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Published online by Cambridge University Press: 24 February 2021
The Secretary of Health and Human Services denies Medicare reimbursement for certain indirect costs associated with health care delivery. This Note reviews arguments supporting and opposing reimbursement of costs that providers incur in three common financial transactions: the use of equity capital, acquisition of providers, and loan financing. The Note considers the Secretary’s regulations in light of the congressional mandate to encourage efficient delivery of health care and concludes that current reimbursement policy promotes inefficiency.
1 42 U.S.C. § 1395x(v)(1)(A) (1976). The Health Insurance for the Aged Act, enacted in 1965, created Medicare. 42 U.S.C. §§ 1395-1395vv (1976 & Supp. IV 1980).
2 This Note uses the term “reimbursement system" to refer only to the process by which Medicare authorities and the federal courts determine how much to pay to health care providers. Decisions such as who Medicare beneficiaries are and what health care services the program should cover are beyond the scope of this Note.
3 The Department of Health and Human Services (HHS) replaced the former Department of Health, Education and Welfare (HEW) effective May 4, 1980. Department of Education Organization Act, Pub. L. No. 96-88, § 509(b), 93 Stat. 668 (1979). All references to HEW in cases discussed in this Note are applicable now to HHS.
4 42 U.S.C. §§ 1395c-1395i-2 (1976 & Supp. IV 1980).
5 42 U.S.C. §§ 1395j-1395w (1976 & Supp. IV 1980). Part C of the Act contains definitions and general provisions applicable to Parts A and B. See 42 U.S.C. §§ 1395x-1395vv (1976 & Supp. 1980).
6 42 U.S.C. § 1395i(a) (Supp. IV 1980).
7 Id.
8 42 U.S.C. § 1395x(v)(1)(A) (1976).
9 In fiscal year 1979, 96 per cent of Part A payments were for inpatient hospital care. Health Care Financing Ad., Dep't of Health And Human Services, Fourteenth Annual Report on Medicare Covering Fiscal Year 1980 1 (1982)Google Scholar [hereinafter 1980 Medicare Annual report].
10 Other types of providers recognized by the Medicare Act are skilled nursing facilities, comprehensive outpatient rehabilitation facilities, and home health agencies. 42 U.S.C. § 1395x(u) (Supp. IV 1980).
11 42 U.S.C. § 1395cc (1976 & Supp. IV 1980). In fact, the Secretary delegated his functions under the Medicare Act to the Commissioner of Social Security. 33 Fed. Reg. 5836 (1968). The validity of the delegation was upheld in Pacific Coast Medical Enters. v. Califano, 440 F. Supp. 296, 305 (C.D.Cal. 1977), aff'd, 633 F.2d 123 (9th Cir. 1980). Despite this delegation, which was effective during the transactions at issue in most cases discussed by this Note, this Note adopts the convention used by the courts of referring to the Secretary as the administrator of the program.
In 1978, Congress delegated the Commissioner’s functions to the Administrator of the Health Care Financing Administration. Act of June 13, 1978, Pub. L. No. 95-292, § 5, 92 Stat. 307 (1978).
12 42 U.S.C. § 1395cc (1976 & Supp. IV 1980).
13 42 U.S.C. § 1395h(a) (Supp. IV 1980). Providers may choose to receive their payments directly from the Secretary, but virtually all providers have chosen to use intermediaries. In 1979, 67 Blue Cross Plans and eight commercial insurers served as intermediaries. 1980 Medicare Annual Report, supra note 9, at 8.
14 See 42 C.F.R. § 405.401(c) (1982). This regulation is promulgated under the authority of 42 U.S.C. § 1395h(a) (1976 & Supp. IV 1980).
15 42 C.F.R. § 405.405 (1981).
16 Congress established the present review procedure in Act of October 30, 1972, Pub. L. No. 92-603, § 243(b), 86 Stat. 1421, which is codified at 42 U.S.C. § 1395oo (1974). The amount in controversy must be at least $10,000. The PRRB consists of five members appointed by the Secretary for three year terms, and they must be knowledgeable in cost reimbursement. This procedure is effective for fiscal years ending June 30, 1973 and later. For earlier years, a different review procedure was effective. Initially, HEW did not provide any type of impartial administrative hearing for providers to contest adverse decisions of fiscal intermediaries. This failure was held to be a denial of due process in Coral Gables Convalescent Hosp. v. Richardson, 340 F. Supp. 646, 650 (S.D.Fla. 1972), and HEW responded by issuing regulations for reviews. See 42 C.F.R. §§ 405.1801-. 1890 (1981). These regulations are still effective for appeals after June 30, 1973 of amounts less than $10,000.
17 42 U.S.C. § 1395oo(c) (1976). At the hearing, the provider’s rights include representation of counsel, introduction of evidence, and direct and cross examination of witnesses.
18 42 U.S.C. 1395oo(f) (Supp. IV 1980).
19 Id.; judical review of intermediary decisions prior to June 30, 1973, was uncertain. The federal district and circuit courts declined to exert jurisdiction over the matters. Dr. John T. MacDonald Found. v. Califano, 571 F.2d 328, 331 (5th Cir. 1978); Chelsea Community Hosp. v. Michigan Blue Cross, 436 F. Supp. 1050, 1055-57 (E.D.Mich. 1977). However, the Court of Claims determined that it did have jurisdiction to hear appeals from intermediary decisions. St. Elizabeth Hosp. v. United States, 558 F.2d 8,11-12 (Ct. Cl. 1977). Thus, all pre-1973 claims are now heard by the Court of Claims. See MacDonald Found., 571 F.2d at 332.
20 42 U.S.C. § 1395f(b) (Supp. IV 1980).
21 See, e.g., American Medical Int'l, Inc. v. Secretary of HEW, 466 F. Supp. 605 (D.D.C. 1979), aff'd 677 F.2d 118 (D.C. Cir. 1982): "The Medicare program is structured around the concept of reasonable cost.” Id. at 609.
22 42 U.S.C. § 1395x(v)(1)(A) (1976).
23 Id.: "Such regulations [promulgated by the Secretary to define reasonable cost] shall take into account the direct and indirect costs of providers of services ... in order that, under the methods of determining costs, the necessary costs of efficiently delivering 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]. . . ."
24 Id. The Secretary’s determination of “reasonableness" in the areas of indirect cost discussed in this Note extends to both the category of cost and the amount of the cost. In the Medicare reimbursement lexicon, reasonable costs (as determined by the Secretary) are “allowable"; unreasonable costs are not allowable.
25 42 C.F.R. §§ 405.401-.488 (1981). The Secretary has also promulgated Medicare regulations dealing with other aspects of the program. See 42 C.F.R. §§ 405.101-.2430; §§ 420.1-.296; §§421.1-.205 (1981).
