                                                                             F I L E D
                                                                      United States Court of Appeals
                                                                              Tenth Circuit
                                       PUBLISH
                                                                              APR 14 1998
                     UNITED STATES COURT OF APPEALS
                                                                          PATRICK FISHER
                                                                                    Clerk
                                  TENTH CIRCUIT



 ST. MARK’S CHARITIES
 LIQUIDATING TRUST, GEORGE E.
 BATES, TRUSTEE,

       Plaintiff-Appellant,

            v.                                              No. 97-4047

 DONNA E. SHALALA, Secretary of
 Health and Human Services,

       Defendant-Appellee.


                      Appeal from United States District Court
                               for the District of Utah
                                (D.C. No. 93-CV-565)


Charles P. Sampson (Carl F. Huefner with him on the brief), of Suitter Axland, Salt Lake
City, Utah, for the appellant.

Anthony J. Steinmeyer, Department of Justice, Washington, D.C., for the appellee.


Before BRISCOE, McWILLIAMS, and LUCERO, Circuit Judges.


BRISCOE, Circuit Judge.
       Plaintiff St. Mark’s Charities Liquidating Trust, the successor to St. Mark’s

Hospital, a former provider of Medicare services, appeals the district court’s judgment

affirming a final administrative decision of the Secretary of Health and Human Services.

We affirm.

                                              I.

       St. Mark’s opened in 1973 and participated as a provider in the Medicare program

until 1987. Pursuant to Medicare regulations, it claimed an annual allowance for

depreciation using the straight-line method and a forty-year estimated useful life for its

facility, as specified in the guidelines of the American Hospital Association. The hospital

was sold on December 31, 1987, for $39,400,000, plus the net book value of patient

accounts receivable, prepaid expenses, and inventory on the date of sale. Based upon an

appraisal, $27,438,284 was allocated to the building and fixed equipment. The historical

cost of these assets was $15,515,754. Over its fourteen-year period of operation, St.

Mark’s reported $7,866,716 in depreciation for these assets, of which $4,025,005 had

been reimbursed by Medicare since not all patients served by St. Mark’s had been

Medicare patients.

       St. Mark’s did not report any gain in its 1987 Medicare cost report for its sale of

the building and fixed assets. Blue Cross and Blue Shield of Utah, the Secretary’s

appointed fiscal intermediary, determined the entire amount of depreciation paid to St.

Mark’s should be “recaptured” in light of its overall gain on the sale of the building and


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the fixed assets. St. Mark’s challenged the determination by filing an administrative

appeal with the Provider Reimbursement Review Board (PRRB). Following an

evidentiary hearing, a majority of the PRRB affirmed the decision. St. Mark’s appealed

to the Administrator of the Health Care Financing Administration, which upheld the

decision of the PRRB, constituting final agency action under delegation from the

Secretary. St. Mark’s then filed this action for judicial review. The district court

affirmed the Secretary’s decision.

                                              II.

Scope of review

       We review the district court’s decision de novo. See Board of Trustees of Knox

County Hosp. v. Shalala, 135 F.3d 493, 499 (7th Cir. 1998). However, our review of the

Secretary’s underlying decision is governed by 42 U.S.C. § 1395oo(f), which incorporates

the standard of review of the Administrative Procedure Act (APA). Id.; see Kidney

Center of Hollywood v. Shalala, 133 F.3d 78, 84 (D.C. Cir. 1998). Under the APA, we

may set aside agency action only if it is “arbitrary, capricious, an abuse of discretion, or

otherwise not in accordance with the law.” 5 U.S.C. § 706(2)(A). Because St. Mark’s

contends the Secretary’s depreciation recapture regulation is not in accordance with the

express language of the Medicare Act, our review is governed by the familiar test set

forth in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837

(1984). See Kidney Center, 133 F.3d at 86; Good Samaritan Hosp. Reg. Med. Ctr. v.


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Shalala, 85 F.3d 1057, 1060 (2d Cir. 1996).



Depreciation reimbursement under Medicare Act

       Under the statutory scheme developed by Congress, Medicare providers are

reimbursed for the “reasonable cost” of providing services to Medicare patients. 42

U.S.C. § 1395f(b)(1). Reasonable cost is defined as “the cost actually incurred, excluding

therefrom any part of incurred cost found to be unnecessary in the efficient delivery of

needed health services,” and is determined pursuant to regulations established by the

Secretary. 42 U.S.C. § 1395x(v)(1)(A). “An appropriate allowance for depreciation on

buildings and equipment used in the provision of patient care is an allowable cost.” 42

C.F.R. § 413.134(a) (previously codified as 42 C.F.R. § 405.415(a)). However, the

regulations also authorize “recapture” of depreciation if disposal of a depreciable asset

“results in a gain.” 42 C.F.R. § 413.134(f)(1) (previously codified as 42 C.F.R. §

405.415(f)(1)). In such circumstances, recapture “is limited to the amount of depreciation

previously included in Medicare allowable costs.” Id.

