Eduardo Morales Coll, Hato Rey, P. R., for plaintiff-appellant.

Jaclyn C. Taner, Asst. Regional Atty., with whom Julio Morales Sanchez, U. S. Atty., Alberto Tellechea, Asst. U. S. Atty., San Juan, P. R. and Frank V. Smith, III, Acting Regional Atty., New York City, were on brief, for defendant-appellee.

Before COFFIN, Chief Judge, CAMPBELL, Circuit Judge, WYZANSKI, Senior District Judge.*

This appeal raises the question whether in seeking reimbursement of its Part A Medicare costs a hospital which has leased its radiology department must apply such portion of the rent which it received from that department as exceeds the hospital's reasonable costs incurred in that department to reduce the hospital's reasonable costs incurred in other departments.

Title XVIII of the Social Security Act establishes the "Medicare" health insurance program. 42 U.S.C. § 1395 et seq. This program, which provides federal reimbursement for medical care to the aged, has two parts: Part A, providing "hospital insurance" funded out of Social Security taxes, and Part B, a voluntary supplementary medical insurance program primarily covering physicians' services.

A hospital may participate in Part A of the Medicare program as a provider and receive federal payments by filing an agreement with the Secretary of Health, Education, and Welfare (hereafter "the Secretary"). 42 U.S.C. § 1395cc. Sometimes the Secretary, but usually one of his fiscal intermediaries, reimburses providers for services rendered to Medicare beneficiaries, 42 U.S.C. § 1395h.

The provider submits its bills for services to the intermediary for audit and payment. Then at the end of the fiscal year the provider submits its cost report. 42 CFR § 405.486(b). After analyzing the cost report to determine the reasonable costs of the services which the provider has rendered to program beneficiaries, the intermediary informs the provider, through a written Notice of Program Reimbursement, of the amount of Medicare reimbursement. 42 CFR § 405.1803. If the provider is dissatisfied with the intermediary's decision, and if the amount in controversy is $10,000 or more, it may request a hearing before the Departmental Provider Reimbursement Review Board, 42 U.S.C. § 1395oo (a); 42 CFR § 405.1835.

Within 60 days after a Board decision, the Secretary, on his own motion, may reverse, affirm or modify that decision. 42 U.S.C. § 1395oo (f)(1). Upon timely appeal, the district court has jurisdiction to review the final decision of the Board or of the Secretary. Id.

Part B is a voluntary health insurance program. An eligible individual may enroll in the program and agree to pay a monthly premium established by the Secretary. The premiums, together with amounts contributed by the federal government, are deposited in the Federal Supplementary Medical Insurance Trust Fund, (hereafter "FSMIT Fund"). After payment of a deductible by the beneficiary, the fund pays 80 percent of the reasonable charge for program services, most of which are rendered by physicians.

Regulations set forth in 42 CFR § 405.840 to § 405.488 govern the source and amount of reimbursement when a hospital-based physician, such as a radiologist, performs services for patients covered by Medicare A or B or both. Of those regulations the one applied by the Secretary in this case is codified as 42 CFR § 405.4861 which the Secretary interpreted in HEW's Provider Reimbursement Manual, HIM-15, (hereafter "the Manual") § 2108.5A.1 and 2.2

Plaintiff San Jorge Hospital, a private proprietary corporation, is a 91-bed general, short-term, acute-care medical facility. It is a "provider of services" under Part A of the Medicare program.

In 1965, the hospital and Dr. Nelson Lugo Rigau, a physician-radiologist, entered into a five-year lease, subsequently renewed on a month-to-month basis, for the operation of the hospital's radiology department. Under the lease the hospital's obligations are to provide space for a radiology department, related utilities and janitorial services, specified equipment, and billing for radiology services provided to inpatients without health insurance. The physician's obligations are to provide the other necessary equipment and supplies, to employ all professional and nonprofessional personnel, to bill all outpatients and those inpatients with health insurance, and to assume all other costs relevant to the operation of the radiology department. The physician pays as rent a percentage of gross revenues from diagnostic services.

In fiscal year 1973 the hospital received from the radiology department $64,671 rent and "incurred x-ray operating costs in the amount of $19,210. . . . (The hospital) initially charged (those) expenses directly to the x-ray department." (A. 9). In fiscal year 1974 the rent was $63,725, the operating costs were $23,319, and the hospital reported in the same way as it had in 1973.

