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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 March 14, 2014 Decided July 8, 2014 

No. 12-5355 

SELECT SPECIALTY HOSPITAL - BLOOMINGTON, INC., ET AL., 

APPELLANTS

v. 

SYLVIA MATHEWS BURWELL, SECRETARY, UNITED STATES 

DEPARTMENT OF HEALTH AND HUMAN SERVICES, 

APPELLEE

Consolidated with 12-5358 

Appeals from the United States District Court 

for the District of Columbia 

(No. 1:09-cv-02008) 

(No. 1:09-cv-02362) 

David J. Bird argued the cause for appellants. With him 

on the briefs were Andrew C. Bernasconi and Daniel Z. 

Herbst. 

Joshua P. Waldman, Attorney, U.S. Department of 

Justice, argued the cause for appellee. With him on the brief 

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

Machen Jr., U.S. Attorney, and Michael S. Raab, Attorney. 

USCA Case #12-5358 Document #1501251 Filed: 07/08/2014 Page 1 of 13
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R. Craig Lawrence, Assistant U.S. Attorney, entered an 

appearance. 

Before: ROGERS, BROWN and MILLETT, Circuit Judges. 

Opinion for the Court filed by Circuit Judge BROWN. 

BROWN, Circuit Judge. A group of long-term care 

hospitals challenges the Secretary’s determination that, 

because the organizations operate out of buildings previously 

owned by hospital entities, they are not “new hospitals.” 

Because we cannot tell how the Secretary arrived at this 

conclusion, we find it arbitrary and capricious. 

I 

 Hospitals are costly to build. Medicare has traditionally 

provided for a “return on equity capital” for the construction 

of such buildings, which includes “depreciation, interest, 

taxes, insurance and similar expenses . . . for plant and fixed 

equipment, and for moveable equipment.” Capital Payments 

Under the Inpatient Hospital Prospective Payment System, 52 

Fed. Reg. 33,168, 33,168 (Sept. 1, 1987). Up until the late 

1980s, capital reimbursements were provided on a reasonable 

cost basis—that is, “on the basis of current costs of the 

individual provider, rather than costs of a past period or fixed 

negotiated rate.” 42 C.F.R. § 413.5(a) (explaining the 

reasonable-cost reimbursement scheme); 52 Fed. Reg. at 

33,168. 

In 1987, Congress directed the Secretary of Health and 

Human Services to develop a capital recovery scheme for 

USCA Case #12-5358 Document #1501251 Filed: 07/08/2014 Page 2 of 13
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hospitals through the inpatient prospective payment system,1

rather than the reasonable-cost reimbursement method. See 

Omnibus Budget Reconciliation Act of 1987, Pub. L. No. 

100-203, § 4006(b)(1), 101 Stat. 1330 (1987); see also 42 

U.S.C. § 1395ww(g)(1). It also authorized the Secretary to 

provide for appropriate exceptions to the capital prospective 

payment system. 42 U.S.C. § 1395ww(g)(1)(B)(iii). To 

comply with the congressional directive, the Secretary 

implemented a ten-year plan, which transitioned the 

Department from the old reasonable-cost capital payment 

system to capital repayments made through the new inpatient 

prospective payment system. See Prospective Payment 

System for Inpatient Hospital Capital-Related Costs, 56 Fed. 

Reg. 43,358 (Aug. 30, 1991). 

 Under this scheme, the Secretary exempted “new 

hospitals” from the inpatient prospective payment system for 

the first two years of existence. Instead, such hospitals would 

be entitled to 85% of their reasonable capital-related costs, 

harking back to the old system. See 56 Fed. Reg. at 43,362, 

43,453. A “new hospital” is a “hospital that has operated 

(under previous or present ownership) for less than 2 years.” 

See Changes to the Hospital Inpatient Prospective Payment 

Systems and Fiscal Year 1993 Rates, 57 Fed. Reg. 39,746, 

39,827 (Sept. 1, 1992); see also 42 C.F.R. § 412.300(b). 

