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MANOR HEALTH CARE CORP. AND LEADER NURSING CENTERS v. COMMONWEALTH PENNSYLVANIA (12/14/88)

COMMONWEALTH COURT OF PENNSYLVANIA


decided: December 14, 1988.

MANOR HEALTH CARE CORP. AND LEADER NURSING CENTERS, INC., PETITIONERS
v.
COMMONWEALTH OF PENNSYLVANIA, DEPARTMENT OF PUBLIC WELFARE, RESPONDENT

Appeal from the Order of the Department of Public Welfare, Office of Hearings & Appeals in the case of Appeal Of: Leader Nursing Centers, Inc., File No. 24-82-2 et al. (Step-Up Appeals), dated April 16, 1987.

COUNSEL

Thomas H. Brock, with him, Malcolm J. Harkins, III, Casson, Harkins & Lapallo, for petitioners.

Bruce G. Baron, Assistant Counsel, for respondent.

Judges Doyle, Barry and McGinley, sitting as a panel of three. Opinion by Judge Doyle. Judge MacPhail did not participate in the decision in this case.

Author: Doyle

[ 122 Pa. Commw. Page 102]

Manor Health Care Corporation (MHC) appeals to this Court from the final order of the Director of the Office of Hearings and Appeals, Department of Public Welfare (DPW), disallowing, upon the recommendation of the Hearing Attorney, certain depreciation costs which were submitted for the purpose of calculating medical assistance reimbursements for the fiscal years 1982 and 1983.

This case arises under Title XIX of the Federal Social Security Act, 42 U.S.C. §§ 1396-1396q (1984), which establishes the Medical Assistance Program, commonly known as "Medicaid." This program is jointly funded and administered by the federal government and the states which elect to participate.*fn1 The federal government matches the money appropriated by the states to pay for health care services, including nursing home care. On behalf of our state, DPW contracts with and pays providers of medical services, who provide services to Medicaid eligible persons.

In the case presently before us, MHC negotiated an agreement with the CENCO corporation whereby CENCO granted MHC a one hundred and twenty-day option to purchase all the shares of its subsidiary, the Leader Healthcare Organization (LHO), for thirty million dollars. CENCO, apparently among its other holdings, was the parent and sole stockholder of LHO. LHO was the owner and sole shareholder of Leader Nursing Centers Incorporated (LNCI), a Pennsylvania corporation which owned and operated seventeen nursing homes whose Medicaid payment rates are the subject of

[ 122 Pa. Commw. Page 103]

    this appeal. In addition, MHC agreed to commence a tender offer for CENCO itself.

On October 19, 1981, MHC exercised its option and purchased all of the stock of LHO. On May 21, 1982, seven months after completing that purchase, MHC merged LNCI into LHO, and then merged LHO into itself, MHC. The corporations were, therefore, "telescoped," and the only surviving corporation was MHC, which then owned seventeen nursing homes. During this period of time, namely, from October 1981 until May 1982, MHC completed a purchase of CENCO, the former parent and grandparent respectively of LHO and LNCI.

In accordance with DPW regulations, LHO filed final cost reports from the beginning of its facilities' fiscal year to the effective date of the merger of LHO into MHC, i.e., January 1, 1982 to May 21, 1982.*fn2 These final cost reports were used by DPW to set the 1982 interim per diem rates*fn3 (interim rates) for MHC's operation of the seventeen nursing homes, effective May 22, 1982 and July 1, 1982. MHC was notified of these interim rates by letters dated July 19, 1982, August 20, 1982, and September 8, 1982. MHC challenged those rates by letter dated September 23, 1982, on the grounds that they did not reflect any of MHC's costs to acquire the LHO facilities.

[ 122 Pa. Commw. Page 104]

As a new provider entering the Pennsylvania Medical Assistance program, MHC picked up where LHO left off and filed projected cost reports (MA-11's) for the period from the change of ownership on May 22, 1982 to the end of the facilities' fiscal year, December 31, 1982.*fn4 MHC initially submitted these cost reports with a claim for an increase in basis for depreciation. However, by letter dated April 29, 1983, DPW required that these reports be resubmitted without such claims. Consequently, the interim rates effective July 1, 1983,*fn5 which were derived from the MA-11's, did not reflect a revaluation of MHC's assets based on the cost of acquiring the new facilities. MHC filed a timely appeal from the notices of the interim rates issued by DPW.*fn6

