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Memorial Hospital of Carbondale and Herrin Hospital v. Heckler

decided: April 18, 1985.


Appeal from the United States District Court For the Southern District of Illinois. No. CV 82-4200 -- Kenneth J. Meyers, Magistrate.

Bauer and Flaum, Circuit Judges, and Grant, Senior District Judge.*fn*

Author: Flaum

FLAUM, Circuit Judge.

Plaintiffs-appellants Memorial Hospital of Carbondale ("Memorial") and Herrin Hospital ("Herrin") are not-for-profit hospitals owned and operated by Southern Illinois Hospital Services ("SIHS"), a not-for-profit Illinois corporation. Both hospitals are qualified health care providers under Title XVIII of the Social Security Act, 42 U.S.C. §§ 1395 et seq. (1982) (the "Medicare Act"). Memorial and Herrin brought this action in the district court seeking review of the defendants' (collectively referred to as the "Secretary") disallowance of Medicare reimbursement for several categories of costs. Both hospitals contested, among other things, the Secretary's decision to disallow the interest paid on money borrowed to establish a bond reserve fund. In addition, Memorial objected to the Secretary's decision to offset against allowable education costs the family practice grant funds received by Memorial from the Public Health Service. Following the magistrate's*fn1 grant of summary judgment to the Secretary on these two issues, the hospitals appealed. We now affirm in part and reverse in part.


The Medicare Act provides that qualified providers of health care services to Medicare beneficiaries will be reimbursed for the lesser of the "reasonable cost" of those services or their "customary charges" with respect to those services. 42 U.S.C. § 1395f(b)(1) (1982).*fn2 "Reasonable cost" is very broadly defined by the Act, to be defined more specifically in regulations promulgated by the Secretary. 42 U.S.C. § 1395x(v)(1)(A) (1982). In addition to these regulations, the Secretary issues the Provider Reimbursement Manual ("PRM") to give guidance in interpreting the regulations. This case involves a challenge to the Secretary's interpretation and application of various provisions in the regulations and PRM.

Providers are normally reimbursed under Medicare through private organizations (usually insurance companies) acting as "fiscal intermediaries," under contract with the Secretary. See 42 U.S.C. § 1395h (1982). The intermediaries determine the amount of reimbursement due to a provider based on the cost report submitted by the provider at the close of each fiscal year. See 42 C.F.R. §§ 405.406(b), 405.453(f) (1984). If a provider disagrees with its intermediary's reimbursement determination, it may obtain review by the Provider Reimbursement Review Board ("PRRB" or the "Board") if the amount in controversy is $10,000 or more. 42 U.S.C. § 1395oo(a) (1982); 42 C.F.R. § 405.1835 (1984). The Board has the authority to "affirm, modify, or reverse a final determination of the fiscal intermediary with respect to a cost report," and may consider issues and evidence not considered by the intermediary in making its final determination. 42 U.S.C. § 1395oo(d) (1982). The Board's decision constitutes final agency action unless, within sixty days after the provider is notified of the Board's decision, the Secretary reverses, affirms, or modifies the Board's decision on her own motion. 42 U.S.C. § 1395oo(f)(1) (1982). The Secretary has delegated this power to the Administrator of the Health Care Financing Administration ("HCFA"), who has redelegated the authority to the Deputy Administrator. See Indiana Hospital Ass'n, Inc. v. Schweiker, 544 F. Supp. 1167, 1177-78 (S.D. Ind. 1982) (upholding validity of these delegations), aff'd, 714 F.2d 872 (7th Cir. 1983) (per curiam), cert. denied, 465 U.S. 1022, 104 S. Ct. 1274, 79 L. Ed. 2d 679 (1984). A provider may obtain judicial review of "any final decision of the Board, or of any reversal, affirmance, or modification by the Secretary. . . ." 42 U.S.C. § 1395oo(f)(1).

Memorial and Herrin filed timely appeals with the Board to contest their intermediary's disallowance of seven items of costs for cost years ending March 31, 1977, 1978, 1979, and 1980. Only two of those items, the offset of Memorial's family practice grant against allowable educational costs and the disallowance of interest on the hospitals' bond reserve fund, are presented in this appeal. The Board conducted a hearing on October 6, 1981, and in a 2-1 decision dated April 6, 1982, upheld the intermediary's determination to offset Memorial's family practice grant and modified the intermediary's decision with respect to interest on the bond reserve fund. PRRB Decision No. 82-D77, 1982 Medicare & Medicaid Guide (CCH) para. 31,944, at 9603-04. The Deputy Administrator of the HCFA, acting as the Secretary's delegate, affirmed the Board's disposition of these issues on June 2, 1982. HCFA Deputy Administrator Decision, 1982 Medicare & Medicaid Guide (CCH) para. 32,046, at 10,031-32. The hospitals then sought judicial review of this final administrative decision in the district court. After the parties consented to trial by magistrate, both sides filed motions for summary judgment. The magistrate granted the Secretary's motion for summary judgment on these two issues on September 21, 1983. This appeal followed.

Our scope of review on appeal is narrow, and we must defer to the Secretary's judgment unless her actions were "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law." 5 U.S.C. § 706(2)(A) (1982). The presumption of regularity afforded the Secretary's decision under this standard does not, however, shield it from a "thorough, probing, in-depth review." Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 415, 28 L. Ed. 2d 136, 91 S. Ct. 814 (1971). With this in mind, we now address the issues presented in this appeal.


