District Memorial Hospital of Southwestern North Carolina, Incorporated v.  Tommy G. Thompson, Secretary, United States Department of Health

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
 DISTRICT MEMORIAL HOSPITAL OF
SOUTHWESTERN NORTH CAROLINA,
INCORPORATED,
Plaintiff-Appellee,
v. No. 03-1401 
TOMMY G. THOMPSON, SECRETARY,
UNITED STATES DEPARTMENT OF
HEALTH AND HUMAN SERVICES, in his
official capacity,
Defendant-Appellant. 
Appeal from the United States District Court
for the Western District of North Carolina, at Bryson City.
Max O. Cogburn, Jr., Magistrate Judge.
(CA-01-259-2-C)
Argued: January 20, 2004
Decided: April 12, 2004
Before NIEMEYER, KING, and DUNCAN, Circuit Judges.
Reversed by published opinion. Judge Niemeyer wrote the opinion,
in which Judge King and Judge Duncan joined.
COUNSEL
ARGUED: Mark Simon Davies, Civil Division, Appellate Staff,
UNITED STATES DEPARTMENT OF JUSTICE, Washington,

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D.C., for Appellant. Susan McNear Fradenburg, SMITH MOORE,
L.L.P., Greensboro, North Carolina, for Appellee. ON BRIEF: Peter
D. Keisler, Assistant Attorney General, Robert J. Conrad, Jr., United
States Attorney, Scott R. McIntosh, Attorney, Civil Division, Appel-
late Staff, UNITED STATES DEPARTMENT OF JUSTICE, Wash-
ington, D.C., for Appellant. Maureen Demarest Murray, SMITH
MOORE, L.L.P., Greensboro, North Carolina, for Appellee.
OPINION
NIEMEYER, Circuit Judge:
The Secretary of Health and Human Services denied District
Memorial Hospital of Southwestern North Carolina, Inc., a special
reimbursement that is available under the Medicare program to hospi-
tals providing inpatient acute care to a "significantly disproportionate
number of low-income patients." This special reimbursement is
known as the "disproportionate share adjustment." Because District
Memorial Hospital used its beds to provide both acute care and nurs-
ing care, when determining whether the hospital qualified for the
adjustment, the Secretary applied regulation 42 C.F.R. § 412.106
(1988) to exclude from the eligibility calculation these dual-use beds
— known as "swing beds" — whenever they were used to provide
nursing care.
The district court, reviewing the Secretary’s determination on
cross-motions for summary judgment, found that the Secretary mis-
construed and misapplied regulation § 412.106. The court concluded
that the regulation is "clear" and "admits of only one meaning" — the
meaning advanced by District Memorial Hospital to justify its claim
for reimbursement of the disproportionate share adjustment. Accord-
ingly, the court remanded the matter to the Secretary "for the prompt
payment" to the hospital of $615,607 plus interest.
Because we conclude that regulation § 412.106 is ambiguous and
that the Secretary’s interpretation is a reasonable construction of the
regulatory language, see Thomas Jefferson Univ. v. Shalala, 512 U.S.
504, 506 (1994), we defer to the Secretary and reverse.
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I
The Medicare program finances health care for the elderly and the
disabled. See 42 U.S.C. § 1395c. Until 1983, the program reimbursed
hospitals for the "reasonable cost" of inpatient services rendered to
Medicare patients. In 1983, Congress overhauled the program and
began reimbursing the cost of inpatient acute care under a "prospec-
tive payment system." The prospective payment system reimburses
hospitals at fixed rates that are based on the patient’s diagnosis upon
discharge. See Social Security Amendments of 1983, Pub. L. No. 98-
21, § 601, 97 Stat. 65, 149-72 (1983). The fixed rates are established
by determining what an efficient hospital would spend to treat a
patient with that diagnosis. Under the 1983 overhaul, expenses
incurred for skilled nursing care continue to be reimbursable under
the old "reasonable cost" basis, which is generally more desirable for
hospitals because reimbursement is not limited by a fixed-rate sched-
ule.
