STATE OF FLORIDA

DIVISION OF ADMINISTRATIVE HEARINGS

BEVERLY CALIFORNIA CORPORATION, )

)

Petitioner, )

)

vs. ) CASE NO. 89-1653

)

DEPARTMENT OF HEALTH AND )

REHABILITATIVE SERVICES, )

)

Respondent. )

)

RECOMMENDED ORDER

Pursuant to notice, the Division of Administrative Hearings, by its duly designated Hearing Officer, William F. Quattlebaum, held a formal hearing in the above-styled case on December 20, 1990, in Tallahassee, Florida.

APPEARANCES

For Petitioner: Joseph E. Casson

David C. Beck CASSON & HARKINS

1233 Twentieth Street Northwest, Suite 800 Washington, D. C. 20036

For Respondent: Peter A. Lewis

Assistant General Counsel Department of Health and

Rehabilitative Services 1323 Winewood Boulevard

Tallahassee, Florida 32399-0700 STATEMENT OF THE ISSUE

On August 1, 1986, Petitioner Beverly California Corporation sold the Suwanee Health Care Center to a real estate investment trust, Beverly Investment Properties, Inc. On the Suwanee facility's Medicaid cost report for the annual period ending June 30, 1987, Petitioner included $242,142 of interest expense and $2,137,556 of debt. Following an audit of the Suwanee cost report, the Department of Health and Rehabilitative Services disallowed the interest expense and debt. The issue in this case is whether the Department's disallowance of the interest expense and debt is appropriate under applicable Medicaid regulations and other Medicaid program materials.

PRELIMINARY STATEMENT

In November 1988, the Respondent notified the Petitioner that certain audit adjustments related to Medicaid cost reports were being made. The Petitioner apparently requested informal hearing. Preliminary discussions between the parties appear to have resulted in substantial disagreement related to material

facts. Thereafter, on March 29, 1989, the Petitioner filed with the Division of Administrative Hearings, a request that a formal hearing be scheduled.

On April 10, 1989, an initial procedural order was issued by the undersigned Hearing Officer. Pursuant to the parties response to the order, the case was set to be heard on June 7, 1989. Upon joint motions, the case was rescheduled several times to permit settlement negotiations to continue. 1/ On September 18, 1990, the parties filed a Joint Stipulation of Partial Settlement setting forth the partial settlement agreement related to this case and other.

The remaining issues were rescheduled for hearing for December 20, 1990.

At hearing, Petitioner presented the testimony of George Turon and Michael Maher and had five exhibits admitted. Respondent presented the testimony of Charles Patterson and Gary Crayton. Joint exhibits numbered 1-5 were admitted. The prehearing stipulation filed by the parties was admitted as a Hearing Officer's exhibit.

A transcript of the hearing was filed on January 22, 1991. Thirty days was allowed for the filing of proposed recommended orders. Both parties timely filed their proposed orders. The proposed findings of fact are ruled upon either directly or indirectly as reflected in this Recommended Order, and in the Appendix which is attached and hereby made a part of this Recommended Order.

FINDINGS OF FACT

1. The Department of Health and Rehabilitative Services ("DHRS") administers Florida's Medicaid program and licenses nursing homes to participate in the program. Florida's Medicaid program operates pursuant to the Florida Title XIX Long-Term Care Reimbursement Plan ("Plan"). The Plan expressly incorporates numerous Medicare statutes and other provisions. Medicare reimbursement principles, set forth in the Medicare Provider Reimbursement Manual ("HIM-15"), are applicable to this case.

   
   

2. The Plan governs reimbursement for nursing homes participating in Florida's Medicaid program. Participating nursing homes are required to submit cost reports to the DHRS, which audits the reports to assure that such costs are allowable under Medicaid program regulations. Beverly submits such reports on behalf of Suwanee to the DHRS.

   
   

3. Prior to August 1, 1986, the Beverly California Corporation ("Beverly") owned and operated Suwanee Health Care Center ("Suwanee"). Suwanee is licensed to participate in the Florida Medicaid program.

   
   

4. Suwanee was constructed in 1983 and was financed through the sale of bonds. In 1985, Beverly organized a real estate investment trust ("REIT"), Beverly Investment Properties, Inc. 2/ An REIT raises capital funds through the sale of stock and pays dividends to shareholders. The payment of dividends constitutes the shareholder return on the invested funds.

