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NORTHWEST HOSPITAL, INC. v. HOSPITAL SERVICE CORP.

October 29, 1980

NORTHWEST HOSPITAL, INC., PLAINTIFF,
v.
HOSPITAL SERVICE CORPORATION ET AL., DEFENDANTS.



The opinion of the court was delivered by: Shadur, District Judge.

MEMORANDUM OPINION AND ORDER

Plaintiff Northwest Hospital, Inc. ("Northwest") has challenged the determination by the Commissioner of Social Security ("Commissioner") denying payment of certain items claimed as reimbursable costs under the Medicare program for Northwest's fiscal year ended April 30, 1974. With the facts not in dispute, each side has moved for summary judgment. For the reasons stated in this memorandum opinion and order, the motion by defendants is granted in part and denied in part, and Northwest's motion is denied.

Facts

Northwest has participated in the Medicare program since its inception in 1966. Under the federal statute, a "provider" facility such as Northwest is reimbursed for the reasonable costs of providing care to the program's beneficiaries. 42 U.S.C. § 1395f(b). Generally a fiscal intermediary such as Hospital Service Corporation is used to determine proper reimbursement for a provider.*fn1 42 U.S.C. § 1395h. To avoid liquidity problems, estimated payments are made to the provider at least once a month with subsequent adjustments for overpayments and underpayments. 42 U.S.C. § 1395g, 1395x(v)(1)(A)(ii). Final determination of a provider's reimbursable costs is made by the fiscal intermediary based on the submission of a cost report after the end of each fiscal year. 42 C.F.R. § 405.406(b).

After a dispute arose regarding the April 30, 1974 fiscal year,*fn2 Northwest requested a hearing before the Provider Reimbursement Review Board ("PRRB"). 42 U.S.C. § 1395 oo(a). PRRB's determination was then reviewed by the Commissioner, and it is his decision of May 28, 1976 that Northwest asks this Court to review. 42 U.S.C. § 1395 oo(f).

Northwest challenges four determinations by the Commissioner:

  1. Northwest is not entitled to depreciation expense
     based on the fair market value of the assets
     acquired from its corporate predecessor, a
     for-profit corporation with the same corporate
     name ("Northwest I"). Instead, the depreciation
     expense must be based on the depreciated
     historical cost to Northwest I.
  2. Northwest is not entitled to deduct interest
     expense on notes given in exchange for the stock
     of Northwest I.
  3. Northwest is not entitled to claim as allowable
     cost the payments made to its auxiliary for the
     services of certain nonpaid workers.
  4. Northwest is not entitled to claim as allowable
     cost the interest expense incurred on loans used
     for the construction of a parking lot and
     professional building.
  Depreciation; Interest on Purchase Price Notes

Each of the first two issues arises from the manner in which Northwest acquired ownership of its hospital operations. Northwest I was a for-profit corporation owned and administered by three men: Pasquale DeMarco (its hospital administrator), Dr. Michael J. Nechtow (its medical director) and John T. Ryan (its legal counsel). In 1965 they proposed a plan to convert the hospital to a not-for-profit institution and ordered appraisals of its assets for that purpose.

On January 18, 1966 the three owners of Northwest I joined with four civic leaders from the community and formed Northwest as a non-profit corporation (all seven men were its directors, with DeMarco, Dr. Nechtow and Mr. Ryan retaining their operating positions). On January 27, 1966 Northwest and Northwest I's stockholders executed an agreement under which Northwest agreed to purchase all the stock in Northwest I, paying $100,000 in cash and delivering $4,900,000 in 14-year notes bearing 4% interest.

That agreement was specifically conditioned on Northwest's receipt of an Internal Revenue Service ruling granting it Section 501(c)(3) tax-exempt status. Northwest did not receive the tax ruling until December 20, 1967, and the purchase transaction was closed January 2, 1968.

As a threshold matter, Northwest argues that the Medicare regulations covering depreciation and interest are not applicable to this case. Both the Medicare statute and the regulations took effect in 1966 (the statute in July and the regulations in November). Northwest argues that the sale of the hospital took place on January 27, 1966 (the date of the contract), so that the regulations do not apply.

However, execution of the agreement was not the legally operative fact. Consummation of the sale was conditioned on obtaining a favorable IRS ruling — and that was a critical substantive condition, for the entire purpose of the transaction would have been frustrated if tax-exempt status had not been forthcoming. It is purchases of hospitals that the regulations govern; and while there was a conditional agreement to purchase before the enactment of the statute and its regulations, it is clear that the actual purchase was not completed until January 2, 1968.

1. Depreciation

Depreciation costs, like all other elements of reimbursable costs, are a function of the "reasonable cost of . . . services" delivered by the provider. 42 U.S.C. § 1395x(v).*fn3 In turn, the specifics of the reimbursement program are governed by the regulations issued by the Secretary. In this case Northwest argues that the purchase price under its contract should be the base for calculating ...


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