1

UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLUMBIA

ARKANSAS DEPARTMENT OF HUMAN 

SERVICES, 

Plaintiff,

v. Civil Action No. 10-1251 (JEB)

KATHLEEN SEBELIUS,

Secretary of the United States Department 

of Health and Human Services,

and

DONALD BERWICK,

Administrator of the Centers for Medicare 

& Medicaid Services,

 Defendants.

MEMORANDUM OPINION

In April 2006, the Centers for Medicare & Medicaid Services (CMS) issued a notice of 

disallowance for $4,449,682 in federal matching funds it had paid to Plaintiff Arkansas 

Department of Human Services for outpatient hospital services. The Department Appeals Board 

(DAB) of the United States Department of Health and Human Services largely upheld the 

disallowance, finding that it was consistent with CMS’s reasonable interpretation of the 

regulation governing Medicaid payment limits for those services. In bringing this case, Arkansas 

seeks to overturn the DAB’s decision on the grounds that it was arbitrary and capricious and not 

in accordance with law, in violation of the Administrative Procedure Act. Arkansas first argues 

that CMS’s interpretation of the regulation is inconsistent with the Medicare, Medicaid and 

SCHIP Benefits Improvement and Protection Act of 2000 (BIPA). Second, it maintains that
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even if CMS’s interpretation is permissible, CMS was precluded from applying it to Arkansas’s 

detriment because Arkansas lacked fair notice of this interpretation. Both parties have now 

moved for summary judgment. Because CMS’s interpretation of the regulation is consistent with 

its reasonable construction of BIPA and because the disallowance does not rise to the level of the 

sanctions contemplated by the “fair notice” doctrine, the Court will grant Defendants’ motion.

I. Background

A. The Medicaid Statutory and Regulatory Framework

The Medicaid program was established in 1965 by Title XIX of the Social Security Act

as a cooperative federal-state initiative intended to assist states in providing medical assistance to 

low-income individuals and families. See 42 U.S.C. § 1396 et seq.; Harris v. McRae, 448 U.S. 

297, 301 (1980). Each state administers its own Medicaid program in accordance with federal 

statutory and regulatory requirements and pursuant to the terms of its state Medicaid plan. See

42 U.S.C. § 1396, 1396a. Once a state’s Medicaid plan is approved by the Secretary of the U.S. 

Department of Health and Human Services, the state becomes eligible to receive federal 

matching funds, or “federal financial participation” (FFP), for a percentage of the amounts 

“expended . . . as medical assistance under the State plan.” §§ 1396b(a)(1), 1396d(b). Federal 

funding levels are set by a statutory formula that calculates reimbursement rates for each state 

based on that state’s Medicaid plan. See § 1396b. 

The Social Security Act requires state Medicaid plans to ensure that payments to service 

providers are “consistent with efficiency, economy, and quality of care.” § 1396a(a)(30)(A). 

Pursuant to this statutory authority, CMS has established regulations imposing limits on state 

Medicaid payments to providers of certain medical services, including outpatient hospital and 

clinic services. See, e.g., 42 C.F.R. § 447.321. As of October 2000, the outpatient hospital and 
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clinic services regulation, 42 C.F. R. § 447.321, provided that “FFP [would] not [be] available 

for any payment that exceed[ed] the amount that would be payable to providers under 

comparable circumstances under Medicare.” Id. (2000). This amount, which functions as a 

ceiling for FFP, is referred to as the “upper payment limit” (UPL). 

In October 2000, HHS proposed a new regulation intended to close a loophole that 

allowed states “to reduce their share of Medicaid costs and cause[d] the Federal government to 

pay significantly more than it should for the same volume and level of Medicaid services.” 

Medicaid Program; Revision to Medicaid Upper Payment Limit Requirements for Hospital 

Services, Nursing Facility Services, Intermediate Care Facility Services for the Mentally 

Retarded, and Clinic Services, 65 Fed. Reg. 60151, 60152 (proposed Oct. 10, 2000) (“Proposed 

Rule”). In the Proposed Rule, HHS proposed, inter alia, to alter the regulation concerning 

outpatient hospital and clinic services, 42 C.F. R. § 447.321, in the following manner: instead of 

a single aggregate UPL for outpatient hospital and clinic services provided by all facilities in a 

state, the Proposed Rule set distinct UPLs for different kinds of facilities. See Proposed Rule, 65 

Fed. Reg. at 60151. “[T]o ensure continued access to care and the ability to adjust to proposed 

changes,” the Proposed Rule also provided for two transition periods to allow certain states to 

come into compliance with the new UPLs. Id. A state would qualify for a transition period if it 

had in place an approved State Plan Amendment (SPA) that would result in payments in excess 

of one or more of the new UPLs. See id. at 60154. Such an SPA is referred to as 

“noncompliant” because its payments exceeded the new UPLs. 

Shortly thereafter, in December 2000, Congress passed BIPA. Pub. L. No. 106-554, 114 

Stat. 2763. BIPA required HHS to issue a final rule about Medicaid UPLs based on the October 

2000 Proposed Rule. See id., 114 Stat. 2763, 2763A-575 to -577. It exempted HHS from 
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complying with “any requirement of the Administrative Procedure Act” with regard to the 

promulgation of the final rule, and it mandated that HHS provide for a longer transition period 

for implementing the UPL changes for certain states. See id. 

CMS then promulgated its Final Rule on January 12, 2001. See Medicaid Program; 

Revision to Medicaid Upper Payment Limit Requirements for Hospital Services, Nursing 

Facility Services, Intermediate Care Facility Services for the Mentally Retarded, and Clinic 

Services, 66 Fed. Reg. 3148, 3148 (Jan. 12, 2001) (“Final Rule”). The Final Rule amended 42 

C.F.R. § 447.321, which had previously provided for a single aggregate UPL for all outpatient 

service providers, so that separate UPLs applied to 1) state government-owned or -operated 

facilities, 2) other government facilities, and 3) privately owned and operated facilities. See 66 

Fed. Reg. at 3148; 42 C.F.R. § 447.321 (2001). The Final Rule took effect on March 13, 2001,

and, consistent with BIPA’s requirement that a longer transition period be added to the two 

mentioned in the Proposed Rule, provided for three transition periods of varying length for states 

with noncompliant SPAs. See 66 Fed. Reg. at 3148-50, 3171; Administrative Record (A.R.) at 

4. 

