B. Summary of Facts
The Provider, St. Vincent Memorial Hospital, is a 179-bed,
acute care, non-profit, general hospital which also operates a
50-bed skilled nursing unit. This appeal concerns the
intermediary's treatment of costs associated with the provision
of computerized tomographic (CT) scanning services under an
agreement with an unrelated party.
On October 26, 1982, St. Vincent entered into an agreement
with Mobile Imaging Laboratories, Inc. (MIL) for the provision
of CT scanning services for a term of three years. Under this
agreement, MIL provided fixed-site CT scanning equipment
installed at St. Vincent's facility and furnished appropriate
technicians/technologists' services to perform the CT scanning
procedures requested by St. Vincent for its inpatients and
outpatients. In addition to providing equipment and personnel,
MIL was responsible for site preparation, installation and
maintenance of the equipment and cross-training of St.
Vincent's personnel. MIL also agreed to carry public and
professional liability insurance consistent with the State's
Medical Malpractice Act. As owner of the equipment, MIL bore
full financial responsibility for the depreciation or
obsolescence of said equipment and would be responsible for
removing the equipment at its own cost upon completion or
termination of the contract.
With respect to St. Vincent's requirements, the agreement
states that adequate space within the hospital facility must be
provided to accommodate the equipment and furnishings. St.
Vincent also agreed to provide housekeeping and all utilities
necessary for the space and equipment, and to furnish the
necessary administrative services to support the provision of
this patient care service. Only St. Vincent's patients under
the care of its medical staff could utilize the CT scanning
services with St. Vincent establishing all charges and
receiving all payments for the services rendered.
In consideration of MIL's performance under the agreement,
St. Vincent agreed to pay MIL at rates predicated on a sliding
scale, fee-for-service schedule based on the average number and
type of CT scans performed. During the initial period of this
agreement (Fiscal Years 1983-1985), capital costs associated
with the CT scanning services furnished by St. Vincent were
neither claimed nor reimbursed under the Medicare program.
In 1985, the arrangement between St. Vincent and MIL changed
and an amendment to the existing contract was effected. The
amendment provided for the installation of a new
third-generation CT scanner (Toshiba TCT 80A) for which MIL
accepted full responsibility for the installation and cost of
renovation to accommodate the operation of the new equipment.
The term of the contract was extended for a period of five
years; however, at the end of three years St. Vincent had the
1. Allow the contract to extend until the end of
its term with prices adjusted for inflation.
2. Purchase the equipment from MIL for a price of
$225,000 plus sales taxes.
3. Lease the equipment from MIL for the balance of
the term of contract for a price of $11,000 per
4. Upgrade the equipment to a new unit (costing
not more than $700,000) for a 20 percent
increase in cost per scan over inflation
adjusted costs for a five year period.
During the 1982-1985 period, MIL employees operated the CT
scanning equipment and were required to train several hospital
employees to operate the CT scanning unit. However, after
installation of the new Toshiba unit, only hospital employees
operated the CT scanning equipment. MIL's services were limited
only to providing technical support of the equipment and
performing/arranging for maintenance of the Toshiba CT scanner.
In accordance with Exhibit B-2 to the Contract Amendment, a new
fee-for-service schedule was established with revised rates
based on the number and type of CT scans performed. Footnotes
to the fee schedule stated that the cost of film and contrast
material was to be borne by St. Vincent, and that the 1985
rates may increase as the CPI rate or the hospital market
basket rate increased. However, no increase greater than eight
percent per year would be permitted.
Subsequent to the contract amendment in 1985, the operational
relationship between St. Vincent and MIL for CT scanning
services remained constant for the 1986-1989 fiscal years.
Throughout this period, St. Vincent claimed a portion of the
payments made to MIL as "capital-related" (pass-through) costs
to be excluded from the Prospective Payment System (PPS). For
the fiscal year ended June 30, 1986, Aetna initially questioned
St. Vincent's treatment of the payments made to MIL under the
contractual arrangement. However, Aetna ultimately allowed
approximately $17,000 to $18,000 per month as "capital-related"
costs. After fiscal year 1986, Aetna ceased being St. Vincent's
fiscal Intermediary and the Blue Cross and Blue Shield
Association assumed that role.
