Petition for Writ of Certiorari — Regents of the University of California v. Shalala

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Supreme Court, U.s.

FILED

96 90 JUL 16 19%

OFFICE OF THE CLERK

No.

IN THE

Supreme Court Of Che United States

October Term, 1996

THE REGENTS OF THE UNIVERSITY OF CALIFORNIA,

Petitioner,

Vv.

DONNA E. SHALALA, Secretary

Department of Health and Human Services;

PROVIDER REIMBURSEMENT REVIEW BOARD,

Respondents.

Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit

PETITION FOR A WRIT OF CERTIORARI

JAMES E. HOLST

JOHN F. LUNDBERG

ROBERT BARNES*

University of California

300 Lakeside Drive, 7th Floor

Oakland, CA 94612-3565

(510) 987-9800

July 16, 1996 *Counsel of Record

Balmar Legal Publishing Services, Washington, D.C. (202) 682-9895

pias

QUESTION PRESENTED

As it is relevant to this action, the Medicare Act and

regulations provide that hospitals furnishing services to Medi-

care beneficiaries should be reimbursed for the “reasonable

cost,” including direct and indirect costs, of such services.

Such indirect, reimbursable, reasonable costs include the in-

terest charges on loans required to enable the hospital to pro-

vide these services to Medicare beneficiaries. Congress and

the Secretary recognize that from time to time cash flow ir-

regularities may force a Medicare provider to borrow working

capital and that the reasonable c~sts of such loans are reim-

bursable expenses. Regulations implementing the Medicare

program provide, however, that such reimbursable costs can-

not include interest expenses which are unreasonably high or

are paid on unnecessary loans. Here, the hospital providers,

owned and operated by Petitioner, had significant cash flow

problems during the 1980’s which necessitated borrowing for

working capital. The provider hospitals had no legal ability to

borrow in their own name. Consequently, Petitioner loaned

the provider hospitals working capital funds from its short-

term investment pool of University funds at an interest rate

well below market rates. Moreover, the interest rates were

below the income expected from the funds had the University

been able to invest the money in other ways. Since the inter-

est payments on the working capital loans were paid by the

hospital providers to a related entity - i.e., Petitioner - the

Medicare program denied reimbursement based on one of its

Medicare regulations which presumes that loans between re-

lated entities are unnecessary and thus, improper. The ques-

tion presented for review is:

1. Whether the Secretary’s irrebuttable presumption

that all interest charges on loans, between The Regents and its

hospitals, are unnecessary, unreasonable, and improper costs

is arbitrary, capricious, an abuse of discretion, and not in ac-

cordance with law.

TABLE OF CONTENTS

PAGE

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STATUTORY PROVISIONS INVOLVED......0.0....cccceeeeeee 2

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REASONS FOR GRANTING THE WRIT. ....0......0....::0c:0000+ 10

I. The Ninth Circuit’s Judgment Should be

Reviewed Because It Conflicts with Other

Circuit Decisions Interpreting 42 C.F.R.

IE peice deci ttedichigiisinictecimriatibegeuthactdmenienidsinarenocing 10

II. Respondents’ Interpretation of 42 C.F.R.

§ 405.419 Establishes a Preference for Re-

ligion Which Violates the First Amendment......... 14

III. The Decision Below Interprets 42 C.F.R.

§ 405.419 In a Manner Inconsistent With

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TABLE OF AUTHORITIES

CASES PAGE(S)

Brown v. Woodland Joint Unified School Dist., 27

F.3d 1373, (9th Cir. SOD asicthaniniciicanigicis ee 18

Califano v. Yamasaki, 442 U.S. 682 Rt hesisitntsiekceeteocca 17

Committee for Public Education & Religious Liberty

v. Nyquist, 413 U.S. 756 EA & | SRIPRP AAI Ne age 17

Grand Rapids School District y. Ball, 473 U.S. 373

(IEE) sternctireniontnioecaniipanormidbitebebaie ies <ooe ote 18

Jackson Park Hospital Foundation y. United States,

Ore OO TOT Cai io eat ne ee 9

Kreisner v. City of San Diego, 1 F.3d 775 (9th Cir.

1993), cert den. 114 S.Ct. 690 ig) aeRO Neen Ine 18, 19

Lemon v. Kurtzman, 403 U.S. 602 UEP OP seicascititintoiitebdee 17

Northwest Hospital, Inc. y. Hospital Services Corp.,

687 F.2d 985 (7th Cir. SPOS wetsithic eabai ee oe ei 9

Ohio State University y. Sullivan, 777 F. Supp. at 582

CFI E asin scaonreosesenicconmtsbnaaiccgna Stee aa ee 3 20

Rucker v. Wabash Railroad Company, 418 F.2d 146

CF SIRs TO wistiniencticaaeace cats ane 17

Shaker Medical Center Hosp. v. Secretary of Health,

686 F.2d 1203 (6th Cir. wine On TREE Se Hie TT RE 9

St. Elizabeth Hospital v. Blue Cross and Blue Shield

Association/Empire Blue Cross and Blue Shield

(September 17, 1993) PRRB Dec. No. tt. 5 Pe 14

Trustees of Indiana University v. United States, 618

sheer be tgs sisans, Ce OT REE Passim

United States v. American T. rucking Associations, Inc.,

PO OB: SIR RO uisiscrcsctiasesissai li ie 13

United States v. Rumely, 345 U.S. 41 si) SUN Sc 17

United States v. Vuitch, 402 U.S. 62 SCE vemnbeiniicicsecentnedes 17

neritic

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CASES PAGE(S)

United Steelworkers of America v. Weber, 443 U.S.

Fete A FO ccs “aceistiiccadbniaictinigillscnaaliahieile ila set acena haataias ol 13

University of Cincinnati v. Heckler, 723 F.2d 1171

ERE Soils BOM Niaciincectediceahigihnntliincacidihdinsincenciesuaiumsnamiate 10

STATUTES, REGULATIONS, AND

CONSTITUTIONAL PROVISIONS

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PAGE(S)

Article LX, section 9 of the California Constitution.................3

U.S. Constitution, Amendment I, clause 1................c:cc0ee0eees 16

§ 1878(f)(1), title XVIII of the Social Security Act................. 4

MISCELLANEOUS

S. Rep. No. 404, 89th Cong., Ist Sess., reprinted in

5365 U.S LSA Bits BF PO sonsnksicicabiaeapaseaniiiiniialiacdanaive 19

No.

IN THE

Supreme Court of the United States

October Term, 1996

THE REGENTS OF THE UNIVERSITY OF CALIFORNIA,

Petitioner,

Vv.

DONNA E. SHALALA, Secretary

Department of Health and Human Services;

PROVIDER REIMBURSEMENT REVIEW BOARD,

Respondents.

Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit

PETITION FOR A WRIT OF CERTIORARI

Petitioner, The Regents of the University of California

(the “University” or “Petitioner”) respectfully requests that a

writ of certiorari issue to review the judgment of the United

States Court of Appeals for the Ninth Circuit, entered on April

17, 1996.’

OPINIONS BELOW

The United States Court of Appeals for the Ninth Circuit

issued a judgment and an opinion. The opinion is reported at

82 F.3d 291, and is reprinted in the Appendix as Appendix A.

' All parties are named in the caption. Petitioner, The Regents of the

University of California, is a constitutional, not-for-profit, educational

institution (corporation) operated for the public benefit. Therefore, no

Rule 29.1 statement is required.

The opinion of the United States District Court for the

Central District of California is not reported. It is reprinted in

the Appendix as Appendix B.

There are two administrative decisions concerning this

case. Respondent, the Provider Reimbursement Review

Board (“PRRB”), is the administrative tribunal with jurisdic-

tion to hear and review Medicare reimbursement disputes. Its

decision in this matter, PRRB Dec. No. 93-D41, is reported in

Medicare & Medicaid Guide (CCH), § 41,453 (May 14,

1993), and is reprinted in the Appendix at A-33. The Admin-

istrator of the Health Care Financing Administration

(“HCFA”) is the agent of Respondent, the Secretary of the

Department of Health and Human Services (the “Secretary”),

with authority for reviewing PRRB administrative decisions.

The decision of the PRRB is final unless the Secretary,

through HCFA, on her/his own motion, reverses or modifies

it. The Administrator of HCFA decided not to reverse or

modify the decision of the PRRB in this case. The Adminis-

trator’s decision is not reported and is reprinted in the Appen-

dix as Appendix D.

JURISDICTION

The judgment of the United States Court of appeals for

the Ninth Circuit was entered on April 17, 1996. This Court

has jurisdiction to review the judgment of the court of appeals

by writ of certiorari pursuant to 28 U.S.C. § 1254(1).

STATUTORY PROVISIONS INVOLVED

The University asserts that the Secretary’s interpretation

of the Medicare Act and implementing regulations concerning

the proper reimbursement for interest on working capital

loans between the University and its hospital providers was

arbitrary, capricious, an abuse of discretion and not in accor-

dance with law. The relevant statutory section, 42 U.S.C.

a aw

§ 1395x(v)(1)(A), and regulation, 42 C.F.R. § 413.153, are set

forth in the Appendix at A-53 and A-49 respectively.

STATEMENT OF THE CASE

Petitioner, The Regents of the University of California is,

pursuant to Article IX, section 9 of the California Constitu-

tion, the operator of the University of California and all its

administrative departments and divisions. (A-68) These vari-

ous administrative divisions include five existing medical

schools and their associated acute care hospitals. All of these

five University hospitals are medicare providers under the

medicare program. Well over one fifth of the care provided

by these hospitals is provided to patients within the medicare

program. (See, Appendix H.)

The University providers involved in this appeal are the

University of California, Los Angeles Medical Center

(“UCLAMC”), University of California, Irvine Medical Cen-

ter (“UCIMC”), and University of California, San Diego

Medical Center (““UCSDMC”). Each are general acute care

hospitals licensed to Petitioner, and are providers of services

under the Medicare Act. Each medical center disputes denial

of reimbursement of Medicare’s share of interest expense on

necessary and proper working capital loans made to the hos-

pitals by Petitioner. UCLAMC raises this issue with regard to

its reimbursement for fiscal years ending June 30, 1982, and

June 30, 1983. UCIMC raises this issue with regard to its

reimbursement for fiscal years ending June 30, 1983 and June

30, 1985. UCSDMC raises this issue with regard to its reim-

bursement for fiscal years ending June 30, 1982 and June 30,

1984. The amount of Medicare reimbursement in dispute for

all the fiscal years in contention is approximately $1,600,000.

(See, Appendix H.)

The University’s provider hospitals’ requests for Medi-

care reimbursement for interest expenses on working capital

loans was denied by the fiscal intermediary, an agent of the

Secretary with responsibility for reviewing provider requests

for Medicare reimbursement. (A-34)

All three University providers appealed from the inter-

mediary’s (Blue Cross’) decision not to reimburse each for

interest expense on loans from Petitioner. Under special ad-

ministrative proceedings available to the three providers be-

fore the PRRB, all their appeals for the fiscal years listed

above were consolidated for hearing because the gravamen of

each appeal was the same “legal” question and because the

factual differences between each provider’s “appeal” were de

minimis. In the end, even these small differences were elimi-

nated by an agreement between the University providers and

the intermediary to proceed by way of a stipulation of facts

and briefs on the law. See, § 1878(f)(1), title XVHII of the So-

cial Security Act and 42 C.F.R. § 405.1837(b). (See, Appen-

dix H.)

As stated above, the underlying facts that constitute the

“heart” of the record below are set forth in a stipulation

reached between the intermediary (Blue Cross) and the pro-

vider at the hearing before the PRRB. This stipulation of

facts (“Stipulation of Facts”) is set forth in the Appendix at A-

66. Both the intermediary and Petitioner agreed to have the

PRRB decide the case on the basis of the Stipulation of Facts

and no other evidence was presented by either side. Conse-

quently, the PRRB heard no live testimony and determined

the case on the basis of the application of medicare law and

implementing regulations to the facts as set forth in that

stipulation. Among those facts set forth in the Stipulation of

Facts is the following: “Funds obtained [working capital

loans made by Petitioner to the three provider hospitals] were

used for necessary and proper purposes related to patient care

within the meaning of 42 C.F.R. § 413.9.” (Emphasis added.)

Stipulation of Facts, number 11 (A-70)

As the facts before the PRRB disclose, Petitioner sub-

mits its proposed annual budget to the Governor in August of

the year prior to the beginning of its fiscal year (July 1). The

Governor’s budget for the University includes a line item by

line item detail of Petitioner’s annual budget. Beginning in

fiscal year 1975-1976, as a result of severe fiscal problems

within the University’s hospitals, the California legislature

appropriated a twenty-five million dollar ($25,000,000) fund

entitled “University of California Teaching Revolving Fund”

(“Fund”). The purpose of the Fund was to supplement peti-

tioner’s hospital need for working capital and to assure that

the hospitals could meet employee salaries, contractor de-

mands and other daily charges without endangering the conti-

nuity of its care of patients. In the mid-1980’s, the California

legislature terminated the fund due to state financial problems.

(A-71)

The abrupt withdrawal of twenty-five million dollars

($25,000,000) of state support from the University’s hospitals

(including the three providers involved in this appeal) created

a financial crisis for these hospitals. None had the legal ca-

pacity to borrow money from outside sources. Consequently,

Petitioner began making loans to the hospitals to cover

working capital needs.’ The loans carried a preferential inter-

est rate well below market and less than Petitioner would have

obtained from investing the funds in the commercial market.

Moreover, Petitioner could not effectively borrow money on

behalf of its hospital’s in the open market because of exorbi-

tant market interest rates. (A-69 and A-70)

As stated above, under the Medicare program, providers

of services to medicare patients are reimbursed for the

“reasonable costs” of providing these services. 42 U.S.C.

§§ 1395f(b) and 1395l(a). The term “reasonable costs” is de-

fined broadly in 42 United States Code section 1395x(v)

which provides, in part that:

* The University’s funds are allocated by budget authorization by the

California Legislature. The hospitals are expected to support themselves

from patient payments.

“(b)(1)(A) the reasonable cost of any services shall

be the cost actually incurred, excluding therefrom

any part of incurred cost found to be unnecessary in

the efficient delivery of needed health services, and

shall be determined in accordance with regulations

establishing the method or methods to be used, and

the items to be included, in determining such costs

for various types or classes of institutions, agencies,

and services;”

42 U.S.C. section 1395x(v)(1)(A).

Applicable Medicare regulations also state that

“reasonable costs” are to be defined to include:

all necessary and proper expenses incurred in fur-

nishing services, such as administrative costs,

maintenance costs, and premium payments for em-

ployee health and pension plans. Jt includes both

direct and indirect costs and normal standby costs.

42 C.F.R. § 413.9(c)(3).

The term “necessary and proper” costs is similarly de-

fined broadly to mean “costs that are appropriate and helpful

in developing and maintaining the operation of patient care

facilities and activities.” 42 C.F.R. § 413.9(b)(2). The regu-

lations provide that these general principles may be supple-

mented by more specific regulations providing that the

“reasonable cost of any services must be determined in accor-

dance with regulations establishing the method or methods to

be used, and the items to be included.” 42 C.F.R. § 413.9

(b)(1).

One such regulation promulgated by the Secretary pursu-

ant to the above statutory authority is 42 C.F.R. 405.419° and

' This regulatory provision was redesignated 42 Code of Federal

Regulations section 413.153 in 1986. (See Appendix E.) No substantive

changes were made to the regulation as a result of the redesignation. In

light of the fact that 42 C.F.R. § 405.419 was consistently used throughout

the proper interpretation of this regulation is the subject of

this petition.

42 C.F.R. § 405.419 provides that an allowable cost for

reimbursement includes “necessary and proper iiterest on

both current and capital indebtedness.” 42 C.F.R.

§ 405.419(a). The regulation further provides that “proper”

interest must “be incurred at a rate not in excess of what a

prudent borrower would have had to pay at the time of the

loan” and “be paid to a lender not related by control or owner-

ship or personal relationship to the borrowing organization.”

42 C.F.R. § 405.419(b)(3)(i) and § 405.419(b)(3)(ii):

According to the Secretary, the objective of this regula-

tion prohibiting Medicare reimbursement for interest paid

between related parties is to avoid paying collusive or im-

properly inflated interest costs which may be brought about

by transactions between closely related entities who are moti-

vated by a desire to increase profits.

42 C.E.R. § 405.419).

Generally, contrary to 42 C.F.R. § 405.419(c), Medicare

regulations allow a provider to claim the costs incurred by its

related party owner or operator in connection with the opera-

tion of the hospital’s programs.

[C]osts applicable to services, facilities, and support

furnished to the provider by organizations related to

the provider by common ownership or control are

includable in the allowable cost of the provider at

the cost to the related organization. However, such

cost must not exceed the price of comparable serv-

ices, facilities, or supplies that could be purchased

elsewhere.

42 C.F.R. § 413.17(a).

all the earlier papers in this case, Petitioner will continue to refer to 42

Code of Federal Regulations section 413.153 under its prior designation,

Code of Federal Regulation section 405.419.