When adopting the prospective payment system in 1983, Congress
recognized that the fixed rates established under that system could
undercompensate hospitals that treated a high proportion of low-
income Medicare patients, because those patients were thought gener-
ally to be in poorer health and would require more services than
would higher-income patients. See H.R. Rep. No. 98-25(I), at 141-42
(1983), reprinted in 1983 U.S.C.C.A.N. 219, 360-61. Accordingly,
Congress instructed the Secretary to formulate an adjustment to the
fixed rates to increase the reimbursement to those hospitals that
served a significantly disproportionate number of low-income patients
— the "disproportionate share adjustment." When the Secretary
delayed publishing a formulation, Congress itself set forth the criteria
in 1986 for this disproportionate share adjustment. See 42 U.S.C.
§ 1395ww(d)(5)(F). The Secretary thereafter published the regulation
at issue in this case, construing and implementing the congressional
enactment. See 42 C.F.R. § 412.106 (1988).
The 1988 regulation provided that, in determining a hospital’s dis-
proportionate share adjustment, the relevant factors were the hospi-
tal’s number of available beds, its number of "patient days," and its
location. 42 C.F.R. § 412.106(a) (1988). The hospital’s number of
patient days was defined to include "only those days attributable to
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areas of the hospital that [were] subject to the prospective payment
system and exclude[d] all others." Id. § 412.106(a)(ii). Because eligi-
bility for the disproportionate share adjustment was based on the
number of patient days attributable to "areas of the hospital that
[were] subject to the prospective payment system" — i.e., areas pro-
viding inpatient acute care — eligibility for the adjustment for hospi-
tals providing both acute care and nursing care depended on how the
Secretary interpreted the regulation to define the areas where acute
care was being performed. The Secretary’s interpretation was espe-
cially critical with respect to hospitals providing both acute care and
skilled nursing care at the same beds.
Distinguishing between "areas of the hospital subject to the pro-
spective payment system" and those subject to reasonable-cost reim-
bursement presented no problem so long as the hospital was divided
into distinct wings, each of which provided only one form of care —
either acute care or skilled nursing care. And before 1980, the provi-
sion of those two types of care was in fact generally divided. Skilled
nursing services were generally rendered in facilities that were sepa-
rate and distinct from hospitals providing acute care. Moreover, in
areas where acute care and skilled nursing care were provided in the
same facility, Medicare required that hospitals provide skilled nursing
care in a "distinct part" of the hospital, such as a building, floor, wing,
or corridor that was physically separate from the inpatient acute care
unit. See Rural Hospitals: Provision of Long-Term Care Services
(Swing-Bed Provision), 47 Fed. Reg. 31,518, 31,518 (July 20, 1982)
("A distinct part . . . must be an entire physically identifiable unit con-
sisting of all the beds within that unit (such as a separate building,
floor, wing, or corridor) . . .").
In the 1970s, the Secretary recognized that this model of separate
facilities for different types of care was difficult for small rural hospi-
tals to achieve, given their limited physical resources. The Secretary
found that rural areas generally had an excess of hospital beds for
acute care and a shortage of beds for skilled nursing care because of
a shortage of nursing homes. To respond to this, Congress authorized
the Secretary to enter into agreements with rural hospitals with fewer
than 100 beds that allowed them to use their inpatient acute care facil-
ities also for services of the type that would be provided at skilled
nursing facilities. 42 U.S.C. § 1395tt(a)(1), (b). With the Secretary’s
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approval, a rural hospital could accordingly use any inpatient bed for
either inpatient acute care or skilled nursing care. These beds, known
as "swing beds," were thus licensed for acute care but were able to
"swing" to use for nursing care when not needed for acute care.
Although acute care and nursing care could now be performed in the
same facility, their reimbursement systems were still separate: swing-
bed skilled nursing care was reimbursed on the reasonable cost basis,
and acute care remained under the prospective payment system. Id.
§ 1395tt(a)(2).
Because the distinction in methods of reimbursement depended on
the nature of services rendered and because only the prospective pay-
ment method was linked with the disproportionate share adjustment,
the Secretary construed regulation 42 C.F.R. § 412.106, which was
promulgated to calculate the disproportionate share adjustment, to
exclude from the calculation any patient day that was attributable to
a swing bed providing skilled nursing care. This became the long-
standing interpretation applied by the Secretary.
District Memorial Hospital is a small (under 100 beds) rural hospi-
tal in Andrews, North Carolina, that had a swing-bed agreement with
the Secretary. Consequently, its beds were licensed for acute care but
could be used for either acute care or skilled nursing care, as needed.
