JACKSON PARK HOSPITAL FOUNDATION v. UNITED STATES

ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

DAVIS, Judge:

Jackson Park Hospital Foundation (Foundation) asks reimbursement under the Medicare Act, 42 U.S.C. § 1395 et seq. (1976) (amended Supp. III 1979), for costs based on the depreciation of its hospital and on interest payments it made. The Government says that regulations promulgated under the Act, 42 U.S.C. §§ 1395x(v)(1)(A), 1395hh (1976), prevent further reimbursement because of the close relationship between the Foundation and its seller and lender. The case properly comes before us on cross-motions for summary judgment. We hold for the defendant.

I

Plaintiff Foundation is a not-for-profit corporation that purchased, on March 31, 1967, nearly all of the stock of Hospital Company, Inc. (Company), a for-profit corporation which then owned and operated Jackson Park Hospital, a provider of services under the Medicare program. Company was liquidated the next day, and Foundation operated the hospital as a provider. According to the administrators, the purchase price for the hospital was $3,012,268, consisting of $462,454 in cash and $2,549,814 in 4% sinking fund bonds issued to Company's participating shareholders. It is admitted, for the purposes of this case, that these were reasonable figures, within the range of fair market values.

In seeking reimbursement for its services under the Medicare Act for the periods ending March 31, 1968 through 1972, the plaintiff claimed depreciation expenses based on the purchase price it paid for the hospital and on interest expenses for the 4% bonds. The Blue Cross Association and Hospital Service Corporation (the Plan), the fiscal intermediary that initially determines the amount of reimbursement the plaintiff is entitled to under the Act, decided that Jackson Park Hospital Company and Jackson Park Hospital Foundation were organizations related through common control, within the meaning of the Medicare regulations, 42 C.F.R. §§ 405.419(c)(1) and 405.4271 — directives which restrict reimbursement for depreciation and interest. After some intermediate steps, now irrelevant,2 the Hearing Officers denied all depreciation above Company's historical cost and also denied all interest. From this decision the plaintiff unsuccessfully appealed within the agency and then sought relief from the District Court for the Northern District of Illinois, which transferred the case to this court pursuant to 28 U.S.C. § 1406(c) (1976).3

II

The opening question is whether Foundation was related to Company within the Medicare regulations on depreciation and interest (42 C.F.R. § 405.419 and § 405.427, supra, note 1). There is no material dispute as to the underlying facts found by the Hearing Officers. Seven of the twelve directors of Foundation were themselves, or through marriage, owners of 83% of Company's common stock and the president of Foundation's board of directors owned 80% of Company's common stock.4 Plaintiff attacks, however, the ultimate administrative conclusion that there was common control of Company (the seller) and Foundation (the buyer).

Whatever our standard of review of that ultimate conclusion,5 we uphold it as a correct application of the regulations, supported by substantial evidence, and neither arbitrary nor capricious. That the people who "owned" the Company "controlled" but did not also "own" the non-profit Foundation is surely not dispositive; Company's majority stockholder-owners plainly controlled it, as the administrators implicitly found.6 The same persons therefore controlled both entities. Several judicial holdings are quite comparable. See, e. g., Stevens Park Osteopathic Hospital, Inc. v. United States, 225 Ct.Cl. 113, ___, 633 F.2d 1373, 1378-79 (1980), in which the court upheld the intermediary's finding of relatedness (the plaintiff had not challenged it) based on an assessment that one Dr. X had the power to play a significant role in the management and control of both the seller and the buyer in the transaction there involved (Dr. X owned 75 percent of the seller's stock and held powerful positions in the management of the buyer); Goleta Valley Community Hospital v. Schweiker, 647 F.2d 894, 896-97 (9th Cir. 1981) (the non-profit buyer's trustee-members were also partners in the for-profit seller); American Hospital Management Corp. v. Harris, 638 F.2d 1208 (9th Cir. 1981) (three of seven of seller's partners had a 30% interest in buyer; president of seller was the only general partner of buyer); Fairfax Hospital Ass'n v. Mathews, 459 F.Supp. 429 (E.D.Va.1977), aff'd sub nom Fairfax Hospital Ass'n v. Califano, 585 F.2d 602 (4th Cir. 1978) (sole owner of a supplier-pharmacy was a member of the provider-hospital's Board of Directors, had originated the plan to build the hospital, and owned 6.3% of its stock). The two organizations in this case were obviously "related" under the regulations.