The Secretary has always so interpreted the regulations.

For example, in guidelines issued to private entities who ad-

minister the Medicare program (intermediaries), the Secretary

identified certain costs incurred by related medical schools

which could be included in a provider’s GME costs, including

costs of a medical library, physician office space and clerical

Support. Intermediary Letter 78-7 (“IL 78-7”). Those costs

normally would be incurred directly by a hospital that oper-

ated GME programs independently of a related medical

school. Id. Similarly, in the case of working capital loans,

the University hospitals involved in the petition would have

incurred interest expenses on market-place loans but for the

fact that it was legally precluded from borrowing in its own

name.

However, with regard to interest on loans between re-

lated parties, the Secretary has interpreted such costs to be

non-reimbursable under the Medicare program pursuant to 42

C.F.R. § 405.419 and contrary to the general rule. The

PRRB’, the Secretary’, the district court’, and the Ninth Cir-

cuit Court of Appeals’ have now all held that reimbursement

for such expenses is not allowable because the loans were

made between related parties--Petitioner and the three provid-

ers. The Ninth Circuit’s decision was based entirely on the

court’s determination that 42 C.F.R. § 405.419, acts as an ab-

solute bar to reimbursement and that no exception can be

made for the University providers even where the facts dis-

close that the loans were absolutely necessary for the care of

the Medicare patients in the facilities, the hospitals could bor-

row from no other entity, and the interest rates were proper

and well below market rates saving the Medicare program

hundreds of thousands of dollars.

* Appendix at C.

* Appendix at D.

* Appendix at B.

’ Appendix at A.

Petitioner’s contrary position is straightforward. 42

C.F.R. § 405.419 was enacted in order to implement Con-

gress’s intent that only necessary or proper Medicare expenses

be reimbursed. Where loans are made between related parties

and interest charged, the arrangement is suspect because the

indicia of “arms-length” negotiations is not present. Conse-

quently, on loans made between related parties exorbitant in-

terest rates might be charged in order to maximize Medicare

reimbursement or the loans may be made when no need to

borrow exists, but a desire to invest in the related entity is pre-

sent. Such “suspect” loans are therefore presumed to be un-

reimburseable because they are presumed to be unnecessary

and improper. Petitioner accepts this presumption against the

reimburseability of the provider’s interest payments. How-

ever, Petitioner vigorously contests the Ninth Circuit’s deter-

mination that the presumption is irrebuttable. Where the pro-

vider can prove that the loans made between related parties

are necessary and the interest rates charged were proper, the

presumption against reimbursement is countered and payment

for patient care services should be made by the Medicare pro-

gram, consistent with the general rule that related party costs

in support of the Medicare program should be reimbursed.

Every appellate court that has reviewed the Secretary’s

inflexible interpretation of the related party rule, 42 C.F.R.

§ 405.419, as it applies to the reimbursement of interest ex-

pense between entities which do not have a profit motive, ex-

cept for the Ninth Circuit, has rejected it. Instead, the courts

have consistently tempered the force of the prophylactic rule

in order to permit special exceptions to the general ban when

consistent with the expressed intent of the regulatory scheme

and the purposes of the Medicare Act. See, Trustees of Indi-

ana University v. United States, 618 F.2d 736 (1980) at 736

(see Appendix G;) Northwest Hospital, Inc. v. Hospital Serv-

ices Corp., 687 F.2d 985; (7th Cir. 1982); Jackson Park Hos-

pital Foundation v. United States, 659 F.2d 131 (1981);

Shaker Medical Center Hosp. v. Secretary of Health, 686 F.2d

1203 (6th Cir. 1982); and University of Cincinnati v. Heckler,

723 F.2d 1171 (6th Cir. 1984)

Petitioner brought suit in the district court under Title

XVIII of the Social Security Act, 42 U.S.C. § 1395 et seq.,

commonly known as the Medicare Act. Jurisdiction in the

district court was proper pursuant to 42 U.S.C. § 139500(f).

There, on cross-motions for summary judgment, the court

determined that the Secretary’s interpretation of the regulatory

bar to reimbursement for related party interest expenses (42

C.F.R. § 405.419) was reasonable and entitled to deference.

The district court’s memorandum and order is dated

September 6, 1994. On September 21, 1994, Petitioner timely

appealed the district court’s decision to the court of appeals.

In a judgment and decision filed on April 17, 1996, the court

of appeals affirmed the district court’s decision.

REASONS FOR GRANTING THE WRIT

I. The Ninth Circuit’s Judgment Should be Re-

viewed Because It Conflicts with Other Circuit

Decisions Interpreting 42 C.F.R. § 405.419.

The facts analyzed by the Court of Claims when it de-

cided Trustees of Indiana University v. United States, (1980)

618 F.2d 736 (Appendix G) are substantively indistinguish-

able from the facts underlying this appeal and the Court of

Claims ordered reimbursement of the Medicare provider’s

related-party interest expense. The salient facts which arise in

both Trustees of Indiana University and this case are as fol-

lows: (1) the non-profit provider(s) is affiliated with a state

university, (2) the state appropriates no money for the hospi-

tal, (3) the hospital is prohibited by state law from borrowing

from outside sources, (4) and the University lends the hospital

essential funds necessary for medicare patient care at less than

the rate of interest available in the marketplace.

In Trustees of Indiana University, the court found that

the relationship of the hospital provider to the University and

to the State of Indiana was special. The hospital was a state

teaching hospital, but received no money from the State for its

operations. Although the State of Indiana provided funds for

the University, state law prohibited the use of any of those

funds for the hospital. Since the hospital was not a separate

legal entity, it could not borrow money from outside the Uni-

versity. If the hospital could not support itself through the

fees it collected from patients, it had to borrow from the Uni-

versity itself. It did so and the interest rate charged by the

University on the loan was less than the prime rate.

The salient facts underlying this appeal are substantially

the same. All three University hospitals involved in this ap-

peal are state teaching hospitals and received no money from

the State of California for their operations. Indeed, prior to

the years involved in this appeal, the State of California had

provided to Petitioner a $25 million revolving fund specifi-

cally designated to defray the University hospitals’ losses.

Part of the reason that the University hospitals desperately

needed working capital funds during the appeal period is be-

cause the state abruptly discontinued this fund beginning in

fiscal year 1980-1981 because of serious California state

budget shortages. (A-71) None of the University medical

centers had the legal ability to borrow money from anyone

other than Petitioner. The University hospitals borrowed

money from Petitioner to cover necessary operating shortfalls

and the loans were instrumental for their continued operation.

(A-70) The interest rates charged by Petitioner to the Univer-

sity hospitals for these working capital loans was far less than

the rate a prudent borrower would have had to pay in the

commercial market at the time the loans were made. (A-69)

Indeed, these interest rates were lower than the amount Peti-

tioner was receiving for the investment of its short-term ex-

cess funds in the market place. (A-70) Finally, the funds bor-

rowed by the University hospitals from Petitioner were neces-

sary for continued hospital operation and the interest rates

were appropriate. (Appendix A-70.)"

The Court of Claims in Trustees of Indiana University

found that a literal reading of 42 C.F.R. § 405.419 without

regard to other, relevant regulatory provisions, the stated pur-

pose of the regulation itself and to the underlying statute

would bar reimbursement for the interest expenses incurred by

Indiana University. The court found that Indiana University

was related to the University hospital because it was the op-

erator of that hospital. Consequently, Indiana University

would not be eligible for medicare reimbursement of interest

expenses on loans to the hospital because of that relationship

if C.F.R. § 405.419 was read strictly. However, the court did

find that Indiana University was entitled to medicare reim-

bursement of its interest charges. It did so without invalidat-

ing 42 C.F.R. § 405.419. It did so, in spite of the fact that it

approved of the prophylactic purpose underlying 42 C.F.R.

§ 405.419. The Court of Claims, quoting the Supreme Court,

held it is a “familiar rule, that a thing may be within the letter

of the statute and yet not within the statute, because not within

* The Ninth Circuit attempts to distinguish the facts of this case from

the facts considered by the Court of Claims in Trustees of Indiana. In

order to do so, it highlights the fact that the hospital provider in Trustees

of Indiana never received state funds directly from the state of Indiana and

was prohibited from receiving state funds. On the other hand, the Ninth

Circuit states that the State of California had provided funds to the Uni-

versity providers in the 1970's. The decision not to fund Indiana Univer-

sity Hospital directly with state funds was a decision made by Indiana’s

legislature. The decision not to fund Petitioner’s hospitals directly with

State funds in the 1980’s was a decision made by California’s legislature.

The Trustees of Indiana, its hospital provider, The Regents of the Univer-

sity of California and its hospital providers had no authority to make these

State budgetary decisions. The end result in both cases is this: no state

funding for the hospitals.

The Ninth Circuit also states that the University had funded its hospital

providers on an interest-free basis in the past. (A-9) There is no record

authority for this statement.

its spirit, nor within the intention of its makers. (Citing

United Steelworkers of America v. Weber, 443 U.S. 193

(1979).)” “Indeed, if the ‘plain meaning’ of a statute produces

an ‘unreasonable’ result ‘plainly at variance with the policy of

the legislation as a whole’ the courts have ‘followed that pur-

pose, rather than the literal words.’ ” (Citing, United States v.

American Trucking Associations, Inc., 310 U.S. 534, 543

(1940).) Trustees of Indiana University, supra, 618 F.2d at

737.

The Court of Claims in Trustees of Indiana University

was swayed by the fact that many of the evils inherent in col-

lusive loans between an entity and its owner or operator are

not present in a loan between a state university and its associ-

ated university hospital. Like religious organizations, neither

party has a profit motive. To the contrary, Indiana University,

like Petitioner in this case, could have received a greater re-

turn on its money by investing it elsewhere. The concern em-

bodied in 42 C.F.R. § 405.419 — to protect the government

and its medicare program from paying the cost of collusive

loans with inflated interest rates designed to benefit enter-

prises associated with providers of medicare services - is sim-

ply not present in either the Trustees of Indiana University

Situation or the situation below involving Petitioner. Conse-

quently, the Court of Claims in Trustees of Indiana University

carved out a specific and limited exception to the regulatory

bar when these circumstances exist: the interest rates are

clearly below market, the loan funds are used for clearly nec-

essary patient care purposes and, because of the special rela-

tionship of the provider and its operator, no profit motive is

present.

The plain fact is, if Petitioner’s hospitals could have bor-

rowed money on their own from outside commercial lenders,

the interest rates would have been higher and the medicare

program would have reimbursed those rates. Similarly, if Pe-

titioner had borrowed money from outside, commercial lend-

ers to meet the needs of its provider hospitals, the interest

rates would have been higher and the Medicare program

would have reimbursed those rates. Clearly, the fact that the

University hospitals borrowed money from Petitioner at Sig-

nificantly lower rates than were available in the open market,

ultimately benefits the Medicare program.”

II. Respondents’ Interpretation of 42 C.F.R.

§ 405.419 Establishes a Preference for Religion

Which Violates the First Amendment

Respondents and the courts below have interpreted

405.419 as an absolute bar to reimbursement of interest ex-

penses on monies borrowed to care for medicare patients

when the loan is between related parties. However, 42 C.F.R.

§ 405.419(c)(2) creates an exception to the regulation where

the provider borrows from a related religious order: “In addi-

tion, if a provider operated by members of a religious order

borrows from the order, interest paid to the order is an allow-

able cost.” The PRRB recently confirmed this exceptional

treatment for interest on loans between a provider and its re-

lated religious order in St. Elizabeth Hospital v. Blue Cross

and Blue Shield Association/Empire Blue Cross and Blue

Shield (September 17, 1993) PRRB Dec. No. 93-D91.

Since 42 C.F.R. § 405.419 was established by the Sec-

retary to assure that the medicare program would not be reim-

bursing costs to a provider which were in reality inflated in-

terest rates charged by a collusive related party, this exception

for providers operated by a religious order makes sense: the

religious order and the provider are not governed by the profit

motive. However, this preference for religious orders cannot

stand scrutiny under the First Amendment’s establishment

clause unless similarly situated non-religious operators are

likewise exempt.

“ If Petitioner had borrowed money from outside commercial lenders at

the available interest rates, the Medicare program could have reimbursed

us share of the higher interest expense. Approximately 75 percent of the

interest charges would be unreimbursed.

It is for this reason Petitioner argued before Respondents

and the courts below that 42 C.F.R. § 405.419 be construed as

the creation of a rebuttable presumption that interest charges

on loans between related parties will not be reimbursed. This

interpretation permits medicare reimbursement in the excep-

tional case where the profit motive does not contaminate the

loan. The relationship of Petitioner to UCLA Medical Center,

UCI Medical Center, and UC San Diego Medical Center is

precisely the same as that of a religious order to its hospital

provider in the respect that none of these entities have a pro-

prietary or commercial motive relative to the interest rates

charged on the borrowings. Consequently, to treat the Uni-

versity providers differently than the provider operated by a

religious order creates constitutional difficulties within the

regulation. On the other hand, if the regulation is viewed as a

rebuttable presumption, as Petitioner has suggested, and con-

sistent with the approach taken by the Court of Claims, the

Sixth Circuit, and the Seventh Circuit, the constitutional diffi-

culties in the regulation are mitigated and the goals of the

Medicare Act are preserved.

There may be several situations involving non-profit

hospitals where borrowing powers are limited and necessary

loans from related operators required. The concerns which

led the Secretary to adopt 42 C.F.R. § 405.419 may simply

not exist under these special circumstances. Indeed, the facts

surrounding these special situations may be more like those

surrounding loans between a provider and its related religious

order than loans between a provider borrowing from a related

for-profit corporation. Under these circumstances, to interpret

this regulatory subsection as an irrebuttable presumption cre-

ates absurd results. This is particularly evident when one con-

siders that the Secretary’s interpretation of her own regula-

tions permits a proprietary organization to advance funds to

its related hospital and receive reimbursement under the

medicare program for any interest expenses above its return

on equity capital. 42 C.F.R. § 405.419(b)(2)(iii). Such an

option does not exist for Petitioner, which is exempt from

taxation. The end result of this disparate treatment therefore,

is that religious orders receive full reimbursement of any in-

terest expenses they charge their related provider, for-profit

corporations receive additional reimbursement for interest ex-

penses in excess of their return on equity capital and Peti-

tioner receives nothing for the cost of any loans to their re-

lated hospital providers other than “encouragement” to bor-

row money from outside lenders at high interest rates.

The Ninth Circuit ruled that Petitioner did not have

Standing to raise this First Amendment establishment clause

issue. The Ninth Circuit misperceives the thrust of Peti-

tioner’s arguments. Petitioner argues that the exception found

in 42 C.F.R. § 405.419(c)(2) is appropriate if it is construed to

include similarly situated non-profit providers and operators

which do not collaborate in the establishment of interest

charges on loans between each other for the purposes of en-

hanced profit. Obviously, if this exception is read into the

regulation, the regulation will serve a valid purpose, imple-

ment Congress’s basic intent and not offend the establishment

clause of the First Amendment. If, on the other hand, the Sec-

retary’s interpretation of 42 C.F.R. § 405.419 is allowed to

Stand, the section will create an impermissible distinction in

treatment between religiously controlled providers on the one

hand and similarly situated non-religiously controlled provid-

ers on the other. This disparate treatment of providers based

solely on their religious or non-religious character is an obvi-

ous violation of the establishment clause: “Congress shall

make no law respecting an establishment of religion. . . .”

U.S. Constitution, Amendment I, clause 1.

Contrary to the Ninth Circuit’s holding that Petitioner

lacks standing to raise this issue, it is Petitioner’s position that

the court, sua sponte, should interpret the regulation in ques-

tion so as to avoid any unconstitutionality under the estab-

lishment clause. This was the holding of the Court of Claims

when it decided Trustees of Indiana University.

“Our conclusion is also supported by the settled

principle that a statute should be construed so as to

avoid any serious doubts concerning its constitu-

tionality. E.g., Califano v. Yamasaki, 442 U.S. 682

(1979); United States v. Vuitch, 402 U.S. 62

(1971); United States v. Rumely, 345 U.S. 41

(1953). The same principle is equally applicable to

administrative regulations. See Rucker v. Wabash

Railroad Company, 418 F.2d 146 (7th Cir. 1969) at

149.

“As noted earlier, the regulation has an explicit ex-

ception for interest paid to a religious order by a

provider operated by members of the order. Deny-

ing reimbursement of interest payments by a non-

profit hospital to its affiliated university while per-

mitting reimbursement of payments to an affiliated

religious order would raise serious questions under

the first amendment, which generally prohibits the

government from giving special favored treatment

to a religious entity. E.g., Committee for Public

Education & Religious Liberty v. Nyquist, 413 U.S.

756 (1973); Lemon v. Kurtzman, 403 U.S. 602

(1971). Our interpretation avoids that problem.”

(Trustees of Indiana University, supra, 618 F.2d at

740.)

