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Southgate Health Care Center v. New Jersey Dep't of Health and Senior Services


January 21, 2009


On appeal from Department of Health and Senior Services.

Per curiam.


Argued September 23, 2008

Before Judges Skillman, Graves and Grall.

Southgate Health Care Center is a nursing facility that is reimbursed, at a per diem rate, for services provided to residents who are beneficiaries of Medicaid. Depreciation is a component of that per diem rate. Southgate appeals from a final decision and order of the Commissioner of Health and Senior Services that compels Southgate to justify a $188,833.53 increase in depreciation in accordance with a federal Medicare regulation. We denied a motion to intervene filed by the Health Care Association of New Jersey but granted the Association leave to file an amicus brief.

Relying on the Administrative Procedure Act (APA), N.J.S.A. 52:14B-1 to -15, and Metromedia, Inc. v. Dir., Div. of Taxation, 97 N.J. 313 (1984), Southgate contends that the Commissioner may not resolve its administrative appeal by applying a federal Medicare regulation that has not been adopted pursuant to N.J.S.A. 52:14B-4.*fn1 For the reasons stated below, we modify and affirm the Commissioner's order.


"The Medicaid program, established by Title XIX of the Social Security Act, is a joint federal-state program designed to provide medical care for indigent, disabled and elderly persons. 42 U.S.C.A. § 1396." United Hosps. Med. Ctr. v. State, 349 N.J. Super. 1, 4 (App. Div. 2002); see 42 C.F.R. § 430.0. Within parameters set by Title XIX and federal Medicaid regulations, each state develops its own plan for Medicaid services, including "payment levels for services." 42 U.S.C.A. §§ 1396a(a)-(b), 1396b(a); see 42 C.F.R. §§ 400.200, 430.0, .10, .12, .15, .35. Under New Jersey law, all Medicaid payments must be "reasonable." N.J.S.A. 30:4D-7(b). Federal law requires payment at a rate "consistent with efficiency, economy, and quality of care" and "sufficient to enlist enough providers."

42 U.S.C.A. § 1396a(a)(30)(A). Responsibility for fixing payment rates for nursing facilities and authority to adopt regulations for reimbursement consistent with federal and state law is delegated to the Commissioner. N.J.S.A. 30:4D-7a, b; see N.J.S.A. 30:4D-4; Executive Reorganization Plan No. 001-1996 at ¶ 14 (published at 28 N.J.R. 2655(a), 2658 (June 3, 1996) (transferring the statutory responsibility)).

Southgate commenced operations in 1986, and Medicaid beneficiaries receive approximately sixty percent of the daily care Southgate provides.*fn2 The per diem Medicaid reimbursement rate for Southgate, and the rate for every other nursing facility participating in the Medicaid program, is set annually for the upcoming year. N.J.A.C. 8:85-3.1, -3.2(a).*fn3

Southgate and other nursing facilities submit annual "cost reports" that provide the data used to establish prospective per diem rates. N.J.A.C. 8:85-3.2. The Department developed the "reimbursement formulae" to meet federal and state standards for reimbursement and "end opportunities for excessive property cost reimbursement." N.J.A.C. 8:85-3.1(f)1-3. Depreciation of a facility's building is one component of the rate formula, which includes capital costs. N.J.A.C. 8:85-3.3(b), -3.10.

Capital costs are screened for reasonableness. Two capital cost figures are calculated, "actual cost" and an "aggregate 'capital facilities allowance' (CFA)." N.J.A.C. 8:85-3.10(c)(1)-(2). The CFA is "the maximum reasonable reimbursement."*fn4 Ibid. The actual cost is the nursing facility's "total actual . . . expenses for depreciation, interest and rental." Ibid. The lower of these two figures is used to calculate the facility's per diem reimbursement rate.

In every annual report for years 1987 through 2001, Southgate listed a depreciation expense of $75,233.68 for its building.*fn5 For those years, Southgate calculated depreciation for its building as a single unit with an estimated useful life of forty years.