About a year after the scheme was established, the following 

language was added to the existing regulations: 

 

1

 This system “reimburse[s] qualifying hospitals at prospectively 

fixed rates . . . that remain static regardless of the costs incurred by 

a hospital.” See Cnty. of L.A. v. Shalala, 192 F.3d 1005, 1008 

(D.C. Cir. 1999). Most hospitals are reimbursed in accordance with 

a standard formula derived from national data, although some are 

reimbursed at hospital-specific rates. See Adirondack Med. Ctr. v. 

Sebelius, 740 F.3d 692, 694–95 (D.C. Cir. 2014). 

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The following hospitals are not new hospitals: 

(1) A hospital that builds new or replacement 

facilities at the same or another location even if 

coincidental with a change of ownership, a 

change in management, or a lease arrangement. 

(2) A hospital that closes and subsequently reopens. 

(3) A hospital that has been in operation for more 

than 2 years but has participated in the Medicare 

program for less than 2 years. 

(4) A hospital that changes its status from a hospital 

that is excluded from the prospective payment 

systems to a hospital that is subject to the capital 

prospective payment systems. 

57 Fed. Reg. at 39,827; see also 42 C.F.R. § 412.300(b)(1)–

(4) (codifying the exceptions). In adding these exceptions, 

the Secretary explained the exemption was intended only for 

“new entrants into the hospital field that do not have a historic 

asset base.” See 57 Fed. Reg. at 39,790. 

 While the “new hospitals” exemption was originally 

conceived as a temporary measure, the Secretary made it a 

permanent one about ten years later. See 67 Fed. Reg. 31,404, 

31,488–89 (May 9, 2002) (proposed rule); see also 67 Fed. 

Reg. 49,982, 50,101 (Aug. 1, 2002) (final rule). The 

provision was intended to be a “special protection to new 

hospitals,” given concerns that “prospective payments . . . 

may not be adequate initially to cover the capital costs of 

newly built hospitals.” See 67 Fed. Reg. at 50,101. But, the 

Secretary said, the exemption would “only be available to 

those hospitals that have not received reasonable cost-based 

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payments under the Medicare program in the past, and would 

need special protection during their initial period of 

operation.” Id. 

A group of long-term care hospitals (“the Hospitals”), all 

associated with the Select Specialty Hospitals organization, 

identified themselves as “new hospitals” within the meaning 

of 42 C.F.R. § 412.300(b). They claimed capital-cost 

reimbursements under the 85% “reasonable cost basis” rule, 

rather than the formulae provided by the prospective payment 

system. See J.A. at 155, 232. Most of the hospitals are 

“hospitals-within-hospitals”—independent entities that 

operate in the same building or campus as an established 

“host” hospital. J.A. at 154, 231. In contrast, some are 

freestanding hospitals. J.A. at 154–55. 

 An intermediary disagreed with the Hospitals’ selfdetermined “new hospital” designation and reduced the 

amount of capital recovery. J.A. at 155, 232. The Hospitals 

appealed the intermediary’s decision to the Provider 

Reimbursement Review Board (“the Board”). In considering 

the appeal, the Board determined the meaning of “hospital” 

under § 412.300(b) was ambiguous, as it was unclear whether 

the term referred to the institutional entity, the brick-andmortar asset, or both. J.A. at 161, 237. As the parties 

stipulated that “all of the [leased] buildings . . . were operated 

by [a] hospital for more than 2 years prior to the lease 

arrangement,” the Board determined the designation did not 

apply. J.A. at 162, 238; see also J.A. at 156, 232. Two board 

members dissented, arguing the majority unceremoniously 

disregarded the newly-formed nature of the business entity 

and the enormous capital expenditures involved in 

rehabilitating and reconstructing the facilities. See J.A. at 

167–68, 242–43. The Medicare Administrator upheld the 

Board’s decision. 

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The Hospitals challenged the Board’s decision in district 

court, but the same outcome awaited them.2

 When presented 

with the Government’s motion for summary judgment, the 

district court concluded both sides offered plausible 

interpretations of 42 C.F.R. § 412.300(b): one that permitted 

consideration of physical assets, and one that precluded it. 