26 Equity capital is the money invested in a corporation by its shareholders. Equity and debt are the two major means by which corporations can raise capital. Debt is money that is lent to a corporation.
27 When Medicare reimburses providers for indirect costs of health care, it does so on a pro-rata basis, so that the costs are spread between Medicare and non-Medicare patients. 42 C.F.R. § 405.402(b) (1981). The costs can be apportioned in one of two ways. 42 C.F.R. §405.404 (1981).
28 For a listing of ancillary costs, see infra note 59 and accompanying text. “Ancillary costs" in this sense refers to costs that are incurred in raising capital, but that are not paid to those from whom the capital is obtained. The costs paid to the capital contributors are the “direct" costs. For debt, the direct cost is the interest expense. For equity, there is no required direct cost, but stockholders typically expect to receive dividends and appreciation in the value of their stock.
29 The federal securities laws, 15 U.S.C. §§ 77a-78kk (1976 & Supp. IV 1980), impose many disclosure and reporting requirements on the public issuance and exchange of securities.
30 Provider Reimbursement Manual, § 2134.9, reprinted in [1979] 1 Medicare & Medicaid Guide (CCH) ¶ 5994:
The following types of costs relevant to the proprietary and equity interests of the stockholders, but not related to patient care, are excluded from allowable costs: costs incurred primarily for the benefit of stockholders or other investors, including, but not limited to, the costs of stockholders’ annual reports and newsletters, annual meeting, mailing of proxies, stock transfer agent fees, stock exchange and registration fees, stockbroker and investment analysis, and accounting and legal fees for consolidating statements for SEC purposes.
There is a similar provision in § 2150.2B of the Manual.
31 One study indicated that the expenses of a public stock issuance, aside from underwriters’ fees, averaged up to 6.8 percent of the value of the issuance. Smith, Alternative Methods for Raising Capital: Rights vs. Underwritten Offerings, 5 J. Fin. Econ. 273, 277 (1977)CrossRefGoogle Scholar. In American Medical, the provider sought $299,000 for just two years worth of stock maintenance costs. PRRB Hearing Dec. No. 77-D61 (Sept. 8, 1977), reprinted in [1977 Transfer Binder] Medicare & Medicaid Guide (CCH) ¶ 28,657.
32 Compare American Medical, 466 F. Supp. at 616 (upholding the Secretary) with AMI- Chanco, Inc. v. United States, 576 F.2d 320, 326 (Ct.Cl. 1978) (overruling the Secretary).
33 Supra notes 21 & 22 and accompanying text.
34 42 U.S.C. § 1395x(v)(1)(A) (1976).
35 AMI-Chanco, 576 F.2d at 323; American Medical, 466 F. Supp. at 613.
36 American Medical, 466 F. Supp. at 612-13.
37 Id. at 614; AMI-Chanco, 576 F.2d at 326-27.
38 42 U.S.C. § 1395x(v)(1)(B) (1976).
39 Pub. L. No. 89-713, § 7, 80 Stat. 1107 (1966).
40 See 112 Cong. rec. 28,220 (1966) (comments of Congressman Byrne), noted in American Medical, 466 F. Supp. at 613-14.
41 Although the statute on its face applies only to extended care facilities, i.e. nursing homes, the Congressional Conference Report directed the Secretary to apply the same principle to proprietary hospitals. H.R. Rep. No. 2317, 89th Cong., 2d Sess. 3, reprinted in 1966 U.S. Code Cong. & Ad. News 3676, 3692-93.
42 The Secretary promulgated the proposal in June, 1966. 31 Fed. Reg. 7871 (1966). It was subsequently published, with modifications, as 20 C.F.R. § 428(a). See 31 Fed. Reg. 14,808 (1966). (Title 20 was redesignated Title 42 in 1977). For an extensive judicial analysis of the legislative history behind the return on equity amendment and the 2 percent allowance, see Hospital Auth. of Floyd County, Ga. v. Schweiker, 522 F. Supp. 569, 570 (N.D.Ga. 1981).
43 For a discussion of the lobbying efforts, see Somers, H. & Somers, A. Medicare and the Hospitals: Issues and Prospects 179-80 (1967)Google Scholar.
44 See discussion of legislative history in Hospital Auth. of Floyd County, 522 F. Supp. at 574.
45 Id.
46 The non-profit providers continued to receive the full 2 percent special allowance. 20 C.F.R. § 405.428. See 31 Fed. Reg. 14,808 (1966). However, the Secretary eliminated the allowances entirely in 1969 by amending § 405.428. 34 Fed. Reg. 9,927 (1969).
47 AMI-Chanco, 576 F.2d at 326-327.
48 American Medical, 466 F. Supp. at 614.
49 Id.:
Senator Long, in the Congressional debate leading to the passage of the return on equity capital provision, stated:
The purpose of the Senate amendment was certainly laudable. What we sought was to guarantee to the individual who invested his funds in a facility organized for profit that he would receive a fair return on the money he had put into the operation. As the proposed medicare regulations stood he would have been only reimbursed for the actual costs of providing services with no specific return given on his investment.
112 Cong. Rec. 27,608 (1966) (emphasis added). Several days later, Congressman Byrnes reiterated the fact that reasonable costs for providing Medicare care does not include costs for investment.
The medicine bill which we passed a year ago, provides for 100 days of post-hospital extended care. However, the bill specified that the amount which will be paid for post-hospital extended care—in other words, the amount that will be paid to the individual nursing home or facility—shall be, and I quote, “the reasonable cost" of furnishing such care. In other words, as the law now stands, fundamentally all the Social Security Administration can pay are the costs, with no allowances for profits or a return on the invested capital.
** * * * *
This amendment provided here does make a step toward recognizing some return on investment must be provided for the proprietary nursing home.
112 Cong. Rec. 28,220 (1966) (emphasis added).
50 It is possible to interpret the silence of the legislative history as an understanding by Congress that “stock maintenance costs" were not part of the return on equity, because stock maintenance costs are “actually incurred.” See Hospital Auth. of Floyd County, 522 F. Supp. at 573 (comments of Senator Anderson).
51 These are among the grounds listed in the Administrative Procedure Act upon which a federal court may overrule the action of an administrative agency. The scope of judicial review is set out in 5 U.S.C. § 706 (1976).
52 AMI-Chanco, 576 F.2d at 322; American Medical, 466 F. Supp. at 613-15. In addition, the providers have sought to invalidate the rule on the ground that its issuance failed to follow the requirements of the Administrative Procedure Act (APA). In brief, that contention was that the stock maintenance costs rule was a substantive rule rather than an interpretative rule. This distinction is important because the APA requires notice of a proposed rule to appear in the Federal Register, with interested members of the public given an opportunity to comment. 5 U.S.C. § 553(b) (1976). Only one court decided this issue; it held that the stock maintenance cost rule was interpretive, because it was “issued to advise the public of the agency’s construction of the statute.” American Medical, 466 F. Supp. at 616. The issue was raised but not decided in AMI-Chanco, 576 F.2d at 321-322, n.3.