Upon auditing the hospital's costs reports for 1973 and 1974, Blue Cross of Florida (BCF), acting as fiscal intermediary, used for the 1973 accounting the $64,671 rent to offset the $19,210 x-ray department costs, and then used the $45,461 balance to offset part of the hospital's general service department costs. The same procedure was adopted with respect to the 1974 accounting the relevant figures being $63,725 rent, $23,319 x-ray department costs, and $40,406 balance applied to general service department costs. Those adjustments reduced the hospital's reimbursements under the Part A Medicare program by $12,514 for 1973 and by $11,789 for 1974.

The hospital sought review of the intermediary's decision with respect to its 1973 and 1974 cost reports before the Departmental Provider Reimbursement Review Board (the Board). The Board reversed the intermediary's adjustment, finding that the portion of the hospital's rent that exceeded the hospital's share of the costs of the x-ray department could not be offset against the other allowable costs of the hospital.

The Administrator of the Health Care Financing Administration, to whom the Secretary of HEW delegated authority to review Board determinations, reversed the Board's decision on May 20, 1977. He concluded that, under 42 CFR § 405.486(b)(1), the rental payments made by the radiologist must be used to eliminate the hospital's share of the costs of the x-ray department and then to reduce the hospital's total allowable costs reimbursable through the Part A Medicare program.

On July 22, 1977 the hospital filed a complaint (Civil Action No. 77-1062) in the United States District Court for the District of Puerto Rico, praying that the Secretary's May 20, 1977 final decision with respect to its 1973 and 1974 cost reports be reversed.

On February 21, 1978 the Secretary moved for summary judgment in that case.

On August 18, 1978 the hospital filed in the Puerto Rico District Court another complaint (Civil Action No. 78-1593). The complaint alleged facts with respect to the hospital and the lease which parallel the findings in 77-1062. It then alleged that in adjusting the hospital's 1976 allowable costs to determine its rights to reimbursement under the Medicare A program, the Blue Cross of Florida, as fiscal intermediary, had offset $35,338 of the 1976 rental income which the hospital had received from its leased x-ray department against the hospital's general service department costs. However, the complaint did not allege that the hospital had sought review of this adjustment before the Board. Nonetheless, the complaint prayed for a judicial order declaring the adjustment of its 1976 allowable costs to be illegal.

On November 21, 1978 the Secretary moved to dismiss the complaint in Civil Action No. 78-1593 for want of subject matter jurisdiction.

On December 14, 1978 the District Court granted the hospital's motion for consolidation of Civil Action No. 78-1593 with Civil Action No. 77-1062.IV. THE DISTRICT COURT'S OPINION AND JUDGMENTS

Being of opinion that in 78-1593 the hospital had not satisfied the statutory prerequisites for judicial review under 42 U.S.C. § 1395oo (f), and that in 77-1062 the hospital's claim must be denied on the merits because the Secretary's decision was warranted by what is now 42 CFR § 405.486(b)(1), the District Court entered on February 23, 1979 judgment for the defendant in both Civil Action No. 77-1062 and Civil Action No. 78-1593.4 March 19, 1979 plaintiff hospital filed its notice of appeal to this court.5

We affirm the District Court's judgment dismissing the complaint in 78-1593 for the reason given by that court. The relevant portion of 42 U.S.C. § 1395oo (f) provides:

A decision of the Board (Provider Reimbursement Review Board) shall be final unless the Secretary (of Health, Education and Welfare), on his own motion, and within 60 days after the provider of services is notified of the Board's decision, reverses or modifies (adversely to such provider) the Board's decision. In any case where such a reversal or modification occurs the provider of services may obtain a review of such decision by a civil action commenced within 60 days of the date he is notified of the Secretary's reversal or modification. . . .

In 78-1593 the complaint does not allege that there has been any decision by either the Provider Reimbursement Review Board or the Secretary of HEW. It does not even allege that plaintiff ever presented to the Board or the Secretary any claim with reference to the hospital's cost reporting for the only period covered by the complaint the year 1976.

The District Court correctly concluded that it lacked jurisdiction of the complaint. Rhode Island Hospital v. Califano, 585 F.2d 1153, 1161 (1st Cir. 1978).

In 77-1062 plaintiff challenges the Secretary's statutory and constitutional authority to require it to set off rental payments received from the hospital's leased radiology department against the hospital's general service department's costs, reimbursable under Medicare A.7

The Secretary based the challenged offset on his interpretation of the fourth sentence of 42 CFR § 405.486(b)(1) which provides:

Any payments received by the hospital under such an arrangement shall be treated as a reduction of allowable costs of the hospital reimbursable through the hospital insurance program.

