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United States Court of Appeals,
Fifth Circuit.
No. 93-4388.
MOTHER FRANCES HOSPITAL OF TYLER, TEXAS, Plaintiff-Appellant,
v.
Donna E. SHALALA, in her official capacity as Secretary of the Department of Health and
Human Services and William Toby, Jr., in his official capacity as Acting Administrator of the Health
Care Financing Administration, Defendants-Appellees.
March 3, 1994.
Appeal from the United States District Court for the Eastern District of Texas.
Before JOHNSON, GARWOOD, and JOLLY, Circuit Judges.
JOHNSON, Circuit Judge:
The dispute in this case concerns the timing of Medicare reimbursement payments for costs
incurred by provider hospitals under the Medicare Program. The particular costs at issue herein stem
from an "advance refunding" transaction conducted by Mother Frances Hospital of Tyler, Texas (the
"Hospital") in 1987. In that transaction, the Hospital incurred "defeasance" costs when it refunded
an old series of bonds ahead of schedule in order to obtain new financing. All parties agree that these
costs are reimbursable. The only issue that is contested is when and how this reimbursement is to be
made. The Hospital maintains that such a loss is reimbursable immediately in a lump sum. By
contrast, the Secretary of Health and Human Services (the "Secretary") contends that reimbursement
should be amortized over the life of the old bonds. The district court ruled in favor of the Secretary.
We REVERSE.
I.
FACTS AND PROCEDURAL HISTORY
In 1987, the Hospital borrowed money by issuing a new series of bonds. Most of the
proceeds of this 1987 bond issue were used in an "advance refunding" t ransaction to refinance an
earlier, 1983 bond issue. In this transaction, the Hospital placed the funds from the new bond issue
into an irrevocable trust account under the direction of an independent trustee. The trustee invested

this money in U.S. Treasury obligations at an interest rate sufficient to pay the principal and interest
of the old bonds as they came due. By means of this transaction, the Hospital was able to transfer
its legal liability for the 1983 bonds to the trustee. Thus, the Hospital's liability for the bonds was
"defeased."
As a result of this transaction, the Hospital incurred a loss.1 This loss occurred because in
order to create a sufficient fund in the trust to service the old bonds, the Hospital had to borrow a
greater principal amount in the new bond issue.2 Thus, after the 1987 transaction, the Hospital had
a greater debt.3
Acting in accordance with Generally Accepted Accounting Principles (GAAP)4, as is required
by 42 C.F.R. § 413.20, the Hospital sought reimbursement for this entire loss in 1987. This request
was denied, though, by the "fiscal intermediary"5 to which such requests are initially routed. Instead,
the intermediary allowed only a portion of this loss in 1987 and sought to space out the remaining
reimbursement by amortizing it over the life of the old bonds. The Hospital appealed this decision
1This loss amounted to in excess of $11 million of which Medicare will reimburse
approximately $4 million.
2Also added to this loss were certain up-front transactional costs the Hospital incurred in this
transaction.
3Even though this transaction would result in a greater debt for the Hospital, it still made
economic sense because, owing to lower interest rates, the new financing could be obtained on
more favorable terms than the old financing. Thus, in reality, the Hospital would end up with a
net economic gain because of reduced interest expense.
4GAAP consists of the three official publications of the American Institute of Certified Public
Accountants (AICPA). These publications are the Accounting Principles Board Opinions, the
Financial Accounting Standards Board statements, and the Accounting Research Bulletins. See
HCA Health Services of Midwest, Inc. v. Bowen, 869 F.2d 1179, 1181 n. 3 (9th Cir.1989). In
1972, the Accounting Principles Board issued APB Opinion 26 which is entitled "Early
Extinguishment of Debt." This opinion states that "[a] difference between the reacquisition price
and the net carrying amount of the extinguished debt should be recognized currently in income of
the period of extinguishment as losses or gains and identified as a separate item.... Gains and
losses should not be amortized to future periods." Opinion 26, ¶ 20.
5The Medicare program provides for the payment of inpatient hospital and related
post-institutional care for eligible individuals. These medical services are rendered by provider
hospitals which participate in the Medicare program by entering into a "provider agreement" with
the Secretary. 42 U.S.C. §§ 1395x(u), 1395cc. The Secretary then reimburses those provider
hospitals through a "fiscal intermediary." 42 U.S.C. §§ 1395g, 1395h. In this case, the fiscal
intermediary was Blue Shield of Texas, Inc.