The governing provision for the short-transition-period states, of which Arkansas was 

one, stated that “payments may exceed [the newly established UPLs] until September 30, 2002.”

See 42 C.F.R. § 447.321(e)(2)(ii)(A). The provisions governing the two longer transition periods 

were more nuanced, requiring states to phase down the amount by which their payments

exceeded the new UPLs based on specified formulae. See id. §§ 447.321(e)(2)(ii)(B), 

447.321(e)(2)(ii)(C). In addition to laying out these three transition periods, the Final Rule also 

established a “general rule,” applicable to states subject to all three transition periods: “The 
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amount that a state’s payment exceeded [the newly established UPLs] must not increase.” Id. § 

447.321(e)(2)(i). As set forth below, this provision is at the heart of the dispute here.

B. Arkansas’s Noncompliant SPA and the Disallowance

Arkansas’s noncompliant SPA, SPA 00-10, was approved by CMS on November 29, 

2000, and was made retroactively effective to May 18, 2000. See A.R. at 5. SPA 00-10 allowed 

Plaintiff to make enhanced Medicaid payments to the University of Arkansas for Medical 

Sciences (UAMS), the state’s sole state-operated teaching hospital, for outpatient services. Id. at 

5-6, 50-52. Pursuant to this SPA, Plaintiff paid providers of outpatient services statewide at a 

rate of 80% of the UPL, and then paid the difference between this amount and the UPL to 

UAMS. See id. at 6; Pl.’s Mot. at 4. This resulted in UAMS receiving a supplemental payment 

beyond the costs of the outpatient services it provided. See A.R. at 6; Pl.’s Mot. at 4; Def.’s Mot. 

and Opp. at 9. 

This payment methodology was consistent with UPL regulations prior to 2001 — the 

UPL applied to outpatient services in the aggregate, so Arkansas could receive FFP for enhanced 

payments to UAMS so long as it remained below the UPL with respect to outpatient services as a 

whole. Because the Final Rule established a distinct UPL for state-owned or -operated facilities, 

however, these supplemental payments were disallowed once the Final Rule became effective. 

See Pl.’s Mot. at 4. SPA 00-10, accordingly, was a noncompliant amendment. In addition, 

because it became effective on or after October 1, 1999, it was subject to the shortest of the three 

transition periods established by the Final Rule. See 42 C.F.R. § 447.321(e)(2)(ii)(A). 

At issue in this case are the supplemental payments made to UAMS pursuant to SPA 00-

10 during the transition period. Plaintiff made these payments consistent with the methodology 

established in SPA 00-10 through September 30, 2002, the end of the applicable transition period 
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and the day the new UPLs promulgated in the Final Rule became effective for Arkansas. See

A.R. at 6; Pl.’s Mot. at 4. Since the amount of the supplemental payments was calculated 

pursuant to a percentage-based formula, the absolute amount of the payments fluctuated over 

time. See A.R. at 6 n.7. More important, the supplemental payment amount increased — both in 

absolute terms and, relevantly, in terms of the amount by which the payments to UAMS 

exceeded the amount to which UAMS would have been entitled under the new UPLs — during 

the transition period. See id.

On April 7, 2006, CMS issued a notice of disallowance for $4,449,682 in FFP it had paid 

to Arkansas during the five quarters between July 1, 2001 and September 30, 2002. A.R. at 6. 

“According to the notice of disallowance, the amount disallowed was the federal government’s 

share of supplemental payments to UAMS that exceeded the limit established by 42 C.F.R. § 

447.321(e)(2)(i),” id. at 6-7, since the “general rule” provided that “[t]he amount that a state’s 

payment exceeded [the newly established UPLs] must not increase.” 42 C.F.R. § 

447.321(e)(2)(i). 

C. Procedural History

Arkansas appealed the disallowance to the DAB in May 2006. See A.R. at 7. The DAB, 

however, stayed its consideration of the case pending its resolution of Missouri Dept. of Social 

Services, DAB No. 2184 (2008), available at http://www.hhs.gov/dab/decisions/dab2184.pdf, 

which concerned an identical “must not increase” provision in a parallel portion of the Final 

Rule. See A.R. at 7. On July 11, 2008, the DAB issued its decision in Missouri, finding that the 

“must not increase” provision was ambiguous, but that CMS had reasonably interpreted it to 

require that “the amount by which a state’s transition-period payments to a group of facilities 

(e.g., non-State government owned or operated facilities) exceed the UPL for that group could be 
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no greater than the amount by which Medicaid payments to that group exceeded that group’s 

UPL in some comparable period prior to March 13, 2001, had that UPL been applicable to those 

payments prior to March 13, 2001.” A.R. at 7 (interpreting Missouri, DAB No. 2184, at 2, 19-

20). Despite finding that Missouri did not have actual notice of CMS’s interpretation of the 

“must not increase” provision, the DAB upheld CMS’s disallowance “because Missouri failed to

show that it relied to its detriment on a reasonable alternative interpretation.” Id. (interpreting 

Missouri, DAB No. 2184, at 27-35, 37). 

After issuing its decision in Missouri, the DAB invited Arkansas and CMS to submit 

supplemental briefing on the application of that decision to this case and to specifically address 

whether Arkansas relied to its detriment on a reasonable alternative interpretation of the “must 

not increase” provision. See id. at 7-8. After considering the parties’ additional arguments, the 

DAB largely upheld the disallowance. See id. at 8. First, it reaffirmed its finding in Missouri

that CMS’s interpretation of the “must not increase” provision was reasonable. Id. at 8-12. 