53 AMI-Chanco, 576 F.2d at 325.
54 See supra note 23.
55 AMI-Chanco, 576 F.2d at 323; American Medical, 466 F. Supp. at 614.
56 See AMI-Chanco, 576 F.2d at 324.
57 Id.; American Medical, 466 F. Supp. at 615.
58 See American Medical, 466 F. Supp. at 615.
59 Id.; AMI-Chanco, 576 F.2d at 325. Ancillary costs of debt issuance include professional fees, underwriters’ fees, appraisers’ fees, and similar costs. Provider Reimbursement Man Ual, § 212.1, reprinted in [1982] 1 Medicare & Medicaid Guide (CCH) ¶ 4983.
60 42 C.F.R. § 405.406(a) (1981) provides that Medicare will reimburse costs determined according to “[s]tandardized definitions, accounting statistics, and reporting practices which are widely accepted in the hospital and related fields. . . .” InAMI-Chanco, 576 F.2d at 324, the court noted that this language signalled an intent to reimburse general and administrative costs.
61 AMI-Chanco, 576 F.2d at 323-24.
62 Id. at 325-26.
63 Id. at 325.
64 576 F.2d 320 (Ct.Cl. 1978).
65 466 F. Supp. 605 (D.D.C. 1979), aff'd 677 F.2d 118 (D.C. Cir. 1982). Oddly, the case does not mention the earlier Court of Claims decision, although the Court of Claims decision preceded American Medical by over eight months.
66 American Medical, 466 F. Supp. at 612-13.
67 See supra notes 57 & 58 and accompanying text.
68 Feldstein, M. The Rising Cost of Hospital Care 68-69 (1971)Google Scholar.
69 These effects are marginal, of course. It is not intended to suggest that this reimbursement policy will absolutely prevent the formation of new proprietary hospitals or the acceptance of Medicare patients; rather, the policy is just a disincentive to do so.
70 The reimbursement statute prohibits cross-subsidization. 42 U.S.C. § 1395x(v)(1)(A) (1976). See supra note 23 and accompanying text.
71 Most hospital costs are paid by insurers, and their payment principles resemble those that Medicare uses. See Meyer, J. Health Care Cost Increases 8 (1979)Google Scholar.
72 The market value of a firm rises with increases in the expected profitability of the firm, and it falls when the expected profitability decreases. Lorie, J. & Hamilton, M. The Stock Market: Theories and Evidence 124 (1973)Google Scholar.
73 This policy may also reduce stock prices and therefore discourage investment by limiting the information available to investors. As one court noted, the purpose of these expenditures is to protect investors by providing information through annual meetings and various reports. American Medical, 466 F. Supp. at 613. Denial of reimbursement for these expenditures may cause providers to minimize the amount spent on the effort, thus reducing the information flow. Investors would then evaluate the providers more cautiously and might discount their estimates of value accordingly.
This argument is not very strong. If the reduced flow of information did reduce the firm’s value, then a rational manager seeking to maximize the value of the provider he manages would certinly spend more on the effort. Cf. Posner, R. Economic Analysis of Law 332 (2d ed. 1977)Google Scholar (opining that disclosures required by the federal securities laws have not increased information available to investors).
74 See supra note 59 and accompanying text.
75 “Capital structure" is the mix of different securities (debt and equity) of the firm. BREALY, R. & MYERS, S. Principles of Corporate Finance 350 (1981)Google Scholar.
76 Id. at 360; see AMI-Chanco, 576 F.2d at 325. A firm that has a high proportion of debt in its capital structure is riskier than a firm that has less debt, ceteris paribus, because the high-debt firm has greater fixed costs (in the form of interest payments) that it must meet before it can show a profit.
77 Interest expenses are reimbursable under 42 C.F.R. § 405.419 (1981).
78 The purchaser may pay for the stock in the provider with cash, notes, stock in itself, other consideration, or any combination thereof.
79 In a leading case on the sale of corporate control, the defendant owned only 28.3 percent of the stock. In Essex Universal Corp. v. Yates, 305 F.2d 572, 575 (2d Cir. 1962), the court noted: "[I]t is commonly known that [power sufficient to elect a majority of the board of directors] usually accrues to the owner of 28.3 percent of the stock.” See Sommer, A.A. Jr. Who’s “In Control?"-S.E.C, 21 Bus. Law. 559, 567-72 (1966)Google Scholar.
80 Delaware’s corporate law, for example, authorizes corporations to purchase and own shares of stock or other securities of other corporations. Del. Code Ann. tit. 8, § 123 (1974).
81 This would be a merger or consolidation, technically, with only one corporation surviving. Del. Code Ann. tit. 8, § 251 (1974).
82 In Pacific Coast Medical Enters. v. Harris, 633 F.2d 123, 127 (9th Cir. 1980), the purchaser paid $7 million in stock for the provider. Of that amount, the reimbursement of $6,075 million was in dispute. See Dec. No. 75-D8, (August 19, 1975), reprinted in [1975 Transfer Binder] Medicare & Medicaid Guide (CCH) ¶ 27,485
83 An asset is simply an economic resource controlled by an entity and for which it paid a measurable price. Anthony, R. & Reece, J. Accounting: Text and Cases 35 (6th ed. 1979)Google Scholar.
84 Assets can be conveniently divided into two types, long-lived and current. Current assets are normally used up in a year or less, while long-lived assets are consumed over a longer period. Examples of current assets are cash, marketable securities, accounts receivable, and inventory. Types of inventory that are normally stored for more than a year, such as tobacco and liquor, are still classified as current assets. Common long-lived assets include property, plant, equipment, investment securities, and goodwill. Id. at 37-39.
85 Id. at 209.
86 Id. at 62-63. Accountants use several different depreciation methods to write off assets at varying rates. See generally id. at 216-22.
87 Id. at 214-15.
88 The regulations allow providers to use straight-line depreciation or, in certain circumstances, accelerated depreciation by the declining balance method. 42 C.F.R. § 405.415(a) (1981). It is important to note that financial depreciation methods are not tied to, or dependent on, cost recovery provisions of the tax laws. Most companies use different depreciation techniques for tax purposes than for financial accounting purposes. Anthony & Reece, supra note 83, at 221-22.
89 Anthony & Reece, supra note 83, at 223.
90 Id. at 228.
91 Accountants often write off long-lived assets over too short a period, with the result that assets which are still productive have a net book value of zero.
