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August 3, 1979

Hempstead General Hospital, Hempstead Park Nursing Home, and East Rockstead Associates, Plaintiffs,
Robert P. Whalen, as Commissioner of Health of the State of New York, Philip L. Toia, as Commissioner of Social Services of the State of New York, Hugh L. Carey, as Governor of the State of New York, David Mathews, as Secretary of the U.S. Department of Health, Education and Welfare and the Church Charity Foundation of Long Island, Defendants.

The opinion of the court was delivered by: PRATT



 In this action plaintiffs challenge the constitutionality of certain New York State Medicaid regulations, claiming that they (1) are inconsistent with federal law, (2) violate the Supremacy Clause, and (3) deprive plaintiffs of their property without due process of law. Plaintiffs seek both declaratory and injunctive relief compelling the state defendants to approve an application made by the defendant Church Charity Foundation to purchase a health-care facility now owned and operated by plaintiffs.

 Plaintiffs have moved for summary judgment, relying on extensive briefs, affidavits and a statement pursuant to E.D.N.Y. General Rule 9(g) of material facts alleged not to be in dispute. Defendants submitted no papers in opposition to the motion other than two brief affidavits which contain some discussion of the facts and brief discussion of the relevant law. It appeals clear from all of the papers filed that the essential facts are not disputed.


 Plaintiffs are three partnerships which own and operate two health-care facilities collectively known as Hempstead General Hospital Medical Center (medical center), consisting of Hempstead General Hospital (hospital), a general care facility which plaintiffs have owned and operated since 1956, and Hempstead Park Nursing Home (nursing home), a skilled nursing facility immediately contiguous to the hospital, which plaintiffs have owned and operated since 1966.

 The state and federal defendants are individuals charged in their official capacities with promulgating and implementing the statutes and regulations involved in this lawsuit.

 Also named as a defendant is the proposed purchaser of the medical center, The Church Charity Foundation of Long Island (CCF), a charitable organization which owns and operates, on a voluntary and not-for-profit basis, three hospitals and several other health-care facilities in the metropolitan New York area.

 In 1973, plaintiffs decided to sell the medical center to a charitable community organization, thereby changing the center from a private health-care facility to one operated on a voluntary, not-for-profit basis. Negotiations were initially had with a local civic group that had been organized as a not-for-profit corporation for the purpose of acquiring the medical center. When CCF became interested in purchasing the medical center, however, the local civic group withdrew from the proposed transaction. Since the medical center derives much of its income from Medicare, Medicaid, and Blue Cross and Blue Shield of Greater New York (Blue Cross), *fn1" plaintiffs and CCF structured their negotiations and preparation for the proposed sale with a view to the government regulations *fn2" and the requirements of those health-care plans.

 In December 1974, CCF filed with the New York State Department of Health a formal application to purchase and operate the medical center with copies forwarded for review to the Long Island Health and Hospital Planning Council, the Nassau-Suffolk Comprehensive Health and Hospital Planning Council, and the New York State Hospital Review and Planning Council. On February 28, 1975, the Long Island and Nassau-Suffolk councils recommended approval of CCF's application, with the sales price to be based upon an independent appraisal.

 As of July 1, 1975 an independent appraiser placed the value of the medical center at $ 12,929,000; *fn3" plaintiffs and CCF thereupon initially agreed to a purchase price of approximately $ 12,500,000. On July 31, 1975 the New York State Hospital Review and Planning Council recommended approval of the application contingent, however, upon a determination by the Department of Health that the proposed transaction would be financially feasible. *fn4" In the meantime, plaintiffs satisfied two other Department of Health prerequisites to the proposed transfer: "structural deficiencies" in the medical center's facilities were corrected and certain renovations made; and unsettled accounts between HEW and the center were resolved, with respect to the latter's indebtedness to the Medicare program.

 Under Article 28 of the New York State Public Health Law no hospital or nursing home may be "established" without the written approval of the New York State Public Health Council. New York Public Health Law § 2801-a(2). At a November 21, 1975 meeting, the Public Health Council deferred making a final decision on CCF's application, citing as reasons the high purchase price of approximately $ 12,500,000 and the view that plaintiffs may have been trying to take advantage of CCF. Plaintiffs and CCF subsequently negotiated a new reduced purchase price of $ 10,350,000, with plaintiffs to participate in financing the transaction by accepting a large long-term mortgage at a relatively low 6% Interest rate. *fn5"

 In a report dated January 15, 1976, the staff of the Department of Health found that the requirements of Public Health Law § 2801-a(3) had been met in that there was a public need for the transfer of ownership; the character, competence and standing of CCF in the community was satisfactory; and CCF had adequate financial resources and sources of future revenue to render the proposed transfer "financially feasible". The staff report, therefore, recommended approval of CCF's application.

 Notwithstanding this report, the Public Health Council at its February 20, 1976 meeting, again deferred action on the application because the available financial information indicated that "the proposed purchase and operation of the hospital and nursing home (was) not financially feasible." The council's specific concern was with how CCF, as a purchaser, would meet its debt obligations each year over the period of the mortgages, considering the limited reimbursement rates for health care that would be paid by Medicaid. The council felt that even when reduced to $ 10,350,000 the purchase price greatly exceeded the value that would be recognized for Medicaid reimbursement purposes, approximately $ 6,000,000; and that while the state, through Medicaid, would reimburse the $ 6,000,000 to CCF over a period of time, the difference would have to be absorbed by CCF.

