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Nature of Suit Code: 151
Nature of Suit: Overpayments under the Medicare Act
Cause of Action: 

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 7, 2014 Decided April 1, 2014

No. 13-5011

ALLINA HEALTH SERVICES, DOING BUSINESS AS ABBOTT

NORTHWESTERN HOSPITAL, DOING BUSINESS AS CAMBRIDGE

MEDICAL CENTER, DOING BUSINESS AS OWATONNA HOSPITAL,

DOING BUSINESS AS UNITED HOSPITAL, DOING BUSINESS AS

UNITY HOSPITAL, ET AL.,

APPELLEES

v.

KATHLEEN SEBELIUS, SECRETARY, UNITED STATES

DEPARTMENT OF HEALTH AND HUMAN SERVICES,

APPELLANT

Consolidated with 13-5015

Appeals from the United States District Court

for the District of Columbia

(No. 1:10-cv-01463)

(No. 1:12-cv-00328)

Stephanie R. Marcus, Attorney, U.S. Department of

Justice, argued the cause for appellant. With her on the briefs

were Stuart F. Delery, Assistant Attorney General, Ronald C.

USCA Case #13-5015 Document #1486407 Filed: 04/01/2014 Page 1 of 16
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Machen Jr., U.S. Attorney, and Anthony J. Steinmeyer, Attorney.

Stephanie A. Webster argued the cause for appellees. 

With her on the briefs were Christopher L. Keough, J. Harold

Richards, Hyland Hunt, and Dennis M. Barry.

Before: GARLAND, Chief Judge, SRINIVASAN, Circuit

Judge, and SILBERMAN, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge

SILBERMAN.

SILBERMAN, Senior Circuit Judge: Appellees are a group of

hospitals that serve a significant number of elderly, very lowincome patients. Congress assumes that such patients cost more

to treat than the average Medicare patients, so these hospitals are

entitled to supplemental payments. These are determined by

calculating what is called the “disproportionate share

percentage” – a formula which is a proxy for the percentage of

low-income patients served.

In 2004, the Secretary issued a rule that addressed one

aspect of this calculation. Although ostensibly only a detail, the

financial impact is apparently substantial, costing the hospitals

hundreds of millions of dollars. Not surprisingly, the hospitals

sued in district court challenging the rule. The court, holding

that the final rule was not a logical outgrowth of the proposed

rule and that the Secretary had insufficiently explained a change

in policy, granted judgment to the hospitals and vacated the rule.

But the court went further, instructing the Secretary to

recalculate reimbursement percentages using the alternate

methodology. We affirm in part and reverse in part.

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I.

Medicare, as is surely well known, is the federal program

providing health insurance for all elderly, as well as the

disabled. The Medicare statute has three parts relevant in this

case: Part A provides direct “fee for service” hospital payments;

Part C is an alternative option providing eligible beneficiaries an

opportunity to enroll in private health insurance plans; and Part

E includes the formula for calculation of the disproportionate

share percentage – the added compensation for the treatment of

a disproportionate number of low-income patients.1

The size of this adjustment is determined by adding together

two fractions. The first fraction, referred to as the Medicare

fraction, measures the percentage of all Medicare patients

(regardless of means) who are low income, i.e., entitled to

supplemental security income benefits. Mathematically, the

numerator of this fraction is the number of “patient days” for

patients who were “entitled to benefits under Part A and were

entitled to supplemental security income benefits.” The

denominator is the total number of “patient days for such fiscal

year which were made up of patients who (for such days) were

entitled to benefits under Part A.” 42 U.S.C. §

1395ww(d)(5)(F)(iv) (emphasis added).

The second fraction accounts for the number of Medicaid

patients – who, by definition, are low income – not entitled to

Medicare. The numerator is the number of patient days

attributable to patients who (for such days) were eligible for

1

 Part A is codified at 42 U.S.C. §§ 1395c to 1395i–5; Part C at

§§ 1395w–21 to 1395w–29; and the relevant provision of Part E at 42

U.S.C. § 1395ww(d)(5)(F)(vi). 

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Medicaid, but “not entitled to benefits under [Medicare] Part A.”

The denominator is the total number of patient days, regardless

of whether the patients were enrolled in a federal medical

benefits program. Id.

The statutory interpretation question that led to this case is

whether enrollees in Part C are “entitled to benefits” under Part

A, such that they should be counted in the Medicare fraction, or

whether, if not regarded as “entitled to benefits under Part A,”

they should instead be included in the Medicaid fraction. As it

turns out, if Part C beneficiaries are included in the Medicaid

fraction rather than the Medicare fraction, the hospitals receive

a great deal more compensation.

