Rfk Medical Center v. Leavitt ( 2008 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
ROBERT F. KENNEDY MEDICAL 
CENTER,
Plaintiff-Appellant, No. 06-56367
v.
 D.C. No.
CV-05-01628-AG
MICHAEL O. LEAVITT, Secretary of
the Department of Health and OPINION
Human Services,
Defendant-Appellee.

Appeal from the United States District Court
for the Central District of California
Andrew J. Guilford, District Judge, Presiding
Argued and Submitted
April 11, 2008—Pasadena, California
Filed May 19, 2008
Before: Alfred T. Goodwin, Harry Pregerson, and
Dorothy W. Nelson, Circuit Judges.
Opinion by Judge Goodwin
5735
ROBERT F. KENNEDY MEDICAL v. LEAVITT 5737
COUNSEL
Patric Hooper, Hooper, Lundy & Bookman, Los Angeles,
California, for the plaintiff-appellant.
Michael S. Raab, Joel McElvain, U.S. Department of Justice,
Washington, D.C., for the defendant-appellee.
OPINION
GOODWIN, Circuit Judge:
Robert F. Kennedy Medical Center (“RFK”) appeals the
district court’s summary judgment, which affirmed the denial
of RFK’s Medicare reimbursement request by the Secretary of
Health and Human Services (“Secretary”). RFK contends that
the Secretary must reimburse it for depreciation losses result-
ing from its disposal of assets through a statutory merger. The
district court held that RFK is not eligible for reimbursement
because this merger did not qualify as a “bona fide sale”
under 42 C.F.R. § 413.134(f). We agree, and affirm the judg-
ment.
I
Title XVIII of the Social Security Act establishes Medi-
care, a federally funded health insurance program for the
5738 ROBERT F. KENNEDY MEDICAL v. LEAVITT
elderly and disabled. 42 U.S.C. §§ 1395 et seq. The Centers
for Medicare and Medicaid Services (“CMS”), formerly cal-
led the Health Care Financing Administration (“HCFA”),
administers the Medicare program on behalf of the Secretary.
Providers of Medicare services are eligible for reimburse-
ment of “the reasonable cost of such services.” Id.§ 1395f(b)(1). The statute defines “reasonable cost” as “the
cost actually incurred” by providers. Id. § 1395x(v)(1)(A).
Under regulations promulgated by the Secretary, providers
may claim reimbursement for “depreciation on buildings and
equipment used in the provision of patient care.” 42 C.F.R.
§ 413.134(a). The depreciation reimbursement amount is cal-
culated by taking the “cost incurred by the present owner in
acquiring the asset,” id. § 413.134(b)(1), and prorating it
“over the estimated useful life of the asset,” usually using the
“straight-line method” of depreciation. Id. § 413.134(a)(2)-
(3). Medicare reimburses providers for the percentage of
depreciation attributable to treatment of Medicare patients.
Depreciation only approximates an asset’s decrease in
value. To ensure that Medicare providers are reimbursed for
actual costs, 42 C.F.R. § 413.134(f) requires an adjustment
when “gains” or “losses” result from certain disposals of
depreciable assets: “If disposal of a depreciable asset . . .
results in a gain or loss, an adjustment is necessary in the pro-
vider’s allowable cost. . . . The treatment of the gain or loss
depends upon the manner of disposition of the asset, as speci-
fied in paragraphs (f)(2) through (6) of this section.”
The only disposition that is relevant in this case is (f)(2),
which governs gains and losses resulting from a “bona fide
sale” of depreciable assets. See id. § 413.134(f)(2). When
Medicare providers dispose of assets in a “bona fide sale” and
receive a “lump sum sale price,” the regulations require them
to “allocat[e] the lump sum sales price among all the assets
sold, in accordance with the fair market value of each asset
. . . .” Id. § 413.134(f)(2)(iv). If providers receive consider-
ROBERT F. KENNEDY MEDICAL v. LEAVITT 5739
ation that is less than the net book value of the depreciable
asset, Medicare reimburses the provider for Medicare’s share
of the “loss.” See id. § 413.134(f); Via Christi Reg’l Med.
Ctr., Inc. v. Leavitt, 509 F.3d 1259, 1262 (10th Cir. 2007). If
the consideration exceeds the asset’s net book value, the pro-
vider must reimburse Medicare for Medicare’s share of the
“gain.” See 42 C.F.R. § 413.134(f); Via Christi Reg’l Med.
Ctr., 509 F.3d at 1262.
Regulations also address the effect of a statutory merger
involving a Medicare provider. See 42 C.F.R. § 413.134(k)(2).1
First, a gain or loss resulting from disposal of depreciable
assets is not allowed when the parties to a statutory merger
are “related.” Id. § 413.134(k)(2)(i)-(ii); see also id.