Second, it found that Arkansas did not have “timely and adequate notice” of that interpretation, 

but that Arkansas “failed to prove that it relied to its detriment on a reasonable alternative 

interpretation.” Id. at 8, 12-16. CMS, therefore, was entitled to enforce its interpretation of the 

provision against Arkansas. See id. Third, however, the DAB found that CMS’s application of 

the provision to Arkansas was inconsistent with its interpretation. Id. at 17-19. In other words, 

the DAB could not conclude that “CMS actually applied its interpretation in calculating the 

disallowance amount.” Id. at 20. It accordingly remanded the case to CMS to permit the 

issuance of a revised disallowance consistent with CMS’s interpretation of the “must not 

increase” provision. Id. The DAB provided that Arkansas could return within 30 days of 

receiving the revised disallowance if it disagreed with CMS’s calculations. Id.
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After recalculating, CMS sought a revised disallowance amount of $4,038,093 plus 

$391,608 in interest. Compl., ¶ 57; Def.’s Mot. and Opp. at 9. Arkansas does not contest that 

this amount is consistent with the DAB’s decision. See Compl., ¶ 57; Pl.’s Mot. at 11. Arkansas 

then filed its Complaint initiating the instant suit on July 23, 2010. The Complaint sought

reversal of CMS’s disallowance and the DAB decision upholding it on two grounds. First, 

Arkansas argues that the DAB’s decision and CMS’s disallowance were unlawful “arbitrary and 

capricious” actions under the Administrative Procedure Act. See Compl., ¶¶ 63-69 (citing 5 

U.S.C. § 706(2)(A)). Second, it contends that CMS’s interpretation of the “must not increase” 

provision constituted “new, substantive rulemaking” that failed to comply with the APA’s 

rulemaking requirements. See id., ¶¶ 70-72 (citing 5 U.S.C. § 553). Both parties now seek

summary judgment.

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II. Legal Standard

Summary judgment may be granted if “the movant shows that there is no genuine dispute 

as to any material fact and the movant is entitled to judgment as a matter of law.” FED. R. CIV. P. 

56(a); see also Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48 (1986); Holcomb v. 

Powell, 433 F.3d 889, 895 (D.C. Cir. 2006). A fact is “material” if it is capable of affecting the 

substantive outcome of the litigation. Holcomb, 433 F.3d at 895; Liberty Lobby, Inc., 477 U.S. at 

248. A dispute is “genuine” if the evidence is such that a reasonable jury could return a verdict 

for the nonmoving party. See Scott v. Harris, 550 U.S. 372, 380 (2007); Liberty Lobby, Inc., 

477 U.S. at 248; Holcomb, 433 F.3d at 895.

Although styled Motions for Summary Judgment, the pleadings in this case more 

accurately seek the Court’s review of an administrative decision. The standard set forth in Rule 

 1 In considering both parties’ summary judgment Motions, the Court has reviewed Plaintiff’s Motion, 

Defendants’ Cross-Motion and Opposition, Plaintiff’s Opposition and Reply, and Defendants’ Reply.
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56(c), therefore, does not apply because of the limited role of a court in reviewing the 

administrative record. See Sierra Club v. Mainella, 459 F. Supp. 2d 76, 89-90 (D.D.C. 2006) 

(citing National Wilderness Inst. v. United States Army Corps of Eng'rs, 2005 WL 691775, at *7 

(D.D.C. 2005); Fund for Animals v. Babbitt, 903 F. Supp. 96, 105 (D.D.C. 1995), amended on 

other grounds, 967 F. Supp. 6 (D.D.C. 1997)). “[T]he function of the district court is to 

determine whether or not as a matter of law the evidence in the administrative record permitted 

the agency to make the decision it did.” Id. (internal citations omitted). Summary judgment thus 

serves as the mechanism for deciding, as a matter of law, whether the agency action is supported 

by the administrative record and otherwise consistent with the APA standard of review. See

Richards v. INS, 554 F.2d 1173, 1177 & n.28 (D.C. Cir. 1977), cited in Bloch v. Powell, 227 F. 

Supp. 2d 25, 31 (D.D.C. 2002), aff’d, 348 F.3d 1060 (D.C. Cir. 2003).

The Administrative Procedure Act “sets forth the full extent of judicial authority to 

review executive agency action for procedural correctness.” FCC v. Fox Television Stations, 

Inc., 129 S. Ct. 1800, 1810 (2009). It requires courts to “hold unlawful and set aside agency 

action, findings, and conclusions” that are “arbitrary, capricious, an abuse of discretion, or 

otherwise not in accordance with law.” 5 U.S.C. § 706(2)(A). This is a “narrow” standard of 

review as courts defer to the agency’s expertise. Motor Vehicle Mfrs. Ass'n of U.S., Inc. v. State 

Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983). An agency is required to “examine the 

relevant data and articulate a satisfactory explanation for its action including a rational 

connection between the facts found and the choice made.” Id. (internal quotation omitted). The 

reviewing court “is not to substitute its judgment for that of the agency,” id., and thus “may not 

supply a reasoned basis for the agency's action that the agency itself has not given.” Bowman 

Transp., Inc. v. Arkansas-Best Freight System, Inc., 419 U.S. 281, 285-86 (1974) (internal 
10

quotation omitted). Nevertheless, a decision that is not fully explained may be upheld “if the 

agency's path may reasonably be discerned.” Id. at 286. 

III. Analysis

Arkansas challenges CMS’s disallowance and the DAB decision upholding it under § 706 

of the APA, which provides that a court may “hold unlawful and set aside” agency actions found 

to be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 

U.S.C. § 706(2)(A). First, Arkansas contends that CMS’s interpretation of 42 C.F.R. § 447.321 

(the “must not increase” provision) is not in accordance with law and arbitrary and capricious 

because it is inconsistent with the governing statutory authority in BIPA. Second, even if CMS’s 

interpretation could stand, Arkansas argues that its application of that interpretation to Plaintiff 

was arbitrary and capricious because Arkansas lacked notice of it. The court will address each 

argument in turn.