As we have previously recognized, the phrase “entitled to

benefits under Part A” is ambiguous. Northeast Hospital Corp.

v. Sebelius, 657 F.3d 1, 13 (D.C. Cir. 2011). Because a Part C

enrollee must, by definition, have been eligible for Part A, it

could mean one was legally entitled to Part A benefits whether

or not one chose Part C’s option, or it could mean only those

who did not choose Part C, and, therefore, remained legally

entitled to Part A benefits. In other words, someone who chose

Part C nevertheless could still be “entitled” to Part A within the

meaning of the statute. 

Prior to 2003, the Secretary treated Part C patients as not

entitled to benefits under Part A. Id. at 16-17. They then should

have been included in the Medicaid fraction. But there was,

apparently, considerable confusion among the hospitals, and

since the disproportionate share percentage was calculated by

fiscal intermediaries (insurance companies) using privacy

protected patient data, the hospitals were unable to confirm that

reimbursement rates were correct. 

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The Secretary, recognizing the confusion, issued a notice of

proposed rulemaking, explaining:

We have received questions whether patients

enrolled in an M+C Plan[2] should be counted in

the Medicare fraction or the Medicaid fraction. .

. .The question stems from whether the M+C plan

enrollees are entitled to benefits under Medicare

Part A since M+C plans are administered through

Part C.

We note that, under 422.50, an individual is

eligible to elect an M+C plan if he or she is

entitled to Medicare Part A. . . .However, once a

beneficiary has elected to join an M+C plan, that

beneficiary’s benefits are no longer administered

under Part A.

Therefore, we are proposing to clarify that once a

beneficiary elects Medicare Part C, those patient

days attributable to the beneficiary should not be

included in the Medicare fraction of the DSH

patient percentage. These patient days should be

included in the count of total patient days in the

Medicaid fraction (the denominator), and the

patient’s days for the M+C beneficiary who is

also eligible for Medicaid would be included in

the numerator of the Medicaid fraction.

2

 “M+C” or “Medicare+Choice” was the previous name of the

program administered under Part C. The program is now called

“Medicare Advantage.” For purposes of clarity, we refer throughout

simply to Part C.

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Medicare Program, Proposed Changes to the Hospital Inpatient

Prospective Payment Systems and Fiscal Year 2004 Rates, 68

Fed. Reg. 27154, 27208 (May 19, 2003).

The Secretary further explained, in estimating the financial

impact of the proposal, that “there should not be a major impact

associated with this proposed change.” 68 Fed. Reg. at 27416.

Only a smattering of hospitals even bothered to comment; their

commentary totaled just 26 pages, and a number of them did not

understand the proposal. 

The next year the Secretary announced a final rule adopting

the exact opposite interpretation of the statute. Medicare Part C

beneficiaries, according to the rule, were to be counted in the

Medicare fraction because “they are still, in some sense, entitled

to benefits under Medicare Part A.” Medicare Program: Changes

to the Hospital Inpatient Prospective Payment Systems and

Fiscal Year 2005 Rates, 69 Fed. Reg. 48916, 49099 (Aug. 11,

2004) (emphasis added).3

The rule change had enormous financial consequences for

the hospitals. Apparently Part C beneficiaries are rarely entitled

to SSI payments or eligible for Medicaid. Thus, by including

Part C beneficiaries in the Medicare fraction, the denominator

(total patient days for Part A eligible patients) is increased,

without having a significant impact on the numerator (total

patient days for Medicare patients who are also receiving SSI

3

 Although the rule was promulgated in 2004, the Code of Federal

Regulations was never actually amended, so in 2007 the Secretary

issued a “technical correction,” conforming the language of the C.F.R.

to the 2004 rule.

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payments). This has the effect of diluting the fraction and

significantly reducing reimbursement rates. By contrast, if the

Part C patients are counted in the Medicaid fraction, there is no

effect on the denominator (total patient days) and a small effect

on the numerator (Medicare Part A eligible patients who are also

eligible for Medicaid). 

In Northeast Hospital Corp. v. Sebelius, a number of

hospitals challenged the Secretary’s rule, arguing that it was an

impermissible interpretation of the statute and that it could not

be retroactively applied to the fiscal years 1999 through 2002.

We held that the Medicare statute did not unambiguously

foreclose the Secretary’s interpretation of the statute. 657 F.3d

1, 13 (D.C. Cir. 2011). In other words, the Secretary’s

interpretation passed Chevron step one.4

 We did not reach the

question whether the Secretary’s interpretation was reasonable

under step two. We held that, even if the Secretary’s

interpretation was reasonable, that interpretation could not be

applied retroactively to the years at issue in the case because,

prior to issuing the rule, the Secretary had a settled practice of

not counting the Part C days in the Medicare fraction. Id. at 17.