§ 413.17(b)(1) (defining “related”). Second, § 413.134(k)
(2)(i) states that merged providers are “subject to the provi-
sions of paragraphs (d)(3) and (f) of this section concerning
recovery of accelerated depreciation and the realization of
gains and losses.” Thus, the regulation on statutory mergers
incorporates 42 C.F.R. § 413.134(f), which specifies the cir-
cumstances in which gains or losses are allowable following
a disposal of depreciable assets.
The Secretary interprets these regulations as allowing an
adjustment for gains or losses resulting from a statutory
merger only if the provider’s depreciable assets were trans-
ferred through one of the categories of disposal listed in
§ 413.134(f). See Principles of Reimbursement for Provider
Costs and for Services by Hospital-Based Physicians,
44 Fed. Reg. 6912, 6913 (Feb. 5, 1979); Program Memoran-
dum A-00-76, at 3 (Oct. 19, 2000), available at http://
www.cms.hhs.gov/transmittals/downloads/A0076.pdf. Under
the Secretary’s interpretation, Medicare will not recognize a
gain or loss on a disposal of depreciable assets through a stat-
1
At the time of the statutory merger in this case, 42 C.F.R. § 413.134(k)
was codified at 42 C.F.R. § 413.134(l). The provision was originally codi-
fied at 42 C.F.R. § 405.415(l).
5740 ROBERT F. KENNEDY MEDICAL v. LEAVITT
utory merger unless the merger qualifies as a “bona fide sale”
under § 413.134(f)(2). See Program Memorandum A-00-76,
at 3.
The Secretary also has interpreted the meaning of the term
“bona fide sale.” In 1996, the HCFA revised the Medicare
Provider Reimbursement Manual to state that “[a] bona fide
sale contemplates an arm’s length transaction between a will-
ing and well informed buyer and seller, neither being under
coercion, for reasonable consideration.” Provider Reimburse-
ment Manual § 104.24; see also Via Christi Reg’l Med. Ctr.,
509 F.3d at 1267. In 2000, the HCFA stated that “in evaluat-
ing whether a bona fide sale has occurred in the context of a
merger or consolidation between or among non-profit entities,
a comparison of the sales price with the fair market value of
the assets acquired is a required aspect of such analysis.” Pro-
gram Memorandum A-00-76, at 3. In the context of a statu-
tory merger between Medicare providers, “a large disparity
between the sales price (consideration) and the fair market
value of the assets sold indicates the lack of a bona fide sale.”
Id.II
Prior to the statutory merger at issue in this case, RFK and
St. Francis Medical Center (“St. Francis”) operated separate
hospitals in California. Catholic Healthcare West (“CHW”)
was the sole corporate member of St. Francis. All entities
were non-profit public benefit corporations. RFK provided
hospital services to Medicare patients under a contract with
the Secretary.
In January 1996, RFK began negotiating with CHW
regarding a potential merger with St. Francis. RFK and CHW
both were represented by their own counsel and negotiating
teams. The negotiations included discussion on “post-merger
governance and operational issues and the price to be paid for
the non-hospital assets.” The parties agreed that RFK would
ROBERT F. KENNEDY MEDICAL v. LEAVITT 5741
merge into St. Francis, and that RFK would cease to exist.
The statutory merger occurred on May 30, 1996. As the sur-
viving corporation, St. Francis changed its name to Catholic
Healthcare West Southern California (“CHW-SC”).
Under the merger agreement, CHW-SC became the new
corporate owner of RFK’s assets and liabilities. RFK trans-
ferred approximately $29 million in current assets (including
cash and cash equivalent) and approximately $21 million in
fixed assets (including land, buildings and equipment). In
exchange, CHW-SC assumed approximately $30.5 million of
RFK’s net liabilities. Thus, RFK transferred assets with a
value of approximately $50 million in exchange for $30.5
million in “consideration” from CHW-SC.
RFK then filed a terminating cost report with Medicare’s
fiscal intermediary, claiming that the merger resulted in a
reimbursable loss from RFK’s disposal of depreciable assets.
In calculating the effect of the merger, the cost report allo-
cated CHW-SC’s consideration (the assumption of liabilities)
to the current assets transferred by RFK (cash and cash equiv-
alent). After this initial allocation, there was no consideration
left to allocate to the depreciable fixed assets transferred by
RFK, including buildings and equipment. RFK claimed a total
loss on these depreciable assets, and sought reimbursement
for Medicare’s share of the loss.