       Prior to 1984, the Medicare Act was silent with respect to reimbursement for, or

recapture of, depreciation. In 1984, the Act was amended by the Deficit Reduction Act of

1984, Pub. L. No. 98-369, 98 Stat. 494 (1984), which added the following provision to

the definition of “reasonable costs”: “[The Secretary’s] regulations shall provide for

recapture of depreciation in the same manner as provided under the regulations in effect


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on June 1, 1984.” 42 U.S.C. § 1395x(v)(1)(O)(ii).

       Between 1974 and 1987, St. Mark’s was reimbursed by Medicare for depreciation

on its buildings and equipment. When the hospital was sold in 1987, the Secretary

determined all of the reimbursed depreciation would be recaptured because the sale had

resulted in a gain to St. Mark’s and the gain exceeded the entire amount of reimbursed

depreciation during the fourteen-year period.

       Although St. Mark’s all but concedes recapture of depreciation for 1984 through

1987 is proper in light of the 1984 amendments to the Medicare Act, it contends the

Secretary is not authorized to recapture any reimbursement payments made prior to that

time period. First, St. Mark’s argues the recapture regulation is contrary to the pre-1984

direction to reimburse providers for actual costs incurred. Second, it argues even though

the 1984 amendments authorized the recapture, application of that method to pre-1984

depreciation payments would be impermissibly retroactive.



Intent of pre-1984 Medicare Act

       According to St. Mark’s, the Secretary’s method of recapture precludes payments

for “reasonable costs,” i.e., actual costs incurred in providing services to Medicare

patients. More specifically, it argues the Secretary’s method of determining whether

depreciation payments have been excessive (i.e., by determining whether the sales price

exceeds the depreciated basis for a particular asset) fails to take into account other factors


                                             -5-
that might explain why an asset was sold for more than its depreciated basis (e.g.,

inflation, governmental regulation of entry, economic forces of supply and demand) and

does not properly account for the fact that depreciable assets are consumed each time they

are used to provide patient services.

       To ascertain the validity of the depreciation recapture regulation, we apply the

familiar two-set test of Chevron. If Congress has “directly spoken to the precise question

at issue,” then we “must give effect to the unambiguously expressed intent of Congress.”

467 U.S. at 842-43. However, if the statute “is silent or ambiguous with respect to the

specific issue,” we must defer to the Secretary’s interpretation if it is reasonable in light

of the structure and purpose of the statute. Id. at 843.

       It is uncontroverted that prior to 1984, Congress did not speak directly to the

precise question at issue, i.e., how depreciation payments should be recaptured (if at all).

Thus, the critical question is whether the depreciation recapture method is reasonable in

light of the structure and purpose of the Medicare statute. To date, the D.C. Circuit, the

Seventh Circuit, the Eleventh Circuit, and the Court of Claims have considered this

precise issue. See Whitecliff, Inc. v. Shalala, 20 F.3d 488 (D.C. Cir. 1994); Mercy

Community Hosp. v. Heckler, 781 F.2d 1552 (11th Cir. 1986); Stewards Foundation v.

United States, 654 F.2d 28 (Ct. Cl. 1981); Professional Medical Care Home, Inc. v.

Harris, 644 F.2d 589 (7th Cir. 1980). The First Circuit and the Eighth Circuit have

considered similar issues. See Creighton Omaha Reg. Health Care Corp. v. Sullivan, 950


                                              -6-
F.2d 563 (8th Cir. 1991); Hoodkroft Convalescent Center, Inc. v. State of New

Hampshire, 879 F.2d 968 (1st Cir. 1989) (reviewing similar recapture rules for Medicaid

providers). Of these courts, four have affirmed the Secretary’s method of recapture and

two have rejected it as contrary to the Medicare Act. The First, Seventh, and Eighth

Circuits, as well as the Court of Claims, have concluded the depreciation recapture

regulation is consistent with Congress’ directive to reimburse providers for “reasonable

costs,” i.e., costs actually incurred. Creighton, 950 F.2d at 565-66; Hoodkroft, 879 F.2d

at 972-75; Stewards, 654 F.2d at 34; Professional Medical Care, 644 F.2d at 592-94.

       In Professional Medical Care, the court noted even though depreciable assets age

over time, “a depreciation formula necessarily produces an inexact estimate of the partial

consumption of a physical asset, and it is difficult to be certain that any particular amount

is a cost actually incurred.” 644 F.2d at 593-94. Accordingly, the court concluded the

depreciation recapture regulation was “a valid implementation of the [Medicare] statute.”

Id. at 594.

       In Hoodkroft, the court agreed the depreciation recapture rules were a reasonable

and lawful interpretation of the federal statute, offering five reasons for its conclusion.