In its 1991-97 cost reports, District Memorial Hospital claimed the
disproportionate share adjustment authorized by 42 U.S.C.
§ 1395ww(d)(5)(F)(i)(I), in the amount of $615,607, asserting that it
served a significantly disproportionate number of low-income
patients. In performing the calculations required by regulation
§ 412.106, the hospital included as "patient days" the days on which
its patients received skilled nursing services in its swing beds because
the beds were physically located in an area licensed for acute care.
Under the Secretary’s standing construction of § 412.106, however,
the Secretary’s intermediary excluded these days from the calculation,
and as a result, District Memorial Hospital failed to qualify for the
disproportionate share adjustment. Accordingly, on October 5, 1998,
the intermediary denied the hospital’s claim for the disproportionate
share adjustment.
The hospital appealed the intermediary’s decision to the Provider
Reimbursement Board, and the Board reversed the intermediary’s
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decision, awarding the hospital the disproportionate share adjustment.
The Board’s decision was thereafter reviewed on behalf of the Secre-
tary by the Deputy Administrator of the Centers for Medicare & Med-
icaid Services (formerly the Health Care Financing Administration).
On August 27, 2001, through the Deputy Administrator, the Secretary
reversed the Board and concluded that there was a "clear statutory
intent" to treat swing-bed hospitals in a manner similar to independent
skilled nursing facilities, and therefore such hospitals generally were
not entitled to the disproportionate share adjustment. The Secretary
determined that the adjustment was available only for inpatient acute
care beds that were subject to the prospective payment system.
The hospital sought judicial review of the Secretary’s decision by
commencing this action in the district court. Ruling on cross-motions
for summary judgment, the district court reversed the Secretary and
held that District Memorial Hospital was entitled to the disproportion-
ate share adjustment. Dist. Mem’l Hosp. v. Thompson, 261 F. Supp.
2d 378, 388 (W.D. N.C. 2003). In its judgment dated February 3,
2003, the court remanded the case to the Secretary for "the prompt
award of the amount in controversy plus interest pursuant to 42
U.S.C. § 1395oo(f)(2)." In rejecting the Secretary’s arguments, the
district court stated that regulation § 412.106(a) was "plain on its face
and permit[ted] the exclusion of patient days only if those days [were]
attributable to geographic areas of the hospital — to beds in a partic-
ular part of the hospital — that [were] excluded from [the prospective
payment system]." Dist. Mem’l Hosp., 261 F. Supp. 2d at 383
(emphasis added). The court rejected the Secretary’s argument that
the word "areas" in context meant to cover only "those patient days
involving inpatient hospital services that could be covered under [the
prospective payment system]." Id.
From the district court’s judgment in favor of District Memorial
Hospital, the Secretary appealed.
II
We review the district court’s summary judgment de novo and
apply the same standard that it was required to apply to review the
Secretary’s interpretation of the Department of Health and Human
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Services’ regulation. See Felty v. Graves-Humphreys Co., 818 F.2d
1126, 1127-28 (4th Cir. 1987).
In considering the Secretary’s construction of 42 C.F.R. § 412.106,
we give "substantial deference to [the] agency’s interpretation of its
own regulations." Thomas Jefferson Univ. v. Shalala, 512 U.S. 504,
512 (1994). More precisely, "the agency’s interpretation must be
given ‘controlling weight unless it is plainly erroneous or inconsistent
with the regulation.’" Id. (quoting Udall v. Tallman, 380 U.S. 1, 16-
17 (1965) (quoting Bowles v. Seminole Rock & Sand Co., 325 U.S.
410, 414 (1945))). Indeed, the Supreme Court has noted that defer-
ence to the Secretary’s interpretations of Medicare regulations is "all
the more warranted," because Medicare is "‘a complex and highly
technical regulatory program,’ in which the identification and classifi-
cation of relevant ‘criteria necessarily require significant expertise
and entail the exercise of judgment grounded in policy concerns.’"
Id. (quoting Pauley v. BethEnergy Mines, Inc., 501 U.S. 680, 697
(1991)). The agency’s interpretation "need not be the best or most
natural one by grammatical or other standards." Pauley, 501 U.S. at
702. Rather, it need only be "a reasonable construction of the regula-
tory language." Thomas Jefferson Univ., 512 U.S. at 506 (emphasis
added).