Based on its review of St. Vincent's cost reports for the
fiscal years ended June 30, 1987, 1988 and 1989, the
Intermediary denied St. Vincent's treatment of the contractual
payments as "capital-related" costs. The effect of the
Intermediary's determinations on Medicare reimbursement is
approximately $64,000, $60,000, and $20,000 for fiscal years
1987, 1988 and 1989, respectively. St. Vincent timely appealed
the Intermediary's determinations to the Provider Reimbursement
Review Board (Board) pursuant to 42 C.F.R. §§ 405.1835-.1841
and has met the jurisdictional requirements of those
II. Standard of Review
Judicial review of the agency's decision is governed by
5 U.S.C. § 706, which requires that an agency action be affirmed
unless it is arbitrary and capricious, contrary to law, or
unsupported by substantial evidence. 5 U.S.C. § 706; see also
Daviess County Hosp. v. Bowen, 811 F.2d 338, 343 (7th Cir.
1987) ("The Secretary's decision may not be disturbed unless it
is arbitrary, capricious, an abuse of discretion, or otherwise
contrary to law; contrary to constitutional right, power
privilege or immunity; exceeding of statutory jurisdiction, or
falling short of statutory right; reached in violation of
established procedure; or unsupported by substantial
evidence.") In evaluating agency action, a reviewing court
accords considerable deference to the agency's expertise and to
the agency's congressionally-mandated duty to administer its
own programs. Udall v. Tallman, 380 U.S. 1, 16, 85 S.Ct. 792,
801, 13 L.Ed.2d 616 (1965). Indeed, "[a]n administrative
agency's interpretation of its own regulation merits
considerable respect by a reviewing court, and will be
controlling absent a showing `that it is plainly erroneous or
inconsistent with the regulation.' Such deference is especially
applicable to areas like Medicare reimbursements that require
judgments about appropriate cost accounting practices."
Abbott-Northwestern Hospital, Inc. v. Schweiker, 698 F.2d 336,
340 (8th Cir. 1983) (citations omitted); see also St. Mary of
Nazareth Hospital Center v. Department of Health & Human
Services, 698 F.2d 1337, 1346 (7th Cir. 1983) (". . . though
courts are not bound by interpretative regulations . . .,
courts will defer to the agency's judgment unless it can be
shown that the agency's determination was arbitrary and
capricious or constituted an abuse of discretion.")
However, a reviewing court is not bound by an agency's
interpretation of a statute or regulation if that
interpretation is inconsistent with the statute under which the
regulation was promulgated, or is plainly inconsistent with the
wording of the regulation. St. Francis Hospital Center v.
Heckler, 714 F.2d 872, 873 (7th Cir. 1983).
In addition, the factual findings of the Board may not be
overturned if they are based upon substantial evidence in the
record. Substantial evidence has been defined by the Supreme
Court as "such relevant evidence as a reasonable mind might
accept as adequate to support a conclusion." Richardson v.
Perales, 402 U.S. 389, 401, 91 S.Ct. 1420, 1427, 28 L.Ed.2d 842
(1971) (quoting Consolidated Edison Co. v. NLRB, 305 U.S. 197,
229, 59 S.Ct. 206, 216, 83 L.Ed. 126 (1930)). The Supreme Court
has further determined that substantial evidence requires
"something less than the weight of the evidence, and the
possibility of drawing two inconsistent conclusions from the
evidence does not prevent an administrative agency's finding
from being supported by substantial evidence." Consolo v.
Federal Maritime Commission, 383 U.S. 607, 620, 86 S.Ct. 1018,
1026, 16 L.Ed.2d 131 (1966). Accordingly,
the PRRB's findings may not be disturbed if they could
reasonably be drawn from the evidence presented.
The crucial issue in this dispute is whether the CT scanner
services provided by MIL to St. Vincent are "capital-related"
costs. If they are, the costs are separately reimbursable to
the hospital. If not, the cost of the scanner is subsumed in
the PPS payments already provided to St. Vincent under the
The regulations generally provide that "leases and rentals,
including licenses and royalty fees, are includable in capital
related costs. . . ." 42 C.F.R. § 413.130(b)(1). Specifically,
when the supplying organization is not related to the provider
(as in the case at bar), none of the charges to the provider
may be considered "capital-related" unless:
(i) The "capital-related" equipment is leased or
rented (as described in paragraph (b) of this
section) by the provider;
(ii) The "capital-related" equipment is located on
the provider's premises, or is located off side
and is on real estate owned, leased or rented by
the provider; and
(iii) The "capital-related" portion of the charge
is separately specified in the charge to the
42 C.F.R. § 413.130(h)(2). Thus, the question of whether or not
the CT scanner was "capital-related" turns on whether or not
the MIL-St. Vincent agreement was a "lease." Exactly what the
regulations define as a "lease" is by no means crystalline.