Arkansas’s Complaint also included a second count, which contended that CMS violated 

the APA by engaging in “new, substantive rulemaking . . . without satisfying the notice and 

comment requirements of 5 U.S.C. § 553” when it interpreted the “must not increase” provision. 

Compl., ¶ 72. As Defendants’ point out, however, Arkansas made no arguments concerning 

§ 553 of the APA in its Motion for Summary Judgment. See Def.’s Mot. and Opp. at 12, 28 

n.13. They argue, accordingly, that Arkansas has “abandoned” this claim. Id. at 28 n.13. 

Arkansas responds that it “has not abandoned Count II,” explaining that “the APA notice and 

comment rulemaking requirements provide an additional wellspring of the fair notice obligation 

that CMS failed to discharge.” Pl.’s Opp. and Reply at 26 n.24. Plaintiff, however, does not 

adhere to the contention it proffered in its Complaint — that CMS was required to announce its 
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interpretation of the “must not increase” provision in a notice-and-comment rulemaking. As 

explained in Section III.B, infra, the Court ultimately need not address § 553.

A. CMS’s Interpretation of the “Must not Increase” Provision

Arkansas first argues that CMS’s interpretation of the “must not increase” provision 

conflicts with BIPA and, as such, is not lawful. Both the regulatory scheme at issue in this case 

and Arkansas’s argument concerning CMS’s interpretation are complex. This controversy will, 

fortunately, not arise again inasmuch as it relates to the transition period before the Final Rule 

took effect. In any event, it makes sense to first outline the conflicting interpretations of the 

regulation and then turn to the statute. Ultimately, CMS’s interpretation of the regulation is 

consistent with a reasonable interpretation of BIPA.

1. The Parties’ Interpretations of the Regulation

The relevant section of the Final Rule provides:

(e) Transition periods—(1) Definitions. For purposes of 

this paragraph, the following definitions apply:

(i) Transition period refers to the period of time beginning 

March 13, 2001 through the end of one of the schedules permitted 

under paragraph (e)(2)(ii) of this section.

(ii) UPL stands for the maximum payment level under the 

upper payment limit described in paragraph (b) of this section if 

that limit had been applied to that year.

(iii) X stands for the payments to a specific group of 

providers described in paragraph (a) of this section in State FY 

2000 that exceeded the amount that would have been under the 

upper payment limit described in paragraph (b) of this section if 

that limit had been applied to that year.

(2) General rules. (i) The amount that a State’s payment 

exceeded the upper payment limit described in paragraph (b) 

of this section must not increase.

(ii) A State with an approved State plan amendment 

payment provision effective on one of the following dates and that 

makes payments that exceed the upper payment limit described in 

paragraph (b) of this section to providers described in paragraph 

(a) of this section may follow the respective transition schedule:
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(A)For approved plan provisions that are effective on or 

after October 1, 1999, payments may exceed the limit 

in paragraph (b) of this section until September 30, 

2002.

(B) For approved plan provisions that are effective after 

October 1, 1992 and before October 1, 1999, payments 

during the transition period may not exceed the 

following—

(1) For State FY 2003: State FY 2003 UPL + .75X.

(2) For State FY 2004: State FY 2004 UPL + .50X.

(3) For State FY 2005: State FY 2005 UPL + .25X.

(4) For State FY 2006: State FY 2006 UPL.

(C) For approved plan provisions that are effective on or 

before October 1, 1992, payments during the transition 

period may not exceed the following:

(1) For State FY 2004: State FY 2004 UPL + .85X.

(2) For State FY 2005: State FY 2005 UPL + .70X.

(3) For State FY 2006: State FY 2006 UPL + .55X.

(4) For State FY 2007: State FY 2007 UPL + .40X.

(5) For State FY 2008: State FY 2008 UPL + .25X.

(6) For the portion of State FY 2009 before October 

1, 2008: State FY 2009 UPL + .10X.

(7) Beginning October 1, 2008: UPL described in 

paragraph (b) of this section.

42 C.F.R. 447.321(e) (2001) (emphasis added). CMS cited the bolded “must not increase” 

provision, 42 C.F.R. 447.321(e)(2)(i), as the legal basis for the disallowance, see A.R. at 1, and it 

is the meaning of that provision upon which this case turns.

CMS interpreted the “must not increase” provision as imposing the following limitation:

[T]he amount by which a state’s transition-period payments to a 

group of facilities (e.g., non-State government owned or operated 

facilities) exceeded the UPL for that group could be no greater 

than the amount by which Medicaid payments to that group 

exceeded that group’s UPL in some comparable period prior to 

March 13, 2001, had that UPL been applicable to those payments 

prior to March 13, 2001.

A.R. at 7. In other words, “the amount of excess UPL payments for all transition periods was 

capped at the amount of the state’s excess UPL payment in a prior comparable period.” Def.’s 
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Mot. and Opp. at 8. CMS maintains that this provision, which is set off as a “general rule,” 

applies to states in all three of the enumerated transition periods. Id.

Arkansas interprets the “must not increase” provision differently. It contends that the 

regulation:

(i) prohibited it from retroactively increasing its fiscal year 2000 

excess UPL payments (which, if done, for some states would have 

the effect of inflating the excess payments permitted during the 

transition period) and (ii) prohibited it from changing its CMSapproved UPL methodology to increase payments during the 

transition period . . . .

Pl.’s Mot. at 6. In other words, Arkansas understood the provision as prohibiting changes to its 

payment methodology — retroactive or otherwise — that would have the effect of increasing its 

excess UPL payments, but did not understand it to institute a “fixed-dollar baseline.” See id. at 

6-8. Following this interpretation, Arkansas believed that if it continued to make payments 

consistent with SPA 00-10 — i.e., making supplemental payments to UAMS pursuant to the 

percentage-based formula established therein — until the end of the transition period, it would be 

in compliance with the “must not increase” provision. See id. at 6-8. 

Because SPA 00-10 calculated the UAMS supplemental payments in percentage terms, 

however, the absolute dollar amount of excess payments increased during the transition period. 