92 The asset may be written off by use of accelerated depreciation, thus assigning most of its cost to its first few years, when in fact it loses the bulk of its value in its later years. See Chirelstein, M. Federal Income Taxation: A Law Student’s Guide to the Leading Cases and Concepts 133 (3d ed. 1982)Google Scholar.
93 Anthony & Reece, supra note 83, at 29.
94 Id. at 28.
The Secretary originally permitted reimbursement of goodwill purchased in acquisitions in 20 C.F.R. § 405.429(a) (1970), but that rule was changed effective August 1, 1970. See 35 Fed. Reg. 12,330 (1970). The regulations now deny reimbursement for goodwill purchased in the acquisition of assets or facilities on or after August 1, 1970. 42 C.F.R. § 405.429(b) (1982). This regulation has been upheld as consistent with the reasonable cost statute. See North Clackamas Community Hosp. v. Harris, 664 F.2d 701 (1980). This Note does not discuss the issue of whether the regulation is justified.
95 42 C.F.R. § 405.415(b) (1981).
96 42 C.F.R. § 405.415(g) (1981). This regulation was amended in 1979. 44 Fed. Reg. 6912 (1979). The earlier version, under which the cases discussed in this Note were litigated, provided:
In establishing the cost basis for a facility purchased as an ongoing operation after July 1, 1966, the price paid by the purchaser shall be the cost basis where the purchaser can demonstrate that the sale was a bona fide sale and the price did not exceed the fair market value of the facility at the time of the sale. ... 42 C.F.R.
§ 405.415(g) (1978).
The regulation now reads:
(g) Establishment of cost basis of facility as an ongoing operation. (1) Assets acquired after July 1, 1966 and before August 1, 1970. The cost basis for the assets of a facility purchased as an ongoing operation after July 1, 1966, and before August 1, 1970, shall be the lowest of:
(i) The total price paid for the facility by the purchaser, as allocated to the individual assets of the facility; or
(ii) The total fair market value of the facility at the time of the sale, as allocated to the individual assets; or
(iii) The combined fair market value of the individually identified assets at the time of the sale.
(2) Assets acquired after July 31, 1970. For depreciable assets acquired after July 31, 1970, in addition to the limitations specified in paragraphs (g)(1) of this section, the cost basis of the depreciable assets shall not exceed the current reproduction cost depreciated on a straightline basis over the life of the assets to the time of the sale.
(3) Transactions other than bona fide. If the purchaser cannot demonstrate that the sale was bona fide, in addition to the limitations specified in paragraphs (g)(1) and (2) of this section, the purchaser’s cost basis shall not exceed the seller’s cost basis, less accumulated depreciation.
97 42 C.F.R. § 405.415(a) (1981).
98 See Homan & Crimen, Inc. v. Harris, 626 F.2d 1201, 1207 (5th Cir. 1980); American Medical Int'l v. Secretary of HEW, 466 F. Supp. 605, 610 (D.D.C. 1979), aff'd 677 F.2d 118 (D.C. Cir. 1982).
99 E.g., Pacific Coast Medical Enters. v. Harris, 633 F.2d 123, 128 (9th Cir. 1980).
100 42 C.F.R. § 405.415(a) (1981).
101 “Basic corporate law indicates that assets of a corporation are owned by the corporate entity, not the stockholders.” American Medical, 466 F. Supp. at 622.
102 Homan & Crimen, 626 F.2d at 1207-09; American Medical, 466 F. Supp. at 622-23; Monterey Life Sys. v. United States, 635 F.2d 821, 825-26 (Ct. Cl. 1980). See also Richey Manor, Inc. v. Schweiker, 684 F.2d 130, 134-35 (D.C. Cir. 1982) (disallowing revaluation for a 100 percent purchase of stock followed by a transfer of the provider’s assets to a new nonprofit corporation).
103 The purchaser or its subsidiary becomes the new owner of the assets of the acquired provider. See supra note 81 and accompanying text.
104 See Memorial, Inc. v. Harris, 655 F.2d 905, 909 (9th Cir. 1980); Pacific Coast, 633 F.2d at 129; Chateau Gardens v. Harris, 497 F. Supp. 133, 134-35 (E.D.Mich. 1980); West Seattle Gen. Hosp. v. United States, 674 F.2d 899, 901 (Ct.Cl. 1982).
105 See supra notes 100-02 and accompanying text.
106 The prohibition of revaluation for related party transactions is based on 42 C.F.R. § 405.427(c) (1981). For a discussion of the related party rule in the context of loans, see infra notes 164 & 165 and accompanying text.
107 References to related parties are found in 42 C.F.R. §§ 405.415, 405.419, and 405.427 (1981).
108 “Related parties" are “organizations related to the provider by common ownership or control “ 42 C.F.R. § 405.427(a) (1981). The regulation provides further:
(b) Definitions—
(1) Related to provider. Related to the provider means that the provider to a significant extent is associated or affiliated with or has control of or is controlled by the organization furnishing the services, facilities, or supplies.
(2) Common ownership. Common ownership exists when an individual or individuals possess significant ownership or equity in the provider. and the institution or organization serving the provider.
(3) Control. Control exists where an individual or an organization has the power, directly or indirectly, significantly to influence or direct the actions or policies of an organization or institution.
109 42 C.F.R. § 405.427(c) (1981) explains the basis for the related party rule:
(c) Application.
(1) Individuals and organizations associated with others for various reasons and by various means. Some deem it appropriate to do so to assure a steady flow of supplies or services, to reduce competition, to gain a tax advantage, to extend influence, and for other reasons. These goals may be accomplished by means of ownership or control, by financial assistance, by management assistance, and other ways.
(2) Where the provider obtains items of services, facilities, or supplies from an organization, even though it is a separate legal entity, and the organization is owned or controlled by the owner(s) of the provider, in effect the items are obtained from itself. An example would be a corporation building a hospital or a nursing home and then leasing it to another corporation controlled by the owner. Therefore, reimbursable cost should include the costs for these items at the cost to the supplying organization. However, if the price in the open market for comparable services, facilities, or supplies is lower than the cost to the supplier, the allowable cost to the provider shall not exceed the market price.
For an early case discussing and upholding the validity of 42 C.F.R. § 405.427, which is the general related party rule, see Fairfax Hosp. Ass'n v. Califano, 585 F.2d 602 (4th Cir. 1978).
110 42 C.F.R. § 405.427(a) (1981). This provision is paralleled by § 405.415(g)(3), quoted supra note 96 and applying to acquisitions of facilities from related parties, and § 405.419(c)(1), discussed infra note 164 and applying to loans from related parties.
This rule applies to all types of transactions, not only acquisitions of providers. See, e.g., Marina Mercy Hosp. v. Harris, 633 F.2d 1301 (9th Cir. 1980) (management fees paid to related party); American Hosp. Management Corp. v. Harris, 638 F.2d 1208 (9th Cir. 1981) (rental payments pursuant to sale and leaseback with related party); Fairfax Hosp. Ass'n, Inc. v. Califano, 585 F.2d 602 (4th Cir. 1978) (pharmacy supplies furnished by related parties); American Medical, 466 F. Supp. at 616 (respiratory care services furnished by related party).