Regulation § 412.106(a)(1), which is at issue in this case, provides:
The factors considered in determining whether a hospital
qualifies for a payment adjustment include the number of
beds, the number of patient days, and the hospital’s location.
(i) The number of beds in a hospital is determined in
accordance with § 412.105(b).
(ii) The number of patient days includes only those days
attributable to areas of the hospital that are subject to
the prospective payment system and excludes all oth-
ers.
(iii) The hospital’s location, in an urban or rural area, is
determined in accordance with the definitions in
§ 412.62(f).
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42 C.F.R. § 412.106(a)(1) (1988) (emphasis added).*
The regulation itself is not being challenged by District Memorial
Hospital. Nor does any party dispute that all skilled nursing services
— including those rendered in "swing beds" — are reimbursed under
the "reasonable cost" system, not under the prospective payment sys-
tem. See 42 U.S.C. § 1395f(b)(1); 42 C.F.R. § 413.1(a)(2)(ii)(B). The
question presented is whether the Secretary may construe and apply
regulation § 412.106 to exclude, in determining the disproportionate
share adjustment, the days that patients spent in the hospital’s swing
beds receiving skilled nursing care and count only the number of days
that patients spent in swing beds receiving acute care, which is subject
to the prospective payment system.
District Memorial Hospital contends that, in calculating the dispro-
portionate share adjustment, it may include patient days "attributable
to areas of the hospital that were subject to the prospective pay sys-
tem," which in its case included all beds in the hospital. It argues that
patient days attributed to any bed licensed for acute care must be
included in the calculation, regardless of how the bed is actually used
under the swing-bed arrangement. According to the hospital, regula-
tion § 412.106 authorizes the disproportionate share adjustment based
on "where a bed is located, not on what basis the hospital receives
reimbursement for the beds." Because all beds at District Memorial
Hospital are located "in the physical area of the hospital subject to the
prospective payment system," they must be included in the calcula-
tion of patient days. When they are so included, the hospital states,
it qualifies for the adjustment. The hospital argues that its "temporary
use" of beds for nursing care in the area licensed for acute care is "ir-
relevant," because geographical area, not function, governs reim-
*To resolve the ambiguity at issue in this case, § 412.106 was
amended in 2003 to read in relevant part:
For purposes of this section, the number of patient days in a hos-
pital includes only those days attributable to units or wards of the
hospital providing acute care services generally payable under
the prospective payment system and excludes patient days asso-
ciated with . . . skilled nursing swing-bed services . . . .
42 C.F.R. § 412.106(a)(1)(ii) (2003).
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bursement of the adjustment. The district court agreed with the
hospital and ordered that it be paid the disproportionate share adjust-
ment.
The Secretary, on the other hand, presses a non-geographical read-
ing of the term "areas," arguing that the term refers to the scope of
activity — in this case, the provision of acute care — rather than to
all beds geographically located in a hospital wing licensed to provide
acute care. Under the Secretary’s construction, acute care services
would be compensated under the prospective payment system as
enhanced by the disproportionate share adjustment, wherever and
whenever acute care services were provided, and nursing care ser-
vices would be compensated under the reasonable cost system, wher-
ever and whenever they were provided. The Secretary argues that
District Memorial Hospital’s expenses for skilled nursing care are
reimbursed adequately by the Medicare program under the "reason-
able cost system," and to make an additional award of the dispropor-
tionate share adjustment, which was designed to enhance only the
fixed rate payments for acute care, would amount to a "significant
financial windfall at the expense of the Medicare program." The Sec-
retary notes that such a windfall would not be made if the Secretary’s
longstanding interpretation of regulation § 412.106 were followed.
The Secretary argues that the district court failed to show the proper
level of deference to his interpretation of regulation § 412.106 by
erroneously applying a standard of review that would evaluate
whether his interpretation was consistent with the "ordinary" meaning
of the regulation’s text, rather than whether the Secretary’s interpreta-
tion was "a reasonable construction."