The Secretary's interpretation is set forth in Manual § 2108.5A.1 which provides:

Any payments received by the hospital under an arrangement where the physician leases a department should be treated as a reduction of allowable costs for purposes of reimbursement under the hospital insurance program. The application of this offset is not limited to the allowable costs for a single department. If the Medicare portion of the income realized by a hospital exceeds the Medicare portion of allowable costs of such department, any remaining income should be applied as a reduction of Medicare reimbursable costs for the other departments of the hospital. (Emphasis added)

We now consider whether the Act gave the Secretary authority to apply the regulation, as thus interpreted, to accomplish the offset here challenged.

The Secretary has no authority directly over rental payments as such. However, the Social Security Act gives him authority to adopt regulations (42 U.S.C. § 1395x(v)(1)(A)) with respect to the allowance of a hospital's reimbursable costs, (42 U.S.C. § 1395f(b)) and a physician's reimbursable costs (42 U.S.C. § 1395l ). Thus the Secretary may allow or refuse to allow, in whole or in part, a relevant rental payment as part of a reimbursable cost. He may also reduce an otherwise reimbursable cost by the amount of a relevant rental payment received.

In considering the relevance of revenues to costs an indispensable first step is to determine what is the unit whose costs are being scrutinized. In the instant case, for the purpose of reimbursement of costs, the radiology department is an "ancillary service" of plaintiff's hospital and as such is in a unit separate8 from the general service department which is among the hospital's "routine services."

Where there are separate units for cost accounting Medicare has always recognized that it is a fundamental principle of correct cost accounting that revenues engendered by costs of one unit are ordinarily not to be set off against costs of another unit. (A. 15, par. 1). This principle is a corollary of the requirement in § 1861 of the Social Security Act, 42 U.S.C. § 1395x(v) (1)(A) that regulations shall make certain that "the necessary costs of efficiently delivering covered services to individuals covered by the insurance programs established by this subchapter will not be borne by individuals not so covered, and the costs with respect to individuals not so covered will not be borne by such insurance programs."

An offset of rent received by the radiology department against reimbursable costs of the general service department marries two departments which 42 CFR §§ 405.404(a)(2), 405.452(c)(1) and 405.452(d)(2) have put asunder. See footnote 8, supra. It is an offset which is so contrary to fundamental accounting principles that, unless specially justified, it is arbitrary.

The Secretary claims that the offset is justified on equitable and policy grounds, not on ordinary accounting principles. He argues that this offset is equitable and consistent with the Act's policy because it protects the FSMIT Fund created by Medicare B from paying more than the Act and the regulations authorize. These are the steps in the Secretary's argument: (1) the physician-lessee will include in his bills to Medicare B patients a charge attributable to his rental payments; (2) since such rental payments reflect not merely the hospital's costs but also the hospital's "profits," the physician-lessee's bill will also reflect hospital costs and profits; but (3) 42 CFR § 405.486(b)(2) does not authorize the physician-lessee to be reimbursed for such part of his bill as reflects the hospital's profits; and, therefore (4) if Medicare B has actually paid the physician's bill reflecting the hospital's profits, the set off is justified as a method of recoupment; if not, it is justified as a prophylactic against inadvertent and almost undetectable excess payments by Medicare B.