111 E.g., Pacific Coast, 633 F.2d at 129.
112 Id. at 136; Memorial, Inc., 655 F.2d at 912-13; Chateau Gardens, 497 F. Supp. at 137; West Seattle, 674 F.2d at 905 (100 percent stock purchase followed by merger into subsidiary of purchaser). But see Rickey Manor, 684 F.2d at 135 (purchase of stock followed by conversion of provider from proprietary to non-profit status). In dictum, the Rickey Manor court also disapproved of the reasoning of the preceding cases.
113 Homan & Crimen, 624 F.2d at 1208; Monterey Life Sys., 635 F.2d at 825; American Medical, 466 F. Supp. at 624.
114 E.g., Homan & Crimen, 624 F.2d at 1208. The providers seek to disregard the distinction between the corporation and its shareholders in order to establish the shareholders as the owner of the corporations’s assets.
115 Id.
116 In addition to contesting the regulations’ validity, some providers have raised other arguments. One provider argued that Medicare should allow revaluation because that practice would accord with generally accepted accounting principles. It urged that regulation § 405.406(a) allows generally accepted accounting principles to control reimbursement unless other regulations clearly indicate otherwise, and that these principles allow revaluation. But the court disagreed and denied revaluation. The court gave three reasons. First, other regulations provide to the contrary; §§ 405.414, 405.419, and 405.427 all establish the net book value rule. Second, the cited regulation—§ 405.406—does not require that generally accepted accounting principles determine reimbursement. Third, generally accepted accounting principles themselves do not require revaluation. American Medical, 466 F. Supp. at 623-24.
Another provider contended that regulation § 405.415(g) allows revaluation even when the assets themselves are not purchased. This section allows revaluation “for the assets of a facility purchased as an ongoing operation. . . .” However, the court construed the section to apply only to acquisitions of facilities, not of stock. The purchaser, rather than acquiring the provider facility directly, acquired only stock in a corporation that owned the facility. Therefore, revaluation was not allowed. Homan & Crimen, at 1207-08.
117 See supra note 112.
118 E.g., Pacific Coast, 633 F.2d at 132; West Seattle, 674 F.2d at 903.
119 Pacific Coast, 633 F.2d at 132.
120 Id. at 132-33; West Seattle, 674 F.2d at 904.
121 See supra note 112.
122 674 F.2d 899 (Ct.Cl. 1982).
123 Id. at 900-01.
124 Id. at 904.
125 Id. at 904-05. The case also raised a subsidiary issue, not directly relevant to this Note, of the date upon which the purchase of assets should be deemed to have occurred. That matter was important because the purchaser sought reimbursement for goodwill purchased in the acquisition as well as for revalued assets. If the purchase of assets were deemed to have occurred in 1969 (when the purchase of stock occurred) then the provider could receive reimbursement for goodwill; but if it were deemed to have occurred in late August 1970 (when the merger was effected), then the provider could not receive reimbursement for goodwill, because the regulations disallow all goodwill incurred after August 1, 1970 (42 C.F.R. § 405.429(b)(2) (1981)). Id. at 902.
126 684 F.2d 130 (D.G. Cir. 1982).
127 Id. at 134.
128 Id.
129 Id.
130 Id. at 135.
131 42 C.F.R. § 405.415(f) (1981).
132 Rickey Manor, 684 F.2d at 135.
133 See supra notes 90-92 and accompanying text.
134 See Nicholson, Intermediate Microeconomics and its Application 467 (1975)Google Scholar.
135 Investors value assets at their fair market value, notwithstanding accounting conventions that misstate value. One of the best examples of investors’ ability to see through financial illusions is the effect on stock prices of a change in the method of depreciation for financial accounting purposes. When a company switches from accelerated depreciation to straight line, the effect is to reduce depreciation expense and therefore raise reported earnings. However, this paper change does not fool investors into paying more for the company’s stock; indeed, the long-term effect seems to be a lower price for the stock, whch probably reflects the economic factors that prompted management to change its depreciation method in the first place. (Note that this scenario does not include a change in depreciation for tax purposes.) See Kaplan, & Roll, Investor Evaluation of Accounting Information: Some Empirical Evidence, 45 J. Bus. 225, 245 (1972)CrossRefGoogle Scholar. In general, financial accounting conventions do not deceive investors, particularly professional financial analysts who evaluate companies. See Brealey & Myers, supra note 75, at 268-70.
136 When inflation causes fair market value to rise above net book value, recapture of the gain on sale should not be required. This gain is illusory; it represents only a nominal increase in value. An example will best illustrate this point. A provider buys an asset in 1973 for $ 100,000 (the book value). The asset has a known useful life of 20 years, and it wears out evenly over that period, with no residual value. By 1983, the asset’s net book value is $50,000. If the provider serves only Medicare beneficiaries, the provider has received $50,000 reimbursement from Medicare. But if inflation has been 10% annually for the last 10 years, the actual value of the asset (if new) is about $260,000, and its current net book value is about $130,000. Although the fair market value substantially exceeds the old net book value, Medicare has not reimbursed too much depreciation. In fact, it has paid too little, because it is repaying the provider’s historical cost with dollars that are worth much less than the dollars used by the provider to buy the asset. In this example, one 1983 dollar is worth 38.6 percent of one 1973 dollar (1/1.110 = 1/2.59 = .386).
A related issue that this Note does not address is the time value of money. One could also argue that providers are not fully reimbursed for the cost of assets when reimbursement is spread out over several years, even if they receive 100 percent of their costs and there is no inflation, because the present value of the “reimbursement stream" will be less than the price paid. For a discussion of present value, see Brealey & Myers, supra note 75, at 11-12. This issue is important to the decision of whether overall Medicare reimbursement is adequate, not just reimbursement after acquisitions.
137 See supra notes 91 & 92 and accompanying text.
138 This can be accomplished by forming a new corporation around the provider or by merging the provider into a new wholly-owned subsidiary. The latter technique was approved in West Seattle, 674 F.2d at 900-01, 905.
139 B. Blttker & J. Eustice, Federal Income Taxation of Corporations and Share Holders § 11.44 (4th ed. 1979).
140 A straight purchase of stock acquisition allows a step-up in basis under I.R.C. § 1012; a two-step purchase of assets is treated similarly under I.R.C. § 334(b)(2).
141 I.R.C. § 362(a) allows the purchasing corporation to increase its basis in property only to the extent that the transferors (the selling shareholders) recognize gain on the transaction.