Southgate took a different approach when it filed its report on costs in 2002. For that year, Southgate revised the estimated useful life of its building by segregating the structural components and estimating the useful life of each component separately. As a consequence, Southgate's depreciation expense rose from $75,233.68 to $264,067.21, an increase of $188,833.53. The increase put Southgate's actual cost over the CFA, and, on that basis, Southgate sought an allowance for capital costs in the amount of the CFA.

There is no evidence of any precedent for Southgate's change in estimated useful life. Neither the Department nor Southgate has identified a prior instance in which a nursing facility was given credit on that ground for depreciation greater than the amount reported in the prior year.

When Southgate filed its report showing an increased depreciation expense, the Department disallowed the increase as based on an unallowable change in the asset's estimated useful life. Although the Department's regulations do not address estimated useful life, N.J.A.C. 8:85-3.1(d) cautions that "an exhaustive list of unreasonable costs" is not provided and reserves the Commissioner's right "to question and exclude any unreasonable costs." Ibid. (referencing the enabling act).

In disallowing Southgate's increased cost, the Department relied upon Medicaid Bulletin 85-5, which was issued in 1985 but not adopted in accordance with N.J.S.A. 52:14B-4. Bulletin 85-5 provided for depreciation of assets with an estimated useful life greater than one year and a value greater than $500 in accordance with a schedule of estimated useful lives provided with the bulletin; forty years was the estimate listed for a building constructed after 1959. Pursuant to Bulletin 85-5, "component depreciation" of a building "is allowable" only if the asset is "segregated into its component parts and . . . so recorded[] in the facility's depreciation records at the time of initial acquisition." The useful life of each component was to be estimated "in accordance with the American Hospital Association guidelines, 1983 Edition."

Southgate challenged the Department's denial in an administrative appeal authorized by N.J.A.C. 8:85-3.21. Southgate relied on guidelines and instructions for calculating and reporting depreciation and amortization that the Department had issued, without formal rulemaking, subsequent to Bulletin 85-5. The guidelines direct that "[a]sset values, and lives, used to calculate depreciation and amortization on [the facility's] tax return should coincide with the reporting." The instructions require reporting in conformity with "Generally Accepted Accounting Principles" and as done "for federal tax purposes." Southgate reasoned that these documents authorized inclusion of all depreciation costs allowable under federal tax law and, on that basis, relied on a 2003 opinion issued by a federal court that allowed a depreciation expense based on a revised estimate of useful life.

Southgate also defended the method it utilized in re-estimating its building's useful life. The estimates, Southgate explained, were based on guidelines published by the American Hospital Association. And, according to Southgate, "its depreciation expense [was reported] in accordance with Medicare requirements and generally accepted accounting principles." (emphasis added).*fn6

The Commissioner concluded that he could not rely on Bulletin 85-5 to deny an increase based on change of an asset's estimated useful life because the bulletin had not been adopted in accordance with N.J.S.A. 52:14B-4. Nevertheless, the Commissioner determined that he had the authority to exclude "unreasonable costs" and compel Southgate to establish grounds for an adjustment by justifying its revised estimate of useful life in accordance with a federal Medicare regulation, 42 C.F.R. § 413.134(b)(7)(iii). See N.J.A.C. 8:85-3.1, 3.21(a)2(iv).

In pertinent part, 42 C.F.R. § 413.134(b) provides:

(7) Useful life. The estimated useful life of a depreciable asset is its normal operating or service life to the provider, subject to the provisions in paragraph (b)(7)(i) of this section. Factors to be considered in determining useful life include normal wear and tear; obsolescence due to normal economic and technological changes; climatic and other local conditions; and the provider's policy for repairs and replacement.

