Select Specialty Hospital—Bloomington, Inc. v. Burwell

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 14, 2014 Decided July 8, 2014

No. 12-5355

SELECT SPECIALTY HOSPITAL - BLOOMINGTON, INC., ET AL.,

APPELLANTS

v.

SYLVIA MATHEWS BURWELL, SECRETARY, UNITED STATES

DEPARTMENT OF HEALTH AND HUMAN SERVICES,

APPELLEE

Consolidated with 12-5358

Appeals from the United States District Court

for the District of Columbia

(No. 1:09-cv-02008)

(No. 1:09-cv-02362)

David J. Bird argued the cause for appellants. With him

on the briefs were Andrew C. Bernasconi and Daniel Z.

Herbst.

Joshua P. Waldman, Attorney, U.S. Department of

Justice, argued the cause for appellee. With him on the brief

were Stuart F. Delery, Assistant Attorney General, Ronald C.

Machen Jr., U.S. Attorney, and Michael S. Raab, Attorney.

2

R. Craig Lawrence, Assistant U.S. Attorney, entered an

appearance.

Before: ROGERS, BROWN and MILLETT, Circuit Judges.

Opinion for the Court filed by Circuit Judge BROWN.

BROWN, Circuit Judge. A group of long-term care

hospitals challenges the Secretary’s determination that,

because the organizations operate out of buildings previously

owned by hospital entities, they are not “new hospitals.”

Because we cannot tell how the Secretary arrived at this

conclusion, we find it arbitrary and capricious.

I

Hospitals are costly to build. Medicare has traditionally

provided for a “return on equity capital” for the construction

of such buildings, which includes “depreciation, interest,

taxes, insurance and similar expenses . . . for plant and fixed

equipment, and for moveable equipment.” Capital Payments

Under the Inpatient Hospital Prospective Payment System, 52

Fed. Reg. 33,168, 33,168 (Sept. 1, 1987). Up until the late

1980s, capital reimbursements were provided on a reasonable

cost basis—that is, “on the basis of current costs of the

individual provider, rather than costs of a past period or fixed

negotiated rate.” 42 C.F.R. § 413.5(a) (explaining the

reasonable-cost reimbursement scheme); 52 Fed. Reg. at

33,168.

In 1987, Congress directed the Secretary of Health and

Human Services to develop a capital recovery scheme for

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hospitals through the inpatient prospective payment system,1

rather than the reasonable-cost reimbursement method. See

Omnibus Budget Reconciliation Act of 1987, Pub. L. No.

100-203, § 4006(b)(1), 101 Stat. 1330 (1987); see also 42

U.S.C. § 1395ww(g)(1). It also authorized the Secretary to

provide for appropriate exceptions to the capital prospective

payment system. 42 U.S.C. § 1395ww(g)(1)(B)(iii). To

comply with the congressional directive, the Secretary

implemented a ten-year plan, which transitioned the

Department from the old reasonable-cost capital payment

system to capital repayments made through the new inpatient

prospective payment system. See Prospective Payment

System for Inpatient Hospital Capital-Related Costs, 56 Fed.

Reg. 43,358 (Aug. 30, 1991).

Under this scheme, the Secretary exempted “new

hospitals” from the inpatient prospective payment system for

the first two years of existence. Instead, such hospitals would

be entitled to 85% of their reasonable capital-related costs,

harking back to the old system. See 56 Fed. Reg. at 43,362,

43,453. A “new hospital” is a “hospital that has operated

(under previous or present ownership) for less than 2 years.”

See Changes to the Hospital Inpatient Prospective Payment

Systems and Fiscal Year 1993 Rates, 57 Fed. Reg. 39,746,

39,827 (Sept. 1, 1992); see also 42 C.F.R. § 412.300(b).

About a year after the scheme was established, the following

language was added to the existing regulations:

1

This system “reimburse[s] qualifying hospitals at prospectively

fixed rates . . . that remain static regardless of the costs incurred by

a hospital.” See Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1008

(D.C. Cir. 1999). Most hospitals are reimbursed in accordance with

a standard formula derived from national data, although some are

reimbursed at hospital-specific rates. See Adirondack Med. Ctr. v.

Sebelius, 740 F.3d 692, 694–95 (D.C. Cir. 2014).

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The following hospitals are not new hospitals:

(1) A hospital that builds new or replacement

facilities at the same or another location even if

coincidental with a change of ownership, a

change in management, or a lease arrangement.

(2) A hospital that closes and subsequently reopens.

(3) A hospital that has been in operation for more

than 2 years but has participated in the Medicare

program for less than 2 years.

(4) A hospital that changes its status from a hospital

that is excluded from the prospective payment

systems to a hospital that is subject to the capital

prospective payment systems.

