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Albert Einstein Medical Center v. Sebelius

May 22, 2009


On Appeal from the United States District Court for the Eastern District of Pennsylvania (D.C. No. 04-cv-06059) District Judge: Honorable Ronald L. Buckwalter.

The opinion of the court was delivered by: Sloviter, Circuit Judge.


Argued October 31, 2008

Before: SLOVITER, STAPLETON and TASHIMA*fn2, Circuit Judges


Germantown Hospital and Medical Center ("Old Germantown") submitted to the representative of the Secretary of Health and Human Services, the Centers for Medicare and Medicaid Services ("CMS" or "Administrator"), a reimbursement claim for loss on depreciable assets resulting from its 1997 statutory merger into Germantown Hospital and Community Health Services ("New Germantown"). The Administrator denied the claim because he found that the Old Germantown merger was between "related parties" and did not constitute a "bona fide sale." Albert Einstein Medical Center, Inc. ("Einstein"), as successor-in-interest to Old Germantown and New Germantown, filed an action in federal court challenging the Administrator's interpretations of the relevant regulations and, in the alternative, challenging the Administrator's factual findings based on those regulatory interpretations. The District Court, the Honorable Ronald L. Buckwalter of the United States District Court for the Eastern District of Pennsylvania, granted summary judgment to the Secretary upholding the decision of the Administrator. Einstein appeals.

I. Factual and Procedural Background

Prior to the 1997 merger at issue in this case, Old Germantown was a not-for-profit hospital, located in Philadelphia, Pennsylvania. David Ricci, who had served as President and CEO, testified before the Provider Reimbursement Review Board ("PRRB") that as a result of the development of managed care and healthcare systems in Philadelphia in the early 1990s, small hospitals realized that they needed to "join[] stronger organizations in order for them to have a future." App. at 685. By the mid-nineties, Old Germantown had seen a decline in admissions and was operating only 125-150 of its 255 licensed beds. Ricci stated that this reduction in patient volume, combined with a "feeding frenzy for acquiring physician practices," caused Old Germantown difficulty in retaining specialists. App. at 685. As a result, Old Germantown experienced yearly operating losses, with its 1996 operating loss amounting to between $2.3 and $2.5 million. In 1996, Old Germantown's outstanding liabilities totaled more than $30 million, including approximately $11.6 million in long-term debt. At about that time, Old Germantown's primary lender decided that the hospital was such a credit risk that it would no longer extend credit to Old Germantown.

By 1997, Old Germantown's assets included endowment funds of approximately $37.9 million in principal, but the hospital could use only the annual interest from these funds. Accordingly, the principal could not be used to satisfy Old Germantown's debts or serve as collateral on future loans. In 1996, the interest income from these endowments was roughly $1.3 million, but there were also restrictions on the permissible uses of the interest income of many of these funds. Therefore, even much of the interest income from these restricted funds could not be used to pay Old Germantown's debts.

Acknowledging the seriousness of its financial predicament, Old Germantown sent a request for proposal ("RFP") to several healthcare systems on December 10, 1996, seeking a merger or a sale of assets. Old Germantown's RFP stated:

The principal objectives the [Old] Germantown Board expects to consider in evaluating proposals will be to: (i) ensure that Germantown continues to serve the health care needs of its community; (ii) enhance the health care services available at Germantown; (iii) maintain, to the extent possible, Germantown's workforce; (iv) achieve a fair value for Germantown's business and assets; and (v) consummate any acceptable transaction expeditiously.

App. at 252.

In response, Old Germantown received proposals from the Albert Einstein Healthcare Network ("AEHN"),*fn3 Temple University, and Primary Health Systems, Inc. ("PHS").*fn4

AEHN proposed to create a new subsidiary within its healthcare network that would assume all of Old Germantown's assets and liabilities. AEHN's proposal also provided that the Board of the new entity would "include current members of the [Old] Germantown Board of Trustees, current management and medical staff leadership as well as AEHN designees." App. at 276. In addition, AEHN would invest $6 million in the new entity over the course of its first five years of existence in order "to increase services to the community and to insure continued access to current healthcare services." App. at 280.*fn5

PHS proposed to purchase the physical assets of Old Germantown for $15 million, with Old Germantown retaining all its other assets and liabilities (including its limited-use endowments) to pay off its debts and liabilities. The proposal was silent as to any continuing role of Old Germantown principals within the governing structure of the hospital after the sale.

Old Germantown opted to pursue a merger with AEHN. The parties entered negotiations and the terms agreed upon were reflected in a non-binding Letter of Intent from AEHN's president, dated February 28, 1997. The letter stated that AEHN would create a new subsidiary that would merge with Old Germantown, that members of Old Germantown's management would have places on the Board of Trustees of the new entity, and that additional members of the Board would be appointed from the community served by the hospital "based upon recommendations submitted by [Old] Germantown" to AEHN. App. at 308. However, the Letter of Intent noted that the "above stated board composition shall be subject to the parties' intentions to maximize Medicare recapture." App. at 308. In addition, the Letter of Intent stated that the members of Old Germantown's Board who were not offered places on the new entity's Board of Trustees would be "offered the opportunity to serve on AEHN's Board of Directors." App. at 309. The Letter of Intent also stated that the "parties intend to preserve, to the extent possible, [Old] Germantown's existing senior management." App. at 309. Finally, AEHN reiterated its plan to contribute $6 million in funds to the new entity over the first five years of its existence.