As the Court of Claims stated in Trustees of Indiana

University, there is no doubt that the First Amendment’s es-

tablishment clause is implicated by the Secretary’s narrow

reading of 42 C.F.R. § 405.419(c)(2). In 1971, the United

States Supreme Court fully articulated the now famous three-

prong test used to determine violations of the establishment

clause in Lemon v. Kurtzman, 403 U.S. 602 (1971). In

Lemon, the court had before it statutes from Pennsylvania that

provided for direct payments, either to the schools or to the

instructors, of salary supplements for teachers of secular sub-

jects.

The court found that the statutes had a secular purpose,

as opposed to a religious purpose, thus satisfying the first

element of its three-part test."" The other two prongs to the

test are that the challenged program (1) must have a primary

affect that does not advance religion and (2) must not result in

excessive entanglement between government and religion. It

is the second prong of the Lemon test--the clear advancement

of religion--which dooms Respondents’ construction of 42

C.F.R. § 405.419(c)(2) in the instant case.

Respondents’ interpretation provides direct financial ad-

vantages to providers which are operated by religious organi-

zations and denies the same reimbursement to Similarly situ-

ated providers which are not operated by religious organiza-

tions. As the Ninth Circuit stated in Brown v. Woodland Joint

Unified School Dist., 27 F.3d 1373, (9th Cir. 1994) advance-

ment of religion through governmental action is prohibited

even where the advancement is unintentional. Moreover, “. . .

a ‘primary’ affect encompasses even nominally ‘secondary’

affects of government action that directly and immediately

advanced .. . religion.”

A government practice has the effect of impermissibly

advancing religion if it is “sufficiently likely to be perceived

by adherents of the controlling denominations as an endorse-

ment, and by the non-adherents as a disapproval, of their indi-

vidual choices.” Grand Rapids School District v. Ball, 473

U.S. 373 (1985), 390. The relevant inquiry “is whether the

government’s action actually conveys a message of endorse-

ment of religion in general or of a particular religion.” Kre-

isner v. City of San Diego, 1 F.3d 775, 783, (9th Cir. 1993),

cert. den. (1994) 114 S.Ct. 690, 126 L.Ed.2d 657.

" Historically, the government has had little trouble satisfying this

prong of the test. In Lemon the court accepted the state’s position that the

additional payments had the secular purpose of improving the quality of

the education received by children who attend church-related schools.

eee

‘

To determine whether the endorsement message is con-

veyed, the Ninth Circuit uses a reasonable observer standard.

“This hypothetical observer is informed as well as reasonable;

we assume that he or she is familiar with the history of the

government practice at issue.” Kreisner v. City of San Diego,

supra, 1 F.3d at 784. There is no colorable argument that can

be made to save Respondents’ construction of 405.419(c)(2).

Any informed, reasonable observer of Respondents’ practice

of reimbursing interest expense to providers who borrow

funds from their religious operator but denying interest reim-

bursement to providers who borrow funds from their non-

religious, non-profit operators, must conclude that religion is

generally advanced by the interpretation.

Ill. The Decision Below Interprets 42 C.F.R.

§ 405.419 In a Manner Inconsistent With The

Medicare Statute

In promulgating the Medicare Act in 1965, Congress

made clear its intent that Medicare providers were to be reim-

bursed, as nearly as possible, for all costs necessarily incurred

in the efficient delivery of health care services to Medicare

beneficiaries. The Senate Report accompanying the Medicare

Act states Congress’ explicit intent:

Although [reimbursement] may be made on various

bases, the objective, whatever method of computa-

tion is used, will be to approximate as closely as

practicable the actual cost (both direct and indirect)

of services rendered to the beneficiaries of the pro-

gram so that under any method of determining

costs, the costs of services to individuals covered by

the program will not be borne by individuals not

covered, and the costs of services to individuals not

covered, will not be borne by the program.

S. Rep. No. 404, 89th Cong., Ist Sess., reprinted in 1965

U.S.C.C.A.N. 1943, 1976.) This expression of Congressional

purpose is codified in the Medicare Act where the Secretary is

directed to issue regulations for determining reasonable costs

under the Medicare program. 42 U.S.C. § 1395x(v)(1){A).

There, Congress directed that the Secretary’s regulations

shall . . . take into account both direct and indirect

costs .. . in order that, under the methods of deter-

mining costs, the necessary costs of efficiently de-

livering covered services to individuals covered by

[Medicare] will not be borne by individuals not so

covered, and the costs with respect to individuals

not so covered will not be borne by [Medicare].

Id. (emphasis added).

The result of the Ninth Circuit’s judgment affirming the

district court decision here is exactly contrary to Congres-

sional intent: it shifts the costs of providing services to Medi-

care beneficiaries to individuals not covered by the program.

See Ohio State University v. Suilivan, 777 F. Supp. at 582

(1991) (“If the Medicare program did not pay its fair share of .

. costs, there is a likelihood that they would be shifted to

non-Medicare patients in violation of the Medicare Act, 42

U.S.C. § 1395x(v)(1)(A) . . .”). Such a result is contrary to

the meaning and purpose of the Medicare Act, and should not

be allowed to stand.

CONCLUSION

For the foregoing reasons, Petitioner respectfully prays

that the Court issue a writ of certiorari to review the judgment

of the Court of Appeals for the Ninth Circuit.

Respectfully submitted,

Robert Barnes

Counsel of Record

JAMES E. HOLST

JOHN F. LUNDBERG

ROBERT BARNES

University of California

300 Lakeside Drive, 7th Floor

Oakland, CA 94612-3565

(510) 987-9800

July 16, 1996

A-1

APPENDIX A

FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

No. 94-56475

D.C. No.

CV-93-04242-RSL

OPINION

Regents of the University of California,

Plaintiff-Appellant,

Donna E. Shalala, Secretary,

Health & Human Services;

Provider Reimbursement Review Board,

Defendants-Appellees.

Appeal from the United States District Court

for the Central District of California

Ronald S.W. Lew, Presiding

Argued and Submitted

March 6, 1996—Pasadena, California

Filed April 17,1996

’ Pursuant to P.L. No. 103-296, the Social Security Independence and

Program Improvements Act of 1994, the function of the Secretary of

Health and Human Services in Social Security cases was transferred to the

Commissioner of the Social Security Administration, effective March 31,

1995. In accordance with section 106(d) of the Act, Shirley S. Chater,

Commissioner of the Social Security Administration, is substituted for

Donna E. Shalala, Secretary of Health and Human Services, as the defen-

dant. Although the Secretary of Health and Human Services was respon-

sible for the actions of the Social Security Administration at the time of its

final decision in this case, we refer to the defendant as “the Commis-

sioner” throughout this disposition for the sake of convenience.

A-2

Before: Harry Pregerson and Thomas G. Nelson,

Circuit Judges, and David A. Ezra,” District Judge.

Opinion by Judge T.G. Nelson

SUMMARY

Health/Medicaid/MediCare And

Government Assistance

The court of appeals affirmed a district court judgment.

The court held that the district court did not err in granting

summary judgment in favor of the Secretary of Health and

Human Services in university regents’ action challenging the

Secretary’s decision to deny Medicare reimbursement for pa-

tient expenses attributable to interest costs incurred on work-

ing loans from the regents to university hospitals.

Appellant the Regents of the University of California

owns and operates three Medicare providers that are not sepa-

rate legal entities from the Regents. The providers cannot

perform certain legal functions in their own names, including

borrowing monies from outside sources.

Regents made working capital loans to the providers, and

the proceeds were used for patient care purposes. The provid-

ers filed claims for Medicare reimbursement for the interest

expenses associated with the loans. The interest expense

claimed on the loans was below then-existing market rates.

The fiscal intermediary denied the claims on the basis of 42

C.F.R. § 405.419 (1985), which disallows reimbursement for

interest expenses on loans between related organizations.

Appellee the Provider Reimbursement Review Board af-

firmed the intermediary and disallowed the interest expense.

The district court, on review, granted appellee the Secretary’s

motion for summary judgment. The Regents appealed.

~ Honorable David A. Ezra, United States District Judge for the Dis-

trict of Hawaii, sitting by designation.

A-3

[1] Under the Medicare program, providers of services to

Medicare patients are reimbursed for the “reasonable costs” of

providing those services. [2] A precise definition of

“reasonable cost” was left to the Secretary. [3] Congress did

not require the Secretary to make exceptions to its policy on

related party loans for arguably meritorious transactions that

involve a specific type of related party. In this case, the Sec-

retary’s interpretation of the regulation was consistent with

the regulation’s plain language and the purpose of the related

party restriction as set forth in the regulation. [4] Moreover,

there was a valid policy reason for upholding the regulation as

interpreted by the Secretary; if an exception in a previous case

was adopted and the Secretary made exceptions for

“necessary, below market rate” loans between nonprofit or-

ganizations and their related hospitals, then those organiza-

tions would have an incentive to recharacterize routine oper-

ating capital allocations as “loans.” In addition, the regula-

tions were designed to avoid case-by-case review.

[5] The prophylactic rule barring reimbursement for in-

terest expenses on loans between related organizations does

not violate due process rights under the Medicare Program.

[6] Regents did not have standing to challenge the con-

stitutionality of the Secretary’s interpretation of an exception

to the related party interest preclusion for cases where the

provider borrows from a related religious order. Regents

failed to establish that it would suffer injury as a result of the

exception for religiously affiliated providers.

[7] Regents offered no evidence that a favorable decision

would sufficiently redress the injury or potential injury.

A-4

COUNSEL

Robert Barnes, Oakland, California, for the plaintiff-appellant

Russell W. Chittenden, Assistant United States Attorney, Los

Angeles, California, for the defendant-appellee.

OPINION

T.G. NELSON, Circuit Judge:

OVERVIEW

Regents of the University of California (“Regents”) ap-

peals the district court’s summary judgment in favor of the

Secretary of Health and Human Services in Regents’ action

under Title XVIII of the Social Security Act, 42 U.S.C.

§ 139500(f)(a), challenging the Secretary’s decision to deny

Medicare reimbursement for patient expenses attributable to

interest costs incurred on working loans from Regents to three

University hospitals (“providers”).

We have jurisdiction under 28 U.S.C. § 1291, and we af-

firm.

FACTS AND PROCEDURAL HISTORY

Regents owns and operates the three Medicare providers

on whose behalf this appeal is taken, UCLA Medical Center,

UC Irvine Medical Center, and UCSD Medical Center. The

providers are not separate legal entities from the Regents and,

as such, cannot sue, be sued, enter into contracts, or perform

other legal functions in their own names, including borrowing

monies from outside sources.

In 1982, 1983, 1984, and 1985, Regents made working

capital loans to the providers. It is undisputed that the pro-

ceeds from the loans were used for necessary and proper pur-

poses related to patient care. These loans were necessitated

by a budget shortfall resulting from a decrease in funding

from the state legislature.

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A-5

The providers filed claims for Medicare reimbursement

for the interest expenses associated with these loans. The

claims were initially reviewed by the fiscal intermediary, Blue

Cross in this case, and were denied on the basis of 42 C.F.R.

§ 405.419 (1985), which disallows reimbursement for interest

expenses on loans between related organizations. Regents

appealed to the Provider Reimbursement Review Board

(“PRRB”), which affirmed the intermediary and disallowed

the interest expense. On review, the district court granted the

Secretary’s motion for summary judgment.

ANALYSIS

1. Standard of Review

We review a grant of summary judgment de novo.

Rendleman v. Shalala, 21 F.3d 957, 960 (9th Cir. 1994). Ju-

dicial review of Medicare reimbursement disputes under 42

U.S.C. § 139500(f)(1) is governed by the Administration Pro-

cedure Act, 5 U.S.C. §§ 701-706 (“APA”). Under the APA,

“(rjeview is limited to determining whether the Secretary’s

action was arbitrary, capricious, and abuse of discretion, not

in accordance with law, or unsupported by substantial evi-

dence on the record taken as a whole.” Vallejo Gen. Hosp. v.

Bowen, 851 F.2d 229, 231 (9th Cir. 1988).

When the meaning of a provision within the expertise of

an agency is involved, the agency’s expertise makes it par-

ticularly suited to interpret the language. Pacific Coast Medi-

cal Enters. v. Harris, 633 F.2d 123, 131 (9th Cir. 1980). In

such cases, we will generally afford deference to the agency’s

construction of its own regulation.

Review of an agency’s interpretation of its regulations

involves a two-pronged analysis. First, we look to the plain

language of the regulation. The words of the regulation must

be “reasonably susceptible to the construction placed upon

them by the Secretary, both on their face and in light of their

prior interpretation and application.” Jd. Second, “the Secre-

A-6

tary’s construction must be reviewed in relation to the gov-

erning statute.” Jd. “Agency regulations must be consistent

with and in furtherance of the purposes and policies embodied

in the Congressional statute which authorize them.” Jd.

If. Statutory Interpretation

Initially, Regents challenges the Secretary’s interpreta-

tion of § 405.419(b)(3)(ii), which disallows reimbursement

for interest expenses on loans between related organizations.

There is no dispute that the providers and Regents are related

entities. Further, there is no dispute that the interest expense

claimed on the instant loans was below then-existing market

rates. Thus, we must determine whether the plain words of

the regulation are “reasonably susceptible to the construction

placed upon them by the Secretary, both on their face and in

light of their prior interpretation and application,” Pacific

Coast, 633 F.2d at 131, and whether the Secretary’s applica-

tion of the prophylactic rule, which deems all expenses arising

out of loans between providers and their related organizations

per se unreasonable, is contrary to Congressional intent.

[1] Under the Medicare Program, as established by Title

XVII of the Social Security Act (42 U.S.C. §§ 1395-95rr),

providers of services to Medicare patients are reimbursed for

the “reasonable costs” of providing these services. The terms

“reasonable costs” is generally defined in 42 U.S.C.

§ 1395x(v)(1)(A):

[T]he reasonable cost of any services shall be the

cost actually incurred, excluding therefrom any part

of incurred cost found to be unnecessary in the effi-

cient delivery of needed health services, and shall

be determined in accordance with regulations es-

tablishing the method or methods to be used, and

the items to be included in determining such costs

for various types or classes of institutions, agencies,

and services. ...

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A-7

[2] The precise definition of “reasonable cost” was left to

the Secretary. Pursuant to that authority, the Secretary prom-

ulgated 42 C.F.R. §405.419 (1985). Subsection(a) of

§ 405.419 provides that “[n]ecessary and proper interest on

both current and capital indebtedness is an allowable cost.”

Under subsection (b)(2)(i) of §405.419, interest is

“necessary” if it is “incurred on a loan made to satisfy a finan-

cial need of the provider.” Further, interest must be “proper,”

which requires interest to be “incurred at a rate not in excess

of what a prudent borrower would have had to pay in the

money market existing at the time the loan was made,”

§ 405.419(b)(3)(i), and be “paid to a lender not related

through control or ownership, or personal relationship to the

borrowing organization.” § 405.419(b)(3)(ii).

Regents asserts that the Secretary’s interpretation of

§ 405.419 to deny reimbursement of interest on operating

loans Regents made to its providers “runs afoul of Congres-

sional intent that proper and necessary medicare patient ex-

penses be reimbursed by the medicare program ....” Regents

argues that because the regulations make exception for

§ 405.419 in certain related party transactions, other excep-

tions must be recognized where interest rates on loans be-

tween related entities are reasonable, the loan proceeds are

necessary for patient care, and the related parties have no

profit motive. Regents further contends that the scope of the

prophylactic rule in (b)(3)(ii) is defined by the language in

§ 405.419(c)(1), which states: “The intent of this provision is

to assure that loans are legitimate and needed and that the in-

terest rate is reasonable.” Thus, according to Regents, the ef-

fect of § 405.419(b)(3)(ii) together with (c)(1) is to disallow

reimbursement of interest costs on loans between related par-

ties unless the loans are necessary, related to patient care, and

are made at reasonable interest rates. Regents thus reads the

reasons expressed in (c)(1) as exceptions to the general rule of

non-reimbursement.

A-8

In support of its argument, Regents cites Trustees of In-

diana Univ. v. United States, 618 F.2d 736 (Ct. Cl. 1980). In

Indiana, the hospitals, although not owned by the University,

were a part of the University and its medical center. Jd. At

737, 740. The court found that the relationship of the hospi-

tals were state institutions, but, unlike the University, received

no money from the state for their operations. Further, al-

though the University received funds from the State of Indi-

ana, Indiana state law prohibited the University from using

any of those funds for the hospitals. Jd. At 737. Because the

hospitals were not separate legal entities, they could not bor-

row money from outside the University. Jd. As such, the

hospitals’ only source of funds, other than from collection of

fees, was through loans from the University. Jd.

Presented with those particular circumstances, the Indi-

ana court held that the prophylactic rule under § 405.419 was

inapplicable. Jd. At 740-41. The court reasoned that “[t}he

evils against which the prohibition is directed are no more

present where the related person to which the payments are

made is a university than where it is a religious order.” Id. At

740. However, the court expressly limited the holding in Jn-

diana to the particular facts of the case:

In holding for the plaintiffs in this case, we stress

the limited scope of our decision. We are not hold-

ing that interest payments to a related person are

reimbursable wherever the particular relationship

does not involve any of the evils against which the

regulation is directed. Nor are we casting any doubt

upon the authority of the Secretary to adopt his pro-

phylactic regulation generally barring reimburse-

ment of interest payments to related persons without

inquiry into the particular circumstances.