A.R. at 6, 16-19. Arkansas, therefore, failed to comply with CMS’s interpretation of the “must 

not increase” provision. Arkansas would have had to make an affirmative change to its payment 

methodology to conform to the hard cap CMS believed to have been established by that 

provision. See Pl.’s Mot. at 8; Def.’s Mot. and Opp. at 14-15. As it did not do so, CMS found it 

in violation and claimed the disallowance.

The Court must “give substantial deference to an agency’s interpretation of its own 

regulations.” Thomas Jefferson Univ. v. Shalala, 512 U.S. 504, 512 (1994); see Auer v. 
14

Robbins, 519 U.S. 452, 461-63 (1997). Unless an agency’s interpretation is “plainly erroneous 

or inconsistent with the regulation,” the Court will not intervene to overturn it. Federal Exp. 

Corp. v. Holowecki, 552 U.S. 389, 397 (2008) (quoting Auer, 519 U.S. at 461) (internal 

quotation marks omitted). “This broad deference is all the more warranted when, as here, the 

regulation concerns ‘a complex and highly technical regulatory program.’” Thomas Jefferson 

Univ., 512 U.S. at 512 (1994) (quoting Pauley v. BethEnergy Mines, Inc., 501 U.S. 680, 697 

(1991)) (deferring to HHS’s interpretation of a Medicare regulation). 

Arkansas does not contend here that CMS’s interpretation of the regulation is internally 

inconsistent; while it argues in favor of one reading, Arkansas concedes and the DAB found that 

the “must not increase” provision is ambiguous. See Pl.’s Mot. at 13; A.R. at 1. Rather, Plaintiff

argues CMS’s interpretation renders the regulation inconsistent with BIPA. Pl.’s Mot. at 10-13. 

The Court must reject an agency’s interpretation of its own regulation if that interpretation is 

inconsistent with Congress’s statutory directives. See Daugherty v. Director, Office of Workers 

Comp. Program, 897 F.2d 740, 742 (4th Cir. 1990) (citing Chevron U.S.A. v. Natural Res. Def. 

Council, 467 U.S. 837, 842-44 (1984)). The question, then, is whether BIPA forecloses CMS’s 

interpretation of the regulation.

2. The Parties’ Interpretations of the Statute

Section 705 of BIPA, which was passed shortly after HHS issued the Proposed Rule on 

which the Final Rule was based, provides:

(a) IN GENERAL.—Not later than December 31, 2000, the 

Secretary of Health and Human Services . . . , notwithstanding 

any requirement of the Administrative Procedures Act . . . shall 

issue . . . a final regulation based on the proposed rule 

announced on October 5, 2000, that—

(1) modifies the upper payment limit test applied to State 

medicaid spending for inpatient hospital services, 

outpatient hospital services, nursing facility services, 
15

intermediate care facility services for the mentally 

retarded, and clinic services by applying an aggregate 

upper payment limit to payments made to government 

facilities that are not State-owned or operated facilities; 

and

(2) provides for a transition period in accordance with 

subsection (b).

(b) TRANSITION PERIOD.—

(1) IN GENERAL.—The final regulation . . . shall provide 

that, with respect to a State described in paragraph (3), the 

State shall be considered to be in compliance with the final 

regulation required under subsection (a) so long as, for each 

State fiscal year during the period described in paragraph (4), 

the State reduces payments under a State medicaid plan 

payment provision or methodology described in paragraph (3) 

. . . , or reduces the actual dollar payment levels described in 

paragraph (3)(B), so that the amount of the payments that 

would otherwise have been made under such provision, 

methodology, or payment levels by the State for any State 

fiscal year during such period is reduced by 15 percent in the 

first such State fiscal year, and by an additional 15 percent in 

each of the next 5 State fiscal years.

(2) REQUIREMENT.—Notwithstanding paragraph (1), the 

final regulation required under subsection (a) shall provide that, for 

any period (or portion of a period) that occurs on or after October 

1, 2008, Medicaid payments made by a State described in 

paragraph (3) shall comply with such final regulation.

(3) STATE DESCRIBED.—A State described in this paragraph 

is a State with a State medicaid plan payment provision or 

methodology . . . which—

(A) was approved, deemed to have been approved, 

or was in effect on or before October 1, 1992 . . . or 

under which claims for Federal financial 

participation were filed and paid on or before such 

date; and

(B) provides for payments that are in excess of the 

upper payment limit test established under the final 

regulation required under subsection (a) (or which 

would be noncompliant with such final regulation if 

the actual dollar payment levels made under the 

payment provision or methodology in the State 

fiscal year which begins during 1999 were 

continued).

(4) PERIOD DESCRIBED.—The period described in this 

paragraph is the period that begins on the first State fiscal year 
16

that begins after September 30, 2002, and ends on September 30, 

2008.

Pub. L. No. 106-554, 114 Stat. 2763, 2763A-575 to -577 (emphases added). 

Arkansas argues that the bolded portions of BIPA foreclose CMS’s interpretation of the 

“must not increase” provision as prohibiting all states from increasing the amount of their excess 

UPL payments during the transition period. See Pl.’s Mot. at 10-13. Those sections of the 

statute, Arkansas contends, “unambiguously required the Final Regulation to provide that long 

transition states” — those described in § 705(b)(3) of BIPA and 42 C.F.R. 447.321(e)(2)(ii)(C) 

— “that appropriately reduced their Medicaid payments after September 30, 2002 could not be 

found out of compliance with the Final Regulation . . . .” Id. at 11 (emphasis added). In other 

words, Arkansas maintains that the statute prohibited HHS from placing any restrictions on longtransition states’ excess UPL payments during the period prior to September 30, 2002. See id. 

As long as long-transition states appropriately reduced their excess UPL payments beginning 

September 30, 2002, the Final Rule was required to deem them compliant no matter what 

occurred prior to that date. See id. Because CMS’s interpretation and the DAB’s analysis 

upholding it rely on the premise that the “must not increase” provision applies to states in all 

three transition periods, see A.R. at 9, Arkansas argues that CMS’s interpretation must be 

rejected altogether since it contradicts BIPA with respect to long-transition states. See Pl.’s Mot. 

at 13.