III

This court has already upheld the validity of § 405.427 (the regulation bearing on the depreciation allowance, note 1, supra) in the somewhat different context of an ongoing relationship, holding that the section supports the purposes of the Medicare Act and provides an acceptable rule for defining "reasonable cost" under 42 U.S.C. § 1395x(v)(1)(A). Stevens Park Osteopathic Hospital, Inc. v. United States, supra, 225 Ct.Cl. 113, ___, 633 F.2d 1373, 1379-80 (1980) (lease terminating in sale); Pasadena Hospital Ass'n v. United States, 223 Ct.Cl. 72, ___, 618 F.2d 728, 732-34 (1980) (lease only). Plaintiff asks us not to apply the same ruling to a one-time sale, as the present one is said to be.7 We reject this invitation and the arguments plaintiff advances.8

First, the regulation's language can apply beyond long-term relationships. Even though the word "sale" never appears, the phrases "costs applicable to * * * facilities * * * furnished to the provider" and "[w]here the provider obtains * * * facilities," see § 405.427(a), (c)(2), can readily apply to a single acquisition by purchase, as well as to an ongoing lease (or other long-term arrangement). Although the example given in section (c)(2) of the regulation describes a lease arrangement, it is no more than an example and does not confine the regulation to that particular situation.9

Secondly, the purposes of § 405.427 apply equally to one-time sales and on-going relationships. The rule has been described as both a prophylactic measure and a means of defining "costs." Stevens Park Osteopathic Hospital, Inc. v. United States, supra, 225 Ct.Cl. at ___, 633 F.2d at 1379, says: "[T]his regulation like other `related organization' rules, is intended to have a `prophylactic' effect in guarding against bad faith dealing between organizations related through common control without inquiry into particular circumstances. * * * It is evident that inquiry into the fairness of transactions between related parties would be a demanding task indeed for the fiscal intermediary, while inquiry into the usually simpler issue of common control probably would have to take place anyway." In Stevens Park, supra, the sale of the hospital terminated a five or six year lease agreement, and so the court treated the relationship as an ongoing one.10 But the prophylactic rule is useful even for a one-time sale. Although it might be easier for the Secretary to look only once into the possibility of self-dealing than to monitor the problem repeatedly as an ongoing relationship could require, it is still a burdensome task, as the court in Stevens Park noted. And the possibility of self-dealing (with resulting excessive or unnecessary charges to Medicare) is as real for a one-time sale as for continuous dealings.11

Connected with this prophylactic goal, § 405.427 embodies a special objective that likewise makes the provision applicable to one-time sales. See Pasadena Hospital Ass'n v. United States, supra, 223 Ct.Cl. at ___, 618 F.2d at 732-33 (1980) (§ 405.427 defines "cost" — for situations in which the parties are related — as cost to the seller, not cost to the buyer). For a one-time sale between related parties, § 405.427 accomplishes the Secretary's goal, expressed repeatedly in 42 C.F.R. § 405.415, of triggering the realization of appreciation (for purposes of obtaining reimbursement for depreciation) only when there is a bona fide transaction ending in a bona fide change in ownership. 42 C.F.R. § 405.415(g). Section 405.427 says that "[w]here the provider obtains items of services, facilities, or supplies from an organization, even though it is a separate legal entity, and the organization is owned or controlled by the owner(s) of the provider, in effect the items are obtained from itself." § 405.427(c)(2). See Stevens Park, supra, 225 Ct.Cl. at ___, 633 F.2d at 1379. Thus, § 405.427 makes it certain that, when the parties to a transaction are related because of common ownership or control, there should be no revaluation upward of the property by fiat of the joint controlling interest. Medicare is not to pay for, or be loaded with, increased costs brought about simply by a sale from one entity to its alter ego.

The sum of it is that the prophylactic rule of § 405.427, as applied here, reasonably supports the dual goals of helping the administrators avoid paying collusive or improperly increased costs, and of reducing the administrative burden.

