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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 1996
- **Citation:** 519 U.S. 991

## Text

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

i
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
NOT EY WEEE BPR isinccsdeccieriesnseseticgucorenpsmencctatosnns 3
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
PR IE HII iiiaitercireniccccccecemseseoveccocitnnensosonies 19

I seit oniishdihideicantincitinnstioncteanhssenkitsbouscenshtrteseoupiinen, 21

ili
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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‘

iV
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.

2

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

3

§ 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

4

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

5

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.

6

“(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

7

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.

8

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.

9

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

10

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

ee

11

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-

12

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.

13

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

14

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.

15

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

16

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.

17

“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.

18

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

‘

19

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

20

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.

21
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,
v.

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:

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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 Ҥ 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).

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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

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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

ee

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:
(c) Borrower-lender Relationship.

(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 e

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386004_1157%3A1. Public record. Not legal advice.