However, Section 413.130(b)(1) explains that the terms "lease"
or "rental of assets" signify that a provider has "possession,
use, and enjoyment of the assets."
A. The Secretary's Position
The Secretary contends that the arrangement between St.
Vincent and MIL for the provision of CT scanning services is a
"service" — not a lease. The regulations do not define
"service." However, the Secretary points out that there are
very few indicia of a contractual lease agreement. The
agreement, for example, is entitled "CT Services Contract
Agreement Between St. Vincent Memorial Hospital and Mobile
Imaging Laboratories, Inc." (Court's emphasis). Thus,
superficially, the agreement does not purport to be a lease
agreement. In addition, the Secretary claims that it is
undisputed that from October 1982 when the agreement was signed
until March 27, 1985 when the agreement was amended, that the
agreement was a service agreement. The agreement resembled a
service agreement because MIL provided all the staffing for the
CT scanner and insured St. Vincent against any failure of the
equipment. In addition, the agreement was not binding on either
party. If the CT program failed to meet expectations, St.
Vincent could either upgrade its service or discontinue its
service. The title to the CT scanner also remained with MIL,
and MIL was responsible for repairs, maintenance, and removal
of the equipment at the end of the agreement. Finally, and most
importantly, there was not a set fee for the services. Rather,
St. Vincent agreed to pay MIL a fee for "each CT procedure
performed." (Tr. 78).
The Secretary also argues that the March 27, 1985 amendments
to the St. Vincent-MIL agreement did not change the agreement
into a lease. Central to these amendments was the fact that St.
Vincent took over the function of employing the technicians who
operate the CT scanning equipment. However, the Secretary
contends that the fact that St. Vincent supplied operating
technicians does not subvert the substance of its agreement
with MIL. Indeed, the amendments did not recognize that the
agreement was transformed to a lease. In fact, the amendments
contained an option to lease the equipment at the end of the
term of the agreement. If the amendments intended the agreement
to be a lease, the Secretary argues, there would be no point in
it containing an option to lease.
Further, the fact that St. Vincent supplied the operating
technicians for the new scanner is not dispositive. St. Vincent
chose to supply the technicians, it was not required to supply
the technicians under the agreement. The implication of the
amendment was that St. Vincent, despite choosing to supply its
own technologists, could have requested MIL to take over the
staffing of the CT scanner at any time. In any event, the
staffing of the CT scanner was only a small part of the bundle
of services that MIL provided. Even after the amendments, MIL
was still ultimately responsible for the proper operations,
maintenance (including a $25,000 x-ray tube replacement), and
Finally, the Secretary cites Bethany Methodist Hospital v.
Blue Cross & Blue Shield Association/Blue Cross & Blue Shield
of Illinois, [1989-1 Transfer Binder] Medicare & Medicaid Guide
(CCH) ¶ 37,658 (PRRB Hearing Decision, February 15, 1989), for
the proposition that "possession, use and enjoyment" of the
asset is irrelevant within the context of a service agreement.
In the Bethany case, the PRRB found that "the agreement the
provider entered into was a service contract in which payments
were predicated on units of service provided." Similarly, in
the instant case, the payments St. Vincent made to MIL were
predicated on units of service provided. Therefore, the
Secretary argues, "possession, use, and enjoyment" is an
improper test to use in this case.
B. St. Vincent's Position
St. Vincent's position is that the only requirement under
federal law for leased or licensed assets to receive
"capital-related" cost treatment is that St. Vincent must have
"possession, use and enjoyment" of such assets in accordance
with 42 C.F.R. § 413.130(b)(1). Because the CT scanning
equipment at issue was (1) located only within the hospital
premises; (2) used exclusively by employees and staff of St.
Vincent for its patients; and (3) enjoyed only by St. Vincent
who established and reaped operational benefits; there is no
doubt that St. Vincent had possession, use, and enjoyment of
the CT scanning equipment.