See J.A. at 330. It also found the exceptions of § 

412.300(b)(1)–(4) added to the interpretive disarray. Calling 

the prefatory language “regrettably . . . ambiguous,” the court 

suggested “the ensuing examples [could be] merely examples, 

but also could be interpreted as enumerating an exclusive 

list.” See Select Specialty Hosp.—Bloomington, Inc. v. 

Sebelius, 774 F. Supp. 2d 332, 340 (D.D.C. 2011). In light of 

the ambiguity, it proceeded to uphold the Board’s 

determination as both reasonable and supported by substantial 

evidence. The Hospitals appealed. 

II 

 We review a district court’s grant of summary judgment 

de novo, “which is to say we ‘review the administrative action 

directly, according no particular deference to the judgment of 

the District Court.’” Roberts v. United States, 741 F.3d 152, 

157–58 (D.C. Cir. 2014) (quoting Holland v. Nat’l Mining 

Ass’n, 309 F.3d 808, 814 (D.C. Cir. 2002)). While we 

 

2

 Because it was unclear whether the agency’s decision applied to 

the freestanding hospitals, the district court remanded the case to 

the Administrator for clarification. See Select Specialty Hosp.—

Bloomington, Inc. v. Sebelius, 774 F. Supp. 2d 332, 344 (D.D.C. 

2011). The Administrator indicated in the affirmative. See J.A. at 

354. The district court upheld the Administrator’s subsequent 

determination regarding the freestanding hospitals. See Select 

Specialty Hosp.—Bloomington, Inc. v. Sebelius, 893 F. Supp. 2d 1, 

5 (D.D.C. 2012). Those hospitals also appealed, and their appeal is 

now before us in this consolidated case. 

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generally give “substantial deference” to an agency’s 

interpretation of its own regulation, deference is unwarranted 

if the interpretation is “plainly erroneous or inconsistent with 

the regulation.” Thomas Jefferson Univ. v. Shalala, 512 U.S. 

504, 512 (1994) (citation and internal quotation mark 

omitted); Kaiser Found. Hosps. v. Sebelius, 708 F.3d 226, 

230–31 (D.C. Cir. 2013). 

III 

 The question before us is whether the Board’s 

interpretation of the Secretary’s regulation—specifically, her 

definition of “new hospital”—is arbitrary and capricious. The 

parties begin at a curious starting point: the meaning of the 

word “hospital.” The Hospitals suggest the meaning is 

clear—42 U.S.C. § 1395x(e) indicates “hospital” means the 

institutional entity, not the physical facility. See Appellants’ 

Br. at 38, 42. As none of the Hospitals—independent 

offshoots of an overarching corporation—existed prior to the 

cost period at issue, they maintain their institutions are all 

“new.” See Appellants’ Br. at 42. But the meaning of 

“hospitals” is beside the point—the Government does not 

contest that a “hospital” could be the organizational entity. 

See Appellee’s Br. at 31–33. Instead, the crux of the 

Government’s concern is the meaning of the word “new”—a 

question to which § 1395x(e) does not speak. Unfortunately, 

neither does the Board’s decision. 

 The Hospitals’ disorientation is understandable; it was 

the Board that first puzzlingly emphasized the interpretation 

of “hospital,” instead of “new.” See J.A. at 161, 237 (“The 

Board finds that the regulation defining a ‘new hospital’ . . . is 

ambiguous, in that it is not clear if the term ‘hospital’ means 

the individual physical assets . . . or the business entity as a 

whole, which would include both bricks and mortar and the 

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operations.”). On appeal, the Government attempts to patch 

up the Board’s maladroitness by claiming the Board was 

interpreting the phrase “new hospital,” as opposed to one 

word or the other. See Appellee’s Br. at 35. But the 

Government’s patch job is too little, too late. Simply put, the 

Board—having resolved a question that was tangential to the 

essential one—never adequately explained how to discern the 

newness of a hospital. Certainly, “individual physical assets” 

are to be considered—but in what way? See J.A. at 161, 237. 