Put another way, CMS’s interpretation of the “must not increase” provision allegedly 

runs afoul of BIPA because CMS’s reading prohibits all states, including those subject to the 

long-transition period, from increasing their excess UPL payments from the moment the Final 

Rule was effective. It would, accordingly, place a limited restriction on long-transition states 

during the eighteen months between the effective date of the Final Rule, March 13, 2001, and the 
17

date of the first required phase down, September 30, 2002. Specifically, a long-transition state 

that complied with the phase-down schedule after September 30, 2002, but increased the amount 

of its excess UPL payments prior to that date, would have failed to conform to the “must not 

increase” provision of the Final Rule, as interpreted by CMS. See id. This, Arkansas believes, 

cannot be correct.

CMS responds that its interpretation of the “must not increase” provision does not 

contradict BIPA because BIPA does not constrain HHS’s ability to restrict long-transition states’

pre-September 30, 2002, excess UPL payments. See Def.’s Mot. and Opp. at 19. Instead, it

interprets the bolded portion of the statute as instructing HHS to add a third transition period, 

pursuant to which certain states were to reduce their excess UPL payments consistent with the

phase-down schedule set forth in § 705(b), to the two transition periods already contained in the 

Proposed Rule. See Def.’s Opp. and Reply at 8. BIPA, accordingly, dictated only what a longtransition state was required to do after September 30, 2002 — the date the phase-down schedule 

was to begin — in order to comply with the Final Rule. See Def.’s Mot. and Opp. at 19. CMS 

does not interpret BIPA as having anything to say about the period before September 30, 2002. 

The crux of the dispute, then, is whether § 705(b) of BIPA precluded HHS from requiring that 

long-transition states not increase the amount of their excess UPL payments during the preSeptember 30, 2002, time period. 

3. Chevron Analysis

In reviewing an agency’s interpretation of a statute it administers, the Court follows the 

two-step analytical framework established by Chevron U.S.A., Inc. v. Natural Res. Def. Council, 

Inc. 467 U.S. 837 (1984); see also, e.g., Shays v. Federal Election Comm’n, 414 F.3d 76, 96 

(D.C. Cir. 2005), Republican Nat’l Comm. v. FEC, 76 F.3d 400, 404 (D.C. Cir. 1996). “First, 
18

always, is the question whether Congress has directly spoken to the precise question at issue. If 

the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, 

must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842-

43. This inquiry is commonly referred to as “Chevron step one.” See, e.g., Intermountain Ins. 

Serv. of Vail v. CIR, 650 F.3d 691 (D.C. Cir. 2011). “‘Although Chevron step one analysis 

begins with the statute's text,’ the court must examine the meaning of certain words or phrases in 

context and also ‘exhaust the traditional tools of statutory construction . . . .’” Sierra Club v. 

EPA, 551 F.3d 1019, 1027 (D.C. Cir. 2008) (quoting Am. Bankers Ass'n v. Nat'l Credit Union 

Admin., 271 F.3d 262, 267 (D.C. Cir. 2001)). 

Section 705(b)(1) of BIPA states that a long-transition state “shall be considered to be in 

compliance with the final regulation . . . so long as, for each State fiscal year during the period 

described in paragraph (4), the State reduces payments” appropriately. The “period described in 

paragraph (4)” “begins on the first State fiscal year that begins after September 30, 2002.” Id. at 

§ 705(b)(4). CMS interprets the provision to require that, with regard to the period after the start 

of the phase-down schedule in September 2002, long-transition states be considered in 

compliance with the Final Rule if they reduced their payments as outlined in the provision.

The question for the Court at this stage is whether, as Arkansas contends, Congress precluded 

this interpretation and required that long-transition states be considered in compliance with every 

provision of the Final Rule if they reduced their payments appropriately post-September 30, 

2002. 

Arkansas emphasizes that “[t]he word ‘shall’ is the language of command in a statute.”

Ass’n of Am. R.R. v. Costle, 562 F.2d 1310, 1312 (D.C. Cir. 1977). While it is clear that 

Congress intended to “command” HHS to do something, it does not follow that it commanded 
19

HHS to permit long-transition states to increase their excess UPL payments prior to September 

30, 2002. Indeed, the statutory text does not clearly establish whether long-transition states that 

complied with the post-September 30, 2002, phase-down schedule must be considered compliant 

with every provision of the final regulation or merely with the phase-down schedule established 

therein. 

“It is a fundamental canon of statutory construction that the words of a statute must be 

read in their context and with a view to their place in the overall statutory scheme.” Davis v. 

Mich. Dep't of Treasury, 489 U.S. 803, 809 (1989); cf. Ariz. Pub. Serv. Co. v. EPA, 211 F.3d 

1280, 1287 (D.C. Cir. 2000) (court must “exhaust[ ] traditional tools of statutory construction” at 

Chevron step one). Context is particularly important here: BIPA was enacted immediately after 

and in reaction to the Proposed Rule on which the Final Rule was based. See generally BIPA, 

Pub. L. No. 106-554, 114 Stat. 2763, 2763A-575 to -577. Section 705(a) of BIPA, which 

described in general terms what Congress sought to accomplish in the subsequent portions of the 

statute, explicitly required HHS to issue “a final regulation based on the proposed rule . . . that . . 

. provide[d] for a transition period in accordance with subsection (b).” Id. (emphasis added). 

This section of the statute suggests that Congress intended § 705(b) to require HHS to add a third 

transition period with the specified phase-down schedule to the two transition periods outlined in 

the Proposed Rule, not to preclude HHS from requiring that long-transition states not increase 

their excess UPL payments prior to the start of that schedule.