 Under the statutory and regulatory framework discussed in Part III, Infra, providers of health-care services are entitled to reimbursement of certain of their costs, including their capital cost, I. e. the cost of depreciation and payments on indebtedness incurred in purchasing their facility. The state regulations challenged here provide that after a transfer, the cost of the capital assets to the buyer of a health-care facility (hospital or nursing home) will be the same as the cost of those assets to the seller. This means that the capital cost component of the Medicaid reimbursement rates now paid to the present owners of a facility (here, the plaintiffs) would, after a sale, be the same amount paid to the new owner (here CCF) without any increase for reimbursement of the purchase price. The state regulations thus recognize only the net depreciated value of the facility in computing the capital cost component of the reimbursement rate paid to the new owner, rather than the higher purchase price actually paid by the new owner. If the full purchase price were to be amortized over the years the money would not come from Medicaid reimbursement, but would have to be met by other income or assets of CCF. This the Public Health Council determined CCF would be unable to provide.

 By letter dated May 17, 1976, the Department of Health requested that CCF provide written assurances that in the event an operational surplus were not available and a sum in excess of the $ 125,000 already pledged were to become necessary, CCF would pledge its assets to assure continued operation of the medical center, and to meet all debt obligations. When such assurances were not forthcoming, the Department of Health staff reevaluated CCF's financial position and issued a report dated May 19, 1976 recommending disapproval of the application on the ground that there were inadequate sources of future revenue, thereby rendering the transaction not financially feasible.

 On June 21, 1976, CCF was notified that the Public Health Council proposed to disapprove its application to purchase and operate the medical center, and CCF promptly requested a hearing pursuant to Public Health Law § 2801-a(2). Even though the present litigation was instituted on December 20, 1976, the state administrative hearing was not held until late in the following year: October 19-21, November 4, 30, December 2, 22, 1977 and January 6, February 16, and March 29, 1978. In a report dated May 27, 1978, the hearing officer recommended that CCF's application be denied because it had failed to demonstrate adequate financial resources and adequate sources of future revenue. The Public Health Council adopted that recommendation.


 The Medicaid program, enacted as Title XIX of the Social Security Act, 42 U.S.C. § 1396 Et seq., provides for federal and state sharing of costs for medical and rehabilitation services provided to certain qualified individuals, specifically those in low income or indigent categories. This program of medical assistance is administered by the states through various state plans which are subject to the approval of the Secretary of HEW. Under the state plans, providers of health-care services, such as hospitals and nursing homes, are reimbursed for certain costs of the services provided. The New York State Plan for Medical Assistance was approved by the Secretary in 1970.

 The Medicaid statute sets forth requirements and guidelines for the content of state plans. It requires, Inter alia, that for hospital services the state plan shall provide for "payment of the Reasonable cost * * * as determined in accordance with methods and standards * * * which shall be developed by the State and reviewed and approved by the Secretary * * *." 42 U.S.C. § 1396a(a) (13)(D) (emphasis supplied). For nursing facilities, the statute requires a state plan to provide for "payment * * * On a reasonable cost related basis, as determined in accordance with methods and standards which shall be developed by the State on the basis of cost-finding methods approved and verified by the Secretary." 42 U.S.C. § 1396a(a)(13)(E) (emphasis supplied).

 Under the Medicaid statute, the reasonable costs for reimbursement of in-patient hospital services are not to exceed the amount that would be determined under the federal Medicare provisions, 42 U.S.C. § 1396a(a)(13)(D). *fn6" Although there is no comparable statutory provision with regard to reimbursement rates for skilled nursing services, the same result is required by the federal regulations which similarly provide that Medicaid reimbursement rates for such services shall not exceed Medicare limitations. See 42 C.F.R. § 447.315(c). *fn7"

 More importantly for purposes of this case, in determining what methods and standards it will apply to ascertain reimbursement rates for both hospitals and nursing homes, the state may either adopt the federal Medicare standards, or adopt different methods and standards, provided they are approved by the regional Medicaid director. 42 CFR §§ 447.261(b)(2), (d) & 447.276(c). Thus, although the Medicare reimbursement methods and standards provide a maximum limit on reimbursement rates, they do not prevent a state from using other methods or standards in fixing its reimbursement rates.

 The reimbursement rate paid to health-care providers is made up of a number of factors, one of which is based on capital cost, I. e., what had been paid for the facility. Prior to 1975, the applicable state regulations permitted a provider's capital cost component to include the cost of purchasing the facility. Under those regulations then, CCF's purchase price of $ 10,350,000 would have been the basis for the capital cost component for reimbursement for Medicaid services. However, on March 10, 1975, the state defendants promulgated amendments to the methods and standards used to calculate Medicaid reimbursement rates; those amendments, which by their terms became effective on October 14, 1975, but which were not approved by the Secretary until August 16, 1976, limit the capital cost component for reimbursement to the net depreciated value of the facility, rather than the purchase price.

 In one of their moving affidavits plaintiffs acknowledge that underlying the new regulations, which had been promulgated in response to New York's nursing home scandals, were certain principles:

1. The State should pay for a facility only once.
2. Reimbursement must be reasonably related to the delivery of health care services and not be dependent upon real estate transactions and changes of ownership.
3. Excessive profits must be eliminated, particularly where they are totally unrelated to the improvement of either the quality or quantity of health care services delivered.
4. Similar facilities should receive similar reimbursement without regard to the nature of ...

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