   
   

5. At all times relevant to this proceeding, the REIT, created to provide capital financing for long term health care facilities, constituted a valid real estate investment trust. The REIT purchased the Suwanee facility using funds raised from investors through the sale of stock, and to whom the REIT paid dividends.

   
   

6. At the time the REIT was organized in 1985, Beverly owned 5% of the REIT's stock (although at the time of hearing, it held two and one-half percent

   of the stock). Five of the nine directors and officers of the REIT were associated with Beverly3. The REIT was advised by Beverly Advisors. LTD., a wholly owned subsidiary of Beverly. 3/

   
   

7. On August 1, 1986, Beverly sold Suwanee to the REIT. 4/ On the same date, Beverly leased Suwanee back from the REIT. The sale and leaseback transaction extinguished Beverly's debt on the property. The lease has a fixed term of 14 years with an optional extension for an additional 40 years. Monthly payments are set forth in the lease and escalate over time. The REIT assumed the debt at the time of the sale. The bonds securing the debt were defeased on August 26, 1986.

   
   

8. Beverly properly provided notice to the DHRS prior to the execution of the transaction and reported the sale-leaseback arrangement as a related party transaction. The DHRS indicated that no certificate of need or change in licensure was required.

   
   

9. On the cost report submitted by Beverly for Suwanee's annual reporting period ending June 30, 1987, Beverly included one month of actual interest and eleven months of "imputed" interest. Beverly based the imputed interest calculation on dividends paid to REIT investors for the period subsequent to the August 1st sale and leaseback.

   
   

10. Prior to the sale and leaseback transaction, Beverly received reimbursement from the Florida Medicaid program for property costs related to the Suwanee facility. Such costs included depreciation on the building and equipment, interest expense on the debt incurred to finance the building and equipment, insurance costs and property taxes.

    
    

11. In preparing the Suwanee facility's fiscal 1987 cost report, Beverly determined that it should report the lesser of either the property costs prior to the sale and leaseback, or the property costs to the REIT. The costs to the REIT included the cost of dividends paid to investors.

    
    

12. The REIT costs were lower that Suwanee's previous property costs. Beverly included the REIT costs on Suwanee's fiscal 1987 cost report. 5/

    
    

13. The initial program audit for the Suwanee fiscal 1987 cost report was performed by Peat Marwick, which provided to Beverly a summary of proposed audit adjustments prior to the audit exit conference. The audit adjustment which is the subject of this case was neither identified in the summary nor discussed at the Peat Marwick-Beverly exit conference.

    
    

14. When the DHRS reviewed the Suwanee cost report audit, the DHRS determined that the imputed interest should be disallowed because Beverly's debt on the Suwanee facility had been extinguished by the sale of the property to the REIT. The DHRS determined that Beverly's equity position related to the "debt- free" facilities should be correspondingly increased. The result of the DHRS adjustment is a reduction in Beverly's property cost basis of more than

    $242,000.

    
    

15. The evidence establishes that, under applicable reimbursement principles, DHRS appropriately disallowed the imputed interest reported by Beverly and appropriately increased Beverly's equity position in the Suwanee facilities.

    CONCLUSIONS OF LAW

    
    

16. The Division of Administrative Hearings has jurisdiction over the parties to and subject matter of this proceeding. Section 120.57(1), Florida Statutes.

    
    

17. The issue in this case is whether the Department's disallowance of the interest expense and debt is appropriate under applicable Medicaid regulations and other Medicaid program materials. Petitioner has the burden of establishing that the audit adjustments are improper. Agrico Chemical Co. v. Department of Environmental Regulation, 365 So.2d 759 (Fla. 1st DCA 1978). The burden has not been met.

    
    

18. In the sale-leaseback transaction which is the subject of the instant case, the sale of the Suwanee facility to the REIT extinguished Beverly's debt on the facility. Dividends paid to REIT investors were claimed by Beverly as "imputed interest" on the Medicaid cost report.

    
    

19. The evidence does not suggest that Beverly attempted to claim additional costs related to the sale and leaseback transaction, or that Beverly attempted to artificially inflate costs or otherwise achieve an inappropriate profit factor through the leaseback from the REIT.