The fiscal intermediary audited RFK’s cost report and
denied the claim. The intermediary gave three reasons for dis-
allowing the loss. First, the intermediary concluded that 42
C.F.R. § 413.17 barred the claim because RFK and St. Francis
were related parties prior to the merger. Second, the interme-
diary stated that the merger was not a “bona fide sale” under
42 C.F.R. § 413.134(f)(2). Third, the intermediary found that
the merger was a “pooling of interests” under accepted
accounting principles, with no resulting gain or loss.
RFK appealed to the Provider Reimbursement Review
Board (“PRRB”), which reversed the fiscal intermediary’s
5742 ROBERT F. KENNEDY MEDICAL v. LEAVITT
determination. The PRRB found no evidence that the parties
were related prior to the merger. It also concluded that the
merger qualified as a “bona fide sale” because “RFK deter-
mined on its own initiative that it should seek affiliation with
a larger health system” and “RFK requested and considered
[merger] proposals from various interested parties.” The
PRRB rejected the fiscal intermediary’s “pooling of interests”
rationale because “[t]he treatment afforded a transaction for
financial statement and Internal Revenue Service purposes
does not control the treatment required for Medicare pur-
poses.”
The CMS Administrator reversed the PRRB’s decision.
First, the Administrator concluded that RFK was related to
CHW-SC, the surviving entity, and that no reimbursable loss
occurs when assets are transferred in a related-party transac-
tion. Second, the Administrator found that the statutory
merger did not qualify as a “bona fide sale”:
[T]he record shows that the Provider transferred
“current assets” valued at approximately $29 million
and “fixed assets” valued at $21 million in
exchanged [sic] for approximately $30.5 million in
net liabilities. This resulted in assets with a net book
value of $50 million being transferred for a total of
$30.5 million in “consideration.” The Administrator
finds that the large disparity of approximately $20
million, between the asset values and the consider-
ation received, reflects the lack of arm’s length bar-
gaining, and thus the lack of a bona fide sale.
As a result, the Administrator concluded that RFK’s loss did
not qualify for reimbursement under 42 C.F.R. § 413.134(f).
RFK appealed to federal district court, which affirmed the
CMS Administrator’s decision. Under Thomas Jefferson Uni-
versity v. Shalala, 512 U.S. 504 (1994), the district court
deferred to the agency’s interpretation of the Medicare regula-
ROBERT F. KENNEDY MEDICAL v. LEAVITT 5743
tions. The court held that the statutory merger was not a “bona
fide sale” because RFK did not receive fair market value for
its assets. Because the district court concluded that RFK was
not entitled to reimbursement, it did not reach the “related
parties” issue.
This appeal followed.
III
RFK contends that the district court erred by affirming the
final agency decision, which held that RFK could not claim
a “loss” on its disposal of assets because its statutory merger
did not qualify as a “bona fide sale.” RFK argues that the Sec-
retary’s decision was arbitrary, and that the “bona fide sale”
requirement does not apply to disposals of assets in the con-
text of statutory mergers. The Secretary contends that the
“bona fide sale” requirement is consistent with the text and
purposes of Medicare statutes and regulations.
[1] The Administrative Procedure Act requires courts to
“hold unlawful and set aside” agency action that is “arbitrary,
capricious, an abuse of discretion, or otherwise not in accor-
dance with law.” 5 U.S.C. § 706(2)(A). We also must set
aside an agency action that is “unsupported by substantial evi-
dence.” Id. § 706(2)(E). Courts must give “substantial defer-
ence” to the Secretary’s interpretation of Medicare
reimbursement regulations. Thomas Jefferson Univ., 512 U.S.
at 512. Under this standard of review,
the agency’s interpretation must be given controlling
weight unless it is plainly erroneous or inconsistent
with the regulation. In other words, we must defer to
the Secretary’s interpretation unless an alternative
reading is compelled by the regulation’s plain lan-
guage or by other indications of the Secretary’s
intent at the time of the regulation’s promulgation.
5744 ROBERT F. KENNEDY MEDICAL v. LEAVITT
Id. (internal quotation marks and citations omitted). This
“broad deference” is especially warranted because Medicare
regulations are “complex and highly technical” and determi-
nations in this area “necessarily require significant expertise
and entail the exercise of judgment grounded in policy con-
cerns.” Id. (internal quotation marks and citations omitted).
[2] The Secretary’s interpretation that the realization of
gains or losses on a statutory merger requires a “bona fide
sale” is a reasonable construction of the Medicare regulations.
The regulation governing statutory mergers, 42 C.F.R.
