was the result of the failure of Hospital Affiliates International (HAI) adequately to depreciate the building and equipment sold to DHA. HAI now seeks reimbursement for part of this loss under 42 CFR § 405.415. The case is presently before the Court upon plaintiff's motion for summary judgment, and the defendant's motion for affirmance of the decision of the Secretary.

A — The Medicare Program

The Health Insurance for the Aged Act, commonly known as "Medicare", created a system whereby certain aged and disabled persons could receive necessary medical care at little or no cost to themselves. The participating hospital, or provider, is reimbursed by the Government for the reasonable or customary cost of providing these services. This includes the cost to the provider of depreciation of capital assets. The reimbursement, and the determination of the amount to be reimbursed, is commonly done by a fiscal intermediary, 42 U.S.C. § 1395h, here Blue Cross/Blue Shield of Tennessee.

In order to insure that providers are not deprived of needed operating capital, the Act provides for intermittent estimated payments to the provider. 42 U.S.C. §§ 1395g, 1395x(v)(1)(A)(ii); 42 CFR §§ 405(b)(1), (2), 405.454. These are usually made monthly. At the end of its fiscal year, the provider submits a final cost report to the intermediary, 42 CFR § 405.406(b), which then either reimburses the provider for amounts not previously paid, or recovers amounts overpaid to the provider, 42 CFR § 405.1803.

B — Facts

1. Background

Newell Hospital was originally built soon after the turn of the century in downtown Chattanooga, Tennessee, by Dr. Edwin Newell, Sr., and a Dr. Dunbar. Dr. Newell, Jr., the son of the founder, sold the hospital to Healthcare, Inc., in the 1960's. The facility was then acquired by the plaintiff, HAI, when it merged with Healthcare in 1971.

In 1974 HAI determined that due to the physical deterioration of the hospital building, it was faced with either closing the hospital altogether, or building a new facility. HAI's first choice was to attempt to build a new structure. HAI applied for and received a Certificate of Need for the construction from the Tennessee Health Facilities Commission. HAI also retained an architectural firm to plan the new building. The initial cost estimate was $3,500,000.00.

Soon thereafter HAI management determined that the company lacked capital resources sufficient to finance the construction. HAI then conceived the notion of transferring the hospital to a local nonprofit corporation while continuing to manage the hospital through a contract with the non-profit corporation.

Local business and professional leaders were approached by Dr. Newell, then on the board of HAI, with the idea of forming the non-profit corporation to own the hospital. This resulted in the incorporation of Downtown Hospital Association (DHA) on January 23, 1975. The original incorporators were Jac Chambliss, a local attorney, Dr. Robert Mabe, a staff physician at Newell, William Brown, Vice President and General Counsel to the American National Bank, and Richard Moore, General Manager of Loveman's, Inc. Prior to this incorporation, the incorporators met with Dr. Newell and Mr. Joseph DeCosimo, Chairman of the Health & Educational Facilities Board of Chattanooga (HEFB). The purpose of these meetings was to attempt to work out a way that the HEFB could acquire the old Newell Hospital from HAI, issue bonds to finance the construction of a new hospital on the site, and lease the hospital to DHA on a longterm basis.

These discussions resulted in an "inducement contract" among HEFB, HAI, and HEFB's financial adviser, J. C. Bradford & Co., executed on March 14, 1975. The terms of this contract provided that HAI would, inter alia: (1) construct and equip a new hospital; (2) lease the underlying real property to the HEFB; and (3) "cause the lessee to enter into a lease with the Board." (R. 0963) The lessee referred to here is DHA, even though it was not a party to the contract. The HEFB agreed: (1) to lease the land from HAI; (2) to issue some $4,200,000.00 in bonds to finance construction of a new hospital; and (3) to lease the land and building to the lessee (again, DHA). HAI also agreed to manage the hospital pursuant to an envisioned contract between HAI and the lessee. When DHA became actively involved in the preliminary negotiations, a new inducement contract was drawn, naming DHA as a party, containing substantially the same terms as the first inducement contract. This second contract was never executed, and there is evidence in the record that the parties abandoned the first inducement contract as superfluous when negotiations began to proceed apace.