Further, St. Vincent argues that the Secretary misreads
Bethany. In that case, the leasing company, not the provider,
furnished the technologists who actually operated the
equipment. Accordingly, the Board found that even if Bethany
Methodist Hospital did have "possession, use, and enjoyment" of
the asset, a lease was not created because the agreement was a
license to provide CT scanning services. However, in this case,
the provider did actually operate the equipment. Further,
because licenses, leases, and royalty fees are all includable
in "capital-related" costs under 42 C.F.R. § 413.130, the
determinative factor should have been whether "possession, use,
and enjoyment" of the capital equipment existed.
C. The Court's Position
(1) The Test
The Court finds that the proper test to determine whether an
asset is "capital-related" is whether the provider has
"possession, use, and control" of the asset.
42 C.F.R. § 413.130(b)(1). No consistent test has yet been adopted by the
Administrator of the HCFA or a PRRB in determining whether an
asset is "capital-related" for the facts at bar. Bethany, for
example, examined the contract for a mobile CT scanner:
The contract at issue was titled "Service
Agreement for Computerized Axial Tomography Total
Body Scanning Services." Under the terms of this
agreement, the supplier agreed to provide the CT
scanner, all supplies necessary for operation, and
personnel to perform the scans. The provider
agreed to provide a site and electrical power for
the equipment, but the supplier agreed to set up,
operate, and maintain the equipment. . . . The
Board determined that these terms described a
service contract in which payments were predicated
on units of service, similar to the provision of
radiology or pathology services by a physician who
provides equipment and services under arrangement.
The Administrator agrees with this conclusion of
the Board. Even though the contract under review
involves the furnishing of equipment, it is one
predominantly for the rendition of services. It is
not a lease or license within the meaning of
42 C.F.R. § 413.130.
Bethany, PRRB Dec. No. 89-D22, at 19,825 (Emphasis ours).
The analysis in Bethany is not particularly helpful. To begin
with, though Bethany found that the contract was "predominately
for the rendition of services," it is unclear what criteria or
which of the facts the Administrator
was emphasizing in reaching that determination. This ambiguity
causes problems in the instant case which presents a much
closer set of facts. Where in Bethany the supplier agreed to
set up, operate, and maintain the equipment, St. Vincent
personnel operated and — to some degree — maintained the CT
scanner after the 1985 amendments.
Second, it is unclear if Bethany tracks applicable
regulations. Because MIL is unrelated to St. Vincent, the Court
turns first to 42 C.F.R. § 413.130(h)(2)(i). Section
413.130(h)(2)(i) provides that no asset may be considered
"capital-related" unless the "equipment is leased or rented (as
described in paragraph (b) of this section). . . ." (Court's
emphasis). The only description of a lease or rental in
"paragraph (b)" [42 C.F.R. § 413.130(b)(1)] states that the
"terms `leases' and `rentals' of assets signify that a provider
has `possession, use, and enjoyment' of the assets." True, what
constitutes "possession, use, and enjoyment" is not further
defined in the regulations. Nevertheless, there is no attempt
in Bethany to address any question of "possession, use, and
In fact, two PRRBs, Keokuk Area Hospital v. Blue Cross and
Blue Shield Association/Blue Cross and Blue Shield of Iowa,
[1992-2 Transfer Binder] Medicare & Medicaid Guide (CCH) ¶
40,119 (PRRB Hearing Decision, March 6, 1992) and Naeve Health
Care Association v. Blue Cross & Blue Shield Association/Blue
Cross & Blue Shield of Minnesota, [1990 Transfer Binder]
Medicare & Medicaid Guide (CCH) ¶ 38,248 (PRRB Hearing
Decision, Nov. 6, 1989) avoided the "possession, use, and
control" test entirely. ("[a]lthough the provider argues that
it has possession, use, and enjoyment of the CT scanner when it
is located on the premises, this does not in and of itself
create a lease." Naeve, PRRB Hearing Dec. No. 90-D3, at 21,
419) (Emphasis ours). Instead, these decisions adopt an
alternative test: "[s]ince IAI (equipment supplier) purchased
the assets and was fully responsible for the operation,
maintenance, and liability associated with the use of the
equipment . . . [and] the ownership costs and risks of
ownership were borne solely by IAI . . . the agreement the
provider entered into was not a capital lease. . . ." Id.
