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
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
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,
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 ...