(i) Initial selection of useful life. In selecting a proper useful life for computing depreciation under the Medicare program, providers must use the useful life guidelines published by CMS [Centers for Medicare & Medicaid Services]. If CMS has not published applicable useful life guidelines, providers must use --(A) The edition of the American Hospital Association useful life guidelines, as specified in CMS Medicare program manuals; or

(B) A different useful life specifically requested by the provider and approved by the intermediary. A different useful life may be approved by the intermediary if the provider's request is properly supported by acceptable factors that affect the determination of useful life. However, such factors as an expected early sale, retirement, demolition or abandonment of an asset, or termination of the provider from the Medicare program may not be used.

(iii) Changing useful life. A change in the estimated useful life may be made if clear and convincing evidence justifies a redetermination of the useful life used by the provider. Such a change must be approved by the intermediary in writing, and the factors cited in paragraphs (b)(7) and (b)(7)(i) of this section are applicable in making such redeterminations of useful life. If the request is approved, the change is effective with the reporting period immediately following the period in which the provider's request is submitted for approval.

The Commissioner's final decision and order determines that the Department's "application of Bulletin 85-5 violates the APA and Metromedia" and "the depreciation methods outlined in federal rules apply in the absence of guidelines promulgated by the [Department]."*fn7 On those grounds, he "ordered that . . . Southgate be required to present evidence at another . . . hearing that a change in useful life is reasonable and justified in accordance with 42 C.F.R. § 413.134(b)."


"[A]dministrative agencies possess extremely broad authority to determine whether to act through rulemaking, adjudication or informal procedures." In re Utilization and Quality Review for Calendar Year 1993, 273 N.J. Super. 205, 224 (App. Div. 1994); see In re Request for Solid Waste Util. Customer Lists, 106 N.J. 508, 518-21 (1987). The choice "is highly discretionary, and . . . agencies have wide latitude in improvising appropriate procedures to effectuate their regulatory jurisdiction." Metromedia, supra, 97 N.J. at 333; see Airwork Serv. Div. v. Dir., Div. of Taxation, 97 N.J. 290, 303 (1984). "'Some principles . . . must be adjusted to meet particular, unforeseeable situations.'" In re Certain Sections of the Unif. Admin. Procedure Rules, 90 N.J. 85, 92 (1982) (quoting SEC v. Chenery Corp., 332 U.S. 194, 201-202, 67 S.Ct. 1575, 1580, 91 L.Ed. 1995, 2002 (1947)).

Nonetheless, the agency's discretion in selection of an appropriate procedure is not absolute. "[A]dministrators must do what they can to structure and confine their discretionary powers through safeguards, standards, principles and rules," Crema v. N.J. Dep't of Envtl. Prot., 94 N.J. 286, 301 (1983) (internal quotation omitted), and choice of procedures must be consistent with the dictates of the APA as construed by our courts. Metromedia, supra, 97 N.J. at 334.

The APA defines an administrative rule as an "agency statement of general applicability and continuing effect that implements or interprets law or policy, or describes the organization, procedure or practice requirements of any agency." N.J.S.A. 52:14B-2(e). The statute expressly includes amendment and repeal of existing rules and excludes decisions and findings in contested cases from that definition. Ibid.

The "outer limits" of an agency's ability to forego rulemaking and opt for informal action or adjudication are set by the standards set forth in Metromedia, supra, 97 N.J. at 334. "[A]n agency determination must be considered an administrative rule when all or most of the relevant features of administrative rules are present and preponderate in favor of the rule-making process." Id. at 331. The characteristics of a decision that typify rulemaking are that it (1) is intended to have wide coverage encompassing a large segment of the regulated or general public, rather than an individual or a narrow select group; (2) is intended to be applied generally and uniformly to all similarly situated persons; (3) is designed to operate only in future cases, that is, prospectively; (4) prescribes a legal standard or directive that is not otherwise expressly provided by or clearly and obviously inferable from the enabling statutory authorization; (5) reflects an administrative policy that (i) was not previously expressed in any official and explicit agency determination, adjudication or rule, or (ii) constitutes a material and significant change from a clear, past agency position on the identical subject matter; and (6) reflects a decision on administrative regulatory policy in the nature of the interpretation of law or general policy. [Id. at 331-32.]

