Liberty Nursing Center, Inc. v. Department of Health and Mental Hygiene

• Decision Date: 01 September 1992
• Docket Number: No. 70,70
• Parties: , 41 Soc.Sec.Rep.Ser. 191, Medicare & Medicaid Guide P 41,563 LIBERTY NURSING CENTER, INC. t/a Granada Nursing Home v. DEPARTMENT OF HEALTH AND MENTAL HYGIENE. ,
• Court: Maryland Court of Appeals

Page 433

330 Md. 433

624 A.2d 941, 41 Soc.Sec.Rep.Ser. 191,

Medicare & Medicaid Guide P 41,563

LIBERTY NURSING CENTER, INC. t/a Granada Nursing Home v. DEPARTMENT OF HEALTH AND MENTAL HYGIENE.

No. 70, Sept. Term, 1992.

Court of Appeals of Maryland.

May 17, 1993.

Stephen J. Sfekas (Weinberg and Green, brief), Baltimore, for petitioner.

Lawrence J. Ageloff, Asst. Atty. Gen. (J. Joseph Curran, Jr., Atty. Gen., Maureen M. Dove, Asst. Atty. Gen., brief), Baltimore, for respondent.

Argued before ELDRIDGE, RODWOSKY, McAULIFFE, CHASANOW, KARWACKI, ROBERT M. BELL and CHARLES E. ORTH, Jr., Judge of the Court of Appeals (Retired, Specially Assigned), JJ.

ROBERT M. BELL, Judge.

We granted certiorari to determine whether regulations pertaining to related organizations preclude reimbursing the provider for interest paid to a non-related, commercial lender, pursuant to a loan the provider made to finance the purchase, from a related organization, of nursing home facilities. The Court of Special Appeals held that they do. Liberty Nursing Center, Inc. v. Dept. of Health & Mental Hygiene, 91 Md.App. 210, 220-21, 603 A.2d 1344, 1348-49, cert. granted, 328 Md. 35, 612 A.2d 897 (1992). We shall reverse.

I.

Liberty Nursing Center, Inc., t/a Granada Nursing Home ("Liberty"), the petitioner, is the operator of a 112 bed licensed nursing home in Baltimore City. It participates in the Maryland Medical Assistance Program ("Medicaid"), a State program partially funded by the federal government, which reimburses nursing homes for their patient related costs of medical care rendered to indigent or medically indigent persons. Almost 100 percent of Liberty patients receive medical assistance.

Michael DeFontes ("DeFontes") currently owns 55 percent of Liberty, the remainder being owned by his brother. It was previously owned by DeFontes's grandmother, Margaret Wessels, who also owned land and a building ("the facilities"), which she leased to Liberty for operation of the nursing home. After Wessels's death, that lease was continued with, however, the Wessels estate as lessor. DeFontes, who also is one of his grandmother's heirs, qualified as personal representative of the estate.

In addition to the building and grounds leased to Liberty, the assets of the Wessels estate consisted of a personal residence, a promissory note, and other miscellaneous property. As a result, estate tax assessments totaled more than $400,000.00--$373,012.30 for federal estate taxes and $37,522.07 for Maryland estate taxes. Because the Wessels estate had insufficient liquid assets to pay them, counsel sought to postpone the payment of the federal estate taxes. That effort proved to be only partially successful, the IRS agreed to defer payment for only one year, which prompted counsel to advise DeFontes that it would be necessary to sell the facilities to pay the estate taxes and close the estate.

Rather than sell to a third party, DeFontes purchased the facilities himself. He paid one million two hundred thousand dollars ($1,200,000) for them. The State had previously appraised the facilities, for Medicaid reimbursement purposes, at approximately two million dollars ($2,000,000). The purchase was financed with a loan DeFontes negotiated, at arms length, from First American Bank, at 11 percent interest and secured by a mortgage on the facilities. DeFontes has neither an ownership interest in, nor control of, First American Bank.

As required by Medicare regulations, Liberty filed a cost report with the Maryland Medical Assistance Program at the end of the fiscal year. Included in that report as an allowable cost was an interest expense ($135,808) paid to First American Bank in connection with the DeFontes loan. Clifton, Gunderson & Company, the accounting firm under contract with the State of Maryland to perform audits of nursing homes cost reports, disallowed the interest on the grounds that Liberty, through DeFontes, and the Wessels estate were "related organizations." Liberty appealed the proposed cost settlement incorporating this disallowance to the Nursing Home Appeal Board ("NHAB" or the "Board"). ¹ When the Board affirmed, Liberty sought judicial review in the Circuit Court for Baltimore City, pursuant to Md.Code (1990, 1992 Cum.Supp.) § 15-108(f) of the Health General Article. That court also affirmed, whereupon Liberty unsuccessfully appealed to the Court of Special Appeals. We granted its petition for certiorari to consider the important issue raised therein.