57 Fed. Reg. at 39,827; see also 42 C.F.R. § 412.300(b)(1)–

(4) (codifying the exceptions). In adding these exceptions,

the Secretary explained the exemption was intended only for

“new entrants into the hospital field that do not have a historic

asset base.” See 57 Fed. Reg. at 39,790.

While the “new hospitals” exemption was originally

conceived as a temporary measure, the Secretary made it a

permanent one about ten years later. See 67 Fed. Reg. 31,404,

31,488–89 (May 9, 2002) (proposed rule); see also 67 Fed.

Reg. 49,982, 50,101 (Aug. 1, 2002) (final rule). The

provision was intended to be a “special protection to new

hospitals,” given concerns that “prospective payments . . .

may not be adequate initially to cover the capital costs of

newly built hospitals.” See 67 Fed. Reg. at 50,101. But, the

Secretary said, the exemption would “only be available to

those hospitals that have not received reasonable cost-based

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payments under the Medicare program in the past, and would

need special protection during their initial period of

operation.” Id.

A group of long-term care hospitals (“the Hospitals”), all

associated with the Select Specialty Hospitals organization,

identified themselves as “new hospitals” within the meaning

of 42 C.F.R. § 412.300(b). They claimed capital-cost

reimbursements under the 85% “reasonable cost basis” rule,

rather than the formulae provided by the prospective payment

system. See J.A. at 155, 232. Most of the hospitals are

“hospitals-within-hospitals”—independent entities that

operate in the same building or campus as an established

“host” hospital. J.A. at 154, 231. In contrast, some are

freestanding hospitals. J.A. at 154–55.

An intermediary disagreed with the Hospitals’ self-

determined “new hospital” designation and reduced the

amount of capital recovery. J.A. at 155, 232. The Hospitals

appealed the intermediary’s decision to the Provider

Reimbursement Review Board (“the Board”). In considering

the appeal, the Board determined the meaning of “hospital”

under § 412.300(b) was ambiguous, as it was unclear whether

the term referred to the institutional entity, the brick-and-

mortar asset, or both. J.A. at 161, 237. As the parties

stipulated that “all of the [leased] buildings . . . were operated

by [a] hospital for more than 2 years prior to the lease

arrangement,” the Board determined the designation did not

apply. J.A. at 162, 238; see also J.A. at 156, 232. Two board

members dissented, arguing the majority unceremoniously

disregarded the newly-formed nature of the business entity

and the enormous capital expenditures involved in

rehabilitating and reconstructing the facilities. See J.A. at

167–68, 242–43. The Medicare Administrator upheld the

Board’s decision.

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The Hospitals challenged the Board’s decision in district

court, but the same outcome awaited them.2 When presented

with the Government’s motion for summary judgment, the

district court concluded both sides offered plausible

interpretations of 42 C.F.R. § 412.300(b): one that permitted

consideration of physical assets, and one that precluded it.

See J.A. at 330. It also found the exceptions of §

412.300(b)(1)–(4) added to the interpretive disarray. Calling

the prefatory language “regrettably . . . ambiguous,” the court

suggested “the ensuing examples [could be] merely examples,

but also could be interpreted as enumerating an exclusive

list.” See Select Specialty Hosp.—Bloomington, Inc. v.

Sebelius, 774 F. Supp. 2d 332, 340 (D.D.C. 2011). In light of

the ambiguity, it proceeded to uphold the Board’s

determination as both reasonable and supported by substantial

evidence. The Hospitals appealed.

II

We review a district court’s grant of summary judgment

de novo, “which is to say we ‘review the administrative action

directly, according no particular deference to the judgment of

the District Court.’” Roberts v. United States, 741 F.3d 152,

157–58 (D.C. Cir. 2014) (quoting Holland v. Nat’l Mining

Ass’n, 309 F.3d 808, 814 (D.C. Cir. 2002)). While we

2

Because it was unclear whether the agency’s decision applied to

the freestanding hospitals, the district court remanded the case to

the Administrator for clarification. See Select Specialty Hosp.—

Bloomington, Inc. v. Sebelius, 774 F. Supp. 2d 332, 344 (D.D.C.

2011). The Administrator indicated in the affirmative. See J.A. at

354. The district court upheld the Administrator’s subsequent

determination regarding the freestanding hospitals. See Select

Specialty Hosp.—Bloomington, Inc. v. Sebelius, 893 F. Supp. 2d 1,

5 (D.D.C. 2012). Those hospitals also appealed, and their appeal is

now before us in this consolidated case.

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generally give “substantial deference” to an agency’s

interpretation of its own regulation, deference is unwarranted

if the interpretation is “plainly erroneous or inconsistent with

the regulation.” Thomas Jefferson Univ. v. Shalala, 512 U.S.