Ultimately, it is not clear whether BIPA had anything at all to say about the period prior 

to September 30, 2002, let alone that it prohibited the Final Rule’s requirement that excess UPL 

payments not increase. Because the statute is ambiguous, the Court must turn to Chevron step 

two. “At Chevron step two we ask whether the agency’s interpretation of the statute is 
20

‘reasonable.’” Northeast Hospital Corp. v. Sebelius, 2011 WL 4036318, at *11 (D.C. Cir. 2011)

(citing Abington Crest Nursing & Rehab. Ctr. V. Sebelius, 575 F.3d 717, 719 (D.C. Cir. 2009)); 

see Chevron, 467 U.S. at 843. At this stage, the Court must uphold the agency’s interpretation if 

it is “based on a permissible construction of the statute.” Chevron, 467 U.S. at 843. “The court 

need not conclude that the agency construction was the only one it permissibly could have 

adopted to uphold the construction, or even the reading the court would have reached if the 

question initially had arisen in the judicial proceeding.” Id. at 843 n.11.

The Court here finds that HHS reasonably filled the statutory gap when it instituted the 

“must not increase” provision. In response to a comment on the Proposed Rule, HHS explained 

the rationale behind requiring that states not increase their excess UPL payments during the 

transition period: “While we have included generous transition periods, we do not think it is 

appropriate to permit States to make payments that would further increase the amount of 

payment that is in excess of the new UPLs.” Final Rule, 66 Fed. Reg. at 3163. The purpose of 

instituting transition periods was to enable states to come into compliance with the new UPLs,

see id. at 60154, not to enable them to move farther out of compliance. When Congress 

mandated that the Final Rule include a third, longer transition period for certain states, HHS 

reasonably interpreted BIPA not to simultaneously and implicitly require that the Final Rule 

permit those states to increase their excess UPL payments prior to beginning the phase-down 

schedule. 

Seeking to demonstrate that Defendants’ interpretation is unreasonable, Arkansas 

suggests that “[o]n the government’s view (that BIPA does not address the period prior to 

September 30, 2002), CMS could have published a regulation requiring long-transition-period 

states to comply with the final, new UPLS between March 13, 2001 and September 30, 
21

2002 . . . , before these states benefitted from the phase-down schedule after September 30, 

2002.” Pl.’s Opp. and Reply at 4. The fact that BIPA did not require that long-transition states 

be able to increase their excess UPL payments prior to September 30, 2002, however, does not 

imply that it need permit this hypothetical regulation. Indeed, such a regulation might very well 

be inconsistent with both the Proposed Rule, on which Congress stated that the Final Rule should 

be based, and BIPA inasmuch as it would defeat the entire purpose of the transition periods. In 

any event, the plausibility of CMS’s interpretation of BIPA with respect to the regulation at issue 

in this case does not turn on the plausibility of that interpretation with respect to a regulation it 

did not promulgate.

In addition, it is worth noting that Arkansas’s own interpretation of the regulation is 

likely inconsistent with its interpretation of BIPA. Arkansas argues that BIPA prohibited any

restriction on long-transition states’ pre-September 30, 2002, excess UPL payments and 

challenges CMS’s interpretation of the regulation on that ground. Arkansas’s interpretation of 

the regulation, however, seems to suffer from the same alleged defect. Arkansas emphasizes that 

it “has never denied that excess UPL payments in the transition period were subject to “some 

limitation” and that the “point of dispute between Arkansas and CMS” is simply “the contour” of 

that limit. Pl.’s Opp. and Reply at 16; see also id. at 30. According to Arkansas, the “must not 

increase” provision “prohibited it from retroactively increasing its fiscal year 2000 excess UPL 

payments . . . and . . . from changing its CMS-approved UPL methodology to increase payments 

during the transition period . . . .” Pl.’s Mot. at 6. Even under Arkansas’s interpretation, 

therefore, long-transition states could comply with the post-September 30, 2002, phase-down 

schedule and still run afoul of the final regulation if, for example, they increased payments 

during the preliminary transition period. 
22

In the final analysis, CMS reasonably interpreted BIPA to permit some limits on longtransition states’ excess UPL payments prior to September 30, 2002. Its interpretation of the 

“must not increase” provision of the Final Rule is consistent with this reasonable interpretation 

of the statute. The Court, therefore, will not overturn the DAB’s decision on BIPA grounds.

B. Fair Notice

Even if CMS’s interpretation of the “must not increase” provision is consistent with 

BIPA, Arkansas argues that CMS may nevertheless not apply that interpretation to its payments. 

See Pl.’s Mot. at 13-28. Citing a line of D.C. Circuit cases concerning the “fair notice” doctrine, 

Arkansas contends that an agency may not apply its interpretation of an ambiguous regulation to 

a party’s detriment where, as here, that party lacked notice of the agency’s interpretation. See id. 

This Circuit’s “fair notice” doctrine has its roots in the Fifth Amendment’s Due Process 

Clause. General Electric Co. v. EPA, 53 F.3d 1324, 1328 (D.C. Cir. 1995); see also United 

States v. Chrysler Corp., 158 F.3d 1350, 1354-55 (D.C. Cir. 1998); Albert C. Lin, Refining Fair 

Notice Doctrine: What Notice is Required of Civil Regulations, 55 BAYLOR L. REV. 991, 992-98

(2003). “Of course, it is in the context of criminal liability that this ‘no punishment without 

notice’ rule is most commonly applied.” General Electric, 53 F.3d at 1329. In General Electric,

however, our Circuit confirmed that the “fair notice” doctrine also applies to civil regulations:

[A]s long ago as 1968, we recognized this “fair notice” 

requirement in the civil administrative context. In Radio Athens, 

Inc. v. FCC, we held that when sanctions are drastic — in that 

case, the FCC dismissed the petitioner’s application for a radio 

station license — “elementary fairness compels clarity” in the 

statements and regulations setting forth the actions with which the 

agency expects the public to comply. 

Id. at 1329 (quoting Radio Athens, Inc. v. FCC, 401 F.2d 398, 404 (D.C. Cir. 1968)). What 

began, then, as a principle of due process in the criminal context “has now been thoroughly 
23

‘incorporated into administrative law.’” Id. at 1329 (quoting Satellite Broadcasting Co. v. FCC, 

824 F.2d 1, 3 (D.C. Cir. 1987)); see also Envtl. Serv. Inc. v. EPA, 937 F.2d 649, 654 n.1, 655 

(Edwards, J. concurring in part and dissenting in part) (fair notice doctrine is “basic hornbook 

law in the administrative context” and “simple principle of administrative law”). 