On appeal, MHC argues that its purchase of one hundred percent of the stock of LHO, followed by the subsequent merger of LNCI into LHO, and then LHO into MHC, was a single transaction by which MHC intended

[ 122 Pa. Commw. Page 105]

    to acquire, and did acquire, the assets and ongoing business of LNCI and its nursing facilities in Pennsylvania. As a result, MHC argues that it is entitled to base its claims for reimbursement on the price paid to acquire the facilities for the fiscal years 1982 and 1983.*fn7

As a preliminary matter, DPW concluded that the challenged rates effective May 22, 1982 and July 1, 1982, were properly set because MHC did not claim a step-up in the final cost report filed by LHO from January 1, 1981 through May 21, 1982, and since no step-up was claimed, the interim rates effective May 21, and July 1, 1982, must stand. This Court, however, does not find this to be an accurate depiction of the facts set forth in the record. LNCI did file "final cost reports" for the beginning of its facilities' fiscal year, January 1, 1982 to the date of the merger of LHO and LNCI into MHC, May 21, 1982. This was done in accordance with the Medical Assistance Manual. See 55 Pa. Code § 1181.73(a).*fn8 MHC was not yet able to claim a higher reimbursement or file an MA-11, under Section 1181.67(4) as there had not yet been a change of corporate operations.*fn9

[ 122 Pa. Commw. Page 106]

Furthermore, MHC was unable to file an interim report in accordance with 55 Pa. Code § 1181.72, as the language of that regulation requires a cost report to cover a period of six months or more.*fn10

DPW further argues that MHC did not preserve the right to challenge the interim rates for the period beginning July 1, 1983,*fn11 due to MHC's failure to include the claims in an MA-11.*fn12 This Court does not find this to be an accurate reflection of the record either. In fact, all seventeen of the facilities filed MA-11's with DPW for the period beginning May 22, 1982, claiming an increased cost basis reflecting MHC's cost to acquire LHO and LNCI. DPW, however, in a letter dated April 28, 1983, stated that DPW did not view the purchase of LHO by MHC as a stock transaction, and therefore a step-up would not be allowed. DPW requested MHC to resubmit its MA-11 reports using the original cost basis for each facility prior to the stock purchase. That is exactly what MHC did. MHC then properly filed an administrative appeal of the rates under 55 Pa. Code

[ 122 Pa. Commw. Page 107]

§ 1181.101(a)(1), claiming that it was improperly denied reimbursement for its depreciation costs. This Court believes this to have been the appropriate action.

What is left for us to determine as the essential and controlling issue is whether a "step-up" of the capital costs of the acquisition should have been granted.

The Medicare/Medicaid regulations require that participating providers be reimbursed for the reasonable costs of services provided. Capital depreciation of assets is generally recognized as a reimbursable expense. See 42 C.F.R. 413.134(a)(b)(f). The amount allowed for the depreciation of an asset is based on the historical cost of the asset, i.e., the cost actually incurred in acquiring the asset. See 42 C.F.R. 413.134(a)(2). Assets are revalued or the cost basis is "stepped-up" when assets are transferred and the provider that acquired the assets thereafter depreciates them according to the amount it paid. However, a simple purchase of stock of a corporation will not entitle a purchaser to a stepped-up basis. Richey Manor, Inc. v. Schweiker, 684 F.2d 130 (D.C. Cir. 1982). It is, therefore, vital to MHC's claim that its transaction (i.e., its purchase of all of the stock of LHO and subsequent liquidation of LHO and LNCI) be deemed an asset acquisition, not merely a purchase of stock. Richey Manor.

The leading case on this issue is Pacific Coast Medical Enterprises v. Harris (PCME), 633 F.2d 123 (9th Cir. 1980). In PCME, a stock purchase agreement was entered into in May 1969, providing for the acquisition of one hundred percent of the stock of Community Hospital. Nine months later, Community Hospital, as a corporate entity, was liquidated and its assets were distributed to PCME. In PCME, it was stipulated that the exchange of stock was made between unrelated parties in an arm's length bona fide transaction. The Ninth Circuit found that this was common business practice and that it is generally recognized that a one hundred percent

[ 122 Pa. Commw. Page 108]

    stock purchase and subsequent liquidation is, in essence, an acquisition of assets, and, hence, a purchase of an ongoing operation entitling the acquirer to a new cost basis.