 “[T]here are cases where an agency’s failure to state its 

reasoning or to adopt an intelligible decisional standard is so 

glaring that we can declare with confidence that the agency 

action was arbitrary and capricious.” Checkosky v. S.E.C., 23 

F.3d 452, 463 (D.C. Cir. 1994). This is one of them. We can 

easily recognize the two guiding principles motivating the 

Board’s decision: (1) eliminating the possibility of double 

reimbursement and (2) giving newcomer hospitals without a 

historic asset base an opportunity to establish new operations. 

And yet, we cannot discern how the Board’s decision serves 

these two principles. 

A 

We start with the first impetus—that “the exemption to 

receive cost reimbursement for the capital-related costs 

should be limited only to assets for which the Medicare 

program has not previously made payment under the 

reasonable cost principles.” J.A. at 161–62, 237. After 

pronouncing that “at the very least, an analysis of the physical 

assets” is necessary under 42 C.F.R. § 412.300(a), the Board 

jumped to the conclusion that the prior operation of the 

various physical assets by other hospital entities meant that 

the assets had already been the subject of a reasonable cost 

basis reimbursement. See J.A. at 161, 237. The source of the 

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Board’s sweeping presumption remains a mystery. Nothing 

in the record suggests a physical asset used by another 

hospital organization for a period of more than two years is 

inherently one that has already received capital 

reimbursement based on reasonable cost principles. Nor do 

we know how such a categorical approach faithfully serves 

the double-reimbursement principle. Even if prior hospital 

organizations had obtained reimbursement for an original 

building construction, additional costs specific to 

renovations—such as for new equipment—would not have 

been previously reimbursed. The Board’s failure to connect 

the dots makes remand necessary. See Phila. Gas Works v. 

FERC, 989 F.2d 1246, 1250 (D.C. Cir. 1993) (explaining an 

agency’s submission of an “inadequate explanation for its 

conclusions” warrants remand to the agency). 

B 

 Before we reach the Board’s other rationale, some 

untangling is in order. At oral argument, the Government’s 

counsel seemed to suggest the Board employed a “new 

building” rationale, i.e., a new hospital (organizationally 

speaking) that constructs a facility from scratch is the only 

type of entity deserving of reimbursement based on 

reasonable cost principles. See Oral Arg. at 39:15 (“And the 

Secretary reasonably concluded here that newly built facilities 

are a more compelling need because there are greater capital 

costs . . . .”). This observation is distinct from the Board’s 

reasoning. In the comments made during the initial 

promulgation of the exemption, the Secretary did say the 

exemption “would not apply to a facility that opens as an 

acute care hospital if that hospital has operated in the past 

under current or previous ownership and has a historic asset 

base.” 57 Fed. Reg. at 23,649. But the Secretary also 

emphasized the newness of hospitals as entities and 

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organizations which, because of their newness, would have a 

harder time entering the field. See id. (“The exemption is 

intended to protect hospitals that come under the capital 

prospective payment system without a historic asset base and 

need special consideration for their original plant and 

equipment costs during their initial years of operation.” 

(emphasis added)); see also 57 Fed. Reg. at 39,790 (“[W]e 

believe it is appropriate to restrict the new hospital exemption 

under the capital prospective payment system to new entrants 

into the hospital field that do not have a historic asset base.” 

(emphasis added)). It appears the Board hewed to this holistic 

approach by stating only that, “at the very least,” 

consideration of the physical assets is required. J.A. at 161, 

237. The Secretary’s position on appeal, however, is that new 

construction is a necessary condition. 

Organizationally speaking, the Hospitals are newcomers 

to the field. No one disputes that, though the Hospitals are the 

progeny of a parent corporation specializing in the 

establishment of long-term care hospitals. But they are 

independent entities nonetheless, and the Board’s decision 

evinces no difference between the Hospitals and new entrants 

to the field that are unaffiliated with any parent entity which 

would deprive them of the preferential treatment the 

regulations provide. 