Accordingly, after Northeast Hospital, the validity of the

Secretary’s rule as applied to future years remained an open

question.

When the Secretary, in 2009, published reimbursement

calculations for FY 2007 (one of the future years), the

4

 Concurring in the judgment, Judge Kavanaugh argued that the

statute unambiguously foreclosed the Secretary’s interpretation. 657

F.3d at 18.

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petitioners learned that their payments would decrease by tens

of millions of dollars per year. The hospitals challenged these

calculations before the agency, and ultimately appealed to the

district court. The court held that the 2004 rule was invalid on

two grounds: It was not a logical outgrowth of the proposed rule,

and it did not adequately acknowledge and justify the

Secretary’s change in policy. The court vacated the rule and

ordered the Secretary to recalculate the hospitals’

reimbursements by counting Part C days under the Medicaid

fraction. This appeal followed.

II.

An agency may promulgate a rule that differs from a

proposed rule only if the final rule is a “logical outgrowth” of

the proposed rule. Ass'n of Private Sector Colleges &

Universities v. Duncan, 681 F.3d 427, 442 (D.C. Cir. 2012). A

final rule is a logical outgrowth if affected parties should have

anticipated that the relevant modification was possible. CSX

Transp., Inc. v. Surface Transp. Bd., 584 F.3d 1076, 1080 (D.C.

Cir. 2009) (citations omitted).

The Secretary points out that the 2003 notice proposed to

codify one of only two possible interpretations of the statute:

Under the Medicare statute, a Part C beneficiary is either

entitled to benefits under Part A, or not. Therefore, the Secretary

argues, the hospitals should have been on notice that the

Secretary might adopt either interpretation. The hospitals

counter by arguing that the notice did not actually “propose”

adopting a rule; rather, the notice proposed merely to “clarify”

an existing practice. There is nothing in the text of the notice,

the hospitals argue, to suggest that the Secretary was thinking of

reconsidering a longstanding practice. Moreover, the notice

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indicated that “there should not be a major impact associated

with this change.” 68 Fed. Reg. at 27416. Although the

government’s argument is not insubstantial, we agree with the

hospitals in light of the regulatory context that we have just

described.

This case is similar to one we decided in 2005. In

Environmental Integrity Project v. E.P.A., the EPA issued a

notice in which it “proposed to codify” an interpretation of a

regulation that the agency had applied in previous adjudications.

425 F.3d 992, 994 (D.C. Cir. 2005). In its final rule, however,

the agency adopted an interpretation precisely opposite to the

one it had proposed codifying. We held that this was unlawful,

explaining that there was no indication in the notice that the

agency was open to reconsidering the interpretation that it has

previously adopted through adjudication. Id. at 998. We said that

agencies may not “pull a surprise switcheroo on regulated

entities.” Id. at 996.

So, too, here. The hospitals should not be held to have

anticipated that the Secretary’s “proposal to clarify” could have

meant that the Secretary was open to reconsidering existing

policy. The word “clarify” does not suggest that a potential

underlying major issue is open for discussion. 

The government would distinguish Environmental Integrity

Project by arguing that the Secretary did not previously actually

include Part C days in the Medicaid fraction, so it cannot be

thought that she was merely endorsing a prior policy. But this

argument disregards our holding in Northeast Hospital, where

we explicitly stated that the Secretary did have a prior practice

of excluding Part C days from the Medicare fraction. 657 F.3d

at 17. Granted, we did not say the Secretary counted the Part C

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days in the Medicaid fraction, but the statute unambiguously

requires that Part C days be counted in one fraction or the other

(a Part C-enrolled individual is either eligible for Medicare Part

A, or not), so the necessary implication of our opinion is

obvious. Moreover, a party reviewing the Secretary’s notice of

proposed rulemaking understandably would have assumed that

the Secretary was proposing to “clarify” a then-existing policy,

i.e., one of excluding Part C days from the Medicare fraction

and including them in the Medicaid fraction.

The Secretary’s estimated financial impact of its proposal

– that there should not be a major impact associated with this

proposed change – supports our conclusion. See 68 Fed. Reg. at

27416. If, as the government contends, the 2003 notice had

actually suggested a binary choice, between maintaining a

preexisting policy and reversing that policy, then the potential

estimated financial impact should have been stated in the

hundreds of millions of dollars. That would doubtless have

triggered an avalanche of comments, in contrast to the mere 26

pages that were actually submitted.