First, the Secretary, who had broad legal power to determine the scope of the federal

statute, had concluded depreciation recapture was consistent with the statute (also noting

the 1984 amendment was evidence that Congress itself believed the recapture rules were

consistent with the statute). 879 F.2d at 972-73. Second,


                                              -7-
       the law can, and often does, use the concept of “depreciation costs” to refer
       not to a physical fact (e.g., that a piece of equipment is worn), nor to an
       economic fact (e.g., that wear and tear make it less valuable than a new
       piece of equipment), but rather to an accounting fact, namely, a certain
       percentage of the nominal historical price paid for the item.

Id. at 973. The court concluded this “stylized allowance” “promises no more than that an

investor will eventually receive back the historical, nominal dollars that he invested in an

asset.” Id. Third, the court compared the Medicare/Medicaid program to public utility

regulation systems, which “typically promise[] the regulated firm only a reasonable dollar

profit calculated as a percentage of investment, as measured by historical, nominal dollar

costs.” Id. Fourth, the main reason for using historical, nominal dollars to calculate

depreciation and other costs was administrative efficiency. Id. at 974.

       To try to measure the current value of a facility each year; to try to assess
       the actual yearly economic losses caused by equipment wear and tear; to try
       to determine the extent to which any gain on resale reflects (a) less-than-
       expected wear and tear, (b) inflation, or (c) special market factors such as
       shortages, all would pose formidable administrative difficulties.

Id. Finally, the court concluded “it [wa]s difficult to say that the ‘historical cost’ system,

despite its failure to take inflation into account, [wa]s seriously unfair, as long as a facility

and its investors underst[oo]d the ground rules in advance.” Id. at 975.

       The Eleventh and District of Columbia Circuits have taken a different view. In

Mercy Community Hosp., the court concluded the Secretary’s interpretation of the

depreciation recapture regulation was not reasonably related to the purposes of the

enabling legislation. 781 F.2d at 1558. In reaching this conclusion, the court stated:


                                               -8-
               The . . . sale of the unconsumed remainder of . . . depreciable assets
       at a price in excess of their depreciated book value does not necessarily
       imply . . . that the provider did not actually incur some portion of the costs it
       was reimbursed for the consumption of the asset before it was sold. It may
       indeed be the case that, upon the sale of a long-lived asset, it will become
       apparent that some or all of the excess of selling price over depreciated
       book value reflects some miscalculation of the consumption of the asset that
       actually occurred while it was in the service of the Medicare program. . . .
               A gain on the sale of depreciable assets might result from other
       factors, however, that cannot possibly be said to suggest that the provider
       was overcompensated for consumption that occurred or compensated for
       consumption that did not occur. An increase in the demand for the
       provider’s assets, for example, may cause the market value of the
       unconsumed remainder of the provider’s assets to increase, although they
       are still being consumed at precisely the rate used to calculate the
       depreciation allowances that are paid under the Medicare program.

Id. at 1557. Similarly, in Whitecliff, the court noted “[t]he price of a hospital sold many

years after it was purchased will reflect a host of factors other than depreciation or wear

and tear.” 20 F.3d at 492-93. For example, “the role of inflation,” and “[c]hanges in the

availability of building materials and appropriate hospital sites.” Id. at 493. In light of

these other factors, the court concluded “a purchase in which the sale price exceeds the

depreciated basis does not necessarily indicate that depreciation payments made in the

past have been excessive. The two figures are, or at least may be, as apples and oranges

are to each other.” Id. Accordingly, the court concluded “the Secretary’s simplistic

linking of depreciation costs with diminished value” violated Congress’ decision that “the

cost actually incurred” be granted to Medicare providers. Id.

       We adopt the majority position and conclude the Secretary’s depreciation recapture

regulation is a reasonable and lawful interpretation of the Medicare Act. As noted by the

                                              -9-
First and Eleventh Circuits, and as exemplified by the parties’ arguments in this case, it is

difficult, if not impossible, to devise a depreciation formula that will accurately reflect

actual consumption of a physical asset at a particular point in time. Thus, the Secretary

has chosen to focus on the historical cost of an asset rather than its economic value and to

base annual depreciation estimates on that historical cost and the estimated life of the

asset. The result is that a provider is guaranteed recovery of the historical nominal dollars

it invests in each depreciable asset. The fact that this formula may not precisely reward a

provider with the actual costs of consuming a particular asset does not make the

regulation contrary to the Medicare Act, nor does it justify adoption of a different formula

that would require complicated and expensive administrative analysis.

       Having concluded the depreciation recapture regulation is a reasonable

interpretation of the pre-1984 Medicare Act, we find it unnecessary to address the

remaining argument concerning retroactivity of the 1984 amendment to the Medicare Act.

                                             III.

       The judgment of the district court is AFFIRMED.




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