504, 512 (1994) (citation and internal quotation mark

omitted); Kaiser Found. Hosps. v. Sebelius, 708 F.3d 226,

230–31 (D.C. Cir. 2013).

III

The question before us is whether the Board’s

interpretation of the Secretary’s regulation—specifically, her

definition of “new hospital”—is arbitrary and capricious. The

parties begin at a curious starting point: the meaning of the

word “hospital.” The Hospitals suggest the meaning is

clear—42 U.S.C. § 1395x(e) indicates “hospital” means the

institutional entity, not the physical facility. See Appellants’

Br. at 38, 42. As none of the Hospitals—independent

offshoots of an overarching corporation—existed prior to the

cost period at issue, they maintain their institutions are all

“new.” See Appellants’ Br. at 42. But the meaning of

“hospitals” is beside the point—the Government does not

contest that a “hospital” could be the organizational entity.

See Appellee’s Br. at 31–33. Instead, the crux of the

Government’s concern is the meaning of the word “new”—a

question to which § 1395x(e) does not speak. Unfortunately,

neither does the Board’s decision.

The Hospitals’ disorientation is understandable; it was

the Board that first puzzlingly emphasized the interpretation

of “hospital,” instead of “new.” See J.A. at 161, 237 (“The

Board finds that the regulation defining a ‘new hospital’ . . . is

ambiguous, in that it is not clear if the term ‘hospital’ means

the individual physical assets . . . or the business entity as a

whole, which would include both bricks and mortar and the

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operations.”). On appeal, the Government attempts to patch

up the Board’s maladroitness by claiming the Board was

interpreting the phrase “new hospital,” as opposed to one

word or the other. See Appellee’s Br. at 35. But the

Government’s patch job is too little, too late. Simply put, the

Board—having resolved a question that was tangential to the

essential one—never adequately explained how to discern the

newness of a hospital. Certainly, “individual physical assets”

are to be considered—but in what way? See J.A. at 161, 237.

“[T]here are cases where an agency’s failure to state its

reasoning or to adopt an intelligible decisional standard is so

glaring that we can declare with confidence that the agency

action was arbitrary and capricious.” Checkosky v. S.E.C., 23

F.3d 452, 463 (D.C. Cir. 1994). This is one of them. We can

easily recognize the two guiding principles motivating the

Board’s decision: (1) eliminating the possibility of double

reimbursement and (2) giving newcomer hospitals without a

historic asset base an opportunity to establish new operations.

And yet, we cannot discern how the Board’s decision serves

these two principles.

A

We start with the first impetus—that “the exemption to

receive cost reimbursement for the capital-related costs

should be limited only to assets for which the Medicare

program has not previously made payment under the

reasonable cost principles.” J.A. at 161–62, 237. After

pronouncing that “at the very least, an analysis of the physical

assets” is necessary under 42 C.F.R. § 412.300(a), the Board

jumped to the conclusion that the prior operation of the

various physical assets by other hospital entities meant that

the assets had already been the subject of a reasonable cost

basis reimbursement. See J.A. at 161, 237. The source of the

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Board’s sweeping presumption remains a mystery. Nothing

in the record suggests a physical asset used by another

hospital organization for a period of more than two years is

inherently one that has already received capital

reimbursement based on reasonable cost principles. Nor do

we know how such a categorical approach faithfully serves

the double-reimbursement principle. Even if prior hospital

organizations had obtained reimbursement for an original

building construction, additional costs specific to

renovations—such as for new equipment—would not have

been previously reimbursed. The Board’s failure to connect

the dots makes remand necessary. See Phila. Gas Works v.

FERC, 989 F.2d 1246, 1250 (D.C. Cir. 1993) (explaining an

agency’s submission of an “inadequate explanation for its

conclusions” warrants remand to the agency).

B

Before we reach the Board’s other rationale, some

untangling is in order. At oral argument, the Government’s

counsel seemed to suggest the Board employed a “new

building” rationale, i.e., a new hospital (organizationally

speaking) that constructs a facility from scratch is the only

type of entity deserving of reimbursement based on

reasonable cost principles. See Oral Arg. at 39:15 (“And the

Secretary reasonably concluded here that newly built facilities

are a more compelling need because there are greater capital

costs . . . .”). This observation is distinct from the Board’s

reasoning. In the comments made during the initial

promulgation of the exemption, the Secretary did say the

exemption “would not apply to a facility that opens as an

acute care hospital if that hospital has operated in the past

under current or previous ownership and has a historic asset

base.” 57 Fed. Reg. at 23,649. But the Secretary also

emphasized the newness of hospitals as entities and

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organizations which, because of their newness, would have a

harder time entering the field. See id. (“The exemption is

intended to protect hospitals that come under the capital

prospective payment system without a historic asset base and

need special consideration for their original plant and

equipment costs during their initial years of operation.”

