Opinion ID: 450362
Heading Depth: 2
Heading Rank: 4

Heading: Stock Acquisition Costs and Liquidation

Text: 33 In separate transactions conducted between May 17, 1969, and June 18, 1971, Humana acquired 100 percent of the corporate stock of twelve health care facilities, eight of which were subsequently merged or dissolved into Humana or a subsidiary. Humana argues that each of the twelve facilities was purchased as an ongoing operation within the meaning of 42 C.F.R. Sec. 405.415(g) (1983), 53 which entitles it to reimbursement for capital costs--including depreciation, 54 interest on loans used to finance the acquisitions, 55 and return on equity 56 --based on its purchase price rather than the cost of the assets to the acquired entities. For transactions in which the acquired facilities remained separate corporations, this claim is foreclosed by AMI, which upheld the Secretary's denial of such reimbursement with respect to the purchase ... of 100 percent of the stock of the [acquired] hospitals.... 57 Humana seeks to distinguish AMI on the ground that the district court evaluated the reimbursement claims on the basis of its interpretation of Sec. 405.415(a)-(b), and not under Sec. 405.415(g). 58 However, AMI's analysis of non-liquidating stock transactions in fact turned on the statutory requirement that only health care providers be reimbursed for their reasonable costs of patient care, 59 and the court's reasoning controls the case before us: 34 To participate in the Medicare program and to be eligible for Medicare payments, a provider must file an agreement with the Secretary pursuant to 42 U.S.C. Sec. 1395cc. While the agreement is in effect, the Secretary will reimburse the provider for its reasonable costs of providing patient care to beneficiaries eligible under the program. Such costs are reimbursable only to the extent that they are actually incurred. 42 U.S.C. Sec. 1395x(v)(1)(A). The providers in this case are the [acquired] plaintiff hospitals, not Chanco. Both before and after the stock transfer, plaintiff hospitals, not their owners, were and are the providers of medical services within the meaning of the Medicare Act. Only their reasonable costs in rendering medical services to beneficiaries can be reimbursed. 35 ... [I]t would only make sense to allow plaintiff hospitals to be reimbursed for the depreciation costs of assets that the plaintiff hospitals themselves acquired because the statute only permits reimbursement for costs actually incurred. 42 U.S.C. Sec. 1395x(v)(1)(A). This must mean actually incurred by the provider because it is the provider that is being reimbursed. Reimbursement for depreciation from a cost established by the expenditure of Chanco, the stockholder, would be to allow reimbursement for costs not actually incurred by plaintiff hospitals, the providers, and would, therefore, be contrary to the Act. The regulations reflect this by permitting reimbursement only for the acquisition of facilities, 42 C.F.R. Sec. 405.415.... 60 36 The Secretary's construction of Sec. 405.415(g) is thus reasonable, and indeed is required by the underlying statute. 61 37 Humana next argues that a step-up in basis is appropriate for the eight transactions in which the stock acquisition was part of a two-step transfer of assets to the acquiror, citing Pacific Coast Medical Enterprises v. Harris (PCME). 62 In that case, PCME acquired 100 percent of the stock of Community Hospital of Los Angeles (Community) in an arms-length transaction, liquidating the acquired company approximately nine months later. The Secretary refused to characterize the transaction as a single purchase of an ongoing provider, but treated the stock purchase and liquidation as distinct events. The stock purchase was analyzed using 42 C.F.R. Sec. 405.626(c) (1979), 63 which established that a transfer of corporate stock would not, in itself, constitute a change of ownership requiring the filing of a new Medicare provider agreement. 64 Similarly, the Secretary reasoned, a stock transfer does not constitute a change in ownership of assets for purposes of Medicare reimbursement. The Secretary then analyzed the liquidation of Community under 42 C.F.R. Sec. 405.427(c)(2) (1983), which states that when a provider obtains facilities from an organization owned or controlled by the provider, the allowable basis is the cost of the facilities to the owned or controlled entity. 65 38 The Ninth Circuit found [t]he common usage and understanding of this transaction [to be] overwhelmingly contrary to the Secretary's characterization. 66 Common business practice, generally accepted accounting principles, the Internal Revenue Service, the Securities and Exchange Commission, and the California Commissioner of Corporations all recognized that PCME's 100 percent stock purchase and liquidation was in substance an acquisition of assets, 67 and was therefore a purchase of an ongoing operation entitling the acquiror to a new cost basis. The same principles govern our decision today. 68 As in PCME, the Secretary separately analyzes Humana's stock purchases and subsequent liquidations. And as in PCME, the Secretary's characterization of [a liquidating] transaction as two independent events, instead of a single purchase of an ongoing provider, [is] arbitrary, erroneous and irrational. 69 While permitting reimbursement for asset purchases but not 100 percent stock acquisitions is reasonable in light of the statute, 70 it is not reasonable to deny reimbursement for integrated transactions that are, in substance, asset acquisitions. The only possible basis we see for distinguishing Humana's transactions from straightforward asset purchases would be absence of a consistent intent to acquire assets. In PCME, the acquiror had intended from the outset of the transaction eventually to transfer to itself the assets of the acquired company. 