    
    

20. Beverly and the REIT were related parties at the time of the sale- leaseback transaction. Costs applicable to facilities furnished to a provider by related organizations are governed by 42 CFR 405.427 Medicare (Title XVIII) Principles of Reimbursement, and Chapter 10, HIM-15. Section III, Subsection F, Florida Title XIX Long-Term Care Reimbursement Plan.

    
    

21. Generally, costs applicable to services, facilities, and supplies furnished to the provider by organizations related to the provider by common ownership or control are includable in the allowable cost of the provider at the cost to the related organization. However, such cost must not exceed the price of comparable services, facilities, or supplies that could be purchased elsewhere. The purpose of this principle is two-fold: (1) to avoid the payment of a profit factor to the provider through the related organization (whether related by common ownership or control), and (2) to avoid payment of artificially inflated costs which may be generated from less than arm's-length bargaining. Section 1000, Chapter 10, HIM-15.

    
    

22. The related organization's costs include all reasonable costs, direct and indirect, incurred in the furnishing of services, facilities, and supplies to the provider. The intent is to treat the costs incurred by the supplier as if they were incurred by the provider itself. Therefore, costs which are unallowable when incurred by the provider, are unallowable when incurred by the related organization. Principles of reimbursement set forth in HIM-15 will be generally followed in determining the reasonableness and allowability of the related organization's costs, except where application of a principle to a nonprovider entity would be clearly inappropriate. Section 1005, Chapter 10, HIM-15.

    
    

23. Interest paid by a provider to organizations related to the provider is generally not allowable as cost. One of the elements required for interest to be considered allowable under applicable reimbursement principles is that the interest not be paid to a lender related through control, ownership, or personal relationship to the borrowing organization. Where the owner uses his own funds

    in a business, the funds are considered invested funds or capital, rather than borrowed funds. Therefore, when a related organization makes a loan to a provider and the interest on the loan is not allowable as cost, the loan is considered as part of the equity capital of the provider. Sections 218 and 218.1, Chapter 2, HIM-15. Similarly, health care providers may not report dividends as allowable costs. Therefore, unless the application of this principle is clearly inappropriate, dividends paid by the REIT are not allowable costs.

    
    

24. A provider may lease a facility from a related organization, however, the rent paid to the lessor by the provider is not allowed as cost. In such cases the provider would include, as part of its allowable costs, the cost of ownership of the facility. Generally, these would be costs such as depreciation (subject to limitations), interest on the mortgage, real estate taxes, and other expenses attributable to the leased facility. The effect is to treat the facility as though it were owned by the provider. Section 1011.5, Chapter 10, HIM-15.

    
    

25. Beverly suggests that HIM-15, Section 110, which permits the inclusion of rent in allowable costs, is applicable to the sale-leaseback transaction in this case. In part, section 110 provides:

    
    

    Sale and Leaseback Agreements--Rental Charges.

    --Where a provider enters into a sale and leaseback agreement with a non-related pur- chaser involving plant facilities or equipment the incurred rental specified in the agreement is includable in allowable costs if the fol- lowing conditions are met:

    1. The rental charges are reasonable based upon a consideration of rental charges of com- parable facilities and market conditions in the area; the type, expected life, condition and value of the facilities or equipment rented and other provisions of the rental agreements;

    2. Adequate alternative facilities or equipment which would serve the purpose are not or were not available at lower cost; and

    3. The leasing was based upon economic and technical considerations.

       If all these conditions were not met, the rental charge cannot exceed the amount which

       the provider would have included in reimbursable costs had he retained legal title to the facilities or equipment, such as interest on mortgage, taxes, depreciation, insurance and maintenance costs. (emphasis supplied)

       
       

26. Beverly's asserts that their related party status with the REIT is merely a "condition" which limits the amount of reimbursement. However, the referenced section clearly applies only to sale and leaseback agreements between providers and a non-related purchasers. The plain language of section 110 designates the "conditions" as those identified by numbers 1-3.

27. At hearing, Beverly asserted that, if the DHRS audit adjustments are determined to be appropriate, Beverly is entitled to reimbursement according to the Fair Rental Value System ("FRVS"). The Plan provides as follows:

    
    

    Facilities leased on or after October 1, 1985 shall be reimbursed for leased costs and other property costs based on FRVS per Section V.E.1.a.-g. of this plan. Allowable ownership costs shall be documented to HRS for purposes of computing the fair rental value.

