St. Luke's Hosp. v. Sebelius, No. 09-5352.

Decision Date06 July 2010
Docket NumberNo. 09-5352.
Citation611 F.3d 900
PartiesST. LUKE'S HOSPITAL, Appellantv.Kathleen SEBELIUS, Secretary of Health and Human Services, Appellee.
CourtU.S. Court of Appeals — District of Columbia Circuit

Appeal from the United States District Court for the District of Columbia (No. 1:08-cv-00883-JR).

Robert E. Mazer argued the cause for the appellant. Leslie DeMaree Goldsmith was on brief. James P. Holloway entered an appearance.

Joel McElvain, Attorney, United States Department of Justice, argued the cause for the appellee. Ronald C. Machen, Jr., United States Attorney, and Michael S. Raab, Attorney, David S. Cade, Acting General Counsel, and Janice Hofman, Associate General Counsel, United States Department of Health and Human Services, were on brief. R. Craig Lawrence, Assistant United States Attorney, entered an appearance.

Before GINSBURG, HENDERSON and GARLAND, Circuit Judges.

Opinion for the Court filed by Circuit Judge HENDERSON.


Appellant St. Luke's Hospital (St.Luke's), a non-profit hospital located in Bethlehem, Pennsylvania, submitted to the Centers for Medicare and Medicaid Services (CMS) 1 a claim for reimbursement regarding a $2.9 million loss allegedly incurred by Medicare provider Allentown Osteopathic Medical Center (Allentown) when it merged with St. Luke's through a “statutory merger.” St. Luke's claimed as its loss the difference between the portion of the merger consideration ($4,848,188.60 in debt assumption) allocable to its depreciable assets and those assets' net book value. CMS disallowed the claim on the ground the merger lacked “reasonable consideration” and was therefore not a “bona fide” transaction as required for revaluation and loss reimbursement under 42 C.F.R. § 413.134(f) and ( l ).2 St. Luke's sued the HHS Secretary in district court challenging the denial of its reimbursement claim. The district court granted summary judgment to the Secretary holding, inter alia, the Secretary had reasonably interpreted her own regulation to require that reasonable consideration be paid before depreciable assets may be revalued and the resulting losses reimbursed. St. Luke's Hosp. v. Sebelius, 662 F.Supp.2d 99 (D.D.C.2009). We affirm.


A Medicare provider is entitled to compensation for the “reasonable cost” of Medicare services, 42 U.S.C. § 1395f(b)(1), which, pursuant to the Secretary's depreciation regulation, includes an “appropriate allowance for depreciation on buildings and equipment.” 42 C.F.R. § 413.134(a). The depreciation allowance for an asset is generally based on its “historical cost,” id. § 413.134(a)(2)-i.e., “the cost incurred by the present owner in acquiring the asset,” id § 413.134(b)(1)-[p]rorated over the estimated useful life of the asset.” Id. § 413.134(a)(3). The resulting annual allowance is reimbursable to the extent the asset is used to provide Medicare services. In other words, the annual reimbursable allowance is equal to the actual cost divided by the number of years of its useful life and then multiplied by the percentage of the asset's use devoted to Medicare services in the given year.

In addition to an annual depreciation reimbursement, historically, a provider could receive a credit (or debit) upon disposition of the asset if the disposition resulted in a gain (or loss).3 Under the depreciation regulation, an asset's gain or loss is equal to the difference between the consideration received upon disposition and its “net book value,” which consists of the Medicare depreciable basis (generally the historical cost) less past Medicare depreciation allowances, 42 C.F.R. § 413.134(b)(9). See Lake Med. Ctr. v. Thompson, 243 F.3d 568, 569 (D.C.Cir.2001). If the disposition of an asset before December 1, 1997 result [ed] in a gain or loss under this regime, “an adjustment is necessary in the provider's allowable cost.” 42 C.F.R. § 413.134(f)(1).

Under subsection (f) of the depreciation regulation, the “treatment of the gain or loss depends upon the manner of disposition of the asset.” Id. § 413.134(f)(1). If an asset is disposed of through a “bona fide” sale, the treatment is straightforward: If there is a gain, the selling provider must compensate Medicare therefor; if there is a loss, Medicare reimburses the provider. Id. § 413.134(f)(2). If the sale of the assets is not a bona fide transaction, the regulation does not provide for any adjustment.4 Under subsection ( l ), if the disposition is through a “statutory merger”-i.e., “a combination of two or more corporations under the corporation laws of the State, with one of the corporations surviving”-the merged corporation “is subject to the provisions of paragraph[ ] ... (f) of [ section 413.134] concerning ... the realization of gains and losses.” Id. § 413.134( l ) (1997) (now § 413.134(k)). According to the preamble to the proposed rule, subsection ( l )(2) “points out that a statutory merger is treated as a sale of assets.” Fed. Health Ins. for the Aged and Disabled, Establishment of Cost Basis on Purchase of Facility as an Ongoing Operation, and Transactions Involving Provider's Capital Stock, 42 Fed.Reg. 17,485, 17,485 (proposed Jan. 17, 1977). This case involves such a statutory merger.