142 Compare supra note 113 with supra note 112.
143 See American Medical, 466 F. Supp. at 622-23.
144 The statute does not specify that costs be actually incurred by the provider. 42 U.S.C. § 1395x(v)(1)(A) (1976). The fact that costs were incurred in the acquisition of the provider should satisfy the statute. Indeed, in the two-step procedure of West Seattle, discussed supra notes 122-25 and accompanying text, it was the parent-purchaser that incurred the cost of the acquisition. Further, the allowance of a return on equity at a variable rate indicates congressional recognition that not all costs are static. The return on equity allowed for providers varies with the interest rate on certain government securities. See 42 U.S.C. § 1395x(v)(1)(B)(1976).
145 See supra note 112.
146 5 U.S.C. §§ 701-06 (1976), made applicable to Medicare reimbursement by 42 U.S.C. § 1395oo(f)(1) (Supp. 1980).
147 5 U.S.C. § 706(2)(A) (1976).
148 West Seattle, 674 F.2d at 904.
149 In terms of burden of proof, the Secretary need not offer any reason until the plaintiff has made a prima facie case.
150 See supra note 113.
151 Homan & Crimen, 626 F.2d at 1208. See Barber, Piercing the Corporate Veil, 17 Willamette L. Rev. 371, 376-77 (1981)Google Scholar.
152 Generally accepted accounting principles (GAAP) are the basis of accounting. They are principles promulgated by the Financial Accounting Standards Board and its predecessor, the Accounting Principles Board. GAAP are not legally binding, but accountants rarely deviate from them. Anthony & Reece, supra note 83, at 222-23.
153 The generally accepted accounting principles discussed infra note 154 apply only to purchasers, not to acquired companies. See American Medical, 466 F. Supp. at 624.
154 American Medical considered the applicability of Opinion No. 16 of the Accounting Principles Board, entitled “Business Combinations,” to this issue. 466 F. Supp. at 624. That opinion dealt with the proper financial accounting treatment for business combinations, which it defined as an event in which “a corporation and one or more incorporated or unincorporated businesses are brought together into one accounting entity.” Accounting Principles Board, Opinion No. 16, at ¶ 1. The primary issue which the Opinion addresses is whether the transaction should give rise to a new basis of accounting; i.e., whether assets of the acquired firm should be revalued to market value. See id. at ¶ 16. Although this Opinion seems directly applicable to the Medicare reimbursement issue, it is not. The difficulty is that the Opinion approaches the question solely from the perspective of the consolidated books of the entity. Id. at ¶ 2. It does not say how the acquired company, if it continues to exist separately, should account for the acquisition. American Medical, 466 F. Supp. at 624.
155 Anthony & Reece, supra note 83, at 7.
156 Under the historical cost concept, an asset is initially valued at the price paid to acquire it, and that value is systematically reduced by depreciation. Accountants realize that it would be more relevant to continually revalue assets at their fair market value, but they reject that approach as too uncertain and costly. Therefore, accountants will only revalue assets when they are purchased in a market transaction. Id. at 27-29.
A straight purchase of stock acquisition is a market transaction that conclusively establishes the value of a firm. When this type of transaction occurs, generally accepted accounting principles usually require the purchaser to revalue the assets of the acquired company on the purchaser’s books. This process means that the accountant must estimate the fair market value of each asset. If the sum of the estimated values does not equal the purchase price, then the balance is assigned to (positive or negative) goodwill. Id. at 335-36.
157 See Financial Accounting Standards Board, 103 Status Rep. 3 (July 9 , 1980)Google Scholar, in which the Board “decided not to add to its agenda a project to determine whether a major change in the ownership of an enterprise should establish a new accounting basis for the enterprise’s assets and liabilities."
158 For example, in American Medical the plaintiff providers did not revalue their assets on their own books following Chanco Medical Industries’ acquisitions of them. However, when Chanco merged with American Medical International several years later, the providers did revalue their assets on their own books. 466 F. Supp. at 621.
159 The reason that accountants prefer to avoid revaluation, absent reimbursement concerns, is that revaluation will reduce the business’ stated earnings because of the larger depreciation deductions. Although this reasoning may be economically questionable, it seems persuasive to accountants. For example, in 1973 the Securities and Exchange Commission proposed a rule that would require revaluation after a 50 percent or more purchase of stock within a 12-month period. The SEC characterized the proposal as “a relatively simple extension of ‘purchase’ accounting.” Accountants reacted strongly against the proposal and persuaded the SEC to withdraw the proposal. See [1972-73 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 79,256.
160 The Secretary has made efforts to eliminate revaluation after two step purchase of assets acquisitions. He has promulgated a new regulation, 42 C.F.R. § 405.415(l) (1981). As yet untested in court, this regulation simply puts into print the interpretation that the Secretary had earlier unsuccessfully urged on the courts. This Note argues that this regulation is invalid for precisely the reasons that the preceding interpretation was. The mere promulgation of the regulation does not add any greater force to the Secretary’s position, as it is still without a rational basis and contrary to established practice. This regulation should be declared invalid by the courts. Compare id. at § 405.415(/)(2)(ii) with West Seattle, 674 F.2d at 901-02.
161 42 C.F.R. § 405.419(c)(1) (1981).
162 A “related party" is an organization that is tied to the provider by common ownership or control. 42 C.F.R. § 405.427(b) (1981). See supra note 108 for the text of the regulation. For cases in which providers have contested the finding of a relationship, see, e.g., American Hosp. Management Corp. v. Harris, 638 F.2d 1208, 1211 (9th Cir. 1980); Marina Mercy Hosp. v. Harris, 633 F.2d 1301, 1303 (9th Cir. 1980); Jackson Park Hosp. Found. v. United States, 659 F.2d 132, 135 (Ct. Cl. 1981); Northwest Community Hosp. v. Califano, 442 F. Supp. 949, 949 (S.D. Iowa 1977).
163 Supra notes 107-110 and accompanying text.
164 42 C.F.R. § 405.419 (1981) provides in part:
(a) Principle. Necessary and proper interest on both current and capital indebtedness is an allowable cost. However, interest cost incurred as a result of judicial review by a federal court (as described in § 405.454(1)) is not an allowable cost.
(b) Definitions. -
(1) Interest. Interest is the cost incurred for the use of borrowed funds. Interest on current indebtedness is the cost incurred for funds borrowed for a relatively short term. This is usually for such purposes as working capital for normal operating expenses. Interest on capital indebtedness is the cost incurred for funds borrowed for capital purposes, such as acquisition of facilities and equipment, and capital improvements. Generally, loans for capital purposes are long-term loans.
(2) Necessary. Necessary requires that the interest:
(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.
(ii) Be incurred on a loan made for a purpose reasonably related to patient care.
