Kidney Center of Hollywood v. Shalala

Decision Date20 January 1998
Docket NumberNo. 96-5074,96-5074
Parties, Medicare & Medicaid Guide P 45,997 The KIDNEY CENTER OF HOLLYWOOD, et al., Appellants, v. Donna E. SHALALA, Secretary, United States Department of Health and Human Services, Appellee.
CourtU.S. Court of Appeals — District of Columbia Circuit

Eugene A. Massey, Washington, DC, argued the cause for appellant, with whom Richard J. Webber was on the briefs.

Janice L. Hoffman, Attorney, U.S. Department of Health & Human Services, Baltimore, MD, argued the cause for appellee with whom Frank W. Hunger, Assistant Attorney General, U.S. Department of Justice, Eric H. Holder, Jr., U.S. Attorney at the time the brief was filed, Harriet S. Rabb, General Counsel, U.S. Department of Health & Human Services, Robert P. Jaye, Acting Associate General Counsel, Henry R. Goldberg, Deputy Associate General Counsel, Washington, DC, and Thomas W. Coons, Attorney, Baltimore, MD, were on the brief.

Before: WALD, WILLIAMS, and GINSBURG, Circuit Judges.

Opinion for the Court filed by Circuit Judge GINSBURG.

GINSBURG, Circuit Judge:

The ten appellants in this case provide outpatient kidney dialysis services to patients who are suffering from end-stage renal disease, or ESRD. They dispute the amount of money to which they are entitled from the Secretary of Health and Human Services as reimbursement for medical services rendered under the Medicare program. Specifically, the appellants challenge (1) the Secretary's decision that the merger of their parent company with another corporation was a related-party transaction, such that certain costs associated with the merger were not reimbursable under Medicare; and (2) the regulation capping reimbursement for "bad debts" at a provider's actual cost of providing dialysis service, which they claim is inconsistent with the statutory requirement that Medicare reimburse each dialysis provider in a prospectively set amount.

The district court upheld the Secretary's decision with respect both to the merger transaction and to the bad debt regulation. We agree with the district court that the merger was a related-party transaction. We reverse the district court, however, with respect to the validity of the bad debt regulation because we cannot tell, upon the present record, whether the regulation is based upon a reasonable interpretation of the Medicare statute. Therefore we vacate the rule and remand this matter for the Secretary to provide a more adequate explanation of her rationale for the rule.

I. Background

Under the Medicare program the Secretary reimburses providers of ESRD dialysis services at 80% of a prospectively set rate and the Medicare beneficiary is responsible for the remaining 20% as a co-payment. See 42 U.S.C. § 1395rr(b)(2)(A); 42 C.F.R. § 413.170(b)(1), (d) (1996). 1 If, after making reasonable collection efforts, the provider is unable to collect the 20% co-payment, then the uncollected amount is considered a "bad debt." 42 C.F.R. § 413.80(b)(1), (e). At the end of the year the Secretary reimburses the dialysis provider for bad debts, but she caps total reimbursement per treatment at the particular provider's cost of providing the service. Id. § 413.170(e)(1).

During the relevant time period (1984-85) National Medical Care, Inc. owned, either directly or through a subsidiary, the ten dialysis providers that press this appeal. NMC itself changed ownership during that period, and the NMC subsidiaries reported, as reimbursable Medicare costs, certain costs associated with the acquisition of their parent company. If those costs are allowable, then the effect will be to increase those providers' bad debt cap. The Secretary disallowed the merger-related costs, however, on the ground that the merger was between related entities. The NMC subsidiaries then filed this lawsuit challenging both that determination and the regulation providing for the cap upon reimbursement of bad debts.

A. Statutory and Regulatory Background

The Congress established the ESRD program in § 299I of the Social Security Amendments of 1972, Pub.L. No. 92-603, 86 Stat. 1329, 1463-64, by extending Medicare coverage to patients who have permanent kidney failure and require either dialysis or a kidney transplant. See Medicare Programs; End-Stage Renal Disease Program; Prospective Reimbursement for Dialysis Services, 47 Fed.Reg. 6,556, 6,556-57 (1982) (history of ESRD program). Medicare Part A, 42 U.S.C. §§ 1395c to 1395i-4, covers inpatient dialysis services provided by hospitals, while Medicare Part B, 42 U.S.C. §§ 1395j to 1395w-4, covers outpatient dialysis treatments by hospital-based and independent providers (such as NMC).