Id.

In Indiana, the University received funds from the state,

but pursuant to state law, those funds could not be diverted for

A-9

the use of the hospitals. Jd. At 737. Further, the hospitals

were prohibited by state law from receiving money from the

State of Indiana. Jd. Therefore, the only way for the hospital

in Indiana to obtain operating funds was through the Univer-

sity.

Regents’ arguments that /ndiana applies here are unper-

suasive. First, in the case at bar, the providers had received

state funds in the past, and unlike the situation in /ndiana,

there is no state law prohibiting the providers from receiving

funds from the state. Further, prior to the 1981 policy of

charging interest on working capital, the providers received

working capital contributions from the Regents. Thus, the

holding in Indiana is a limited exception to the prophylactic

rule, and as the Jndiana court itself warned, its holding should

be limited exclusively to the facts particular to that case.

[3] Second, Congress did not require the Secretary to

make exceptions to its policy on related party loans for argua-

bly meritorious transactions involving a specific type of re-

lated party. In fact, the Secretary’s interpretation of the regu-

lation is consistent with the plain language of the regulation

and the purpose of the related party restriction as set forth in

the regulation itself. Regents’ argument that the reasons for

the regulation found in (c)(1) should be read as exceptions to

the general rule is contrary to the terms of the regulations and

certainly to the Secretary’s interpretation of the regulation.

Third, in Goleta Valley Community Hosp. v. Schweiker,

647 F.2d 894 (9th Cir. 1981), we were asked to access the

statutory and constitutional validity of the related party inter-

est rule of § 405.419(b)(3)(ii), and we held that the regulation

was valid. Regents argues that Goleta Valley may be distin-

guished from this case because the related parties in Goleta

Valley had a profit motive. However, there is no indication

that the holding in Goleta Valley was influenced by this fac-

tor. In Goleta Valley, we held:

A-10

Once a determination has been made that the or-

ganizations are related, the Board need not inquire

into whether the reimbursements claimed were rea-

sonable because Regulation [405.419(b)(3)(ii)] op-

erates as a prophylactic rule and defines any charges

in excess of actual costs as per se unreasonable.

Id. At 897.

[4] Moreover, there is a valid policy reason for uphold-

ing the regulation as interpreted by the Secretary. If the ex-

ception in Jndiana were adopted and the Secretary made ex-

ceptions for “necessary, below market rate” loans between

nonprofit organizations and their related hospitals, then those

organizations would have incentive to recharaterize routine,

operating captial allocations as “loans” in order to take ad-

vantage of the interest expense reimbursement policy of

Medicare. In addition, the exceptions would swallow the rule,

requiring the case-by-case review the regulations were de-

signed to avoid.

Ill. Due Process

According to Regents, the effect of the prophylactic rule

prohibiting reimbursement of interest expenses for loans be-

tween related parties is an irrebuttable presumption which

violates Regents’ right to due process. Viandis v. Kline, 412

U.S. 441, 447 (1973) (“Statutes creating permanent irrebutta-

ble presumptions have long been disfavored under the Due

Process Clause of the Fifth and Fourteenth Amendments.”).

Regents’ argument lacks merit because the law regarding

the constitutionality of irrebuttable presumptions in social

programs has been well settled. Weinberger v. Salfi, 422

U.S. 749 (1975); Goleta Valley, 647 F.3d at 894. In Salfi, the

Supreme Court approved of a per se rule defining the length

of marriage needed to qualify for social security benefits

“which sweeps more broadly than the evils with which they

seek to deal.” 422 U.S. at 784. The Court explained:

Ia Ne Oey AE ae el

A-11

The Constitution does not preclude such policy

choices as a price for conducting programs for the

distribution of social insurance benefits. ... There

is thus no basis for our requiring individualized de-

terminations when Congress can rationally conclude

not only that generalized rules are appropriate to its

purposes and concerns, but also that the difficulties

of individual determinations outweigh the marginal

increments in the precise effectuation of congres-

sional concern which they might be expected to

produce.

Id. At 785.

Other courts have also rejected the irrebuttable presump-

tion challenge to the prophylactic rule under § 405.419. In

Hillside Community Hosp. v. Mathews, 423 F. Supp. 1168,

1176 (N.D. Cal. 1976), the court found that the classifications

under § 405.419 had a reasonable basis: “[T]o assure that

loans are legitimate and needed, and that the interest rate is

reasonable.” “[I]n the context of social welfare programs, a

classification will not be voided just because it ‘is not made

with mathematical nicety or because in practice it results in

some inequality.” Jd. (quoting Danbridge v. Williams, 397

U.S. 471, 485 (1970). “If there is some ‘reasonable basis’ for

the rule, it must be upheld.” Jd.

In Caylor-Nickel Hosp. Inc. v. Califano, N.D. Ind., Civ.

No. F 77-83 (Sept. 10, 1979), 1980 Medicare & Medicaid

Guide (CCH) 930,718, citing Salfi, 422 U.S. 749, the court

held that § 405.419(b)(3)(ii) did not create an unconstitutional

irrebuttable presumption:

Salfi dictates that this court reject Caylor-Nickel’s

characterization of 42 C.F.R. § 405.419(b)(3)(ii) as

involving an irrebuttable presumption that all trans-

actions involving organizations related to Caylor-

Nickel were illegitimate. The regulation presumes

only that many transactions between related institu-

A-12

tions are not legitimate, not needed, or not at rea-

sonable interest; the Secretary, acting under statu-

tory authority, has made a policy choice that, in the

words of Sal/fi, “limited resources would not be well

spent in making individual determinations.”

[5] In light of Salfi, Hillside, and Goleta Valley, we reject

the argument that the prophylactic rule barring reimbursement

for interest expenses on loans between related organizations

violates due process rights under the Medicare Program. The

Secretary has the authority to make a policy choice to exclude

reimbursement for interest expense arising from loans be-

tween related entities.

IV. Establishment Clause

Next, Regents challenge the Secretary’s interpretation of

42 C.F.R. § 405.419(c)(1),’ the provision which precludes re-

lated party interest, and § 405.419(c)(2), the provision which

creates an exception to the related party interest preclusion for

cases where the provider borrows from a related religious or-

der. Subsection (c)(2), provides: “[I]f a provider operated by

members of a religious order borrows from the order, interest

paid to the order is an allowable cost.”

Regents argues that although it does not fall within the

plain language of the (c)(2) exception, the Secretary should

interpret the exception to cover secular, nonprofit organiza-

Section 405.419(c)(1) provides in part:

To be allowable, interest expense must be incurred on indebt-

edness established with lenders or lending organizations not

related through control, ownership, or personal relationship to

the borrower. Presence of any of these factors could affect the

“bargaining” process this usually accompanies the making of

a loan, and could thus be suggestive of an agreement on

higher rates of interest or of unnecessary loans. Loans should

be made under terms and conditions that a prudent borrower

would make in armslength transactions with lending institu-

tions. ...

A-13

tions such as itself. According to Regents, if the (c)(2) ex-

ception is interpreted categorically to disallow interest reim-

bursement for secular Medicare providers, it may create an

unconstitutional preference for religion in violation of the

First Amendment Establishment Clause of the United States

Constitution.

Finding that Regents lacked standing to make a First

Amendment challenge to the regulations, the district court did

not reach the merits of this argument. Regents urges this

court to interpret, sua sponte, the regulation so as to avoid any

unconstitutionality under the Establishment Clause.

For the reasons discussed below, Regents’ arguments are

unpersuasive. At oral argument, it was conceded by Regents

that it was not challenging the constitutionality of the regula-

tion or the exception, in and of themselves. Rather, Regents’

Establishment Clause challenge is directed at the Secretary's

interpretation of the (c)(2) exception.

Regents maintains that the exception found in

§ 405.419(c)(2) would be appropriate if it was read to include

similarly situated non-profit providers and operators who do

not collaborate in the establishment of interest charges on

loans between each other for the purposes of enhanced profit.

Thus, Regents seeks to strike the Secretary’s limitation on the

exception itself. This, we decline to do. If we were to hold

that the Secretary’s interpretation of § 405.419(c)(2) violates

the Establishment Clause, we would essentially be holding

that § 405.419(c)(2) was unconstitutional, because the Secre-

tary’s interpretation is wholly consistent with plain language

of the exception. In such case, our remedy would be to strike

the exception rather than to rewrite the regulation to create

new exceptions or to strike the entire regulation.

Before we reach the issue of the constitutionality of the

(c)(2) exception, we must first determine whether Regents has

standing to challenge the Secretary’s interpretation of the ex-

ception under the Establishment Clause. Standing is reviewed

A-14

de novo. United Union of Roofers No. 40 v. Insurance Corp.

of Am., 919 F.2d 1398, 1399 (9th Cir. 1990). “A district

court’s factual findings on jurisdictional issues must be ac-

cepted unless they are clearly erroneous.” Reebok Int’l. Lid

v. Marnatech Enter., Inc., 970 F.2d 552, 554 (9th Cir. 1992)

(quotations omitted).

To establish standing, we must determine “whether the

interest sought to be protected by the complaint is arguably

within the zone of interests to be protected or regulated by the

Statute Or constitutional guarantee in question.” Association

of Data Processing Serv. Orgs., Inc., v. Camp, 397 U.S. 150,

153 (1970). Thus, in order to have Standing, the complainant

must be aggrieved by the agency action within the meaning of

the statute. Jd. The complainant must establish that he has

suffered injury-in fact. Jd. However. potential injury may be

sufficient to confer standing. City of Rohnert Park v. Harris,

601 F.2d 1040, 1048 (9th Cir. 1979).

[6] In this case, Regents does not have Standing to chal-

lenge the constitutionality of the Secretary’s interpretation of

the (c)(2) exception. Regents failed to establish that it would

suffer injury as a result of the (c)(2) exception for religiously

affiliated providers. The district court determined that the

potential injury to Regents from the application of the excep-

tion for hospitals affiliated with religious organizations is too

attenuated to establish standing.

[7] Further, Regents offered no evidence that a favorable

decision would sufficiently redress the injury or potential in-

jury. A decision by this court that the Secretary could no

longer permit religiously affiliated providers to include inter-

est pursuant to the exception would not benefit Regents, as

Regents would still be precluded from including interest by

the other terms of the regulation. Without any evidence of

injury to Regents as a result of the alleged unconstitutional

interpretation of the regulation and without evidence that a

favorable ruling redress the injury, the district court’s deter-

A-15

mination that Regents lacked standing to raise this issue was

not erroneous.

CONCLUSION

For the reasons stated above, the district court’s sum-

mary judgment is AFFIRMED.

A-16

APPENDIX B

UNITED STATES DISTRICT COURT

CENTRAL DISTRICT OF CALIFORNIA

No. CV-93-4242-RSWL (Ex)

THE REGENTS OF THE

UNIVERSITY OF CALIFORNIA

Plaintiff

Vv.

DONNA E. SHALALA, Secretary,

United States Department of

Health and Human Services,

Defendant.

Filed September 6, 1994

Clerk, U.S. District Court

Central District of California

Entered September 7, 1994

Clerk, U.S. District Court

Central District of California

ORDER

I. INTRODUCTION

Before the Court are the parties’ cross motions for sum-

mary judgment. The matter came up for hearing on the

Court’s law and motions calendar on August 29, 1994. Now,

having carefully considered all of the papers filed in support

of and in opposition to the motions, the Court hereby

GRANTS Defendant, Department of Health and Human

Services’ cross motion for summary judgment and DENIES

Plaintiff, Regents of the University of California’s motion for

summary judgment.

A-17

Il. BACKGROUND

Plaintiff, The Regents of the University of California

(“The Regents”) filed its complaint in this case asking the

Court to review an administrative decision by the Provider

Reimbursement Review Board (“the Review Board”) denying

it certain cost reimbursements under the Medicare program.

The Regents’ complaint arises out of a dispute over medical

care provider reimbursements for its affiliated medical cen-

ters. These reimbursements initially are reviewed by “fiscal

intermediary,” which serves as the agent of Defendant, De-

partment of Health and Human Services (“HHS”) and evalu-

ates a provider’s claims for reimbursements at the end of each

year. In the present case, Blue Cross/Blue Shield of Califor-

nia acted as the fiscal intermediary, initially denying the re-

imbursement requests at issue in this case.

Appeals from adverse decisions of a fiscal intermediary

are heard by the Review Board, whose decisions are final un-

less the Secretary of HHS revises or modifies such a decision

on her own motion. In this case, the Review Board heard and

affirmed Blue Cross/Blue Shield’s initial denial of The Re-

gents’ reimbursement requests and the Secretary took no fur-

ther action on The Regents’ claims. The Regents (the pro-

vider) has a right to judicial review in district court of the Re-

view Board’s final decision or any subsequent action taken by

the Secretary. 42 U.S.C. § 139500(f). It is in this posture of

review that the case is presently before the Court.

Specifically at issue in this case is The Regents’ claim

that it is entitled to reimbursement for interest expenses in-

curred on money it loaned to its UCLA, UC Irvine and UC

San Diego medical centers. Defendant claims, and the Re-

view Board held below, that reimbursement for such interest

expenses is not available under applicable regulations because

the loans at issue were between related parties, that is, the

medical centers and The Regents. It is undisputed that the

medical centers and The Regents are the same legal entity and

A-18

thus, related parties for purposes of the relevant regulations.

Each UC medical center involved in this case has various

claims for interest reimbursement for the years 1982 through

1985. These claims were consolidated for review in the ad-

ministrative proceedings below, and are consolidated for pur-

poses of this case as well.’ The total amount of disputed in-

terest expense that The Regents claims to be entitled to in this

case is $1.6 million.

It is uncontested that the interest expense claimed on

loans made by The Regents to its various medical centers

during the years at issue was well below then-existing market

rates. Nonetheless, Defendant asserts that its regulation, 42

C.F.R. § 405.419 (1985) (“Regulation 405.419”),’ prohibits

reimbursement of The Regents for this interest because it was

incurred through related party borrowing. Defendant justifies

its regulation by asserting that it acts as a prophylactic rule to

prevent abuses that could occur in lending transactions be-

tween related parties. Specifically, Defendant is concerned

that without such a prophylactic regulation, unnecessary loans

will be made, or excessive rates of interest charged on bor-

rowings between related entities.’ It is uncontested that there

is no evidence of such abuses in this case. Defendant asserts,

Although the Regents is the lender in this case, it nonetheless stands

as plaintiff in that its related medical centers are not independent legal

entities and therefore lack the capacity to sue or be sued.

The Regents asserts that the related party loans in question were ne-

cessitated by the fact that its providers did not have the legal capacity to

borrow money from outside sources. The basis of such loans, however, is

irrelevant to the question of whether Defendant’s denial of reimbursement

for expenses attributable to them was a reasonable interpretation of the

relevant statute and regulations.

This provision was redesignated 42 C.F.R. S 413.153 in 1986. No

substantive changes have been made to the regulation.

These justifications for the prohibition on related party interest re-

imbursement are outlined in the applicable regulation itself. 42 C.F.R.

§ 405.419(c) (1985) (redesignated as 42 C.F.R. § 413.153(c) (1993)).

A-19

however, that its regulation must nonetheless apply. Both

parties have thus agreed that the issue presented to the Court

is whether Defendant’s application and interpretation of

Regulation 405.419 disallowing reimbursement for related

organization interest expenses, even when such expenses are

in fact proper, was arbitrary and capricious, or otherwise im-

proper under law.

At the administrative level, this case was decided on

Stipulated facts, with no oral argument having been heard by

the Review Board. Thus, the case comes to this Court under

the same stipulated factual record. In its motion, The Regents

challenges both the Defendant’s interpretation of Regulation

405.419, as well as its promulgation of that regulation under

the Medicare statute. In addition, The Regents points to sev-

eral potential constitutional problems raised by Defendant’s

interpretation of the regulation to argue that such interpreta-

tion is erroneous. The Regents points to these constitutional

issues aS support for its argument that Regulation 405.419

must be interpreted not as an absolute, prophylactic bar to

reimbursement for related party interest expenses, but rather,

as a rebuttable presumption that such expenses are not reim-

bursable. In this case, The Regents argues, the uncontested

fact that its loans were proper serves to rebut that presump-

tion.

Il. STANDARD FOR ISSUANCE OF SUMMARY

JUDGMENT

Summary judgment is appropriate when there is no

genuine issue of material fact and the moving party is entitled

to judgment as a matter of law. Fed. R. Civ. P. 56(c). The

moving party bears the initial responsibility of identifying this

absence of a genuine issue of material fact. Celotex v. Catrett,

477 U.S. 317, 323, 106 S. Ct. 2548, 2553 (1986). The non-

moving party, on the other hand, is required by Rule 56(e) to

go beyond the pleadings and designate specific facts showing

that there is a genuine issue for trial. Jd. at 324, 106 S. Ct. at

A-20

2553. Nonmoving parties can meet this requirement by use of

affidavits, depositions, interrogatories, or admissions on file.