Old Germantown and AEHN signed a definitive agreement ("Agreement") on May 30, 1997. In large part, the Agreement preserved the terms reflected in the Letter of Intent, except with respect to the composition of the new entity's Board of Trustees and AEHN's Board of Directors. The new entity, New Germantown, would have a Board of Trustees of up to forty members and include four members from Old Germantown's Board, three members of Old Germantown's medical staff, at least two of whom had not previously sat on its Board, the President and CEO of Old Germantown, twelve members from the Germantown community (not to be recommended by Old Germantown, as the Letter of Intent had contemplated), and up to twenty members chosen by AEHN. All Board members would be subject to the approval of the AEHN "Nominating Committee, which approval shall not be unreasonably withheld." App. at 338. Old Germantown's Chairman of the Board as of the date of the merger would serve as the initial Chairman of the Board of New Germantown. Two members of Old Germantown's Board of Trustees would serve on the "Executive Committee of [AEHN]'s Board of Directors," and in addition AEHN would offer the remaining members of Old Germantown's Board "the opportunity to serve on [AEHN]'s Board of Directors." App. at 338. Finally, the President and CEO of Old Germantown would become the President and CEO of New Germantown.

With respect to the composition of the new Board, David Ricci, who had served as President and CEO of Old Germantown, and now served as President and CEO of New Germantown, later conceded at the hearing before the PRRB that Old Germantown was worried about having more than twenty percent representation on the new Board because it wanted to "minimize anything that would jeopardize the loss of those [Medicare] dollars we believe we were rightfully owed." App. at 710.

In June of 1997, AEHN created a subsidiary under the name of Germantown Hospital and Community Health Services ("New Germantown"), a non-profit corporation, and on September 1, 1997, the parties completed the merger of Old Germantown into New Germantown according to the terms of the Agreement. Effective as of this merger, Old Germantown ceased to exist and all of its assets and liabilities passed to New Germantown by operation of law. The monetary assets assumed by New Germantown were valued at $57.9 million (including the $37.9 million in endowment funds), and the fixed assets were valued at $14.5 million, totaling slightly over $72 million. In exchange for gaining these assets, New Germantown assumed Old Germantown's liabilities of $34 million. As anticipated, AEHN also pledged $6 million in "contingent consideration" to be paid to New Germantown over the next five years. App. at 64.

On May 27, 1998, New Germantown submitted a final cost report to Medicare's fiscal intermediary on behalf of Old Germantown, claiming that it had "incurred a loss on sale of depreciable assets" through its merger with New Germantown, and sought reimbursement. App. at 620. Because the consideration (liabilities assumed by New Germantown) was less than the assets' "net book value" (described below), New Germantown's position was that the assets had depreciated more than Medicare had estimated and that, as a result, Medicare's share of that loss was $4,876,356, later revised to $4,793,668.

On May, 26, 1999, Medicare's fiscal intermediary denied the claimed loss, and New Germantown appealed the decision to the PRRB, which allowed the claim on September 1, 2004. However, the Administrator reversed the PRRB decision, disallowing the loss because he concluded that the merger was between "related parties" and did not constitute a "bona fide sale." Einstein, as successor-in-interest to New Germantown and Old Germantown, sought review of the Administrator's decision in the District Court for the Eastern District of Pennsylvania, which granted summary judgment in favor of the Secretary on August 1, 2007. Albert Einstein Medical Center, Inc. v. Leavitt (Einstein), No. 04-6059, 2007 WL 2221417 (E.D. Pa. Aug. 1, 2007). The District Court held that the Secretary's interpretations of 42 C.F.R. § 413.17 ("Related Party Regulation"), 42 C.F.R. § 413.134(k)(2) ("Statutory Merger Provision"), and 42 C.F.R. § 413.134(f)(2) ("Bona Fide Sale Provision") were reasonable and consistent with CMS' prior interpretations. Einstein, 2007 WL 2221417 at *10-12. In addition, the District Court found that the Secretary's factual findings were based on substantial evidence. Id. at *11, 14. Einstein timely filed a notice of appeal with this court.

II. Jurisdiction and Standard of Review

The District Court had jurisdiction to review the Administrator's decision under 42 U.S.C. § 1395oo(f)(1) and we have jurisdiction under 28 U.S.C. § 1291. We review the agency's decision under the standards set forth in the Administrative Procedure Act ("APA"), 5 U.S.C. § 706. 42 U.S.C. § 1395oo(f)(1). As such, we "can set aside the Administrator's decision only if it is 'unsupported by substantial evidence,' is 'arbitrary, capricious, an abuse of discretion, or [is] otherwise not in accordance with law.'" Mercy Home Health v. Leavitt, 436 F.3d 370, 377 (3d Cir. 2006) (quoting 5 U.S.C. ยงยง 706(2)(A), (E)) (alteration in original). "Substantial evidence is 'more than a mere scintilla. It means ...

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