It should be noted that since the Secretary was disposed to

codify an interpretation that was favorable to the hospitals, there

was no reason for the hospitals to fear that another party would

offer comments opposed to such an interpretation. (There is no

obvious constituency opposed to greater compensation for

hospitals.) In that regard, this case differs from, for example,

environmental regulation cases, where regulated industries can

usually anticipate fierce opposition from environmental groups,

and it might be thought prudent to submit comments in support

of favorable proposed rules.

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We are sympathetic to the view expressed by the Seventh

Circuit that proposed rules that might seem obscure to the

average reader should alert members of the regulated class to the

possible options that an examination of a policy would imply.

See Alto Dairy v. Veneman, 336 F.3d 560, 570 (7th Cir. 2003);

but see Natural Res. Def. Council v. U.S. E.P.A., 279 F.3d 1180,

1188 (9th Cir. 2002). But we ask ourselves, would a reasonable

member of the regulated class – even a good lawyer – anticipate

that such a volte-face with enormous financial implications

would follow the Secretary’s proposed rule. Indeed, such a

lawyer might well advise a hospital client not to comment

opposing such a possible change for fear of giving the Secretary

the very idea.

In sum, we agree with the district court that the Secretary’s

final rule was not a logical outgrowth of the proposed rule.

* * *

The government argues that even if the 2003 notice is

inadequate, the hospitals cannot show that they were prejudiced

by the procedural defect, so we should find any error harmless.

The Administrative Procedure Act does tell us that reviewing

courts shall take “due account. . .of the rule of prejudicial error.”

5 U.S.C. § 706(2)(F). But, as the hospitals point out, the

Medicare statute has no harmless error exception: 

If the Secretary publishes a final regulation that

includes a provision that is not a logical outgrowth of

a previously published notice of proposed rulemaking

or interim final rule, such provision shall be treated as

a proposed regulation and shall not take effect until

there is the further opportunity for public comment and

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a publication of the provision again as a final

regulation.

42 U.S.C. § 1395hh(a)(4).

The government suggests that we ignore this explicit text,

citing a few cases in which we have drawn parallels between

other aspects of the APA and the Medicare statute. For example,

we once stated that the Medicare statute “places notice and

comment requirements on the Secretary’s substantive

rulemaking similar to those created by the APA.” Monmouth

Med. Ctr. v. Thompson, 257 F.3d 807, 814 (D.C. Cir. 2001)

(emphasis added); cf. Baptist Health v. Thompson, 458 F.3d 768,

776 n.8 (8th Cir. 2006) (holding that § 1395hh preserves the

APA’s distinction between legislative and interpretive rules);

Warder v. Shalala, 149 F.3d 73, 79 n.4 (1st Cir. 1998) (same).

But that the Medicare statute is similar to the APA hardly means

it is identical, and the government has presented no reason to

depart from the plain meaning of the text. 

We need not decide this question, however, because even if

the APA applied, we would reject the government’s harmless

error claim. We have not been hospitable to government claims

of harmless error in cases in which the government violated §

553 of the APA by failing to provide notice. The most egregious

are cases in which a government agency seeks to promulgate a

rule by another name – evading altogether the notice and

comment requirements. See Sugar Cane Growers Co-op. of

Florida v. Veneman, 289 F.3d 96 (D.C. Cir. 2002). That sort of

case can be analogized to an illegal failure to afford a formal

hearing under § 554. In that circumstance, we decline to even

consider whether a petitioner would be successful if it had had

the benefit of a formal hearing. In rulemaking, the comment

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period performs an analogous function, and the government’s

statement of basis and purpose equates to the formal decision in

an adjudication. 

More difficult are the cases in which an agency has relied

on data or information that was not disclosed to commenters.

They are troublesome because, as the Supreme Court

emphasized in the seminal Vermont Yankee opinion, one of the

advantages of informal rulemaking is an agency’s ability to rely

on internal information in its files. Vermont Yankee Nuclear

Power Corp. v. Natural Res. Def. Council, Inc., 435 U.S. 519,

556 (1978). Still, we have held for many years that an agency’s

failure to disclose critical material, on which it relies, deprives

commenters of a right under § 553 “to participate in

rulemaking.” See Air Transp. Ass'n of Am. v. F.A.A., 169 F.3d 1,

7 (D.C. Cir. 1999) (citing Association of Data Processing

Service Organizations, Inc. v. Board of Governors of the

Federal Reserve System, 745 F.2d 677, 684–85 (D.C.Cir.1984)).