Id. However, conclusory allegations unsupported by factual

data are insufficient to create a triable issue of fact so as to

preclude issuance of summary judgment. Exxon Corp. v.

Federal Trade Comm’n, 663 F.2d 120, 127 (D.C. Cir. 1980).

The judge must view the evidence in the light most favorable

to the nonmovant, with all justifiable inferences drawn in its

favor. Anderson v. Liberty Lobby, 477 U.S. 242, 252, 106 S.

Ct. 2505, 2512 (1986); Pacific Express. Inc. v. United Air-

lines. Inc., 959 F.2d 814, 816 (9th Cir.), cert. denied, 113 S.

Ct. 814 (1992).

Summary judgment is a particularly appropriate vehicle

for resolving appeals from administrative agency determina-

tions, since the agency itself serves as the fact finder, and the

appeal is generally limited to questions of law. First National

Bank v. Smith, 508 F.2d 1371, 1374 (8th Cir. 1974), cert. de-

nied, 421 U.S. 930, 95 S. Ct. 1655 (1975); see also 10A A.

Wright & C. Miller, Federal Practice and Procedure “§ 2733,

at 366-67 (1983).

IV. DISCUSSION

Under the Medicare statute, medical care providers are to

be reimbursed for the “reasonable costs” of services they pro-

vide Medicare patients. 42 U.S.C.A. § 1395f(b) (Supp. 1994).

Regulations promulgated under this statute by HHS include

within the definition of reasonable costs, “[{nJecessary and

proper interest on both current and capital indebtedness.” 42

C.F.R. S 405.419(a) (1) (1985); see also 42 U.S.C.A.

§ 1395x(v) (Supp. 1994) (defining reasonable costs and

granting HHS the authority to promulgate explanatory regula-

tions). Under applicable regulations, however, to be reim-

bursable, interest expense “must be incurred on indebtedness

established with lenders . . . not related through control. own-

ership or personal relationship to the borrower.” 42 C.F.R.

§ 405.419(c)(1) (emphasis added).

A-21

A. Review of Defendants Regulatory Interpretations

and Promulgation.

Review over administrative determinations made by the

Review Board is governed by 42 U.S.C.A. § 139500(f)(1)

(Supp. 1994), which specifically incorporates the standards of

review contained in the Administrative Procedures Act

(“APA”), 5 U.S.C. §§ 701-706. The APA requires that the

district court “decide all relevant questions of law, interpret

constitutional and statutory provision, and determine the

meaning or applicability of the terms of an agency action.”

Id. § 706. Furthermore, under the APA, the court must “hold

unlawful and set aside agency action, findings, and conclu-

sions found to be . . . arbitrary, capricious, an abuse of discre-

tion, or otherwise not in accordance with law.” Jd. In this

case, The Regents challenges both the Review Board’s inter-

pretation of the relevant Medicare regulation (Regulation

405.419) as well as HHS’s initial promulgation of that Regu-

lation under the Medicare statute.

1. Defendant’s Interpretation of its Regulation.

a. Standard of review.

Courts generally give considerable deference to any

agency interpretation involving an issue within that agency’s

particular expertise. Pacific Coast Medical Enters. v. Harris,

633 F.2d 123, 131 (9th Cir. 1980). “This is especially true

when an agency’s own regulation is involved, and ordinarily,

its construction will be affirmed if it is not clearly erroneous

or inconsistent with the regulation.” Jd. (citing Udall v.

Tallman, 380 U.S. 1, 16-17, 85 S. Ct. 792, 801 (1965))

(emphasis added). While a large degree of deference is given

to such agency determinations, “ ‘the deference owed to an

expert tribunal cannot be allowed to slip into a judicial iner-

tia.”” Id. (quoting, American Ship Building Co. v. NLRB,

380 U.S. 300, 318, 85 S. Ct. 955,967 (1965)). Thus, the Re-

view Board’s decision in this case upholding Defendant’s in-

terpretation of Regulation 405.419 must be given a consider-

able, although not unlimited, degree of deference.

A-22

b. Defendant’s interpretation of the regula-

tions.

The Regents argues that for various reasons, the related

party interest restrictions contained in Regulation 405.419

cannot be interpreted to act as an automatic bar to the recov-

ery of interest expense owed by providers (i.e. its medical

centers) to related entities (i.e. The Regents itself). Rather, it

argues that the regulatory scheme should be interpreted to es-

tablish a rebuttable presumption that related party loans are

improper. This presumption could be overcome, The Regents

argues, by a showing that the particular loans at issue were in

fact proper. Defendant argues, on the other hand, that the ap-

plicable regulatory language is unequivocal: related party in-

terest expenses are not reimbursable.

Examination of an agency’s interpretation of a regulation

involves a two prong analysis. First, the words of a regulation

must be “reasonably susceptible to the construction placed

upon them by the Secretary, both on their face and in light of

their prior interpretation and application.” Pacific Coast

Medical, 633 F.2d at 131. In this case, the applicable regula-

tion, on its face, prohibits reimbursement of related party in-

terest expenses. Thus, Defendant’s interpretation must pre-

vail under this component of the analysis, since it is undis-

puted that The Regents and its medical providers are related

entities.

Under the second component of the regulatory interpre-

tation analysis, “the Secretary’s construction must be re-

viewed in relation to the governing statute.” Jd. “Agency

Under the regulations, to be “proper,” interest expense must be

“paid to a lender not related through control or Ownership, or personal

relationship to the borrowing organization.” 42 C.F.R. § 405.419(b)(3 (ii)

(1985). In addition, in order “to be allowable, interest expense must be

incurred on indebtedness established with lenders or lending organizations

not related through control, ownership, or personal relationship to the bor-

rower.” Id. § 405.419(c).

i i ro pare ed

‘

oe Deen wre tO

a ee

Sintec tindeereis

Aeon Naa RT at i

A-23

regulations must be consistant with and is favthowncs af she

purposes and policies embodied in the congressional statutes

which authorize them.” Jd. The statutory mandate applicable

in this case requires only that providers be reimbursed for the

“reasonable cost” of services they provide. 42 U.S.C.

§ 1395f(b). Moreover, the Secretary is specifically authorized

by the Medicare statute to further define what constitutes

“reasonable cost,” and the items to be included in that defini-

tion. 42 U.S.C. § 1395x(v)(1)(A). Thus, for Defendant to

deny reimbursement for related party borrowing seems en-

tirely consistent with the statutory scheme Congress estab-

lished for reimbursements under the Medicare program.

In spite of the result mandated by application of the

Medicare regulations, however, The Regents argues that in its

case, the related party interest restriction should not apply. the

Regents bases its argument on several decisions by other

courts that viewed Defendant’s interpretation of Regulation

405.419 as inconsistent with the reimbursement mandate of

the Medicare statute itself. See Trustees of indiana University

v. United States, 618 F.2d 736, 739 (Ct. Cl. 1980); South

Boston Gen. Hosp. v. Blue Cross, 409 F. Supp. 1380, 1384-85

(W.D. Va. 1970). Contra Hillside Community Hosp. v.

Mathews, 423 F. Supp. 1168, 1176 (N.D. Ca. 1976)

(upholding Defendant’s interpretation). In particular, The

Regents cites the Court of Claims’ decision in Indiana Uni-

versity for the proposition that a per se application of the re-

lated party interest exclusion in Regulation 405.419 is incon-

sistent with the purpose of the Medicare statute itself, that is,

to reimburse providers for Medicare-related expenses. 618 F.

2d at 739; see also South Boston, 409 F. Supp. at 1384-85

(requiring Defendant to give individualized scrutiny to party

borrowings). This inconsistency, the Court of Claims con-

cluded, meant that it was not bound to follow the express

wording of the regulation. Indiana University, 618 F.2d at

739 (citing United States v. American Trucking Ass’ns, Inc.,

310 U.S. 534, 543, 60 S. Ct. 1059, 1064 (1940) and Rucker v.

A-24

Wabash R.R. Co., 418 F.2d 146 (7th Cir. 1969)). In making

its determination, however, the Court of Claims, made no

mention of the deference it is required to give an agency’s

Statutory interpretations.

Despite the holdings of other courts invalidating Defen-

dant’s interpretation of Regulation 405.419 based on its al-

leged inconsistency with the mandate of the Medicare Statute,

this Courts determination of the issue is governed by the

Ninth Circuit’s decision in Goleta Valley Community Hospital

v. Schweiker, 647 F.2d 894 (9th Cir. 1981). In Goleta Valley,

the Court stated:

The [provider] argues that the application of

[Regulations 405.427 and 405.419] automatically to

deny reimbursement is contrary to both the Medi-

care Act and the United States Constitution. We

have recently upheld both the Statutory and consti-

tutional validity of Regulation 405.427 by finding

that the regulation is reasonably related to achieving

a permissible objective. “The classification of

‘related entity’ . . . was established to prevent the

reimbursement of excessive charges resulting from

self-dealing ....” The related entity classification

was a reasonable method of achieving this objec-

tive. The same related entity classification is used

in Regulation 405.419 for exactly the same purpose:

to ensure that entities deal with each other at arm’s

length. Thus we find regulation 405.419 is also

valid.

Id. at 897 (quoting American Hospital Management Corp. v.

Harris, 638 F.2d 1208, 1212, 1213 (9th Cir. 1981)) (citations

omitted and emphasis added). Thus, Defendant’s contention

that the related party interest expense limitation does apply

Should prevail, despite the apparent over-inclusiveness of the

regulation when applied to the facts of the present case. See

id. (holding that under a comparable regulation, “[o]nce a de-

A-25

termination has been made that the organizations are related,

the Board need not inquire into whether the reimbursements

claimed were reasonable”).

2. Defendant’s Promulgation of the Regulation.

a. Standard of review.

Finding the Secretary’s interpretation of the applicable

regulation to be proper, the Court must next address the issue

of whether the regulation itself is a proper interpretation of the

authorizing legislation. Review over an agency’s exercise of

its rule-making authority “is limited to determining whether

the regulation is reasonably related to the purpose of the rele-

vant enabling legislation, as well as to the more particular

purpose through which the regulation implements those ob-

jectives in a particular area.” American Hospital, 638 F.2d at

1212. Substantial deference must be given to the agency’s

interpretation of the enabling legislation. It is that agency

which has been directed by Congress to interpret the statute,

and presumably, in promulgating its regulations, it has used

its particular expertise in the area to interpret that statute. /d.

b. promulgation of the regulation.

This Court’s review of an agency’s adoption of a regula-

tion is limited to making a determination as to whether it is

reasonably related to the purpose of the enabling legislation.

American Hospital, 638 F.2d at 1212. In the present case, it is

clear that the objective of Medicare reimbursement is “to ap-

proximate as closely as practicable the actual cost (both direct

and indirect) of services the beneficiaries of the [medicare]

program.” S. Rep. No. 404, 89th Cong. Ist Sess. at 36 (1965),

reprinted in 1965 U.S.C.C.A.N. 1943, 1976. This intent is

reflected in the Medicare statute itself. 42 U.S.C.

§ 1395x(v)(1)(A) (mandating that both direct and indirect

costs be taken into consideration by HHS when calculating

Medicare reimbursement).

The Ninth Circuit’s discussion of a Medicare regulation

similar to that involved in this case is relevant to this court’s

A-26

interpretation of Regulation 405.519. In American Hospital,

the Ninth Circuit stated:

The [Medicare] statute mandates that only costs

actually incurred in the efficient delivery of needed

health care services be reimbursed. The regulation

implements that requirement by providing that

where facilities, services or supplies are furnished to

a provider by a “related” entity, the provider is to be

reimbursed at the cost of those items to the related

entity rather than at the cost charged to the pro-

vider.... The regulation is thus designed to pre-

vent seemingly separate entities from engaging in

what is in fact self-dealing at the expense of the

Medicare program. .. . So long as the regulation has

a reasonable basis in fact, the regulation must be

upheld as a valid exercise of the Secretary’s discre-

tion.

638 F.2d at 1212. Unlike the regulation at issue in American

Hospital, in the present case the applicable regulation denies

The Regents ail interest cost, not just that deemed over actual

or market rates. The Regents uses this fact to argue that it

should at least be entitled to recover related party interest ex-

penses incurred at under-market rates. However, Defendant

asserts that the justification for the related party interest regu-

lation is not only a concern over excessive interest

(comparable to the concern over excessive costs at issue in

American Hospital). Rather, Defendant Asserts that its regu-

lation preventing any reimbursement for related party interest

expense is further justified by a concern that unnecessary

loans will be made in the first place, in an attempt to recoup

interest reimbursement from the Medicare program. Defen-

dant’s concern is that controlling entities such as The Regents

will loan money to their related providers rather than make

ordinary capital contributions in order to recover interest ex-

penses from the Medicare program. This concern is entirely

reasonable and this, will suffice as a basis for the Court to up-

ee ae

ee wi tid at Site x atl

ee ee

A-27

hold the validity of Regulation 405.419. See American Hos-

pital, 638 F.2d at 1212. Moreover, the reasonableness of the

regulation is in line with Ninth Circuit’s interpretations of re-

lated party reimbursement restrictions contained in other

Medicare regulations. As the Court has stated:

[I]n a program as complex and ripe with potential

abuse as Medicare, the Secretary has broad discre-

tion to control excessive costs by adopting general

prophylactic rules which, despite their inherent im-

precision, eliminate the need for a cumbersome and

expensive process of adjudicating item-by-item the

reasonableness of costs. .

Marina Mercy Hosp. v. Harris, 633 F.2d 1301, 1304 (9th Cir.

1980); see also American Hospital, 638 F.2d at 1212: Goleta

Valley, 647 F.2d at 897; Wisconsin Dep’t of Health & Human

Servs. v. Bowen, 797 F.2d 391, 399 (7th Cir. 1986) (holding

that the over-inclusiveness of a regulation does not necessar-

ily mean that it is arbitrary and capricious, so long as the

agency has some “reasonable justification” for the rule).

Thus, in this case, it is clear that Defendant’s authority for

promulgating rules is broad, and that such authority has not

been exceeded by the adoption of Regulation 405.419.

B. Irrebuttable Presumption Disallowing Related Party

Interest as Violative of Due Process.

Notwithstanding the reasonableness of Defendant’s in-

terpretation and promulgation of Regulation 405.419, The

Regents asserts two constitutional grounds for its contention

that Defendant’s interpretation of that regulation is erroneous.

In its first constitutional challenge, The Regents contests the

constitutionality of Defendant’s interpretation of Regulation

405.419 by claiming that it establishes an irrebuttable pre-

sumption violating the Due Process Clause of the Fifth

Amendment. See Vlandis v. Kline, 412 U.S. 441, 447, 93 S.

Ct. 2230, 2233 (1973) (“Statutes creating permanent irrebut-

A-28

table presumptions have long been disfavored under the Due

Process Clause of the Fifth and Fourteenth Amendments.”).

The Regents argument, however, must fail, again based

on the Ninth Circuit’s decision in Goleta Valley, 647 F.2d at

894. As discussed supra, in Goleta Valley the Ninth Circuit

specifically held that Regulation 405.419’s automatic denial

of related party interest expense reimbursement was constitu-

tionally valid. Jd. at 897. This determination is consistent

with the Supreme Court’s directive that social welfare regula-

tions need not be invalidated on due process grounds merely-

because they are not “made with mathematical nicety or be-

cause in practice [they] result [ ] in some inequity.” Dan-

dridge v. Williams, 397 U.S. 471, 485, 90 S. Ct. 1153, 1161

(1970). According to the Court, if there is some reasonable

basis for the rule, it must be upheld. Jd. Regulation 405.419

States its justification as “to assure that loans are legitimate

and needed, and that the interest rate is reasonable.” 42

C.F.R. § 405.419 (1985). “If the owner uses his own funds in

a business, it is reasonable to treat the funds as invested funds

or capital, rather than borrowed funds.” Jd. The Regents does

not challenge the general reasonableness of this regulation,

only the application of the regulation in this case. However,

pursuant to the Supreme Court’s decision in Dandridge, and

the Ninth Circuit’s holding in Goleta Valley, the Due Process

challenge to the related party interest regulation must fail. See

also Hillside Community Hosp. v. Mathews, 423 F. Supp

1168, 1176 (N.D. Cal. 1976) (rejecting a Medicare provider’.

argument that inflexible application of Regulation 405.419

amounts to an unconstitutional irrebuttable presumption).

C. First Amendment Violations.

The Regents’ second constitutional challenge to Defen-

dant’s interpretation of Regulation 405.419 is based on the

Establishment Clause of the First Amendment. In particular,

The Regents cites a provision in Regulation 405.419 allowing

reimbursement for related party interest expenses when “a

provider operated by members of a religious order borrows

A var Wa shin a ii iia

A-29

from the order.” 42 C.F.R. § 405.419(c)(2) (1985). The Re-

gents cites this provision to claim that if the regulation is in-

terpreted categorically to disallow interest reimbursement for

nonreligious related entities, then the exception allowing re-

imbursement for borrowing between related religious entities

will violate the Establishment Clause of the First Amendment

by giving such entities a preference over secular Medicare

providers.