§ 413.134(k)(2), incorporates 42 C.F.R. § 413.134(f), which
lists the categories of asset disposal that trigger readjustment
for gains or losses. See 42 U.S.C. § 413.134(k)(2)(i) (stating
that merged providers are “subject to the provisions of para-
graph[ ] . . . (f) of this section concerning . . . the realization
of gains and losses.”). A “bona fide sale” is the only category
listed in § 413.134(f) that arguably applies to a disposal of
assets through statutory merger. See id. § 413.134(f)(2)-(6);
Via Christi Reg’l Med. Ctr., 509 F.3d at 1275. Thus, the Sec-
retary reasonably interpreted these regulations as allowing
gains or losses on the disposal of depreciable assets only
when the statutory merger qualifies as a “bona fide sale.”
[3] The Secretary’s interpretation that a “bona fide sale”
requires “reasonable consideration” and a “comparison of the
sales price with the fair market value of the assets” also is
supported by the text and purpose of the Medicare statutes.
Providers are entitled to reimbursement only for the “cost
actually incurred” in servicing Medicare patients. 42 U.S.C.
§ 1395x(v)(1)(A). As the Secretary noted when promulgating
42 C.F.R. § 413.134(f), “if a gain or loss is realized from [a]
disposition, reimbursement for depreciation must be adjusted
so that Medicare pays the actual cost the provider incurred.”
See Principles of Reimbursement for Provider Costs and for
Services by Hospital-based Physicians, 44 Fed. Reg. 3980(Jan. 19, 1979) (emphasis added). The Secretary’s require-
ments of “reasonable consideration” and “fair market value”
ROBERT F. KENNEDY MEDICAL v. LEAVITT 5745
ensure that Medicare reimburses actual costs, instead of pro-
viding a windfall to providers.
In a case with similar facts, the Tenth Circuit recently
upheld the Secretary’s interpretation of these Medicare regu-
lations. In Via Christi Regional Medical Center, the court
analyzed the Secretary’s “bona fide sale” requirement in the
context of a consolidation between Medicare providers. See
509 F.3d at 1274-77. The Tenth Circuit held that the Secre-
tary’s interpretation was reasonable, and noted that “[e]ven if
a consolidation or statutory merger is not a ‘sale’ per se, treat-
ing it as a sale pursuant to § 413.134(f)(2) ensures that any
depreciation adjustment will represent economic reality,
rather than mere ‘paper losses.’ ” Id. at 1275. The Tenth Cir-
cuit’s reasoning is persuasive.
RFK contends that the “bona fide sale” requirement for
statutory mergers contradicts the Secretary’s intent at the time
of the regulation’s promulgation. RFK argues that a document
known as the “Wolkstein Letter”2 states that statutory mergers
are to be treated as if they are bona fide sales. This argument
misses the point that the Wolkstein Letter merely clarifies
that, unlike purchase of capital stock, statutory mergers effect
a change in asset ownership. The letter does not address
whether statutory mergers also must meet the “bona fide sale”
requirement to qualify for gains or losses under 42 C.F.R.
§ 413.134(f). Thus, the Wolkstein Letter does not contradict
the Secretary’s interpretation, which is reasonable and entitled
to deference. See Thomas Jefferson Univ., 512 U.S. at 512.
[4] In this case, substantial evidence supports the Secre-
tary’s determination that RFK’s statutory merger was not a
“bona fide sale.” First, the transaction lacked “reasonable con-
sideration.” See Via Christi Reg’l Med. Ctr., 509 F.3d at 1267.
2
The letter is dated January 24, 1974, and was written by Irwin Wolk-
stein, Deputy Director for Program Policy at the Department of Health,
Education and Welfare’s Bureau of Health Insurance.
5746 ROBERT F. KENNEDY MEDICAL v. LEAVITT
The CMS Administrator noted that RFK transferred approxi-
mately $50 million in assets for $30.5 million in “consider-
ation” from CHW-SC. As the Secretary argues, CHW-SC
paid almost nothing for RFK’s hospital buildings and equip-
ment despite their appraised value of approximately $12 mil-
lion.
[5] Second, the Administrator concluded that RFK did not
attempt to obtain “fair market value” for its assets. See id. at
1276 (“In the ‘bona fide sale’ context, the reasonable consid-
eration inquiry involves determining whether the provider
received fair market value for its assets.”). RFK gave several
reasons for seeking a merger, none of which involved the
receipt of fair market value. Similarly, none of RFK’s criteria
for selecting a merger partner involved receiving a fair price
for its assets.
[6] The district court correctly concluded that substantial
evidence supports the Secretary’s determination. RFK is ineli-
gible for reimbursement under 42 C.F.R. § 413.134(f) because
its statutory merger with CHW-SC does not qualify as a
“bona fide sale.” Because this issue is dispositive in this case,
we do not reach the “related parties” issue.
AFFIRMED.