A. Introduction

The Medicare regulations specify that a provider may be reimbursed for the "net cost" of "approved educational activities," 42 C.F.R. § 405.421(a) (1984), including training programs for interns and residents. Id. § 405.421(c). For the cost years at issue in this case, net educational costs were determined by deducting from the cost of approved educational activities "any reimbursements from grants, tuition, and specific donations." 42 C.F.R. § 405.421(b)(2) (1978). The regulation on grants and gifts similarly provided that while unrestricted grants did not have to be deducted to determine allowable costs, grants "designated by a donor for paying specific operating costs" were to be offset against operating costs in determining allowable costs. 42 C.F.R. § 405.423 (1982).*fn3 The Provider Reimbursement Manual provided an exception to the offset requirement for "seed money" grants, defined as grants "designated for the development of new health care agencies or for expansion of services of established agencies. . . ." PRM § 612.2.

The Public Health Service ("PHS") received authorization from Congress in 1971, through an amendment to title VII of the Public Health Service Act, 42 U.S.C. §§ 201 et seq. (1982), to make grants to hospitals to "plan, develop, and operate, or participate in, an approved professional training program . . . in the field of family medicine. . . ." Pub. L. No. 92-157, § 107(b), 85 Stat. 457 (1971) (codified at 42 U.S.C. § 295e-1). On February 13, 1974, Memorial applied for one of these family practice training grants. PHS approved a three-year grant on June 29, 1974, and Memorial's training program began the following month. Memorial received $131,893 and $64,254 in grant funds for its 1977 and 1978 fiscal years, respectively.

Memorial alleges that there was "considerable doubt within HEW whether the family practice grants should be offset against the cost of approved educational activities." See PRRB Decision No. 82-D77, 1982 Medicare & Medicaid Guide (CCH) para. 31,944, at 9602. This confusion was highlighted by a sequence of events in the Atlanta regional office of the Department of Health, Education, and Welfare ("HEW") (predecessor agency to the Department of Health and Human Services) in 1975-76. On January 22, 1975, the Atlanta office issued a letter to intermediaries within that region (not the region in which Memorial is located), instructing them to treat family practice grants as seed money grants exempt from offset under section 612.2 of the PRM. The letter was withdrawn in July 1976 by order of the Bureau of Health Insurance, which administered the Medicare program before the transfer of functions to the HCFA in 1977. Despite the inconsistent treatment of family practice grants within that region, however, and despite some internal debate over the proper position to adopt, the Department's consistent practice was to require the deduction of family practice grants in determining allowable educational costs.

On April 8, 1977, Congressman Paul Rogers, who was Chairman of the Subcommittee on Health and the Environment of the Committee on Interstate and Foreign Commerce (the subcommittee with jurisdiction over Public Health Service legislation), wrote to HEW Secretary Califano asking him to reconsider the Department's policy of offsetting family practice grants on the basis that it was undermining federal and state efforts to encourage family practice training programs. He stated that "to require monies received from primary care training be deducted is, in large measure, negating the action of the Congress and State legislatures in appropriating monies for such training." In a response to Congressman Rogers dated January 18, 1978, Califano stated that family practice grants were "restricted grants" subject to offset under 42 C.F.R. §§ 405.421 and 405.423, and that they should have been treated as such by the Atlanta regional office. Califano further stated, however, that in order to support Congress's and the Administration's priority of encouraging more doctors to become primary care physicians, the Department intended to propose appropriate modifications to its existing regulations in order to exempt family practice grants from the offset requirement.

On August 10, 1979, the Secretary proposed these modifications in a notice of proposed rulemaking. 44 Fed. Reg. 47,117 (Aug. 10, 1979). A final rule was issued nearly a year later. 45 Fed. Reg. 51,783 (Aug. 5, 1980). The rule amended 42 C.F.R. § 405.421 by revising and redesignating subsection (b)(2), the general offset provision, as subsection (g)(1), and adding a new subsection (g)(2) which provided that "effective for cost reporting periods beginning on or after January 1, 1978, grants and donations that the donor has designated for internship and residency programs in family medicine, general internal medicine, or general pediatrics are not deducted in calculating net costs." 45 Fed. Reg. at 51,787. Because the family practice grant exception to the general offset requirement was only made retroactive to cost years beginning on or after January 1, 1978, however, the family practice grant monies received by Memorial in its cost reporting periods ending March 31, 1977 and 1978 (cost years 1977 and 1978) are subject to the previously existing requirements.

Memorial's intermediary offset Memorial's family practice grant funds in determining allowable educational costs. Memorial appealed to the Board, arguing that its family practice grant was exempt from offset either as a seed money grant under section 612.2 of the PRM or as a "last dollar" grant in accordance with longstanding agency policy. Memorial also asserted that if the former regulation required offset of family practice grants, it was contrary to the statute authorizing such grants (the Public Health Service Act) and therefore invalid. The Board affirmed the intermediary's determination, holding that the family practice grants were neither seed money grants nor last dollar grants. The Deputy Administrator of the HCFA affirmed the Board's decision without further discussion. The magistrate upheld the agency's actions after also finding that family practice grants were neither seed money grants nor last dollar grants and that their offset was not contrary to statute.

B. Discussion

Memorial's contention that family practice grants qualify as seed money grants, and are thus exempt from offset, is based on section 612.2 of the ...

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