    
    

28. Beverly entered into the leaseback arrangement with the REIT on August 1, 1986.

    
    

29. The DHRS asserted that such issue was irrelevant to this hearing since as of the hearing date, the DHRS had not determined whether Beverly was or was not entitled to reimbursement under the FRVS. The Suwanee cost report audit has not been analyzed for rate setting under the FRVS. Should the DHRS determine that Beverly is not entitled to reimbursement under the FRVS, Beverly would could petition for a separate administrative hearing to challenge the DHRS' action.

    
    

30. Nonetheless, the DHRS offered testimony indicating that the FRVS was not intended to provide reimbursement for such related party transactions as have occurred in this case, and indicated that Beverly would not be entitled to reimbursement under the Fair Rental Value System.

    
    

31. It should be noted that nothing in the Plan related to the FRVS appears to prohibit reimbursement for the fair rental value of facilities leased from a related organization. However, until such time as the DHRS makes an official determination as to whether and to what extent Beverly is entitled to FRVS reimbursement, it is premature to address this issue.

RECOMMENDATION

Based on the foregoing, it is hereby recommended that the Department of health and Rehabilitative Services enter a Final Order dismissing the Petition of Beverly California Corporation filed in this case.

RECOMMENDED this 17th day of May, 1991, in Tallahassee, Florida.

WILLIAM F. QUATTLEBAUM

Hearing Officer

Division of Administrative Hearings The DeSoto Building

1230 Apalachee Parkway

Tallahassee, FL 32399-1550

(904) 488-9675

Filed with the Clerk of the Division of Administrative Hearings this 17th day of May, 1991.

ENDNOTES

1/ During this period, the parties resolved approximately 30 similar cases involving Medicaid reporting period audit adjustments for other facilities. The parties further resolved most of the issues raised in this case other than the dispute related to capital cost reimbursement.

2/ The REIT is now known as Nationwide Health Properties, Inc.

3/ These include Chairman/Director David R. Banks (Beverly President and Chief Executive Officer), Vice President/Chief Financial Officer/Director William M. Wright (Beverly Chief Financial Officer), Vice President/Treasurer/Director David A. Davidson (Beverly Vice President and Treasurer), Vice President/Controller Sherri E. Lee (Beverly Vice President, Controller and Chief Accounting Officer), and Secretary Larry B. Cornish (Senior Vice President, Secretary, and Chief Legal Officer of Beverly).

4/ Beverly owned 5% of the REIT stock at the time of the transaction.

5/ Beverly reduced the reported REIT costs by approximately $66,000 to account for rental costs paid by Beverly to the REIT in excess of actual REIT property costs.

APPENDIX TO RECOMMENDED ORDER, CASE NO. 89-1653

The following constitute rulings on proposed findings of facts submitted by the parties.

Petitioner

The Petitioner's proposed findings of fact are accepted as modified in the Recommended Order except as follows:

1. The greater weight of the evidence establishes that five (rather that three) of nine REIT officers and directors were associated with Beverly.

   
   

2. Rejected, subordinate.

13. Rejected, subordinate.

23-24. Rejected, Petitioner's exhibit #4 is uncorroborated hearsay.

Respondent

The Respondent's proposed findings of fact are accepted as modified in the Recommended Order except as follows:

1. First sentence, rejected, immaterial. Beverly's other nursing homes are immaterial to this case.

COPIES FURNISHED:

Robert B. Williams, Secretary

Department of Health and Rehabilitative Services 1323 Winewood Boulevard

Tallahassee, Florida 32399-0700

Linda K. Harris

Acting General Counsel

Department of Health and Rehabilitative Services 1323 Winewood Boulevard

Tallahassee, Florida 32399-0700

Sam Power Agency Clerk

Department of Health and Rehabilitative Services 1323 Winewood Boulevard

Tallahassee, Florida 32399-0700

Joseph E. Casson David C. Beck CASSON & HARKINS

1233 Twentieth Street N.W., Suite 800

Washington, D.C. 20036

Peter A. Lewis

Assistant General Counsel

Department of Health and Rehabilitative Services 1323 Winewood Boulevard

Tallahassee, Florida 32399-0700

Docket for Case No: 89-001653

Orders for Case No: 89-001653