The Secretary's argument starts with a doubtful premise. The Secretary has not shown us any regulation or formal interpretation which unmistakably authorizes a physician to include in his bill the rent he pays to a hospital. The third sentence of 42 CFR § 405.486(b)(2) states that "The reasonable charges of a physician who enters into a lease . . . would be based upon the remuneration he received for his services immediately prior to the leasing arrangement plus his reasonable costs of operation, taking into account the hospital's cost experience in providing such services." Looked at in isolation, that third sentence of § 405.486(b)(2) seems to allow a physician to recover as one of his "reasonable costs of operation" at least that portion of the rent which reflected the hospital's costs. But the third sentence of 42 CFR § 405.486(b)(1) provides that "Where . . . a hospital initially pays some or all of the operating expenses of a hospital department . . . even though subsequently those items and services for which it pays the operating expenses are furnished for the use of the physician in return for an agreed upon payment by the physician to the hospital, such operating costs . . . are not to be reflected in the reasonable charges of the physician." Plaintiff had initially borne as part of its operating expenses the cost of the premises and services furnished to the radiologist. Rental payments are the quid pro quo for the premises and services. Hence it would seem that the physician is forbidden to reflect any portion of his payments of rent in his bill. We find no way to reconcile the third sentence of 42 CFR § 405.486(b)(2) and the third sentence of 42 CFR § 405.486(b)(1). We might say that 42 CFR § 405.486 is invalid for ambiguity; or that § 405.486(b)(1) governs this case because it is an exception to the rule stated in § 405.486(b)(2), third sentence; or that the portion of the third sentence of § 405.486(b)(1) which we have quoted in this paragraph is arbitrary and lacking support in the Social Security Act because it denies a physician compensation for what is one of his reasonable costs and, hence, § 405.486(b)(2) governs this case. We follow the last course and conclude that under 42 CFR § 405.486(b)(2) the physician is entitled to be compensated by Medicare B for that part of the rent which represents the reasonable costs of the hospital for the premises and services it furnishes, but is not entitled to be compensated by Medicare B for that part of the rent which reflects the profit of the hospital. The conclusion just stated, but not our reasoning, has been assumed to be correct by the Secretary9 and by courts which have construed 42 CFR § 405.486. Dr. John T. MacDonald Foundation, Inc. v. Mathews, 534 F.2d 633-637 (5th Cir. 1976), vacated 571 F.2d 328 (5th Cir. 1978); Faith Hospital Ass'n v. United States, 585 F.2d 474 (Ct.Cl.1978); Lodi Memorial Hospital v. Califano, 451 F. Supp. 651 (D.C.D.C.1978). Vallejo General Hospital v. Weinberger, CCH Medicare and Medicaid Guide, para. 28, 373 (N.D.Cal. February 9, 1977).

However, the mere fact that § 405.486(b)(2) does authorize the physician to include in his bill charges reflecting his rent does not prove that Dr. Rigau's bills to his Medicare Part B patients did indeed reflect his rental payments to plaintiff. Cf. Lodi Memorial Hospital v. Califano, 451 F. Supp. 651, 677, col. 2 (D.C.D.C.1978). Even if we were to assume that the physician did include in his charges something on account of rent, we do not know whether the inclusion reflected the hospital's profits as well as its costs. Moreover, as the Board pointed out (A. 15-16), we do not know, and we are not offered any formula for ascertaining, what percentage of the physician's rental payments was charged to Medicare B patients, and what percentage to non-Medicare B patients.10

Furthermore, the offset might result in a recovery by Medicare A of sums already recovered by, or subject to recovery by, Medicare B. Medicare B has the right to recover from the physician any unreasonable charges which reflect the hospital's profit element in the rent. Cf. 42 CFR § 405.486(b)(2). See Faith Hospital Ass'n v. United States, supra, p. 480; Dr. John T. MacDonald Foundation, Inc. v. Mathews, supra, p. 638; Lodi Memorial Hospital v. Califano, supra, p. 658. It would be inequitable to permit Medicare Part A to duplicate any such recovery.

The most important objection to the Secretary's equitable or policy argument is that he assumes that Medicare A and Medicare B are all one. But there is no such connection between Medicare A and Medicare B as to furnish a proper basis for setting off an excess payment made by Part B against an otherwise reimbursable cost of Part A. Medicare A and Medicare B are two different programs which have different purposes and, to some degree, different agencies of administration. Payments of Part B claims come from the FSMIT Fund; payments of Part A claims come from a wholly different fund with wholly different beneficiaries. If the offset were allowed, there would be a totally unmerited enrichment of the Medicare A fund, without any mechanism for Medicare A to transfer the unmerited enrichment to the FSMIT Fund. (A. 15-16).

The Secretary defends the offset on the ground that it will discourage hospitals from oppressive leasing arrangements which ultimately inflate patients' medical costs. But the Secretary has no statutory power to limit medical costs but only to limit reimbursement of costs, 42 U.S.C. § 1395l. The Secretary may not control rents charged by a hospital or any other landlord. His power is to refuse to reimburse physicians for any excessive rents which they pay.

Finally, the Secretary relies on the following quotation from the Court of Claims' opinion in a parallel case, Faith Hospital Ass'n v. United States, supra, at p. 482:Plaintiff, by changing the form, but not the substance, of the relationship between the hospital and the doctors in the departments, would have Medicare's obligation change to permit reimbursement not only of the operating expenses of the hospital and of the monies paid to and retained by the doctors but also a profit factor charged by the hospital as its fee for granting the doctors a monopoly in their areas of specialization. Such an excess charge is obviously inimical to the statute's purposes, and a regulation which purported to allow it would be suspect.