We find that neither party’s interpretation of regulation § 412.106
is clearly beyond the plain meaning of the regulation’s text and that
the term "areas" is ambiguous. We therefore conclude that the Secre-
tary’s interpretation is at least a reasonable construction of the regula-
tory language. The word "area" may refer to a physical space, a
geographical area, as found by the district court, or it may refer to
"the sphere or scope of operation or action." Webster’s Third New
International Dictionary 115 (1993). Thus, employing this alternative
definition, someone may say, "I practice in the area of Medicare
law." Under this alternative definition, "areas of the hospital that are
subject to the prospective payment system" would encompass activi-
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ties that are defined by whether they are reimbursed under the pro-
spective payment system, regardless of where the activities
geographically took place. In other words, "days attributable to areas
of the hospital that are subject to the prospective payment system"
would mean "days attributable to hospital activities that involve acute
care and therefore are reimbursed under the prospective payment sys-
tem." While it is true that this interpretation relies on an alternative
definition of "area," an agency’s interpretation "need not be the best
or most natural one by grammatical or other standards." Pauley, 501
U.S. at 702. Rather, it need only be a reasonable construction.
Thomas Jefferson Univ., 512 U.S. at 506.
Even if one were to insist that the word "area," as used in regula-
tion § 412.106, be read to carry its geographical connotation, the Sec-
retary’s interpretation would remain a reasonable construction of the
regulatory language. The word "area" would then refer to the location
of any bed used to provide acute care when such services were being
provided, and the disproportionate share adjustment would apply to
that location at such times. Similarly, the word "area" would not refer
to the location of a bed when skilled nursing services were being pro-
vided at that bed because such services were not "subject to the pro-
spective payment system." Under this interpretation, the word "areas"
in a geographical sense would be referring to the locations of individ-
ual beds, as opposed to wings or units of the hospital. Use of this
meaning would result in the same interpretation advanced by the Sec-
retary, who counted "patient days" when beds were actually being
used for acute care. Although the reimbursement status of each swing
bed might thus change daily, as the use of the bed shifted between
acute care and skilled nursing care, such a daily reassessment would
be consistent with the regulatory language, which refers to "days
attributable to areas of the hospital that are subject to the prospective
payment system." 42 C.F.R. § 412.106(a)(1)(ii) (1988).
Not only do we conclude that the Secretary’s interpretation is a rea-
sonable construction of the regulatory language, we also conclude, as
did the district court, that the Secretary’s interpretation more closely
fits the policy considerations underlying the regulation than does the
hospital’s interpretation. The disproportionate share adjustment was
authorized to correct for the undercompensation that resulted from the
fixed rates of the prospective payment system used for acute care in
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locations where the hospital had a substantially disproportionate share
of low-income patients. It was not intended to be an enhancement for
reimbursement under the reasonable cost system. Because skilled
nursing services were already fully reimbursed on a reasonable cost
basis — a system that was more favorable to the hospital than the pro-
spective payment system — construing the regulation in a manner
that would grant the disproportionate share adjustment to District
Memorial Hospital for skilled nursing services performed in swing
beds would result in overcompensation to the hospital — i.e., reim-
bursement for reasonable costs plus an adjustment above the reason-
able costs.
In response to the Secretary’s argument that his interpretation of
regulation § 412.106 fulfills the policy behind the disproportionate
share adjustment, District Memorial Hospital argues that Congress
never intended that the disproportionate share adjustment be given
only in connection with the prospective payment system for acute
care. To make such an argument, however, District Memorial Hospi-
tal would have to be challenging the regulation itself, rather than the
Secretary’s interpretation of the regulation, because the regulation
draws an unequivocal connection between the prospective payment
system and the disproportionate share reimbursement. See 42 C.F.R.
§ 412.106(a)(1)(ii) (1988). Yet District Memorial Hospital did not
make this argument either before the administrative agency or before
the district court, and we will not entertain it for the first time on
appeal. See Pleasant Valley Hosp., Inc. v. Shalala, 32 F.3d 67, 70 (4th
Cir. 1994).
In sum, we conclude that the Secretary’s interpretation of 42
U.S.C. § 412.106(a) (1988) is "a reasonable construction of the regu-
latory language" and therefore must be given "controlling weight."
Thomas Jefferson Univ., 512 U.S. at 506, 512. Accordingly, we
reverse the judgment of the district court.
REVERSED
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