II.

The Medicaid Program, Title XIX of the Social Security Act, 42 U.S.C. § 1396 et seq., which is subsidized by both state and federal funds, has as its purpose the provision of medical assistance to persons whose income and resources are insufficient to meet the cost of necessary medical care and services. See 42 U.S.C. § 1396; Md.Code (1990, 1992 Cum.Supp.) § 15-103 of the Health-Gen. Article. It requires that providers of necessary medical care and services be reimbursed at "reasonable and adequate" rates, 42 U.S.C. § 1396a(a)(13)(A), which is the cost actually incurred, as determined in accordance with federal regulations, promulgated pursuant to the Medicare Program, Title XVIII of the Social Security Act, 42 U.S.C. § 1395 et seq., "establishing a method or methods to be used, and the items to be included[.]" 42 U.S.C. § 1395x(v)(1)(A). The regulations provide that, to be reimbursable, costs must be "reasonable," "necessary," and "related to the care of beneficiaries." 42 C.F.R. § 413.9(a). Costs incurred by nursing homes participating in the Medicaid program are reimbursed:

... through the use of rates (determined in accordance with methods and standards developed by the State) ... which the State finds, and makes assurances satisfactory to the Secretary, are reasonable and adequate to meet the costs which must be incurred by efficiently and economically operated facilities in order to provide care and services in conformity with applicable State and Federal laws, regulations, and quality and safety standards....

42 U.S.C. § 1396a(a)(13)(A).

In Maryland, the Department of Health & Mental Hygiene is authorized to "adopt rules and regulations for the reimbursement of the providers under the [Medicaid] program." Md.Code (1990, 1992 Cum.Supp.) § 15-105(a) of the Health-Gen. Article. Pursuant to that authority, it has chosen to calculate a provider's "final per diem rate" "according to the principles established under Title XVIII of the Social Security Act, 42 U.S.C. § 1395 et seq., and contained in the Medicare Provider Reimbursement Manual, HCFA ² Publication 1-1, unless otherwise specified by this chapter[.]" Md.Regs.Code tit. 10, § 09.11.08B(1) and § 09.11.10B.

The federal regulations specifically address reimbursement in the "related organizations context." In 42 C.F.R. § 413.17, it is provided:

(a) Principle. Except as provided in paragraph (d) of this section, 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 if an individual or individuals possess significant ownership or equity in the provider and the institution or organization serving the provider.

(3) Control. Control exists if 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. ³

Section 413.153 provides, in pertinent part:

(a)(1) Principle. Necessary and proper interest on both current and capital indebtedness is an allowable cost.

* * * * * * (c) Borrower--Lender relationship. (1) Except as described in paragraph (c)(2) of this section, to be allowable, interest expense must be incurred or indebtedness established with lenders or lending organizations not related through control, ownership, or personal relationship to the borrower. Presence of any of these factors could affect the "bargaining" process that usually accompanies the making of a loan, and could thus be suggestive of an agreement on higher rates of interest or of unnecessary loans. Loans should be made under terms and conditions that a prudent borrower would make in armslength transactions with lending institutions. The intent of this provision is to assure that loans are legitimate and needed, and that the interest rate is reasonable. Thus, interest paid by the provider to partners, stockholders, or related organizations of the provider would not be allowable. If the owner uses his own funds in a business, it is reasonable to treat funds as invested funds or capital, rather than borrowed funds. Therefore, if interest on loans by partners, stockholders, or related organizations is disallowed as a cost solely because of the relationship factor, the principal of such loans is treated as invested funds in the computation of the provider's equity capital under § 413.157. ⁴

Section 413.134(g)(3), relating to cost basis upon purchase of a facility as an ongoing operation, provides:

(3) Transaction other than bona fide. If the purchaser cannot demonstrate that the sale was bona fide, in addition to the limitations specified in paragraph (g)(1) and (2) of this section, the purchaser's cost basis may not exceed the seller's cost basis, less accumulated depreciation.

Although this provision does not, in terms, refer to related organizations, the cases that have considered it have determined that a sale between related part...