The Court identified these characteristics of rulemaking in consideration of principles implicated by agency action. When an agency is addressing matters not resolved by statute and involving "broad policy issues" and "affect[ing] a large segment of the regulated public or general public" or is contemplating a change in the "status quo," there is a "need for general fairness and decisional soundness." Id. at 330-31. The procedures required for rulemaking - prior public notice, a "flexible and expansive" fact-finding process, and an opportunity for interested parties and the public to present information and participate in formulation of the determination before it is final - serve those needs. Ibid.; see N.J.S.A. 52:14B-4.

The Commissioner's decision has two components, which must be tested separately under the Metromedia standard. The first component is the Commissioner's decision to disallow Southgate's increased depreciation cost unless Southgate demonstrates that its revised estimate of useful life is "reasonable." The second component is the Commissioner's determination to require Southgate to demonstrate reasonableness in accordance with 42 C.F.R. § 413.134(b).

First, the Commissioner's decision to disallow Southgate's dramatic increase in depreciation expense as "unreasonable" absent proof of a justification is not invalid for failure to promulgate a regulation. The Commissioner's obligation and intention to limit payment to "reasonable" costs consistent with "economy" is directly stated in the state and federal laws and state regulations. N.J.S.A. 30:4D-7b; 42 U.S.C.A. § 1396a(a)(30)(A); N.J.A.C. 8:85-3.1; see Airwork, supra, 97 N.J. at 301. Further, the Commissioner's decision to question the dramatic increase based on a revision of an asset's estimated useful life is not inconsistent with any regulation or past administrative policy or practice. Change in an asset's estimated useful life was not expressly authorized by statute or regulation, and it was prohibited by an agency directive not promulgated in accordance with N.J.S.A. 52:14B-4. Moreover, there is no evidence that any nursing facility, including Southgate, ever revised an asset's estimated useful life prior to Southgate's attempt. Southgate's attempt deviated from prior practice and policy and that action led to the agency's response.

Southgate argues that the Department's challenge to its increased depreciation expense conflicts with policy and practice established when the Department directed nursing facilities to report depreciation cost as reported on tax returns. But in making that argument, Southgate relies on a judicial decision addressing depreciation for purposes of federal taxation that was not issued until 2003. Department guidelines and instructions issued before that decision cannot have been informed by the ruling, nor do those documents purport to incorporate federal tax law without regard to its content.

Southgate also contends that the Department's challenge to Southgate's "actual" cost report is in conflict with the Department's regulation establishing the CFA as the maximum reasonable cost. That argument is inconsistent with statutory law, which limits payment to costs that are reasonable and economical, and with the regulation, which provides for the "lower" of the CFA or actual costs. Long before Southgate's attempt to revise estimated useful life, the Department revised its regulations to "more closely relat[e] reimbursement to costs incurred in providing nursing facility services." 27 N.J.R. 3314(a), 3315 (September 5, 1995); 27 N.J.R. 156(a) (January 3, 1995).

Faced with Southgate's unprecedented request to change an estimate of an asset's useful life and yield a depreciation expense more than double that reported in fifteen prior years, the Commissioner excluded that expense as unreasonable pending Southgate's proof of a justification. That action was consistent with the Commissioner's clear statutory obligation to provide reasonable reimbursement consistent with economy, N.J.S.A. 30:4D-7b and 42 U.S.C.A. § 1396a(a)(30)(A), and regulations authorizing exclusion of unidentified "unreasonable costs" and affording an administrative appeal. N.J.A.C. 8:85-3.1, 8:85-3.21. Without question, this aspect of the Commissioner's final order is a permissible application of the enabling law and the Department's regulations, and it did not require rulemaking in accordance with the APA. See In re Utilization and Quality Review for Calendar Year 1993, supra, 273 N.J. Super. at 223-24.