1. The Regents’ Standing to Assert an Establish-

ment Clause Challenge.

An initial question is raised as to The Regents standing

to bring an Establishment Clause challenge to the religious

order exception contained in Regulation 405.419.° One Court

addressing the issue stated in dicta, that a provider similarly

situated to The Regents “may lack the requisite standing to

challenge the regulation in that [the fiscal intermediary] did

not invoke Subsection (c)(2), the alleged unconstitutional sub-

section, when making adjustments to the [provider’s] cost re-

port.” Frankford Hospital v. Davis, 647 F. Supp. 1443, 1452

(E.D. Pa. 1986). Although its motion fails to address the

standing issue in any way, at oral argument on the present

motions The Regents asserted that its standing to challenge

the constitutionality of Regulation 405.419 was based on its

position as a competitor of religiously affiliated Medicare

providers. That is, since religiously affiliated competitors

may recover related party interest expense and The Regents

may not, those competitors are placed at an unfair advantage

solely based on their religious affiliation. The Regents claims

that this competitor advantage could cause it an economic in-

jury sufficient to confer standing to challenge Defendant’s

interpretation of Regulation 405.419 under the Establishment

Clause. A review of the doctrine of competitor standing,

however, demonstrates that The Regents’ argument must fail.

° 42 C.F.R. § 419.405(c)(2) (1985) (redesignated 42 C.F.R. § 413.153

(c)(2) (1993)).

A-30

In order to invoke the doctrine of competitor standing, a

party must “first allege that the challenged [regulatory] action

has caused him injury in fact, economic or otherwise.” Asso-

ciation Of Data Processing Service Orgs., Inc. v. Camp, 397

U.S. 150, 152, 90 S. Ct. 827, 829 (1970). In order for the re-

viewing court to find standing, “the plaintiff [must] show an

injury to himself that is likely to be redressed by a favorable

decision. Absent such a showing, exercise of its power by a

federal court would be gratuitous and thus inconsistent with

the Art. III limitation.” Simon v. Eastern Ky. Welfare Rights

Org., 426 U.S. 26, 38, 96 S. Ct. 1917, 1924 (1976). When a

party asserts only an indirect injury, it is substantially more

difficult for a court to find standing created by that injury. Jd.

at 44-45, 96 S. Ct. at 1927; see also City of Rohnert Park v.

Harris, 601 F.2d 1040, 1048 (9th Cir. 1979), cert. denied, 445

U.S. 961, 100 S. Ct. 1647 (1980).

In the present case, The Regents has not alleged that De-

fendant’s invocation of the religious order exception in

Regulation 405.419 has caused it 27, direct injury. Rather,

The Regents makes only a vague, hypothetical assertion that

the religious order exception could be invoked in such a man-

ner by Defendant so as to cause it an economic injury. That

injury would presumably relate to a loss of patients and reve-

nue due to the higher prices The Regents would have to

charge Medicare patients by not being reimbursed for related

party borrowing expenses. Such attenuated and hypothetical

injuries are an insufficient basis for this Court to find standing

for The Regents to challenge Regulation 405.419 under the

Establishment Clause. “Although potential injury may be suf-

ficient to confer standing, the relationship between the injury

here and the alleged illegal agency action is too attenuated to

meet the minimum Article III requirements.” Rohnert Park,

601 F.2d at 1049.

In order to find standing, the Court, without any evidence

being presented by The Regents, would have to assume a

number of elements in the causal chain between Defendant’s

A-31

action and The Regents’ asserted economic injury. These as-

sumptions include: (1) that the religious order exception con-

tained in Regulation 405.419 has been invoked by Defendant;

(2) that religiously-affiliated Medicare providers gained some

financial benefit from related party borrowing, and were al-

lowed Medicare reimbursement from Defendant; (3) that such

providers were competitors of The Regents; and (4) that being

able to take advantage of the related party expense exception

allowed such competitors to undercut The Regents in their

provision of Medicare services, thus causing The Regents a

competitive, economic injury. Without any evidence of such

factors, the Court must find that The Regents assertions of

possible economic injury are too conjectural and hypothetical

to confer competitor standing. See Rohnert Park, 601 F.2d at

1049. Thus, having found that The Regents has no standing

to challenge the religious order exception to related party in-

terest reimbursement contained in Regulation 405.419, the

merits of its Establishment Clause challenge need not be ad-

dressed by the Court.

V. CONCLUSION

Regulation 405.419 on its face denies The Regents reim-

bursement for interest expenses incurred through loans made

to its related medical centers. This prophylactic regulation,

while potentially over-inclusive in scope, has been reasonably

interpreted by Defendant, and is itself a proper and reasonable

interpretation of the Medicare statute. The constitutional

challenges The Regents has made to the regulation must also

fail. Agency regulation of social welfare programs such as

the Medicare statute is given a broad degree of discretion and

need not apply with any mathematical degree of precision in

order to comply with the constitutional requirements of due

process. While an Establishment Clause issue is raised by the

religiously affiliated provider exception contained in Regula-

tion 405.419, The Regents failure to illustrate how this ex-

ception caused it any sort of economic harm requires the

A-32

Court to find that The Regents has no standing to assert this

challenge. Therefore, the Provider Reimbursement Review

Board’s determination on The Regents claims for reimburse-

ment of related party interest expenses must be affirmed.

Finding no disputed issue of material fact in this matter,

and that Defendant is entitled to judgment as a matter of law,

the Court hereby GRANTS Defendant’s Cross-Motion for

Summary Judgment and Denies Plaintiff's Motion for Sum-

mary Judgment. Defendant’s Statement of Uncontroverted

Facts and Conclusions of Law is hereby incorporated into this

Order.

IT IS SO ORDERED.

DATED: SEP 6 1994

/s/ RONALD S. W. LEW

RONALD S.W. LEW

United States District Judge

No. CV-93-4242-RSWL(Ex}, The Regents of the University

of California v. Donna Shalal, Secretary, United States De-

partment of Health and Human Service, Plaintiff’s Motion for

Summary Judgment, Defendant’s Cross Motion for Summary

Judgment.

A-33

APPENDIX C

[1 41,453] The Regents of the University of Califor-

nia—Working Capital Interest Expense Group Appeal.

PRRB Hearing Dec. No. 93-D41, May 14, 1993 (cost re-

porting periods ending-various). Case No. 86-0548G.

Before: MARTIN, SLOAN, PETTY-HANKINS, and ROARK.

MEDICARE: INTEREST EXPENSE PAID

TO RELATED ORGANIZATION

Provider reimbursement—Allowable costs—Interest

expense—lInterest on loans from lenders related to the

provider.—Interest expense is an allowable cost under Reg.

Sec. 404.413 (redesignated 413.153) only if it is incurred on

indebtedness established with lending organizations not re-

lated through control, ownership, or personal relationship to

the borrower. The regulation provides exceptions for interest

expenses on loans from a related organization if the loans are

(1) between a provider’s donor-restricted fund and its general

fund, (2) to a provider’s general fund from its funded depre-

ciation account or qualified pension plan, or (3) from a related

religious order. An intermediary properly disallowed the in-

terest expenses and paid by a group of teaching hospitals to a

related organization for working capital loans. The source of

the loans was the related organization’s short-term investment

pool, which received its funds form a variety of sources.

Further, the general rule for related parties in Reg. Sec.

405.427 (redesignated 413.17), which permits reimbursement

of costs to a related organization if the costs are necessary and

reasonable, cannot supersede the specific regulation dealing

with interest expense.

See 1 5033.40, 5047, 5061.

A-34

{Test of Decision]

Issue:

Whether the Intermediary’s adjustments disallowing in-

terest expenses paid by the Providers to The Regents of the

University of California, a related party, were proper.

Summary of Facts.

The Providers in this group appeal are general, acute care

teaching hospitals which are licensed to and operated by The

Regents of the University of California (The Regents). For

the fiscal years in contention, the Intermediary made adjust-

ments to the Providers’ Medicare cost reports which denied

interest expense claims on working capital loans made to the

Providers by The Regents. The basis for the Intermediary’s

adjustments was that The Regents and the providers are re-

lated organizations and, therefore, the interest would not be

allowable under the regulatory provisions of 42 C.F.R.

§ 405.419 [1 4900]. The Providers appealed the Intermedi-

ary’s reimbursable cost determinations to the Provider Reim-

bursement Review Board (Board) under the provisions of 42

C.F.R. §§ 405.1835-1841 and have met the jurisdictional re-

quirements of those regulations. The amount of Medicare

reimbursement in dispute for all of the fiscal years in conten-

tion is approximately $1,600,000.

In the interest of expediting the administrative appeal

process the parties entered into a Stipulation of Facts which

included the following statements.

* The Regents operated the Providers pursuant to Ar-

ticle IX, section 9 of the California Constitution which

provides in relevant part as follows:

The University of California shall constitute a public

trust, to be administered by the existing corporation known as

“The Regents of the University of California,” will full pow-

ers of organization and government, subject only to such leg-

islative control as may be necessary to insure the security of

A-35

its fund in compliance with the terms of the endowments of

the University.

* Each of the Providers to this appeal cannot sue or be

sued, enter into contracts or perform other legal functions

in their own name. Each is precluded from borrowing

monies from outside sources.

¢ During the fiscal years under appeal, the Providers

received working capital loans from The Regents and

paid an annual interest rate on the loans.

¢ For each of the fiscal years in contention, the annual

interest rate on the working capital loans obtained by

each of the Providers was lower than the applicable an-

nual prime interest rate, and was also lower than the av-

erage rate earned by the University’s short-term invest-

ment pool, from which the loan funds were borrowed.

¢ The short-term investment pool of the University

receives cash from various sources including plant and

loan funds, revenue bond funds, invested endowments,

the University retirement system and others.

* As a result of severe fiscal problems by University

hospitals during the 1976-1977 fiscal year, the Legisla-

ture of the State of California appropriated a $25 million

fund entitied “University of California Teaching Hospital

Revolving Fund.” This fund was to be used for the Uni-

versity hospitals’ working capital requirements along

with other funds of the University... Due to a state budget

crisis, the $25 million working capital fund was with-

drawn from the University during the 1980—1981 fiscal

year.

* Because of the State of California’s withdrawal of

financial operating support, the University hospitals had

to find alternative means of providing for working capi-

tal needs. On January 22, 1981, a new policy of charg-

ing interest on working capital was implemented, and

A-36

this official policy is reflected in the University of Cali-

fornia’s accounting manual.

Provider’s Contentions:

The Providers contend that the regulation should be con-

Strued to permit the allowance of interest expense on reason-

able, proper and necessary loans between related parties. In

support of their position, the Providers present the following

analysis of the regulation which states in pertinent part the

following:

(a)(1) Principle. Necessary and proper interest on

bu.h current and capital indebtedness is an allowable

cost.

(b)(2) Necessary. Necessary requires that the inter-

est.

(i) Be incurred on a loan made to satisfy a financial

need of the provider. Loans which result in excess funds

or investments would not be considered necessary.

Be incurred on a loan made for a purpose reasona-

bly related to patient care.

(i) Be incurred at a rate not in excess of what a prudent

borrower would have had to pay in the money market

existing at the time the loan was made.

(ii) Be paid to a lender not related through control

or ownership, or personal relationship to the borrowing

organization. However, interest is allowable if paid on

loans from the provider’s donor-restricted funds, the

funded depreciation account, or provider’s qualified pen-

sion funds.

(b)(3) Proper. Proper requires that interest:

(1) To be allowable, interest expense must be incurred on

indebtedness established with lenders or lending organi-

i is cra cp ep room tee re wee I

A-37

zations not related through, control, ownership, or per-

sonal relationship to the borrower. Presence of any of

these factors could affect the “bargaining” process that

usually accompanies the making of a loan, and could

thus be suggestive of an agreement on higher rates of

interest or of unnecessary loans. Loans should be made

under terms and conditions that a prudent borrower

would make in arms-length transaction with lending in-

Stitutions. The intent of this provision is to assure that

loans are legitimate and needed, and that the interest

rate is reasonable. Thus, interest paid by the provider to

partners, stockholders, or related organizations of the

provider would not be allowable. Where the owner uses

his own funds in a business, it is reasonable to treat the

funds as invested funds or capital, rather than borrowed

funds. Therefore, where interest on loans by partners,

stockholders, or related organizations is disallowed as a

cost solely because of the relationship factor, the princi-

pal of such loans shall be treated as invested funds in the

computation of the provider’s equity capital under

§ 405.429.

(2) Exceptions to the general rule regarding interest on

loans from controlled sources of funds are made in the

foilowing circumstances. Interest on loans to providers

by partners, stockholders, or related organizations made

prior to July 1, 1996, is allowable as cost, provided that

the terms and conditions of payment of such loans have

maintained in effect without modification subsequent to

July 1, 1966. Where the general fund of a provider

“borrows” from a donor restricted fund and pays interest

to the restricted fund, this interest expense is allowable

cost. The same treatment is accorded interest paid by the

general fund on money “borrowed” from the funded de-

preciation account of the provider or from the provider’s

qualified pension fund. Jn addition, if a provider oper-

ated by members of a religious order borrows from the

A-38

order, interest paid to the order is an allowable cost

(emphasis added).

42 C.F.R. § 405.419 [94900]

The Providers contend that the clear intent of the above

regulations is to assure that loans are legitimate and needed

and that the interest rate is reasonable. With respect to loans

between related organizations, the purpose of the regulation is

to prevent proprietary owners of the provider from inimically

capitalizing the entity, advancing funds in the form of loans

rather than capital and, thus, permitting the owners to be re-

paid while receiving the benefits of interest income charged

through the controlled relationship of the provider. The dis-

allowance of such interest expense to proprietary owners is

compensated by treating the loans as investment funds in the

computation of a proprietary provider’s return on equity

capital. In this case, the Providers point out that they are not

proprietary entities and, thus, the treatment of working capital

loans as investment in equity is not an available alternative.

In addition to the interest expense regulations at 42

C.F.R. § 405.419, the regulations at 42 C.F.R. § 405.427

[15675] define costs to a related organization and permit the

reimbursement of such costs if the expense is necessary and

reasonable. The providers contend that reconciliation of these

two regulations compels the conclusion that each transaction

between related organizations must be reviewed in light of the

abuse the regulations are designed to prevent, and that pro-

phylactic application of the regulations was never intended

and is unwarranted. The prophylactic application of the

regulations make the operation of 42 C.F.R. § 405.419 far

harsher in result than 42 C.F.R. § 405.427. The Providers be-

lieve that permitting necessary and reasonable interest ex-

pense between related organization will result in the prohibi-

tion of unnecessary inflated costs to the Medicare program or

the incurrence of unnecessary loans at inflated interest rates.

A-39

In support of their position, the providers cite the Court

of Claims decision in The Trustees of Indiana University v.

U.S., U.S. Court of Claims, No. 71-78, dated March 19, 1980

{1980 Transfer Binder § 30,398]. The providers state that

their case is very similar to the Indiana University case in

that, except for clinical teaching support, the hospitals re-

ceived no operating funds from the state. In addition, they

were not able to borrow outside the University to meet opera-

tional requirements since they were not separate legal entities.

In permitting reimbursement of interest paid to the Trustees of

Indiana University by its teaching hospitals, the court held as

follows:

Moreover, a regulation must be inteipreted so as to har-

monize with and further and not to conflict with the ob-

jective of the statute it implements. See, e.g. Clark v.

United States, 220 Ct.Cl. — 599 F.2d 411 (1979); Far-

rell Lines, Inc. v. United States, 204 Ct. Co. 482, 499

F.2d 587 (1974).

In light of these principles, we conclude that the regula-

tion does not bar reimbursement for the interest the hos-

pitals paid to Indiana University. As the regulation itself

indicates, its purpose is to protect the governnient against

paying the cost of collusive loans with inflated interest

rates that are designed to benefit enterprises associated

with providers of Medicare services. The relationships

the regulations describes indicate the evils against which

the ban is directed; (1) persons or an organization who

control the hospital (e.g., a member of the board of di-

rectors Or manager); (2) persons or an organization who

own the hospital (e.g., a commercial venture which runs

a proprietary hospital); (3) persons who have a personal

relationship with the hospital (e.g., a staff doctor). In

each of these instances, the other party, because of its

own interest, may unduly influence the hospital’s deci-

sion to the prejudice of the government if the latter reim-

burses the hospital for the interest payments.

A-40

None of these evils is present in the loan between Indi-

ana University and Indiana University Hospitals. Nei-

ther party had a profit motive. To the contrary, Indiana

University could have received a greater return on its

money by investing it elsewhere. The charged interest,

moreover, was far below the market rate, and the loans

were made because the University was the sole source

the hospitals could turn to for operating capital. . . .

