Medical Center of Independence v. Harris

• Citation: 628 F.2d 1113
• Decision Date: 28 August 1980
• Docket Number: No. 79-1702,79-1702
• Parties: MEDICAL CENTER OF INDEPENDENCE, Appellant, v. Patricia Roberts HARRIS, Secretary of Health, Education and Welfare, * Blue Cross of Kansas City, Blue Cross Association, Appellees.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1113

628 F.2d 1113

MEDICAL CENTER OF INDEPENDENCE, Appellant, v. Patricia Roberts HARRIS, Secretary of Health, Education and Welfare, ^* Blue Cross of Kansas City Blue Cross Association, Appellees.

No. 79-1702.

United States Court of Appeals Eighth Circuit.

Submitted March 11, 1980.

Decided Aug. 28, 1980.

J. D. Epstein, Wood, Lucksinger & Epstein, Houston, Tex., argued, Dennis M. Barry, George R. Laughead, Houston, Tex., and F. Philip Kirwan, Margolin & Kirwan, Kansas City, Mo., on brief, for appellant.

E. Eugene Harrison, Asst. U. S. Atty., Kansas City, Mo., Bruce Granger, Dept. of HEW, Kansas City, Mo., argued, Ronald S. Reed, Jr., U. S. Atty., and Paul P. Cacippo, Regional Atty., Kansas City, Mo., on brief, for appellees.

Before BRIGHT, ROSS and McMILLIAN, Circuit Judges.

BRIGHT, Circuit Judge.

Medical Center of Independence, Inc. (MCI), appeals from a judgment of the district court ¹ denying MCI reimbursement under the Medicare program for certain management fees, interest expense, and rent. On appeal, MCI argues that the district court erred in its interpretation and application of the "related organization principle" found in 42 C.F.R. § 405.427 (1979). We disagree and therefore affirm.

I. Background.

MCI leases and operates a hospital facility in Independence, Missouri, with a financially troubled history. The Lutheran Missionary Homestead Association, Inc. (LMHA), began construction on the hospital in 1966. LMHA was unable to sell enough bonds to complete construction, and soon it was forced into Chapter X bankruptcy proceedings. Pursuant to a court-approved 1968 plan of reorganization, MCI was formed as a nonprofit corporation to operate the hospital when completed. Americare Center, Inc., a hospital management firm, acquired all the assets of LMHA in return for satisfying certain creditor's claims and undertaking to complete the hospital facility and lease it to MCI. MCI agreed to operate the facility as a general acute care hospital, to engage Americare as a management company, and to give notes to various creditors.

Americare completed construction of the hospital but began to fail financially and had difficulty equipping the facility. MCI advertised in health care journals in an effort to locate a successor management contractor to Americare. Having received no satisfactory response to its advertisements, MCI entered into negotiations with Hospital Affiliates International, Inc. (HAI). On June 19, 1970, HAI purchased the assets of the hospital from Americare. HAI then entered into a fifteen-year lease with MCI, to become effective August 1, 1970, and a management agreement to run concurrently with the lease. HAI also agreed, as had Americare, to lend up to $200,000 in necessary working capital to MCI.

In August 1970, the bylaws of the hospital were amended to increase the number of directors from eleven to fourteen, to allow nonlocal directors to vote by proxy, and to increase the number of officers' positions. In October 1970, six HAI employees were elected as directors of MCI; two were also elected as MCI officers. Under HAI's direction the hospital began operation and soon became a successful enterprise.

Since the hospital opened MCI has served as a provider of health services under Medicare Part A, 42 U.S.C. §§ 1395c-1395i-2 (1976 & Supp. II 1978). See 42 U.S.C. § 1395x(u) (1976). As such, MCI does not bill patients who are eligible under Medicare for covered services. See 42 U.S.C. § 1395cc (1976 & Supp. II 1978). Instead, it is to be reimbursed by the Government for its reasonable cost of providing these services or, if lower, the customary charges for them. See 42 U.S.C. § 1395f(b) (1976 & Supp. II 1978).