Under the Part B reimbursement system in place before 1983 the Secretary paid an independent provider of outpatient services 80% of the provider's "reasonable charge" (up to $138 per treatment). See 42 C.F.R. pt. 405, subpt. E (1982); 47 Fed.Reg. at 6,557. The Secretary paid an outpatient hospital-based provider 80% of the "reasonable cost" per treatment (also subject to a maximum of $138). See 42 C.F.R. pt. 405, subpt. D (1982); 47 Fed.Reg. at 6,557. The Medicare beneficiary was responsible for the remaining 20%. See 47 Fed.Reg. at 6,557.

Medicare also treated independent providers and hospital-based providers differently for the purpose of reimbursing "bad debts" run up by patients who did not pay their 20% share. Medicare reimbursed hospital-based facilities for bad debts as part of the reasonable cost reimbursement system. See 42 C.F.R. § 405.420 (1982); 47 Fed.Reg. at 6,568. The Secretary expected independent providers, however, "to absorb bad debts within the level of their charges." 47 Fed.Reg. at 6,568.

The cost of the ESRD program rose significantly in the 1970s. Id. at 6,556. In order to contain that cost the Congress passed the ESRD Program Amendments of 1978, Pub.L. No. 95-292, 92 Stat. 307 (codified as amended in scattered sections of 42 U.S.C.), in which it directed the Secretary to prescribe by regulation methods and procedures to "determine the costs incurred" by ESRD facilities, and to "determine, on a cost-related basis or other economical and equitable basis ... the amounts of payments to be made" for dialysis services. 42 U.S.C. § 1395rr(b)(2)(B). The second sentence of this new provision (which was deleted in 1981), required that the new regulations provide incentives for cost reduction and set either prospective or target rates. See Pub.L. No. 95-292, § 2, 92 Stat. at 309.

In 1980 the Secretary proposed to adopt a prospectively determined reimbursement rate, which the provider "would retain, even if its costs were below that rate." Medicare Program; Incentive Reimbursement for Outpatient Dialysis and Self-Care Dialysis Training, 45 Fed.Reg. 64,008, 64,009 (1980). The Secretary rejected the "target rate" approach under which there would be a "retroactive adjustment" to the prospective rate at the end of the year so that the Government and the provider would share in any cost savings. The Secretary believed that this approach would not have the same incentive for cost reduction as a prospectively set rate. Id.

In the 1980 proposal the Secretary opined that it was "appropriate to reimburse the facility for Medicare bad debts," id. at 64,010, and considered two options for doing so. The first was to "allow for the payment of bad debts written off during the year in a special payment at the end of the year." The second option was not to "allow a specific write-off of bad debts" but to "include an allowance for bad debts in the dialysis charge and the calculation of the [prospective] rate." The Secretary chose the former option because it "would permit [her] to pay each facility the exact amount of its bad debts." Accordingly the 1980 proposal did not cap the amount of bad debt that could be reimbursed per treatment.

Before the Secretary had issued a final rule implementing the 1978 amendments, however, the Congress amended the statute again, see Omnibus Budget Reconciliation Act of 1981, Pub.L. No. 97-35, § 2145, 95 Stat. 357, 799-800 (codified at 42 U.S.C. § 1395rr), requiring the Secretary to adopt a prospective payment system. See 42 U.S.C § 1395rr(b)(7). The Congress also modified sub-paragraph (b)(2)(B) of 42 U.S.C. § 1395rr by deleting the option of target rates and the requirement that the Secretary promulgate regulations to implement "appropriate incentives" for efficiency. As amended this subsection reads:

The Secretary shall prescribe in regulations any methods and procedures to (i) determine the costs incurred by providers of services and renal dialysis facilities in furnishing covered services to individuals determined to have end-stage renal disease, and (ii) determine, on a cost-related basis or other economical and equitable basis (including any basis authorized under section 1395x(v) of this title) and consistent with any regulations promulgated under paragraph (7), the amounts of payments to be made for part B services furnished by such providers and facilities to such individuals.

The section to which reference is made defines "reasonable costs" as the "costs actually incurred" in providing services; it also prohibits "cross-subsidization" by requiring that the Secretary

take into account both direct and indirect costs of providers of services ... in order that, under the methods of determining costs, the necessary costs of efficiently delivering covered services to individuals covered by [Medicare] will not be borne by individuals not so covered, and the costs with respect to individuals not so covered will not be borne by such insurance program[ ].

42 U.S.C. § 1395x(v)(1)(A).

In the wake of the 1981 amendments the Secretary issued another notice of proposed rulemaking, in which she said that her

basic approach is to identify the legitimate costs of what appear to be economically and efficiently operated dialysis facilities and...

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