Even if assets were to govern the analysis, we still do not 

understand the Board’s predilection for having something 

built from the ground up. Consider the fact that lease 

payments and renewals are included in the definition of 

reimbursable capital assets. See 42 C.F.R. § 412.302(b)(3); 

42 C.F.R. § 413.130. This seems to suggest that a hospital (as 

an institution) need not build a physical asset brick-by-brick 

to be eligible for reimbursement on a reasonable-cost basis. 

See J.A. at 161, 237 (“The Board also finds significant that 

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this regulation which defines a new hospital explicitly states 

its purpose at 42 C.F.R. § 412.300(a) as establishing a 

reimbursement methodology for inpatient hospitals ‘capitalrelated costs,’ which are defined in § 412.302 and includes 

physical assets.”). And yet, in its inquiry to determine the 

newness of a “hospital,” the Board looked to when the “bricks 

and mortar were established” for a particular physical asset 

and who had laid them. Id. What is the difference between 

an old hospital building that has been completely gutted and 

renovated and a new hospital building built from the ground 

up? Will the Board’s decision allow for recompense for the 

latter, but not the former?3

At oral argument, counsel equivocated when asked to 

describe the Board’s decisional rationale. Compare Oral Arg. 

at 34:13 (“I think the definition now is you have to be both a 

new entity and you have to have a new facility, and the only 

thing the Secretary clarified here is that a renovation is not the 

same as a new building, and therefore you are not a new 

 3

 The Government explains that a case-by-case 

determination as to the “newness” of a hospital would 

“require the Department to conduct time-consuming 

examinations to determine how many renovations are 

‘enough’ to make the facility ‘new,’ or how much a 

theoretical, newly-built facility would have cost if it had been 

constructed, and whether the renovations at issue were more 

costly.” Appellee’s Br. at 49–50. The Board, of course, did 

not articulate this particular rationale in its decision, and we 

therefore cannot entertain the Government’s post hoc 

justification. See Catholic Healthcare W. v. Sebelius, 748 

F.3d 351, 354 (D.C. Cir. 2014) (“[W]e do not affirm agency 

decisions on a legal analysis other than that expressed by the 

agency.”). 

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hospital, but I think the Secretary is leaving open what 

happens in the next case when what you’ve renovated has 

never been a hospital.”), with Oral Arg. at 38:16 (“What’s 

dispositive is whether you build something new or whether 

you’re just merely renovating.”). His equivocation is telling. 

Despite the Board’s decision, the district court’s opinion, the 

Government’s briefs on appeal, and oral argument, we still 

cannot discern precisely what the Board’s decisional standard 

was. It is a standard that requires hospitals be built from the 

ground up, yet also a standard which leaves open the 

possibility of an existing building that had never served as a 

hospital or an older hospital—say, nonoperational for fifty 

years—being renovated and subsequently reimbursed under 

reasonable cost principles. Such an amorphous rule is, by 

definition, arbitrary and capricious. See Coburn v. McHugh, 

679 F.3d 924, 934 (D.C. Cir. 2012) (noting agency decisions 

that “lack coherence” and “make it impossible for this court to 

determine whether [such decisions] survive arbitrary and 

capricious review under the APA” fail the test of “reasoned 

decisionmaking”). 

IV 

 To be clear, we have no reason to doubt the Secretary’s 

authority to define what a “new hospital” is. Nor do we have 

cause to question the Board’s ability to adopt a decisional 

standard based on that definition. But when ambiguity begets 

ambiguity, making it such that we cannot discern the 

decisional standard, much less the correctness of its 

application, we have little choice but to declare the decision 

arbitrary and capricious—especially as our review is 

constrained to the rationale provided by the Board, see SEC v. 

Chenery Corp., 332 U.S. 194, 196 (1947), however 

unintelligible it may be. 

 

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 We reverse the district court’s grant of the Appellee’s 

motion for summary judgment and remand with instruction to 

return this case to the Secretary for further proceedings not 

inconsistent with this opinion. 

So ordered.

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