The second question remains. That question is whether the Commissioner can require Southgate to demonstrate that its change in the estimated useful life of this asset is reasonable and justified in accordance with 42 C.F.R. § 413.134(b)(7)(iii) without adopting that regulation in accordance with N.J.S.A. 52:14B-4. We conclude that on these facts, the Commissioner's decision to apply the standards set forth in that Medicare regulation in resolving Southgate's challenge is not invalid for failure to adopt the rule.*fn8

As noted above, when the Department requested an explanation of Southgate's "factual basis for . . . chang[ing] the estimated asset life of the building," Southgate responded by asserting that it used "AHA Guidelines in accordance with Medicare requirements and generally acce[p]ted accounting principles." Because Southgate relied on the consistency of its action with "Medicare requirements," we affirm that aspect of the Commissioner's order. In light of Southgate's proffer, the Commissioner did little more than identify the relevant Medicare regulation and gave Southgate an additional opportunity to prove the justification it asserts.

Thus, in the context of this case, the considerations that militate in favor of the rulemaking process are not implicated. Presumably, the federal Medicare rule was promulgated in accordance with federal-rulemaking procedures, which diminishes the importance of additional "broad fact-finding and informational procedures typical of rulemaking" to "buttress the soundness of the determination[s]" incorporated in the Medicare regulation. See Airwork, supra, 97 N.J. at 301. Further, application of the Medicare regulation cannot be deemed unfair to Southgate, because Southgate asserted, in part, that its change in the estimated useful life of the asset was consistent with Medicare requirements and therefore reasonable. See ibid.

We recognize that the Commissioner's decision is not based on Southgate's assertion of conformity with Medicare requirements, but courts review "orders and judgments . . . not . . . opinions, oral decisions, informal written decisions, or reasons given for the ultimate conclusion." Do-Wop Corp. v. City of Rahway, 168 N.J. 191, 199 (2001).

Our approval of the Commissioner's reliance on Medicare standards without formal rulemaking is limited to application of 42 C.F.R. § 413.134(b)(7)(iii) in this case and only to the extent that the standards are not in conflict with regulations, guidelines and policies the Department has applied in the past.*fn9

Under Metromedia and the APA, any application of 42 C.F.R. § 413.134(b)(7)(iii) that results in a de facto revision of existing regulations or prior policy should be adopted by rule.

We reject the Commissioner's broad conclusion that 42 C.F.R. § 447.205 permits the Department to adopt a Medicare regulation for general application as part of the State's Medicaid plan without complying with the APA. Ordinarily, federal law and regulations require states to amend Medicaid plans through a public process. 42 U.S.C.A. § 1396a(a)(13); 42 C.F.R. § 447.205. Section 447.205(b) provides a narrow exception that applies when a state amendment incorporates Medicare rules. That exemption from federal requirements has no impact on the Commissioner's obligations under the APA.

While Medicare and Medicaid are related in some respects,*fn10 the programs are separate and, as noted above, Medicaid plans are essentially state plans. In other instances, when the Department has incorporated Medicare standards, it has done so through rulemaking. See, e.g., N.J.A.C. 8:85-3.11(f)1(i)-(iii). And, the Department has not previously given any indication of an intention to regularly develop the State Medicaid plan through ad hoc importation of unidentified Medicare rules and policies. Arguably, such an approach would do little to structure the Department's discretion in ratemaking. See Crema, supra, 94 N.J. at 301.

Accordingly, to the extent that the Commissioner's final decision and order purport to adopt 42 C.F.R. § 413.134(b) and "depreciation methods outlined" therein as a rule of general and prospective application, it is invalid for failure to comply with the APA and Metromedia. Such broad statements of general policy applicable to the regulated class have no validity unless adopted in accordance with the APA. Metromedia, supra, 97 N.J. at 334.

Affirmed as modified.

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