The Medicare statute requires reimbursement for the

“reasonable costs” of the services provided, and the

regulation recognizes that “[n]Jecessary and proper inter-

est... is an allowable cost.” There is nothing to indicate

or even suggest that the interest the hospitals paid to the

University, which was below the going rate and was paid

to the only sources from which the hospitals could bor-

row, was either unnecessary or improper. In light of the

purposes of the statute and the regulations as a whole to

reimburse providers of Medicare services for their rea-

sonable costs in providing those services, we conclude

that the plaintiffs are entitled to reimbursement of the

portions of the interest the hospitals paid to the Univer-

sity in 1970 and 1971 that are attributable to the provi-

sion of Medicare services.

In addition to the Indiana University decision, the Pro-

viders also cite the court decision in Northwest Hospital, Inc.

v. Hospital Service Corp., Blue Cross Association, U.S. Court

of Appeals, Seventh Circuit, No. 83-3038, dated March 14,

1984 [1982 Transfer Binder 132,113]. In the Northwest Hos-

pital decision, the court also permitted an exception to the

regulatory prohibition of interest paid to a related party as re-

quired under 42 C.F.R. § 405.419 stating the following:

Although we do not question, as a general matter,

an agency’s authority to adopt prophylactic regulations

reasonably designed to combat potential abuse or to

avoid the difficulty of multiple individual determina-

SS onl esiah Sail

NA NI 55

A-41

tions, we believe that the blanket disallowance of related-

party interest expense contained in section 405.419(c) is

broader than either the language or the purpose of the

Medicare statute can be construed to authorize.

Section 405.427 does not prohibit reimbursement

for the reasonable costs of materials and services ob-

tained from related-party suppliers; it merely establishes

a rebuttable limitation on cost which will be deemed rea-

sonable (and hence reimbursed). Section 405.419, by

contrast, precludes reimbursements for all interest pay-

ments made on related-party loans, regardless of their

reasonableness, and despite the Secretary’s explicit ac-

knowledgment that necessary and proper interest on both

current and capital indebtedness is an allowable cost.

The Providers contend that the Medicare statute directs

the Secretary of health and Human Services to implement the

program by reimbursing providers the lesser of “reasonable

cost for covered services or customary charges associated

with those services” (42 U.S.C. § 1395f(b)(1) [1 16,588}).

Reasonable cost is defined as being the actual cost less any

portion “unnecessary in the efficient delivery of needed health

care services” (42 U.S.C. § 1395x(b)(1)(A) [116,954]). Inter-

est expense is determined to be a reasonable cost (42 C.F.R.

§ 405. 402(c ) [920,887.5]). A basic principle of the Medicare

program is that costs of caring for Medicare patients not be

borne by individuals not covered by the Social Security Act.

Thus, if the loans were necessary, reasonably related to pa-

tient care and proper, the Providers argue that they would not

be able to charge the Medicare program for their fair share of

interest expense by application of a prophylactic interpretation

of the regulation in 42 C.F.R. § 405.419. This would result in

the Medicare program’s share of interest cost being passed on

to non-Medicare patients contrary to statutory and regulatory

requirements.

A-42

Regarding the provision in 42 C.F.R. § 405.419(c)(2)

which permits a provider operated by a religious order to bor-

row from the order and claim the interest paid as allowable

costs, the Providers believe that this regulatory condition

demonstrates that they are not being treated equally when

compared to hospitals run by religious organizations. They

point out that this provision is a recognition that hospitals op-

erated by religious orders do not have a proprietary or com-

mercial motive and that borrowing within religious orders

should not be treated the same as borrowing within proprie-

tary organizations. The Providers note that their relationship

to The Regents is precisely the same as that of a religious

hospital and its mother organization. Thus, to treat them dif-

ferently than a religious hospital on borrowings of working

capital from its parent organization would deny them equal

protection in violation of the First Amendment to the United

States Constitution.

Intermediary’s Contentions

The Intermediary contends that its disallowance of inter-

est expense claimed by the Providers was properly based on

the application of 42 C.F.R. § 405.419 which states in part

that, for interest expense to be allowable, it must:

(b)(3)(iii) Be paid to a lender not related through

control or ownership, or personal relationship to the bor-

rowing organization.

(c ) Borrower-lender relationship. (1) Except as de-

scribed in paragraph (c ) (2) ot this section, to be allow-

able, interest expense must be incurred on indebtedness

established with lenders or lending organizations not re-

lated through control, ownership, or personal relationship

to the borrower .... Thus, interest paid by the provider

to partners, stockholders, or related organizations of the

provider, would not be allowable.

A-43

The Intermediary does not question the legitimacy, ne-

cessity or inierest rates on the loans. The Intermediary also

realizes that the Providers are not proprietary organizations

and are not entitled to a return on equity capital. However,

the Intermediary states that the regulation is clear and that it

has no choice but to enforce its application in this case.

The Intermediary also acknowledge the Providers’ cita-

tion of the court decision in Indiana University which is

similar to the case at hand. However, the Intermediary notes

that it does not have the authority to circumvent existing

regulations, nor does it view that decision as precedent setting

at this point in the administrative process. By contrast, the

Intermediary refers to the court decision in University of Cin-

cinnati, d/b/a/ Cincinnati General Hospital v. Heckler, U.S.

Court of Appeals, Sixth Circuit, No. 83-3078, May 14, 1984,

[1984-2 Transfer Binder {1 33,969] wherein the court supports

its position and counters the Indiana University decision.

Based on the Stipulation of Facts entered into by the

parties, there is no dispute that The Regents and the Providers

are related parties, and that the loans do not meet any of the

exceptions to the general rule regarding interest on loans from

controlled sources of funds. Accordingly, the Intermediary

believes its adjustments should be affirmed based on its

proper application of 42 C.F.R. § 405.419.

Citation of Law and Regulations:

1. Law—Title XVIII of the Social Security Act:

§ 1861(v)(1)(A)}—Reasonable Cost.................. [1 16,974]

2. Regulations—42 C.F.R.:

§ 405.402 (Redesignated § 413.5}—Cost Reimburse-

I NI cainsiscoecianincenceascicccincnotanentitecasechnten (1 20,887.5]

§ 405.419 (Redesignated § 413.153)}—Interest Expense

saainienbiicanelcilaicaneaatias satiated banteesestenenkatnige nines [1 4900]

A-44

§ 405.427 (Redesignated § 413.17)}—Cost to Related

OPQ ARISRIODS o.ccceense jsccmecssosathenimintiacininnantiiletionts [15675]

§ 405.429 (Redesignated § 413.157}—Return on Equity

Capital of Proprietary Providers ..........:scceeseeses (1 5750]

Findings and Conclusions:

the Board, after consideration of the facts, parties’ con-

tentions and evidence presented finds and concludes that the

Intermediary properly disallowed the interest expense paid by

the Providers to The Regents, the related parent organization,

consistent with the regulatory requirements of 42 C.F.R.

§ 405.419. The Board is bound by Medicare law and regula-

tions. The treatment of interest expense incurred on borrow-

ings from a related party is specifically addressed in the regu-

lation at 42 C.F.R. § 405.419 (c ) which states in part:

Borrower-lender relationship. (1) Except as de-

scribed in paragraph (c )(2) of this section, to be allow-

able, interest expense must be incurred on indebtedness

established with lenders or lending organizations not

related through control, ownership, or personal rela-

tionship to the borrower (emphasis added).

Since the parties in this case have stipulated that the Pro-

viders and The Regents are related under Medicare regulation

42 C.F.R. § 405.427, the Board finds that the above-stated

regulation clearly denies the interest expense paid by the Pro-

viders to their related parent organization.

The Board also considered the specific circumstances

under 42 C.F.R. § 405.419(c )(2) which provide exceptions to

the general rule regarding interest expense on loans from

controlled sources. This regulatory provision treats interest

expense on related-organization loans as an allowable cost

under the following four situations:

(1) Pre-July 1, 1996 loans from partners, stockhold-

ers, or related organizations;

A-45

(2) Loans between a provider’s donor-restricted

fund and its general fund;

(3) Loans to a provider’s general fund from its

funded depreciation account or qualified pension plan;

and

(4) Loans from a related religious order.

Since the source of the funds borrowed by the Providers

was the University’s short-term investment pool which re-

ceives its funds from a variety of sources, the Providers

clearly did not meet any of the specific exceptions of the

regulation. The Board finds the above list to be all-inclusive

and that the regulation does not permit additional exceptions

such as the loans existing between the Providers and The Re-

gents in this case.

With regard to the Providers’ argument that there is a

conflict between the purpose of the related party regulation

(42 C.F.R. § 405.427) and the portion of the interest expense

regulation that deals with related parties (42 C.F.R.

§ 405.419(c)(1) and (2)), the Board does not concur. The

above interest regulation which deals with related party bor-

rowing is the Medicare program’s specific regulation control-

ling this specific type of cost. The general rule for related

parties in 42 C.F.R. §405.427 cannot be used to supersede the

specific regulation dealing with a specific type of expense,

which is interest expense in this case.

The board is also cognizant of the Providers’ argument

that one of the regulatory exceptions under 42 C.F.R.

§ 405.4219(c )(2) permits interest on loans between a relig-

ious hospital and its related mother organization, and that

such discriminatory action denies the equal protection in vio-

lation of the First Amendment of the United States Constitu-

tion. Pursuant to 42 C.F.R. § 405.1867 [20,767] the Board

“must comply with all the provisions of title XVIII of the Act

and regulations issued thereunder .. . .” Consequently, the

A-46

Board is not the proper forum in which to present a constitu-

tionally based challenge to the regulation.

As to the Provider’s reliance on the court decisions in

Indiana University and Northwest Hospital, the Board recog-

nizes that the regulations were, in fact, circumvented by the

courts on the basis that none of the evils which the regulation

sought to prohibit existed in those cases. Notwithstanding the

specific points addressed in the court decisions, the Board is

obligated to adhere to the provisions of Title XVIII of the So-

cial Security Act, as amended, and 42 C.F.R. § 405.1867.

Decision:

The Intermediary’s adjustments disallowing interest ex-

pense paid by the Providers to The Regents of the University

of California, a related party, were proper. The Intermedi-

ary’s adjustments are affirmed.

[Exhibit omitted. |

A-47

APPENDIX D

DEPARTMENT OF HEALTH & HUMAN SERVICES

Health Care Financing Administration

6325 Security Boulevard

Baltimore, MD 21207

RECEIVED: JUL 1, 1993

Robert Barnes, Esq.

University of California

300 Lakeside Drive, 7th Floor

Oakland, California 94612-3565

Dear Mr. Barnes:

Re: The Regents of the University of California, PRRB No.

93-D41 (FYE) Various)

This is to advise that the Administrator of the Health Care Fi-

nancing Administration (HCFA) has declined to review the

decision entered by the Provider Reimbursement Review

Board in the captioned case.

If the Provider wishes to obtain judicial review of the matter,

civil action must be initiated within 60 days of the date the

Board’s decision was received in accordance with 42 C.F.R.

405.1877.

Sincerely yours,

/s/ Marion T. Silva

Marion T. Silva

Attorney Advisor

Enclosure

cc: Bernard M. Talbert, Esq., Intermediary’s Representative

A-48

DEPARTMENT OF HEALTH & HUMAN SERVICES

Health Care Financing Administration

6325 Security Boulevard

Baltimore, MD 21207

Re: The Regents of the University of California,

PRRB Decision No. 93-D41 (05/14/93)

(FYEs Various

I recommend that the Administrator, Health Care Financing

Administration, on own motion, decline to review the deci-

sion entered by the Provider Reimbursement Review Board in

this case.

Sincerely yours,

/s/_ Marion T. Silva

Marion T. Silva

Attorney Advisor

APPROVED:

/s/ Louis B. Hays

Acting Executive Associate

Administrator

Health Care Financing

Administrator

Date: 6/25/93

A-49

APPENDIX E

REGULATORY PROVISION INVOLVED

§ 413.153 Interest expense.

(a)(1) Principle. Necessary and proper interest on both

current and capital is an allowable cost. However, interest

costs are not allowable if incurred as a result of—

(i) Judicial review by a Federal court (as described in

§ 413.64(j));

(ii) An interest assessment on a determined overpayment

(as described in § 405.376 of this chapter); or

(iii) Interest on funds borrowed to repay an overpayment

(as described in § 413.64(j) or § 405.376 of this chapter), up

to the amount of the overpayment, unless the provider had

made a prior commitment to borrow funds for other purposes

(for example, capital improvements).

(2) Exception. In those cases of administrative or judi-

cial reversal, interest paid on funds borrowed to repay an

overpayment is an allowable cost, in accordance with this

section.

(b) Definitions - (1) Interest. Interest is the cost incurred

for the use of borrowed funds. Interest on current indebted-

ness is the cost incurred for funds borrowed for a relatively

short term. This is usually for such purposes as working

capital for normal operating expenses. Interest on capital in-

debtedness is the cost incurred for funds borrowed for capital

purposes, such as acquisition of facilities and equipment, and

capital improvements. Generally, loans for capital purposes

are long-term loans.

(2) Necessary. Necessary requires that the interest be—

(i) Incurred on a loan made to satisfy a financial need of

the provider. Loans that result in excess funds or investments

would not be considered necessary;

A-50

(ii) Incurred on a loan made for a purpose reasonably re-

lated to patient care; and

(ili) Reduced by investment income except if such in-

come is from gifts and grants, whether restricted or unre-

stricted and that are held separate and not commingled with

other funds. Income from funded depreciation that meets the

requirements of § 413.134 or a provider’s qualified pension

fund is not used to reduce interest expense. Interest received

as a result of judicial review by a Federal Court (as described

in § 413.64(j)) is not used to reduce interest expenses.

(3) Proper. Proper requires that interest be—

(i) Incurred at a rate not in excess of what a prudent bor-

rower would have had to pay in the money market existing at

the time the loan was made; and

(ii) Paid to a lender not related througk control or owner-

ship, or personal relationship to the borrowing organization.

However, interest is allowable if paid on loans form the pro-

vider’s doner-restricted funds, the funded depreciation ac-

count, or the provider’s qualified pension fund.

scribed in paragraph (c)(2) of this section, to be allowable,

interest expense must be incurred on indebtedness established

with lenders or lending organizations not related through

control, ownership, or personal relationship to the borrower.

Presence of any of these factors could affect the “bargaining”

process that usually accompanies the making of a loan, and

could thus be suggestive of an agreement on higher rates of

interest or of unnecessary loans. Loans should be made under

terms and conditions that a prudent borrower would make in

armslength transactions with lending institutions. The intent

of this provision is to assure that loans are legitimate and

needed, and that the interest rate is reasonable. Thus, interest

paid by the provider to partners, stockholders, or related or-

ganizations of the provider would not be allowable. If the

owner uses his own funds in a business, it is reasonable to

A-51

treat the funds are invested funds or capital, rather than bor-

rowed funds. Therefore, if interest on loans by partners,

stockholders, or related organizations is disallowed as a cost

solely because of the relationship factor, the principal of such

loans is treated as invested funds in the computation of the

provider’s equity capital under § 413.157.

(2) Exceptions to the general rule regarding interest on

loans from controlled sources of funds are made in the fol-

lowing circumstances. Interest on loans to providers by part-

ners, stockholders, or related organizations made prior to July

1, 1966, is allowable as cost, provided that the terms and con-

ditions of payment of such loans have been maintained in ef-

fect without modification subsequently to July 1, 1966. If the

general fund of a provider “borrows” from a donor-restricted

fund and pays interest to the restricted fund, this interest ex-

pense is an allowable costs. The same treatment is accorded

interest paid by the general fund on money “borrowed” from

the funded depreciation account of the provider or from the

provider’s qualified pension fund. In addition, if a provider

operated by members of a religious order borrows from the

order, interest paid to the order is an allowable cost.

(3) If funded depreciation is used for purposes other than

improvement, replacement, or expansion of facilities or

equipment related to patient care, allowable interest expense

is reduced to adjust for offsets not made in prior years for

earnings on funded depreciation. A similar treatment is ac-

corded deposits in the provider’s qualified pension fund if

such deposits are used for other than the purpose for which

the fund was established.

(d) Loans not reasonably related to patient care. (1) The

following types of loans are not considered to be for a purpose

reasonably related to patient care:

(1) For loans made to finance acquisition of a facility,

that portion of the cost that exceeds—

(A) Historical cost as determined under § 413.134(b); or

A-52

(B) The cost basis determined under §413.134(g); and

(ii) Loans made to finance capital stock acquisitions,

mergers, or consolidations for which revaluation of assets is

not allowed under § 413.134(k).

(2) In determining whether a loan was made for the pur-

pose of acquiring a facility, we apply any owner’s investment

or funds first to the tangible assets, than to the intangible as-

sets other than goodwill, and lastly to the goodwill. If the

owner’s investment or funds are not sufficient to cover the

cost allowed for tangible assets, we apply funds borrowed to

finance the acquisition to the portion of the allowed cost of

the tangible assets not covered by the owner’s investment,

then to the intangible assets other than goodwill, and lastly to

the goodwill. Repayments of the funds borrowed are applied

first to the borrowing related to the tangible assets, then to the

borrowing related to the intangible assets other than goodwill,

and lastly to the borrowing related to the goodwill.