It does not help Foundation to rephrase its objections to § 405.427 as creating an impermissible irrebuttable presumption against providers who buy from related sellers. The regulation establishes a rational prophylactic provision, which itself constitutes the substantive rule, not a presumption of the existence of another underlying fact (such as overreaching or lack of bona fides). In the social security context of Medicare, such reasonable prophylactic provisions are acceptable for reimbursement of a provider's costs. See Weinberger v. Salfi, 422 U.S. 749, 774 et seq., 95 S.Ct. 2457, 2471, 45 L.Ed.2d 422 (1975). Foundation is not in a "suspect" class entitled to heightened protection, and there are no fundamental rights at stake. Under the normal standard, as we have shown, § 405.427 must be upheld.12

IV

The same factors sustain § 405.419 (note 1, supra), barring interest paid to related lenders, and there is no need to duplicate our analysis. Foundation tries, of course, to appeal to Trustees of Indiana University v. United States, 223 Ct.Cl. 88, 618 F.2d 736 (1980). The court there made an exception to § 405.419 limited to those particular facts — the provider was a non-profit hospital affiliated with a state university, received no money from the state, was prohibited by law from borrowing outside, and received its loan from the university at a below-market rate of interest. The low interest rate suggested that the hospital and university did not in fact collude to obtain excessive rates, and there was no suggestion that the loans were unnecessary. Equally important, the circumstances virtually ruled out the likelihood of collusion or undue influence of any kind: — neither the state university nor the non-profit hospital had a profit motive, and the university had only limited control of the hospital. Also, the provider's situation was such that it would have created a plain injustice to disallow its interest payments since it was unable by law to obtain funds on the open market.13 This special exception carved out in Trustees cannot be used in the current case where none of those elements exists. Rather, the seller (Company) was a for-profit corporation, said to be nearly bankrupt, and the possibility of tainted purposes cannot be automatically ruled out.

Plaintiff also invokes the express exception in the regulation for loans between related parties made prior to July 1, 1966, but we affirm the decision of the agency that the loan here does not fall within that qualification. Whether or not this separate treatment is available for loans made but not consummated prior to that date — the agency held not, see also Northwest Hospital, Inc. v. Hospital Service Corp., 500 F.Supp. 1294, 1296 (N.D.Ill.1980) — the regulation clearly requires that "the terms and conditions of payment of such loans have been maintained in effect without modification subsequent to July 1, 1966." 42 C.F.R. § 405.419(c)(2). Company and Foundation modified their agreement in December 1966 to reflect a reduction in the purchase price of the hospital recommended by the Internal Revenue Service so that Foundation could retain its tax exempt status. As a result, an agreement was made in December 1966 to issue the 4% sinking fund bonds to cover $129 per share of the new $130 purchase price of the common stock, instead of $137 per share on $138 as originally agreed before July 1, 1966. This modification in the amount of the loan removes the agreement from the exception and bars recovery, based on that exception, for interest costs between these related parties.14

Finally, Foundation seeks partial reimbursement for interest on the portion of the loan that covers the seller's historical cost for the facility. This claim misconceives the words and structure of § 405.419(c). In its terms, the section bars all interest. The regulation denies interest not so much because of the nature of the transaction for which the loan is obtained but because of the source of the loan. Section 405.419(c) is not as concerned that the sale was between related parties (except to the extent that the necessity of such a sale, and hence of a loan to pay for it, is in doubt) as it is that the loan was between related parties. Thus, even if the sale had been between strangers, § 405.419(c) would operate so long as the loan to pay for it came from a related entity. The Secretary considers it more likely that, when a loan is made between unrelated parties bargaining at arms length, the interest rate will prove reasonable and the loan itself necessary. The Secretary's allowance here of the seller's historical cost for purposes of depreciation reveals nothing about the necessity or propriety of interest payments for a loan to cover the sale (even at that cost) to a related organization. The Secretary would therefore be required to examine the bona fides and reasonableness of the loan even for the pro-rated amount — precisely the kind of investigation the regulation is designed to avoid. In that respect the across-the-board scope of § 405.419(c) is reasonable and acceptable. We therefore hold that the plaintiff is not entitled to reimbursement for a pro-rata portion of its interest payments.15

For these reasons, plaintiff's motion for summary judgment is denied and defendant's cross-motion is granted. The petition is dismissed.