(emphasis added)); see also 57 Fed. Reg. at 39,790 (“[W]e

believe it is appropriate to restrict the new hospital exemption

under the capital prospective payment system to new entrants

into the hospital field that do not have a historic asset base.”

(emphasis added)). It appears the Board hewed to this holistic

approach by stating only that, “at the very least,”

consideration of the physical assets is required. J.A. at 161,

237. The Secretary’s position on appeal, however, is that new

construction is a necessary condition.

Organizationally speaking, the Hospitals are newcomers

to the field. No one disputes that, though the Hospitals are the

progeny of a parent corporation specializing in the

establishment of long-term care hospitals. But they are

independent entities nonetheless, and the Board’s decision

evinces no difference between the Hospitals and new entrants

to the field that are unaffiliated with any parent entity which

would deprive them of the preferential treatment the

regulations provide.

Even if assets were to govern the analysis, we still do not

understand the Board’s predilection for having something

built from the ground up. Consider the fact that lease

payments and renewals are included in the definition of

reimbursable capital assets. See 42 C.F.R. § 412.302(b)(3);

42 C.F.R. § 413.130. This seems to suggest that a hospital (as

an institution) need not build a physical asset brick-by-brick

to be eligible for reimbursement on a reasonable-cost basis.

See J.A. at 161, 237 (“The Board also finds significant that

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this regulation which defines a new hospital explicitly states

its purpose at 42 C.F.R. § 412.300(a) as establishing a

reimbursement methodology for inpatient hospitals ‘capital-

related costs,’ which are defined in § 412.302 and includes

physical assets.”). And yet, in its inquiry to determine the

newness of a “hospital,” the Board looked to when the “bricks

and mortar were established” for a particular physical asset

and who had laid them. Id. What is the difference between

an old hospital building that has been completely gutted and

renovated and a new hospital building built from the ground

up? Will the Board’s decision allow for recompense for the

latter, but not the former?3

At oral argument, counsel equivocated when asked to

describe the Board’s decisional rationale. Compare Oral Arg.

at 34:13 (“I think the definition now is you have to be both a

new entity and you have to have a new facility, and the only

thing the Secretary clarified here is that a renovation is not the

same as a new building, and therefore you are not a new

3

The Government explains that a case-by-case

determination as to the “newness” of a hospital would

“require the Department to conduct time-consuming

examinations to determine how many renovations are

‘enough’ to make the facility ‘new,’ or how much a

theoretical, newly-built facility would have cost if it had been

constructed, and whether the renovations at issue were more

costly.” Appellee’s Br. at 49–50. The Board, of course, did

not articulate this particular rationale in its decision, and we

therefore cannot entertain the Government’s post hoc

justification. See Catholic Healthcare W. v. Sebelius, 748

F.3d 351, 354 (D.C. Cir. 2014) (“[W]e do not affirm agency

decisions on a legal analysis other than that expressed by the

agency.”).

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hospital, but I think the Secretary is leaving open what

happens in the next case when what you’ve renovated has

never been a hospital.”), with Oral Arg. at 38:16 (“What’s

dispositive is whether you build something new or whether

you’re just merely renovating.”). His equivocation is telling.

Despite the Board’s decision, the district court’s opinion, the

Government’s briefs on appeal, and oral argument, we still

cannot discern precisely what the Board’s decisional standard

was. It is a standard that requires hospitals be built from the

ground up, yet also a standard which leaves open the

possibility of an existing building that had never served as a

hospital or an older hospital—say, nonoperational for fifty

years—being renovated and subsequently reimbursed under

reasonable cost principles. Such an amorphous rule is, by

definition, arbitrary and capricious. See Coburn v. McHugh,

679 F.3d 924, 934 (D.C. Cir. 2012) (noting agency decisions

that “lack coherence” and “make it impossible for this court to

determine whether [such decisions] survive arbitrary and

capricious review under the APA” fail the test of “reasoned

decisionmaking”).

IV

To be clear, we have no reason to doubt the Secretary’s

authority to define what a “new hospital” is. Nor do we have

cause to question the Board’s ability to adopt a decisional

standard based on that definition. But when ambiguity begets

ambiguity, making it such that we cannot discern the

decisional standard, much less the correctness of its

application, we have little choice but to declare the decision

arbitrary and capricious—especially as our review is

constrained to the rationale provided by the Board, see SEC v.

Chenery Corp., 332 U.S. 194, 196 (1947), however

unintelligible it may be.

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We reverse the district court’s grant of the Appellee’s

motion for summary judgment and remand with instruction to

return this case to the Secretary for further proceedings not

inconsistent with this opinion.

So ordered.