A provider may be reimbursed for services rendered to Medicare beneficiaries either directly by the Secretary of Health and Human Services (the Secretary) ² or through a "fiscal intermediary" that acts as the Secretary's agent for purposes of reviewing claims and administering governmental payments. See generally Blue Cross Association v. Harris, 622 F.2d 972 (8th Cir. 1980); Columbus Community Hospital, Inc. v. Califano, 614 F.2d 181, 183 (8th Cir. 1980). If a provider is dissatisfied with the fiscal intermediary's determination regarding its claim for costs, it may request a hearing on the matter before the Provider Reimbursement Review Board (PRRB). 42 U.S.C. § 1395oo (a) (1976). The PRRB's determination is the final agency action unless the Secretary, on her own motion and within sixty days after the provider of services is notified of the PRRB's decision, reverses or modifies that decision. 42 U.S.C. § 1395oo (f)(1) (1976).

Although reimbursement under the Medicare program is structured around the concept of reasonable costs, the Medicare statute sets forth only a broad guideline for determining such costs:

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(.) (42 U.S.C. § 1395x(v)(1) (A) (1976).)

The statute requires that the Secretary's regulations take into account the direct and indirect costs necessary for the efficient delivery of covered services to Medicare beneficiaries, so that these costs will not be borne by noncovered individuals. 42 U.S.C. § 1395x(v)(1)(A)(i) (1976).

The Secretary's regulations governing reimbursement of Medicare providers are codified at 42 C.F.R. §§ 405.401-405.488 (1979). As a general rule, payments made by a provider to an outside party for interest expense, facilities, and services are eligible for reimbursement at the provider's cost so long as the payments are reasonable and related to patient care. Under 42 C.F.R. § 405.427 (1979), however, if the provider and its supplier are "related organizations," reimbursement will be limited to the supplier's cost. 42 C.F.R. § 405.427 (1979) provides in relevant part as follows:

(a) Principle. 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 costs 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.

When MCI's fiscal intermediary, Blue Cross of Kansas City, audited MCI's cost reports for fiscal years 1970-73, it determined that MCI and HAI were related through common control. In accordance with the terms of 42 C.F.R. § 405.427 (1979), the intermediary disallowed part of the interest expense, management fees, and rental payments claimed by MCI, reducing its Medicare reimbursement for those years by over $300,000. Only the reimbursement for fiscal year 1973 is before us in this case. ³

MCI appealed the intermediary's 1973 determination to the PRRB. The PRRB rendered a decision in MCI's favor, concluding that MCI had introduced substantial evidence that it and HAI were not related at the time that they entered into their agreement, and that HAI exercised no significant control over MCI thereafter. Subsequently, the Commissioner of Social Security (the Commissioner), acting pursuant to authority delegated by the Secretary, reversed the PRRB's decision. The Commissioner held that the PRRB erred in interpreting 42 C.F.R. § 405.427 (1979) to require the actual exercise of control by one organization over another; according to the Commissioner, HAI's power to control MCI was sufficient to make them related organizations within the meaning of the regulation.

MCI appealed this determination to the district court pursuant to 42 U.C.S. § 1395oo (f)(1) (1976). MCI argued before the district court (1) that the Commissioner was an improper delegate of the Secretary's authority; (2) that the Commissioner's decision was erroneous because it was not supported by substantial evidence; and (3) that the Commissioner's decision was erroneous because the related party principle does not apply to contracts between organizations that are unrelated at the time of contracting. The district court rejected all three contentions. On appeal, MCI renews its challenge to the correctness of the Commissioner's decision under 42 C.F.R. § 405.427 (1979), and in addition challenges the validity of the regulation as applied in this case.

II. Analysis.

A. Standard of Review.

The scope of judicial review of the Commissioner's decision is governed by "the applicable provisions under chapter 7 of title 5 (5 U.S.C. §§ 701-706, the Administrative Procedure Act)." 42 U.S.C. § 1395oo(f)(1) (1976). Under 5 U.S.C. § 706(2) (1976), a reviewing court is directed to hold unlawful and set aside agency action, findings, and conclusions found to be

(A) arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law;

(C) in excess of statutory jurisdiction, authority, or limitations, or short of statutory right; (or)

(E) unsupported by substantial evidence(.)

This court has recognized that an administrative agency's interpretation of its own regulations deserves considerable deference by a reviewing cou...