While it is clear that the notice requirement is not limited to the criminal realm, it also has 

not been applied to limit agencies’ interpretations in all contexts. Nearly all of the cases 

applying the “fair notice” doctrine concern an agency’s imposition of a penalty against a private 

party and, moreover, formulate the doctrine in terms of penalties. See, e.g., Rollins, 937 F.2d at 

653 (“[A] regulation carrying penal sanctions must give fair warning of the conduct it prohibits 

or requires.” (citation omitted)); Howmet Corp. v. EPA, 614 F.3d 544, 553 (D.C. Cir. 2010) 

(providing that an agency may not “penaliz[e] a private party for violating a rule without first 

providing adequate notice”); Trinity v. FCC, 211 F.3d 618, 238 (D.C. Cir. 2000) (invoking the 

doctrine because the agency “imposed a severe penalty”); General Electric, 53 F.3d 1324, 1329-

30 (applying fair-notice analysis explicitly “because the agency imposed a fine”). 

In United States v. Chrysler Corp., 158 F.3d 1350 (D.C. Cir. 1998), however, our Circuit 

rejected the argument that the doctrine only applies to “cases involving explicit penalties or 

actions that the Court described as punitive in some manner.” Id. at 1354 (internal quotation 

marks and citation omitted). The Chrysler Corp. panel instead held that “a recall, which entails 

the expenditure of significant amounts of money, deprives Chrysler of property no less than a 

fine,” and, accordingly, “is a ‘sufficiently grave sanction’ such that the duty to provide notice is 

triggered.” Id. at 1354-55 (quoting Sattelite Broad. Co., Inc. v. FCC, 824 F.2d 1, 3 (D.C. Cir. 

1987)). The focus on the gravity of the sanction involved makes sense: the “fair notice” doctrine 

has its roots in due process, so courts have applied it when an agency “deprive[s] a party of 
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property by imposing civil or criminal liability,” Trinity, 211 F.3d at 238 (quoting General 

Electric, 53 F.3d at 1328-29) (internal quotation marks omitted), “or where sanctions are 

drastic.” Darrell Andrews Trucking, Inc. v. Fed. Motor Carrier Safety Admin., 296 F.3d 1120, 

1130 n.8 (D.C. Cir. 2002) (quoting General Electric, 53 F.3d at 1328-29) (internal quotation 

marks omitted); see also Lin, Refining Fair Notice Doctrine, 55 BAYLOR L. REV. at 996-98

(“[C]ourts have generally found fair notice applicable to civil penalties and in some cases have 

extended its protection to other agency sanctions. The D.C. Circuit, for example, has held that 

the fair notice requirement applies in civil cases ‘when sanctions are drastic.’” (citations 

omitted)). 

A disallowance of federal matching funds that had been provided to a state is 

categorically different from the kinds of sanctions courts have found “sufficiently grave” to merit 

the application of the “fair notice” doctrine. The loss, while not insignificant, amounts to around 

6% of the amount paid to UAMS beyond the UPL for those services, see A.R. at 19, 45, and to a 

miniscule proportion of the total Medicaid federal matching funds Arkansas received during the 

relevant time period. See generally Centers for Medicare & Medicaid Services, Medicaid 

Budget & Expenditure System, CMS-64 Quarterly Expense Report, “Financial Management 

Reports for FY 1997 through FY 2001” and “Financial Management Report FY 2002 through 

FY 2010,” available at http://www.cms.gov/MedicaidBudgetExpendSystem/02_CMS64.asp. 

Plaintiff, moreover, is not a private party, and it is not being forced to relinquish massive 

amounts of its property, like Chrysler in Chrysler Corp., or denied a renewal of a valuable

license, like Trinity in Trinity. The disallowance concerned supplemental payments that were 

not even related to Medicaid costs actually incurred by UAMS — they were payments beyond

the UPL for the medical services actually provided by that facility. See A.R. at 6, 16-18. At 
25

bottom, the disallowance is simply not the type of sanction enforced against a private party that 

would warrant invocation of fair notice. 

Were the “fair notice” doctrine applied, as Arkansas seems to propose, to every case in 

which a party disputes an agency’s interpretation of a regulation, it would swallow Auer

deference. Agencies cannot be expected to regulate with perfect clarity, cf. United States v. 

Williams, 553 U.S. 285, 290 (2008) (“perfect clarity and precise guidance have never been 

required even of regulations that restrict expressive activity” (quoting Ward v. Rock Against 

Racism, 491 U.S. 781, 779 (1989)) (internal quotation marks omitted)); this is especially the case 

with regard to complex regulatory regimes like Medicaid. If an agency were prevented on notice 

grounds from enforcing its interpretation of a regulation against any party who proffered a 

reasonable alternative interpretation and suffered any monetary loss, the practice of deferring to 

an agency’s reasonable interpretation of its regulations, see Auer, 519 U.S. at 461-62, would be 

rendered essentially meaningless. Courts would be flooded with challenges to administrative 

actions, and agencies would be unable to administer their regulations efficiently. The “fair 

notice” doctrine has not been — and ought not be — extended this far.

Finally, because the “fair notice” doctrine Arkansas invokes is inapplicable to the case at 

hand, the Court need not reach the parties’ arguments concerning the adequacy of notice 

provided, the reasonableness of Arkansas’s alternative interpretation, or whether Arkansas was 

required to show detrimental reliance on that interpretation. 

IV. Conclusion

The Court, therefore, will grant Defendants’ Motion for Summary Judgment and deny 
26

Plaintiff’s. A separate Order consistent with this Opinion will be issued this day.

SO ORDERED.

 /s/ James E. Boasberg 

 JAMES E. BOASBERG

 United States District Judge

Date: October 12, 2011