71 If there is no such intent, then the two-step acquisition is not an integrated transaction, and the Secretary's bifurcated analysis is reasonable, if not flatly required by statute. 39 This analysis is consistent with this court's holding in Richey Manor, Inc. v. Schweiker, 72 which involved the purchase of 100 percent of the stock of a for-profit Medicare provider and its subsequent conversion into a not-for-profit corporation. The conversion's only effect 40 was to shift ownership of the assets from a for-profit corporation to a not-forprofit corporation.... [A]lthough the providers' stock changed hands, the assets remained in the hands of the [acquired] corporate entity.... And, although the corporate entities are not identical, the asset ownership continues to rest with a corporation separate and distinct from the purchaser of the stock. 73 41 So characterized, the transaction closely resembled the kind of stock acquisitions for which courts had previously denied stepped-up treatment. 74 42 Richey Manor held only that the conversion of the acquired company to non-profit status was not the equivalent of an asset acquisition for purposes of Medicare reimbursement. The panel in dicta, however, criticized PCME, and therefore the rationale of our holding today, for failing to take proper account of the recapture problem in liquidating transactions, a concern which is also the focus of the Secretary's argument in this case. Depreciation payments to providers are necessarily based on estimates. If the estimated depreciation on an asset exceeds the actual depreciation (due, e.g., to a faulty estimate of an asset's useful life), the provider may recognize gain upon disposition of the depreciated asset, whereupon the Secretary can recapture the excess depreciation payments under 42 C.F.R. Sec. 405.415(f) (1983). 75 The Richey Manor court was worried that, since this recapture provision does not apply to sales of stock (which is not a depreciable asset), allowing a step-up in basis following a 100 percent stock acquisition would destroy the symmetry of the regulatory scheme by divorcing a step up in basis [for the purchaser] from depreciation recapture [from the seller]. 76 43 The scope of this recapture problem is not at all clear. The recapture regulations expressly apply only to the disposal of a depreciable asset [that] results in a gain or loss.... 77 Since a corporation acquired in a simple stock transaction neither sells depreciable assets nor generally recognizes gain upon a subsequent merger or dissolution, treating a two-step transaction as a stock purchase for purposes of the recapture rules would indeed seem to create the loophole feared by the Secretary (and the Richey Manor panel). However, if integrated two-step transactions are characterized as asset purchases for purposes of both basis computations and recapture, they would trigger recapture obligations for the selling corporation. 78 The Secretary suggests that collecting these obligations would present administrative problems. If the acquired corporation is deemed to have sold assets and thereby to have incurred recapture liability, then following a liquidation this liability devolves upon the shareholders who received the sale proceeds (which in fact was payment for their stock). These shareholders may be difficult to locate, and would also no doubt be distressed at the prospect of paying their old corporation's recapture obligations, especially if the characterization of the transaction as an asset sale depends upon the acquiror's intent to acquire assets rather than their intent to sell stock. Even these problems can be avoided, however, if one views two-step transactions as sui generis for purposes of the Medicare scheme, sharing attributes of both stock and asset acquisitions. That is, if the transaction is characterized as an asset purchase for purposes of generating a recapture obligation, and as a stock purchase for purposes of determining the incidence of the liability, then the acquiror is simply liable for the recapture obligation its transaction generated. On this mixed analysis, the only stockholder--and hence the only party responsible for depreciation recapture--of the liquidating corporation following a 100 percent stock acquisition, is the acquiror. In the event of a post-acquisition merger, the surviving corporation (i.e., the acquiror) would inherit the recapture liability of the seller under general principles of corporate law. Thus, though we do not here decide the point, we note that the crisis envisioned by the Secretary and the Richey Manor panel is not necessarily imminent. Moreover, as far as the present case is concerned, Humana has agreed to assume any recapture liability of the acquired facilities, and the Provider Reimbursement Review Board conditioned its favorable determinations for Humana on the reimbursement issue upon the Providers' assuming the responsibility to see that the obligations under the Program relating to any gain to the sellers and appropriate recapture of depreciation are met. 79 But even if the existing regulations do not permit collection of recapture, or would make such collection administratively difficult, that seems to us a problem of the Secretary's own creation, which she must remedy. We believe that the requirements of fair reimbursement should determine the character of the recapture regulations, not vice versa. 80