(iii) Be reduced by investment income except where such income is from gifts and grants, whether restricted or unrestricted, and which are held separate and not commingled with other funds. Income from funded depreciation or provider’s qualified pension fund is not used to reduce interest expense. Interest received as a result of judicial review by a federal court (as described in § 405.454(1)) is not used to reduce interest expense.
(3) Proper. Proper requires that interest:
(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 pension fund.
(c) Borrower-lender relationship.
(1) To be allowable, interest expense must be incurred on indebtedness established with lenders or lending organizations not related through control, ownership, or personal relationship to the borrower. Presence of any of these factors could affect the bargaining process this [sic] 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 [sic] transactions with lending institutions. The intent of this provision is to assure that loans are legitimate and needed, and that the interest rate is reasonable. Thus, interest paid by the provider to partners, stockholders, or related 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 principal of such loans shall be treated as invested funds in the computation of the provider’s equity capital under § 405.429.
165 42 C.F.R. § 405.419(c)(1) (1981).
166 Id.
167 The fiscal intermediary is the Secretary’s agent. See supra note 14 and accompanying text.
168 See Jackson Park, 659 F.2d at 138-39. Cf. Stevens Park Osteopathic Hosp. v. United States, 633 F.2d 1373, 1379 (Ct. Cl. 1980) (“It is evident that inquiry into the fairness of transactions between related parties would be a demanding task indeed for the fiscal intermediary, while inquiry into the usually simpler issue of common control probably would have to take place anyway.”).
169 See Goleta Valley Community Hosp. v. Schweiker, 647 F.2d 894, 897 (9th Cir. 1981); Jackson Park, 659 F.2d at 137; Stevens Park, 633 F.2d at 1381.
170 See Caylor-Nickel Hosp. v. Califano, [1980 Transfer Binder] Medicare & Medicaid Guide (CCH) ¶ 30718 (N.D. Ind. Sept. 10, 1979); Hillside Community Hosp. of Ukiah v. Mathews, 423 F. Supp. 1168 1176-77 (N.D. Cal. 1976).
171 See Stevens Park, 633 F.2d at 1381.
172 See Northwest Hosp. v. Hospital Serv. Corp., 687 F.2d 985, 990 (7th Cir. 1982); Goleta Valley, 647 F.2d at 897; Jackson Park, 659 F.2d at 137; South Boston Gen. Hosp. v. Blue Cross of Va., 409 F. Supp. 1380, 1385 (W.D.Va. 1976).
173 Caylor-Nickel Hosp. v. Califano, [1980 Transfer Binder] Medicare & Medicaid Guide (CCH) ¶ 30,718:
The doctrine of conclusive or irrebuttable presumption occupies the borderlands between the doctrines of equal protection and due process. The doctrine contains an element of equal protection in that it involves the claim that a statutory or regulatory classification has been overinclusive; it contains an element of due process in that it involves the claim that the plaintiff has been denied the opportunity to show that the purpose of the statute is not served by including him in the class.
174 See, e.g., Note, The Conclusive Presumption Shuffle, 125 U. Pa. L. Rev. 761 (1977)CrossRefGoogle Scholar; Note, Irrebuttable Presumptions: An Illusory Analysis, 27 Stan. L. Rev. 449 (1975)CrossRefGoogle Scholar; Note, The Irrebuttable Presumption Doctrine in the Supreme Court, 87 Harv. L. Rev. 1534 (1974)CrossRefGoogle Scholar; Note, The Conclusive Presumption Doctrine: Equal Process or Due Protection?, 72 Mich. L. Rev. 80 (1974)CrossRefGoogle Scholar.
175 Caylor-Nickel, Medicare & Medicaid Guide (CCH) at ¶ 30,718.
176 Id.
177 Id. The presumption is valid despite its imprecision in denying reimbursement to some reasonable transactions between related parties, because it reflects the Secretary’s choice not to devote limited resources to individual determinations of reasonableness.
178 Another potential constitutional objection to § 405.419 was raised in Northwest Hosp., 687 F.2d at 992, and Trustees of Ind. Univ. v. United States, 618 F.2d 736, 740 (Ct. Cl. 1980). Section 405.419(c)(2) exempts from the rule loans from religious orders to providers affiliated with the orders; the courts noted that such special treatment for a religious entity could raise constitutional questions under the first amendment. However, each court avoided the con stitutional issue by basing its decision on other grounds.
179 See Stevens Park, 633 F.2d at 1381-82.
180 42 C.F.R. § 405.429(b)(ii) (1981). The reason for this practice is to allow the related party—who looks like an owner by virtue of being related to the provider and having invested capital in the provider—to realize a return on his investment. The Secretary treats the related party as a shareholder rather than as a lender. This practice is not available for non-profit providers, because they do not have equity investors.
181 Stevens Park, 633 F.2d at 1382-83. The court noted that the statute provides a return on equity for proprietary providers only, because a return on equity is not part of the “normal costs" of a nonprofit provider. Further, the court noted the financial advantages that non-profit providers had over their proprietary counterparts, including Hill-Burton funds, tax-exempt status, and charitable, grant-in-aid, and endowment contributions.
182 See supra note 172.
183 In contrast, the general related party rule of § 405.427 allows reimbursement to the provider up to the net book value of the item in the related party’s hands, so the disallowance of reimbursement is only partial.
184 See Trustees, 618 F.2d at 739-40; South Boston, 409 F. Supp. at 1385. These arguments are often made in cases which involve the purchase of facilities by a provider from a related party, financed with a loan from the related party-seller to the provider-buyer. Such a transaction raises two related party issues: the valuation of the assets and the interest on the loan. The argument that the provider should be allowed to demonstrate the fairness of the transaction is usually made with respect to the asset valuation question. See Goleta Valley, 647 F.2d at 897; Stevens Park, 633 F.2d at 1378. It would seem to apply, a fortiori, to the interest reimbursement question.
185 See Goleta Valley, 647 F.2d at 897.
186 See Trustees, 618 F.2d at 740.
187 See Northwest Hosp., 687 F.2d at 996.
188 See Goleta Valley, 647 F.2d at 897;Stevens Park, 633 F.2d at 1383-84; Caylor-Nickel, [1980 Transfer Binder] Medicare & Medicaid Guide (CCH) at ¶ 30,718; Hillside Community, 423 F. Supp. at 1177; Jackson Park, 659 F.2d at 137.
189 See supra notes 107-10 and accompanying text.
190 618 F.2d 736 (Ct. Cl. 1980).
191 Id. at 738.
192 The Indiana University Hospitals were part of the University and therefore under common control of the Trustees. Id. at 737.
193 Id. at 739, quoting Church of Holy Trinity v. United States, 143 U.S. 457, 459 (1892). Using this approach, a court will not apply the “plain meaning" of a statute when it would produce a result not intended by the statute or the policy behind the statute.