The first meeting of the board of directors of DHA took place on April 3, 1975. Representatives of HEFB presented a draft management contract to the board. The management company was to be Hospital Management Corporation, a wholly owned subsidiary of HAI. The board did not accept the contract at this meeting, but did accept it, after what was called "lively" discussion at its next meeting on April 11, 1975. The board did not solicit bids from other management companies. Instead, it examined the brochures of at least one, and perhaps two others. Before agreeing with Hospital Management, the board obtained concessions concerning renegotiability of the management fee, a loan of approximately $200,000.00 as up-front operating capital from HAI, and a reduction in amount and a change in terms of HAI's fee for supervising construction of the new hospital. The duration of the contract was to be 30 years, a term insisted upon by the bond underwriters, with termination of the contract by either party only for cause.

The negotiations culminated with the closing on August 14, 1975. Various instruments were executed by the parties, which resulted in the following: (1) HEFB issued $3,450,000 in revenue bonds to finance construction of the new hospital facility; (2) DHA and Hospital Management entered into the management contract; (3) HAI leased the land, building, and equipment to HEFB, and also gave the deed of trust to HEFB to secure payment of the bonds; and (4) HEFB leased the land, the proposed new building and equipment to DHA. The result of all this was that HAI owned the underlying fee in the land and was to manage the hospital; HEFB leased the land from HAI and owned the new hospital; DHA leased both the land and the building from HEFB. HAI agreed to subordinate its management fee and the lease payment to the obligation on the bonds, another concession insisted upon by the underwriters.

There is substantial evidence of arms-length bargaining among the parties to these transactions. The best evidence of this are the various concessions made by HAI. The lease payments on the land and equipment were lowered from 15% of appraised value to 11% on the building, or 12% of book value; the fee for supervising the construction was lowered from $200,000.00 to $180,000.00 with no upfront cash; the management fee was made subject to renegotiation at a future date, contingent upon the hospital's increase in size; and, HAI agreed to subordinate its fees and lease payments to the liability on the bonds.

The hospital has operated since its opening on August 23, 1976, under the control of its board of directors. The hospital's administrator and comptroller are employees of HAI, under the terms of the management contract. An internal operating committee was formed as an intermediary between the hospital's staff and the board. The administrator is a member of this committee, but does not have a right to vote. None of the directors of DHA has now, nor apparently has ever had, any financial interest in HAI; none was an employee of HAI, or sat on HAI's board of directors.

2. The Loss to HAI

As was mentioned above, HAI acquired Newell Hospital when it merged with Healthcare, Inc., in 1971. Healthcare's basis in the hospital, and therefore HAI's basis, is the historical cost of the asset less accumulated depreciation. The historical cost to HAI of the building was $388,082.00, and of the equipment, $384,585.75, thus making a total historical cost of $772,667.75. HAI depreciated the hospital and equipment by $340,158.00, leaving an adjusted basis of $432,509.75. HAI has recovered the reimbursable portion of this depreciation in earlier years. HAI sold the hospital for $150,006.75, making for a loss of $282,503.00. HAI claims that this loss is attributable to its failure to depreciate the assets at as rapid a rate as they actually declined in value, with the unreimbursed depreciation reimbursable under 42 CFR § 405.415. The reimbursable portion of this loss comes to $116,529.00, which is the amount in controversy here. These figures are not a matter in dispute at this point, the question being whether HAI is entitled to reimbursement at all.

C — Jurisdiction

HAI's claim for reimbursement was rejected by its fiscal intermediary, Blue Cross/Blue Shield of Tennessee. HAI appealed this denial to the Provider Reimbursement Review Board (PRRB), 42 U.S.C. § 1395oo(a). The PRRB took jurisdiction of the case and affirmed the denial of reimbursement on January 23, 1981. The Secretary declined to review on...