The rationale behind this alternate test is that physical use
of the equipment is an inadequate parameter for determining
"possession" in the context of highly technical equipment worth
several hundred thousand dollars. In this context, the
Secretary argues that "possession" entails more significant
financial risks and responsibilities, including the insurance
liability, maintenance costs, and opportunity costs involved in
committing an organization, hospital or supplier to a
particular piece of expensive equipment.
Nevertheless, these added factors: assuming the risk,
insurance liability, etc., are simply not found in the
regulations. Nor do they comport with a fair reading of the
regulations. Normally, "possession" is equated only with having
"control" or a "qualified right" in an asset:
Possession. The detention and control, or the
manual or ideal custody, of anything which may be
the subject of property, for one's use and
enjoyment, either as owner or as the proprietor of
a qualified right in it, and either held personally
or by another who exercises it in one's place and
Black's Law Dictionary 1047 (5th ed. 1979) (Emphasis ours).
This reading is also consistent with 42 C.F.R. § 413.130(b)(1)
which includes not only leases and rentals, but licenses and
royalty fees as "capital-related" assets. In short,
"possession" does not require a heightened ownership interest
in the property (e.g. title, insurance, assuming the risks
associated with the asset). Rather, "possession" is found where
the possessee has "control" and a "qualified right" in some
asset. As the Court will show, St. Vincent had "control" of the
CT scanner in the years in question. Moreover, it had a
qualified right in the scanner because of its license to allow
its personnel to operate the scanner.
In any event, as with Bethany, Naeve and Keokuk are
distinguishable from the case at bar. These cases involve
mobile equipment which the supplier transported by truck from
hospital to hospital. The issues thus presented as to
"possession" and "use" are very different between equipment in
truck used at many hospitals and equipment here permanently
placed for St. Vincent's exclusive use on the fifth floor of
its building. In addition, Naeve and Keokuk do not address the
issue of whether the agreement is "capital-related" when the
provider maintains control of the "operation" of the asset.
(2) Possession, Use, and Control
The Court agrees with the analysis of dissenting board-member
Joseph F. Sloan that Bethany dicta indicates that St. Vincent
had "possession, use, and enjoyment" of the CT scanner. In
Bethany, the HCFA Administrator adopted the PRRB's
determination that the CT scanner agreement at issue was a
"license." Further, the Administrator found that:
The regulation does not authorize capital
pass-through payments for all licenses. A
qualifying license is one permitting a hospital to
use a piece of depreciable equipment. The Board did
not find the license to be for the provider to use
a depreciable asset, but for the supplier to be
permitted entry on the provider's premises in order
for the supplier to place the CT scanner in service
and to operate it.
Bethany, PRRB Dec. No. 89-D22 at ¶ 19,825. (Emphasis ours).
Importantly, unlike Bethany where the equipment supplier's own
technicians operated the CT scanner, the 1985 amendments
"permitted" St. Vincent to "use" the CT scanner equipment.*fn1
Not only did St. Vincent personnel operate the scanner, but St.
Vincent also established charges for the service and rendered
services only to St. Vincent patients through St. Vincent's
medical staff. In all respects, St. Vincent had complete
control of the use of the equipment. Indeed, the Secretary
concedes the fact that St. Vincent had "use" of the equipment
(per 42 C.F.R. § 413.130(b)(1)) in its response. St. Vincent's
control of the CT scanner, and its "qualifying license" to use
a piece of depreciable equipment, supports this Court's finding
that St. Vincent had "possession, use, and enjoyment" of the
(3) Separate Specification of a Capital Asset
Finally, the Secretary argues that St. Vincent did not comply
with the third prong of 42 C.F.R. § 413.130(h)(2). This prong
requires that the "capital-related" portion of a charge must be
separately specified in the charge to a provider. In this case,
the Secretary contends that neither the initial agreement nor
the 1985 amendments split out the "capital-related" portion of
MIL's charges. The PRRB confirms this argument in its finding
The majority of the Board rejects the Provider's
belated attempt to comply with the separate charge
provision by having a `capital-related' amount
typed unto (sic) MIL's monthly invoices. The
`capital-related' amounts included on the invoices
are neither supported by any of the compensation
provisions of the contractual agreement nor by any
corroborative calculation of how the
`capital-related' portion was determined.
PRRB Decision at 10.