Perhaps because of the possible tension between Vermont

Yankee and our critical material doctrine, we have more

carefully examined whether a failure to disclose such material

actually harmed a petitioner. But it is sufficient for a petitioner

to show that an opportunity to comment regarding an agency’s

important information created “enough uncertainty” as to its

possible affect on the agency’s disposition. See Chamber of

Commerce of U.S. v. S.E.C., 443 F.3d 890, 906 (D.C. Cir. 2006).

Our case involves a third category: whether the final rule

violates the notice requirement of § 553 because it is not a

logical outgrowth of the proposed rule. Even if a final rule were

regarded objectively as an abrupt departure from a proposed

rule, if parties directed comments to such a denouement, it might

well be properly regarded as a harmless error – depending on

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how pointed were the comments and by who made. If the

petitioner itself made such a comment, it would presumably be

hoist on its own petard. And even if the comment were made by

others, if it were the same point that petitioner would press, it

would still presumably be non-prejudicial because all that is

necessary in such a situation is that the agency had an

opportunity to consider the relevant views. In other words, the

concepts of logical outgrowth and harmless error merge if the

final rule is, in fact, anticipated, whether or not that anticipation

was objectively foreseeable. In this case, there were a few

commenters who initially commented in support of the final

rule, apparently not understanding its implications, and another

commenter who read the proposed rule as if it were the final

rule. But the tiny handful of comments mostly revealed hopeless

confusion, rather than focused opposition to the final rule, so we

cannot conclude that the agency’s error was harmless. 

* * *

We turn to the question of remedy. The government argues

that, under our precedents, vacatur was inappropriate. To be

sure, although vacatur is the normal remedy, we sometimes

decline to vacate an agency’s action. See Advocates for Highway

& Auto Safety v. Fed. Motor Carrier Safety Admin., 429 F.3d

1136, 1151 (D.C. Cir. 2005). That decision depends on the

“seriousness of the order's deficiencies” and the likely

“disruptive consequences” of vacatur. Allied-Signal, Inc. v. U.S.

Nuclear Regulatory Comm'n, 988 F.2d 146, 150-51 (D.C. Cir.

1993). Neither factor favors the government. 

First, deficient notice is a “fundamental flaw” that almost

always requires vacatur. Heartland Reg'l Med. Ctr. v. Sebelius,

566 F.3d 193, 199 (D.C. Cir. 2009). Second, there is no

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indication that vacatur would lead to disruptive consequences.

This is not a case in which the “egg has been scrambled,” and it

is too late to reverse course. Sugar Cane Growers Co-op. of

Florida v. Veneman, 289 F.3d 89, 97 (D.C. Cir. 2002). The

district court thus correctly concluded that vacatur was

warranted.5

The court went further, however; it ordered the Secretary to

recalculate the hospitals’ reimbursements “without using the

interpretation set forth in the 2004 Final Rule.” In other words,

the district court required the Secretary to affirmatively count

Part C days under the Medicaid fraction for 2007. The

government complains that, even if the 2004 rule is invalid, the

Secretary might achieve the same result through adjudication.

The government is right to object. The question whether the

Secretary could reach the same result through adjudication was

not before the district court; therefore the court erred by

directing the Secretary how to calculate the hospitals’

reimbursements, rather than just remanding after identifying the

error. Sec. & Exch. Comm'n v. Chenery Corp., 332 U.S. 194,

201 (1947) (“After the remand was made, therefore, the

5

 The hospitals dispute the government’s interpretation of our

vacatur precedents, and also raise another argument: that the plain text

of § 1395hh requires vacatur in cases of inadequate notice. (“If...a

final regulation...is not a logical outgrowth of...a...notice...[it] shall not

take effect.”) This argument appears to be correct, and we note that the

government made no effort to refute it, but because vacatur is clearly

appropriate even under the APA, we need not reach it.

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Commission was bound to deal with the problem afresh,

performing the function delegated to it by Congress.”).6

Because the deficient notice is an adequate basis to vacate

the Secretary’s rule, we do not reach the district court’s alternate

holding – that the Secretary had failed to adequately explain a

major change in policy.

III.

We hold that the Secretary did not provide adequate notice

and opportunity to comment before promulgating its 2004 rule,

and so affirm the portion of the district court’s opinion vacating

the rule. We reverse only the portion of the district court’s

opinion directing the Secretary to recalculate the hospitals’

reimbursements using the alternate methodology.

So ordered.

6

 Only in rare cases, when the reviewing court is convinced that

remand would serve no purpose, does the court direct the agency how

to resolve a problem. See Nat'l Ass'n of Regulatory Util. Comm'rs v.

U.S. Dep't of Energy, 736 F.3d 517, 520 (D.C. Cir. 2013); Checkosky

v. SEC, 139 F.3d 221, 227 (D.C. Cir. 1998).

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