Allentown and St. Luke's, each a Medicare provider, signed a merger agreement on October 16, 1996, under which the former was to merge with the latter effective January 1, 1997, with St. Luke's as the surviving entity.5 For its part, St. Luke's agreed to (1) continue operating an acute inpatient services hospital at Allentown's campus for a minimum of two years (provided that a specified operating loss was not incurred) and indefinitely thereafter (provided that a cumulative operating surplus was maintained) and (2) invest in the Allentown “campus plant, equipment, programs, and services based on a well-defined plan that meets community needs and is economically responsible and feasible.” Confidential Merger Agreement § 2.5, JA 188-89.

The merger went through as planned and all of Allentown's assets totalling approximately $25.1 million were transferred to St. Luke's. As consideration to Allentown, St. Luke's assumed Allentown's debt in the amount of approximately $4.8 million. After allocating the consideration among all of the transferred assets, St. Luke's filed a Medicare reimbursement claim totalling approximately $2.9 million for fiscal year 1996, treating the difference between the net book value of the depreciable assets and their allocated consideration as a loss. The Medicare fiscal intermediary denied St. Luke's claim and St. Luke's filed an appeal with the Provider Reimbursement Review Board (PRRB).6

In October 2000, while the appeal was pending, the Secretary issued a guidance document to determine if a statutory merger triggers a revaluation of the merged entity's depreciable Medicare assets. Clarification of the Application of the Regulations at 42 C.F.R. 413.134( l ) to Mergers and Consolidations Involving Non-profit Providers, Program Memorandum A-00-76 (Oct. 19, 2000) (PM A-00-76) (republished as PM A-00-96 (2001)). The document clarified that subsection ( l )'s cross reference to subsection (f) requires that for “mergers and consolidations involving non-profit providers[,] ... as with transactions involving for-profit entities, in order for Medicare to recognize a gain or loss on the disposal of assets, the merger or consolidation must occur between or among parties that are not related as described in the regulations at 42 C.F.R. 413.17 and the transaction must involve one of the events described in 42 C.F.R. 413.134(f) as triggering a gain or loss recognition by Medicare ( typically, a bona fide sale, as defined in the [Provider Reimbursement Manual (PRM) ] at § 104.24[) ].” PM A-00-76 at 1 (emphasis added); see also id. at 3 (“Notwithstanding the treatment of the transaction for financial accounting purposes, no gain or loss may be recognized for Medicare payment purposes unless the transfer of the assets resulted from a bona fide sale as required by regulation 413.134(f) and as defined in the PRM at § 104.24.”). PRM § 104.24, referenced in PM A-00-76, provides that a “bona fide sale” includes inter alia, payment of “reasonable consideration” for the depreciable assets: “A bona fide sale contemplates an arm's length transaction between a willing and well informed buyer and seller, neither being under coercion for reasonable consideration. An arm's-length transaction is a transaction negotiated by unrelated parties, each acting in its own self interest.” PRM § 104.24 (emphasis added). PM A-00-76 elaborates on what constitutes reasonable consideration:

As with for-profit entities, in evaluating whether a bona fide sale has occurred in the context of a merger or consolidation between or among non-profit entities, a comparison of the sales price with the fair market value of the assets acquired is a required aspect of such analysis. As set forth in PRM § 104.24, reasonable consideration is a required element of a bona fide sale. Thus, a large disparity between the sales price (consideration) and the fair market value of the assets sold indicates the lack of a bona fide sale. With regard to non-profit mergers or consolidations, often the sales price consists of assumed debt only, but may also include cash and/or new debt. Non-monetary consideration, such as a seller's concession from a buyer that the buyer must continue to provide care for a period of time or to provide care to the indigent, may not be taken into account in evaluating the reasonableness of the overall consideration (even where such elements may be quantified in dollar terms). These factors are more akin to goodwill than to consideration.

PM A-00-76 at 3.

In January 2008, the PRRB issued its decision which reversed the Medicare fiscal intermediary and allowed St. Luke's claim. Shortly thereafter, CMS, reviewing the PRRB decision pursuant to 42 U.S.C. § 1395 oo(f)(...

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