194 Although the State of Indiana contributed funds to the University, state law did not allow the University to use any of those funds in the hospitals. The hospitals also claimed that they could not borrow money from other sources because they were not a separate legal entity. Trustees, 618 F.2d at 737.
195 [W]e stress the limited scope of our decision. We are not holding that interest
payments to a related person are reimbursable [sic] wherever the particular relation ship 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 prophylactic regulation generally barring reimbursement of interest payments to related persons, without inquiry into the particular circumstances. . . . We hold. only that in the particular and unusual circumstances of this case . . . [that] the prohibition in the regulation against reimbursement of interest paid to a related organization is inapplicable.
Id. at 740-41.
196 687 F.2d 985 (7th Cir. 1982).
197 Prior to the sale, the provider, Northwest Hospital, was a for-profit corporation with three stockholders. In 1966, the three stockholders and four other persons formed a new nonprofit corporation with themselves as trustees. In late 1967, the nonprofit corporation purchased the proprietary corporation for $5,000,000. The purchase price was $100,000 in cash, the balance in unsecured subordinated 15-year promissory notes at 4% interest, payable to the three former shareholders. The nonprofit corporation acquired the stock, liquidated the proprietary corporation, and began its operations as a nonprofit corporation. Id. at 987.
198 Id. at 996.
199 42 C.F.R. § 405.419(a) (1981) states that “necessary and proper interest on both current and capital indebtedness is an allowable cost.” § 405.419(b)(2) defines “necessary"; § 405.419(b)(3) defines “proper.” See supra note 164.
200 42 C.F.R. § 405.427(d) (1981) establishes four criteria that, if proved, will allow a provider reimbursement for the full price (rather than net book value) of services, facilities or supplies (products) purchased from a related party. Briefly, the requirements are: (1) the related organization must be separate from the provider; (2) a substantial part of the related organization’s business must be carried on with organizations other than the provider or other related entities, in a competitive market; (3) the related organization’s products must be of a type commonly obtained by hospitals from suppliers; and (4) the price paid by the provider must be the competitive price.
For a case interpreting this exception, see American Medical Int'l, Inc. v. Secretary of HEW, 466 F. Supp. 605, 616-20 (D.D.C. 1979), qff'd, 677 F.2d 118 (D.C. Cir. 1982).
201 Northwest Hasp., 687 F.2d at 994.
202 The court felt that the requirement that all interest be necessary and proper would protect the Medicare program from abuse due to related party loans. Providers will still have to show that the loans were made to satisfy a financial need of the provider, and were made for a purpose reasonably related to patient care, and that the interest rate was reasonable under then-existing money market conditions. Id. at 989, 992.
203 Id. at 985.
204 Goleta Valley, 647 F.2d 894 (9th Cir. 1981).
205 Northwest Hosp., 687 F.2d at 992.
206 Id. at 996.
207 Id. The court noted that if it were to allow reimbursement of interest expense on the entire loan, then the provider could circumvent the net book value rule that restricts reimbursement for assets by arranging a reasonable rate on a loan with an overly high principal amount. Id. at 992 n.11.
208 409 F. Supp. 1380 (W.D.Va. 1976).
209 Id. The purchase price was $650,010, payable entirely in fifteen annual installments at 4 percent. Id. at 1383.
210 Id. at 1385.
211 Id.
212 In an ordinary competitive market with many sellers, those whose prices are higher will sell less (or no) goods. It is the preference of consumers to buy goods at the lowest price available that creates competition among sellers to keep the price as low as possible. A provider whose costs were higher because of inefficient interested transactions would have to charge more to Medicare and non-Medicare patients. In a competitive market, the non-Medicare patients, if they were paying their own hospital bills, would go to other providers who charged less for the same services.
213 In calendar year 1977, the federal government paid 54.4 percent of hospital care expenses for all ages, and private health insurance paid 36.2 percent. Muse, D. & Sawyer, D. The Medicare and Medicaid Data Book, 1981, at p.12 (1982)Google Scholar.
214 See Feldstein, supra note 68, at 22-35, noting that private insurance coverage, government programs like Medicare and Medicaid, and the nonprofit status of many hospitals as major reasons why hospital costs have risen so rapidly.
215 See 42 C.F.R. § 405.419(a),(b) (1981), which requires that all interest expense be incurred on loans that are “necessary" and “proper,” regardless of whether the parties are related.
216 The evaluation of the fairness of a loan to decide whether it was necessary and proper would presumably involve scrutiny of accounting statements and the loan documents. The accounting statements, such as the balance sheet, income statement, and cash flow statement of the provider, are easily interpreted. Similarly, the loan documents should be relatively easy to interpret.
Moreover, there is little problem caused by an evaluation that occurs after the transaction is completed, in contrast to a short-lived good or a personal service, where an appraisal by the fiscal intermediary, after the good has been used up or the service rendered, would be more difficult and less useful.
217 42 C.F.R. § 405.419(b)(2) (1981).
218 Interested transactions can involve any number of fact patterns in which one person is involved in the ownership, management, or control of both corporations. For example, in Abeles v. Adams Eng'g Co., 35 N.J. 411, 173 A.2d 246 (1961), a director of the defendant Adams Engineering Co. was also president of an investment banking corporation. The subject matter of the suit was a contract between the investment bank and the defendant; the defendant sought to escape liability on the contract on the ground that it was unfair because of the director-president’s dual capacity. Id. at 430, 173 A.2d at 256.
219 The duty of loyalty doctrine is not confined to directors. It extends to officers and controlling shareholders as well. See generally Vagts, D. Basic Corporation Law 237-75 (2d ed. 1979)Google Scholar.
220 Stewart v. Lehigh Valley R.R. Co., 38 N.J.L. 505, 523 (1875).
221 Phillips, Managerial Misuse of Property: The Synthesizing Thread in Corporate Doctrine, 32 Rutgers L. Rev. 184, 190-91 (1979)Google Scholar.
222 Robotham v. Prudential Ins. Co. of Am., 64 N.J.Eq. 673, 709, 53 A. 842, 856 (Ch. 1903).
223 Id. at 709-10, 53 A. at 857.
224 Marsh, Are Directors Trustees?, 22 Bus. Law. 35, 43 (1966)Google Scholar.
225 Id..
226 The Robotham court realized as much: "Common directors abound, and common directors are better than dummies.” Robotham v. Prudential Ins. Co. of Am., 64 N.J. Eq. at 709, 53 A. at 856.
227 Vagts, supra note 219, notes that one investment banking firm once had members holding 100 seats on boards of directors.
228 Phillips, supra note 221, at 190-91.
229 Id.
230 See supra notes 212-14 and accompanying text.
231 The Northwest Hosp. court pointed out that the interest rate on the loan from the related party was less than the provider would have paid for outside financing. 687 F.2d at 993.