PCME establishes that where it can be shown that the intent of a transaction was an acquisition of assets -- even though it occurs through a series of steps -- it may be treated as an acquisition of assets, so long as the parties were unrelated when the transaction began. However, in order for this "single transaction" rule to apply, there must be evidence that "the acquirer had intended from the outset of the transaction eventually to transfer to itself the assets of the acquired company." Humana, Inc. v. Heckler, 758 F.2d 696, 705 (D.C. Cir. 1985).

DPW, in determining whether MHC had intended to purchase the assets of LNCI from the outset, looked to MHC's agreement to purchase the stock of CENCO. DPW concluded that this agreement did not express any original intent to merge CENCO's other subsidiaries. We do not believe this reasoning to be supported by the record. Upon examining the record, we believe that the operative transaction that should have been examined by DPW was MHC's purchase of one hundred percent of LHO's stock from CENCO, and not the purchase of CENCO, an entirely different corporation with other holdings.*fn13 At that time, LHO was the parent corporation and sole shareholder of LNCI. Seven months later, all on the same day, MHC merged LNCI into LHO and then merged LHO into itself, MHC. MHC then assumed all debts and obligations of LNCI and LHO. We believe this transaction clearly illustrates an intent on the part of MHC to acquire the assets of both

[ 122 Pa. Commw. Page 109]

LHO and LNCI, and, as did occur, to merge the two companies into itself.*fn14 Moreover, we believe this transaction to be identical to those routinely determined to be acquisitions of assets. As stated above, LHO facilities were transferred to MHC through the purchase of LHO stock and liquidation of the subsidiary corporation that owned the facilities (LNCI) -- a transaction which courts have equated to an asset acquisition. PCME; Chateau Gardens, Inc. v. Harris, 497 F. Supp. 133 (E.D. Mich. 1980).

DPW, citing 42 C.F.R. 405.415(1)(2)(ii) in its adjudication, determined that the transaction between MHC and LNCI was between "related parties," and therefore disallowed the depreciation expense submitted by MHC.*fn15 Again, we do not believe the record supports this finding.*fn16

[ 122 Pa. Commw. Page 110]

By making this assertion, DPW is assuming that two separate transactions have taken place and that the initial sale of LHO stock to MHC has tainted the subsequent transfer and telescoping of its assets with the consequence that the transaction was between related parties. Chateau Gardens. This Court does not agree with the reasoning of this argument.

At the time the purchase of LHO was negotiated, MHC and CENCO were two separate and distinct corporations. The purchase price for LHO was established in a bona fide arm's length transaction. When MHC purchased LHO, LHO was parent and sole shareholder of LNCI, and MHC's purchase of LHO was tantamount to its purchase of LNCI. Seven months later, MHC merged the two corporations into itself.

We view this entire transaction as a single transaction carried out in two steps, and we believe that the arm's length relationship continued to exist until the transaction was complete. Id. Therefore, we do not believe the parties were "related" as DPW asserts.

In its brief, DPW asserts that the PCME "test" no longer applies, citing Fairwinds Manor v. Department of Public Welfare, 517 Pa. 106, 535 A.2d 42 (1987) and Mountain Rest Nursing Home, Inc. v. Department of Public Welfare, 73 Pa. Commonwealth Ct. 42, 457 A.2d 600 (1983). DPW contends that Fairwinds and Mountain Rest maintain that DPW can preclude step-up under Manual Section IV-D-9-f, found at 8 Pa. B. 2832 (1978), and that under Title XIX no step-up at all is required.*fn17 We do not agree with DPW's interpretation of the law.

[ 122 Pa. Commw. Page 111]

    states that transactions deemed as asset acquisitions will receive reimbursement based on the purchase price of the stock. See Richey Manor at 133. The portion of the Richey Manor decision invoked by DPW is dicta and will not be considered as persuasive authority by this Court. Furthermore, that portion of the Richey Manor decision was reconciled with the PCME decision in Humana, which concluded that a one hundred percent stock purchase and subsequent liquidation is an acquisition of assets, as long as there is an intent to acquire the assets from the outset of the transaction.

Accordingly, for the reasons stated above, this Court will reverse the order of DPW.

Order

Now, December 14, 1988, the order of the Department of Public Welfare in the above-captioned matter is hereby reversed.

Judge MacPhail did not participate in the decision in this case.

Disposition

Reversed.


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