(3) When a provider borrows funds but only some of the

funds are necessary, repayments of the loan (principal and in-

terest portions) are applied first to pay for the necessary por-

tion of the loan. Only after all of the necessary portion of the

loan (principal and interest) has been repaid are any repay-

ments applied to the unnecessary portion of the loan. Repay-

ments toward non-allowable borrowing pertaining to assets or

activities not related to patient care are considered invest-

ments, and the provisions of paragraph(b)(2)(iii) of this sec-

tion are applied.

(e) Limitation on Federal participation for capital ex-

penditures. The allowance for depreciation is not an allow-

able cost for certain capital expenditures as described in

§ 413.161.

[51 FR 34793, Sept. 30, 1986, as amended at 56 FR 43457,

Aug. 30, 1991; 59 FR 45402, Sept. 1, 1994]

A-53

APPENDIX F

STATUTORY PROVISION INVOLVED

42 U.S.C. Section 1395x(v)(1)(A)

(v) Reasonable costs

(1)(A) The reasonable cost of any services shall be the

cost actually incurred, excluding therefrom any part of in-

curred cost found to be unnecessary in the efficient delivery of

needed health services, and shall be determined in accordance

with regulations establishing the method or methods to be

used, and the items to be included, in determining such costs

for various types or classes of institutions, agencies, and

services; except that in any case to which paragraph (2) or (3)

applies, the amount of the payment determined under such

paragraph with respect to the services involved shall be con-

sidered the reasonable cost of such services. In prescribing

the regulations referred to in the preceding sentence, the Sec-

retary shall consider, among other things, the principles gen-

erally applied by national organization or established prepay-

ment organizations (which have developed such principles) in

computing the amount of payment, to be made by persons

other than the recipient of services, to providers of services on

account of services furnished to such recipients by such pro-

viders. Such regulations may provide for determination of the

costs of services on a per diem, per unit, per capita, or other

basis, may provide for using different methods in different

circumstances, may provide for the establishment of limits on

the direct or indirect overall incurred costs or incurred costs of

specific items or services or groups of items or services to be

recognized as reasonable based on estimates of the costs nec-

essary in the efficient delivery of needed health services to

individuals covered by the insurance programs established

under this subchapter, and may provide for the use of charges

or a percentage of charges where this method reasonably re-

flects the costs. Such regulations shall (i) take into account

A-54

both direct and indirect costs of providers of services

(excluding therefrom any such costs, including standby cost,

which are determined in accordance with regulations to be

unnecessary in the efficient delivery of services covered by

the insurance programs established under this subchapter) in

order that, under the methods of determining costs, the neces-

sary costs of efficiently delivering covered services to indi-

viduals covered by the insurance programs established by this

subchapter will not be borne by individuals not so covered,

and the costs with respect to individuals not so covered will

be borne by such insurance programs, and (ii) provide for the

making of suitable retroactive corrective adjustments where,

for a provider of services for any fiscal period, the aggregate

reimbursement produced by the methods of determining costs

proves to be either inadequate or excessive.

A-55

APPENDIX G

THE TRUSTEES OF INDIANA UNIVERSITY

(Indiana University Hospitals)

THE UNITED STATES.

No. 71-78.

United States Court of Claims.

March 19, 1980.

Indiana University Hospitals brought an action claiming

its entitlement to reimbursement under the Medicare Act for

interest which it paid to Indiana University on money bor-

rowed from it. Upon hospitals’ motion for summary judg-

ment and the government’s cross motion for summary judg-

ment, the Court of Claims, Friedman, C.J., held that in light of

facts that hospitals were teaching hospitals, received no

money from state for their operation and could not borrow

money from outside University because they were not sepa-

rate legal entity, regulation limiting reimbursement of interest

to amount paid to nonrelated persons did not bar hospitals’

claim for reimbursement.

Hospitals’ motion for summary granted; Government’s

motion for summary judgment denied; case remanded.

Kunzig, J., filed concurring opinion.

A-56

TRUSTEES OF INDIANA UNIVERSITY

UNITED STATES

Cite as 618 F.2d 736 (1980)

1. Administrative Law and Procedure

412

Statutes 189

Where “plain meaning” of a statute produces an unrea-

sonable result plainly at variance with policy of legislation as

a whole, courts may follows that purpose rather than the lit-

eral words; foregoing principles are also applicable in con-

struing administrative regulations.

2. Administrative Law and Procedure

412

A regulation must be interpreted so as to harmonize with

and further and not to conflict with objective of statute it im-

plements.

3. Social Security and Public Welfare

241.10

In light of facts that Indiana University Hospitals were

teaching hospitals, received no money from state for their op-

eration and could not borrow money from outside University

because they were not a separate legal entity, regulation lim-

iting reimbursement of interest to amount paid to nonrelated

persons did not bar hospitals’ claim for reimbursement under

Medicare Act for interest which they paid to University on

money borrowed from it. Social Security Act, § 1861(v)(1)

(A), 42 U.S.C.A. § 1395x (v)(1)(A).

A-57

4. Constitutional Law 48(3)

Statute should be construed so as to avoid any serious

doubts concerning its constitutionality.

William S. Hall, Indianapolis, Ind., attorney of record,

for plaintiffs. Hall, Render & William, Indianapolis, Ind., of

counsel.

John W. Showalter, Washington, D.C. with whom was

Asst. Atty. Gen. Alice Daniel, Washington, D.C. for defen-

dant. Sanford Teplitsky, Dept. of H.E.W., Washington, D.C.,

of counsel.

Before FRIEDMAN, Chief Judge, COWEN, Senior

Judge, and KUNZIG, Judge.

ON PLAINTIFFS’ MOTION FOR SUMMARY JUDG-

MENT AND DEFENDANT’S CORSS-MOTION FOR

SUMMARY JUDGMENT.

FRIEDMAN, Chief Judge:

The question in this case is whether the Indiana Univer-

sity Hospitals are entitled to reimbursement under the Medi-

care Act (42 U.S.C. § 1395x(v)(1)(A) (1976) for the interest

the hospitals paid to Indiana University on money they bor-

rowed from it. The Blue Cross Association, which the hospi-

tals selected as their fiscal intermediary to determine the

amount of reimbursement to which they are entitled under the

Medicare statute, denied reimbursement on the ground that a

Medicare regulation limits reimbursement of interest to

amounts paid to nonrelated persons. Both parties have moved

for summary judgment, and we heard oral argument. We

conclude that the plaintiffs are entitled to reimbursement for

the interest. Therefore we deny the defendant’s and grant the

plaintiffs’ motion for summary judgment.

The plaintiffs, the Trustees of Indiana University, operate

Indiana University, a State university. Indiana University

Hospitals are a part of the University and its Medical Center.

A-58

The hospitals provide services to low-income patients under

the Medicare Act, and, under the Act, as a “provider” of those

services, are entitled to reimbursement for their reasonable

costs of doing so.

The relationship of the hospitals to the University and to

the State of Indiana is unique. They are state teaching hospi-

tals, but received no money from the State for their opera-

tions. Although the State of Indiana Provides funds for the

University, State law prohibits funds for the University, State

law prohibits the use of any of those funds for the hospital.

Since the hospitals are not a separate legal entity, they cannot

borrow money from outside the University. If the hospitals

cannot support themselves through the fees they collect, they

must borrow from the University itself.

Beginning in 1968, the hospitals borrowed money from

the University’s general fund to compensate for their operat-

ing losses. The University charged 5 percent annual interest,

which it subsequently increased to 6 percent; the interest rate

consistently has been below the prime rate.

The hospitals paid the University interest of $221,488 for

ihe fiscal year ending June 30, 1970, and $317,005 for the fis-

cal year ending June 30, 1971. The portions of those interest

payment’s attributable to the hospitals’ provision of Medicare

services were $24,054 and $37,59, respectively. The Univer-

sity sought reimbursement for this interest, but the Blue Cross

Association denied it. The University then filed in the United

States District Court for the Southern District Court for the

Southern District of Indiana the present suit to recover those

amounts. The district court transferred the case to this court

pursuant to 28 U.S.C. § 1406(c ) (1976).

A. The Medicare program was established pursuant to

subchapter XVIII of the Social Security Act, 42 U.S.C.

§ 1395 et seq. (1976), to provide health insurance for the aged

and disable. Under the program, hospitals are certified to treat

A-59

eligible patients and reimbursed for the “reasonable costs” of

the services provided. Jd. § 1395(b)(1). Section 1395x(v)

(1)(A) defines what is reimbursable for the and authorizes the

Secretary of health, Education, and Welfare to promulgate

regulations governing the procedures and the standards for

making that determination:

The reasonable cost of any services shall be the cost

actually incurred, excluding therefrom any part of

incurred cost found to be unnecessary in the effi-

cient delivery of needed health services, and shall

be determined in accordance with regulations es-

tablishing the method or methods to be used, and

the items to be included, in determining such costs

for various types or classes of institutions, agencies,

and services . . . Such regulations shall (I) take into

account both direct and indirect cost of providers of

services . . . in order that, under the methods of de-

termining costs, the necessary costs of efficiently

delivering covered services to individuals covered

by the insurance programs established by this sub-

chapter will not be borne by individuals not so cov-

ered, and the costs with respect to individuals not so

covered will not be borne by such insurance pro-

grams, and (ii) provide for the making of suitable

retroactive corrective adjustments where, for a pro-

vider of services for any fiscal period, the aggregate

reimbursement produced by the methods of deter-

mining costs proves to be either inadequate or ex-

cessive.

The Secretary has promulgated regulations specifying

the costs that are reimbursable. Principles of Reimbursement

for Provider Cost and for Service by Hospital Based Physi-

cian, 42 C.F.R. § 405.401 et. seq. (1979). “[T]he principles

give recognition to such factors as depreciation, interest, bad

debts, educational costs, compensation of owners, and an al-

A-60

lowance for a reasonable return on equity capital of proprie-

tary facilities.” Jd. § 405.405 (c).

Section 405.419(a) provides: “Necessary and proper in-

terest on both current and capital indebtedness is an allowable

cost.” Section 405.419(b)(3)(ii) states that to be “proper” in-

terest, the money must “[b]e paid to a iender not related

through control or ownership, or personal relationship to the

borrowing organization.”

The regulation then explains the reason for and scope of

the prohibition against reimbursement for loans between re-

lated parties:

Presence of any these factors could affect the

“bargaining process [that] usually accompanies the

making of a loan, and could thus be suggestive of an

agreement on higher rates of interest or of unneces-

sary loans. Loans should be made under terms and

conditions that a prudent borrower would make in

arms length transactions with lending institutions.

The intent of this provision is to assure that loans

are legitimate and needed, and that the interest rate

is reasonable. Thus, interest paid by the provider to

partner, stockholders, or related organizations of the

provider would not be allowable.

Id. § 405.419(c (1)

The regulation provides three exceptions, which do not

touch on the issues in this case. It also provides that if a pro-

vider “operated by members of a religious order borrows from

the order, interest paid to the order is an allowable cost.” Id.

§ 405. 419(c)(2).

There have been three district court cases challenging the

ban on reimbursement of interest to related persons; two

A-61

courts have upheld the regulation, and one has invalidated it.’

Although the parties vigorously argue the validity of the

regulation, we find it unnecessary to reach that issue because

we construe the regulation as not prohibiting reimbursement

for the interest payments here allowed.

[1, 2] B. Read literally and without regard to the other

provisions or the purpose of the regulation and to the under-

lying statute (as the defendant would have us read it), the bar

on reimbursement for payments to related organizations

would appear to cover this case. The lender here, Indiana

University, is “related through control or ownership . . . to the

borrowing organization [the hospitals].” “It is [, however,} a

‘familiar rule, that a thing may be within the letter of the stat-

ute and yet not within the statute, because not within its spirit,

nor within the intention of its makers.’ ”. United Steelworkers

of America v. Weber, 443 U.S. 193, 99 S.Ct. 2721, 2727, 61

L.Ed.2d 480 (1979) (quoting Church of Holy Trinity v. United

States, 143 U.S. 457, 459, 12 S.Ct. 511, 512, 36 L.Ed. 226

(1892)). Indeed, if the “plain meaning” of a statute produces

an “unreasonable” result “ ‘plainly at variance with the policy

of the legislation as a whole’ ” the courts have “followed that

purposes, rather than the literal words.” United States v.

American Trucking Associations, Inc. 310 U.S. 534, 543, 60

S.Ct. 1059, 1064, 84 L.Ed. 1345 (1940). These principles are

no less applicable in constructing administrative regulations.

Rucker v. Wabash Railroad Co., 418 F.2d 146 (7th Cir. 1969).

Moreover, a regulation must be interpreted so as to harmonize

' Caylor-Nickel Hosp. v. Califano, No. F77-83 (N.D.Ind. Sept. 10,

1979) (regulation constitutional; loans from doctors who managed the

hospital and from associated clinic); Hillside Community Hosp. v.

Mathews, 423 F.Supp. 1168 (N.D. Cal. 1976) (regulation constitutional;

payment for purchase of building from company owned in part by mem-

bers of hospital board of directors); South Boston Gen. Hosp. v. Blue

Cross, 409 F.Supp.1380 (W.D.Va.1976)(regulation invalid as contrary to

purpose of Act to reimburse for reasonable costs; loan on purchase of

building from predecessor hospital).

A-62

with and further and not to conflict with the objective of the

Statute it implements. See, e.g., Clark v. United States, 220

Ct.Cl. —, 599 F.2d 411 (1979); Farrell Lines, Inc. v. United

States, 204 Ct.Cl. 482, 499 F.2d 587 (1974).

[3] In light of these principles, we conclude that the

regulations does not bar reimbursement for the interest the

hospitals paid to Indiana University. As the regulation itself

indicates, its purpose is to protect the government against

paying the cost of collusive loans with inflated interest rates

that are designed to benefit enterprises associated with pro-

viders of Medicare services. The relationships the regulation

describes indicate ithe evils against which the ban is directed:

(1) persons or an organization who control the hospital (e.g., a

member of the board of directors or manager); (2) persons or

an Organization who own the hospital(e.g. a commercial ven-

ture which runs a proprietary hospital); (3) persons who have

a personal relationship with the hospital (e.g., a staff doctor).

In each of these instances, the other party, because of its own

interests, may unduly influence the hospital’s decision to the

prejudice of the government if the latter reimburses the hos-

pital for the interest payments.

None of these evils is present in the loan between Indi-

ana University and Indiana University Hospitals. Neither

party has a profit motive. To the contrary, Indiana University

could have received a greater return on its money by investing

it elsewhere. The charged interest, moreover, was far below

the market rate, and the loans were made because the univer-

sity was the sole source the hospitals could turn to for operat-

ing capital. The University does not “own” the hospitals;

both are State institutions. Its control over the hospitals is

also limited. The hospitals receive income not from the Uni-

versity or form the State but from fees charged for their serv-

ices. They thus are run separately from the education func-

tions of the university which receive direct state funding. The

problem of a “personal relation” described in the regulation

does not apply to these parties.

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The Medicare statute requires reimbursement for the

“reasonable costs” of the service provided, and the regulation

recognized that “[njecessary and proper interest . . is an al-

lowable cost.” There is nothing to indicate or even suggest

that the interest the hospitals paid to the University, which

was below the going rate and was paid to only source from

which the hospitals could borrow, was either unnecessary or

improper. In light of the purposes of the statute and the regu-

lations as a whole to reimburse providers of Medicare services

for their reasonable costs in providing those services, we con-

clude that the plaintiffs are entitled to reimbursement of the

portions of the interest the hospital paid to the University in

1970 and 1971 that are attributable to the provision of Medi-

care services.

[4] C. Our conclusion also is supported by the settled

principle that the statute should be construed so as to avoid

any serious doubts concerning its constitutionality. E.g.

Califano v. Yamasaki, 442 U.S. 82, 89 S.Ct. 2545, 61 L.Ed2d

176 (1979); United States v. Vuitch, 402 U.S. 62, 91 S.Ct.

1294, 28 L.ed2d 601 (1971); United States v. Rumely, 345

U.S. 41, 78 S.Ct.4543, 97 L.Rd. 770 (1953). The same prin-

ciple is equally applicable to administrative regulations. See

Rucker, supra, 418 F.2d at 149.

As noted earlier, the regulation has an explicit exception

for interest paid to a religious order by a provider operated by

members of the order. Denying reimbursement of interest

payments by a nonprofit hospital to its affiliated university

while permitting reimbursement of payments to an affiliated

religious order would raise serious questions under the first

amendment, which generally prohibits the government from

giving special favored treatment to a religious entity. E. g.,

Committee for Public Education & Religious Liberty v.

Nyquist, 413 U.S. 756, 93 S.Ct. 2955, 37 L.Ed.2d 948 (1973);

Lemon v. Kurtzman, 2105, 29 L.Ed.2d 745 (1971). Our inter-

pretation of the regulation avoids that problems.

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Indeed, the explicit exception to the prohibition against

reimbursement of interest payments to related persons for re-

ligiously affiliated entities further supports our conclusi

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