Court Opinion

ID: 2659079
Source: CourtListenerOpinion
Date Created: 2014-04-01 14:49:52.423571+00
Date Added: 2024-06-11T12:17:54.486854
License: Public Domain

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.
                                2

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 low-
income 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.
                                 3

                                 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).
                                4

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.
                                5

    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.
                                  6

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.
                                 7

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.
                                8

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
                               9

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
                                10

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.
                                 11

     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
                              12

         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
                                13

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
                                 14

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
                                     15

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.
                                 16

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).