We disagree with that analysis. Neither Medicare A nor Medicare B is obliged to pay anything on account of the hospital "profit" on the lease. Medicare A pays no one anything on account of the rent charged the physician. Medicare B is obliged to pay only the hospital cost factor not the hospital profit factor in any charges made by the physician. 42 CFR § 405.486(b)(2).

Our conclusion is that the application of 42 CFR § 405.486 by BCF and the Secretary to reduce plaintiff's otherwise reimbursable costs of its general service department by a portion of the rental payments plaintiff received from Dr. Rigau was invalid because it was arbitrary. That application was not authorized by any provision of the Social Security Act relied upon by the Secretary. We need not decide whether it was also in violation of plaintiff's provider contract with the Secretary. Nor need we decide whether it was also a deprivation by an official agency of the United States of plaintiff's property rights under the contract without the due process of law guaranteed by the Fifth Amendment to the United States Constitution.

There having been in the District Court no motion by plaintiff for summary judgment, plaintiff is entitled merely to have the judgment for defendant reversed.

Judgment in 77-1062 reversed for further proceedings not inconsistent with this opinion. Judgment in 78-1593 affirmed.

LEVIN H. CAMPBELL, Circuit Judge (concurring).

I fully concur in the court's comprehensive and excellent analysis, and would only emphasize the following.

First, I find it particularly significant that the Secretary nowhere justifies offsetting the hospital's leasing profit against its general costs as being a necessary or proper way to determine the hospital's "reasonable cost" of caring for Medicare A patients. See 42 U.S.C. § 1395x. Rather the Secretary justifies the offset in terms of its being a kind of windfall profits tax related to presumed excessive Medicare reimbursement of radiologists under Part B. Had the Secretary offered rational justification for the offset in terms of his authority to determine "reasonable cost" under Part A, I would have gone a considerable distance to accept his justification. Matters of accounting, unless they "be the expression of a whim rather than an exercise of judgment," are for the agency. American Telephone & Telegraph Co. v. United States, 299 U.S. 232, 237, 57 S. Ct. 170, 172, 81 L. Ed. 142 (1936). But no principle is here articulated that one factor in a rational formula for arriving at the cost of caring for Medicare A patients would be to deduct radiology department profits.

Second, I do not read this court's opinion as necessarily precluding some rational method for recapturing that portion of the leasing profits as is attributable to the Medicare B patients of treating radiologists, cf., at page 481, Faith Hospital Association v. United States, 585 F.2d 474 (Ct.Cl.1978). In the present situation, however, there are simply too many disparities to justify the mechanism in use. The Secretary's formula recaptures profits on the basis of the hospital's Medicare population, which may or may not be proportionately the same as the radiologists' Medicare population. Furthermore, as Judge Wyzanski demonstrates, under the Secretary's procedure the offset benefits the wrong fund; excessive Medicare B reimbursement to radiologists should be returned to the fund being held for Part B of the program, a fund deriving from sources different from the Medicare A fund.

Still, I would not read our opinion as preventing the Secretary from using practical means to control overcharges. The Medicare legislation gives the Secretary broad powers to determine the reasonableness of charges. The Secretary is not at the mercy of hospitals and physicians who seek unwarranted reimbursement, and retains a large reservoir of express and implied power to adopt rational requirements that guard against waste and fraud. Such regulations may include reasonably based presumptions and policy determinations reflecting the Secretary's judgment as to what is required to make the program work. Here one can understand the difficulty that led to the present attempted solution. Even in an era of computers, it is probably impractical for the Part B intermediary to screen the radiologists' bills in terms of the leasing hospital's actual costs. The Medicare B intermediary is unlikely to have ready access to the hospital's books, and, even if it does, the practicalities disfavor effective utilization of this information in reviewing myriad individual bills which come from the physician, not the hospital. Such considerations led the Secretary into the present system, which catches the real villain (if there is one) the hospital at a time when its defenses are down and its books on the table. The problem is, the link between the assumed Medicare B overpayments and the Medicare A exaction is too tenuous not to mention that the benefit of the offset will accrue to the wrong account. These fatal flaws do not signal, however, that a more finely tuned system aimed at accomplishing a similar end will be doomed to failure.