to the Provider Reimbursement Review Board, a body established by the Secretary pursuant to 42
U.S.C. § 1395oo to hear these appeals. Finding that the regulations implementing the Medicare
program provided for the use of GAAP in the absence of specific regulations to the contrary, the
Board reversed the decision of the intermediary and issued a decision calling for full reimbursement
in 1987.
The Board's decision was, in turn, reviewed by the Administrator of the Health Care Finance
Administration. In making his decision, the Administrator relied on a policy announced in section 233
of the agency's Provider Reimbursement Manual (PRM) calling for amortization of advance refunding
costs. Accordingly, the Administrator reversed the decision of the Board. Under 42 C.F.R. §
405.1875, this decision represented the final decision of the Secretary.
From this decision, the Hospital appealed to the district court where arguments were heard
before a magistrate judge. The magistrate judge issued a Report and Recommendation in favor of
the Hospital finding that section 233 was no more than a manual provision without the force and
effect of law and thus was ineffective to change the meaning of the governing regulations, 42 C.F.R.
§ 413.20(a) and 413.24(a) and (b)(2), which call for the use of GAAP. This recommendation was
rejected by the district judge, however, who found that section 233 was merely interpretive of the
regulations and was therefore valid. Hence, the district court granted summary judgment for the
Secretary, 818 F.Supp. 990. The Hospital timely appeals from this decision.
II.
DISCUSSION
Under the Medicare statute, the Secretary must reimburse provider hospitals for the
reasonable costs of services rendered to eligible Medicare beneficiaries. The calculation of these
reasonable costs "shall be determined in accordance with regulations establishing the method or
methods to be used...." 42 U.S.C. § 1395x(v). Moreover, "[i]n prescribing the regulations, the
Secretary shall consider, among other things, the principles generally applied by national
organizations...." Id. These "national organizations" utilize GAAP.
This statute only states that the Secretary must "consider" GAAP in making regulations. It

does not say that she must pass regulations adopting GAAP. However, under 42 C.F.R. § 413 et
seq., entitled "Principles of Reasonable Cost Reimbursement," she appears to have done so. Under
section 413.20(a), the regulations state that
[t]he principles of cost reimbursement require that providers maintain sufficient financial
records and statistical data for proper determination of costs payable under the program.
Standardized definitions, accounting, statistics, and reporting practices that are widely
accepted in the hospital and related fields are followed (emphasis added).
Moreover, section 413.24(a) states that "[t]he cost data must be based on an approved method of
cost finding and on the accrual basis of accounting." Lastly, section 413.24(b)(2) instructs that
[u]nder the accrual basis of accounting, revenue is reported in the period when it is earned,
regardless of when it is collected, and expenses are reported in the period in which they are
incurred, regardless of when they are paid (emphasis added).
In light of GAAP, the manifest conclusion from reading these regulations is that the Hospital was
entitled to full reimbursement for this advance refunding loss in 1987.
Nevertheless, the Secretary seeks to avoid this result. She argues that the regulations merely
provide for GAAP with respect to a hospital's reporting of its costs and do not compel a result with
respect to the timing of cost reimbursement. Instead, she maintains that the timing of cost
reimbursement in advance refunding transactions should be governed by PRM § 233. This provision
speaks directly to advance refunding transactions and, contrary to GAAP, clearly provides for
amortization of the loss.6
This argument by the Secretary has not fared well in the federal courts. Aside from the
decision by the district court herein, every district court to have addressed the issue of the timing of
reimbursement for an advance refunding loss has held, consistent with GAAP and contrary to the
Secretary's argument, that this loss is immediately reimbursable.7 Further, this issue was thoroughly
6Specifically, this section instructs that:
When a provider defeases or repurchases debt incurred for necessary patient care
through an advance refunding ... [u]namortized discounts or premiums (reduction
of debt cancellation costs) and debt issue costs of the refunded debt must be
amortized over the period from the issue date of the refunding debt to the date the
holders of the refunded debt will receive the principal payment ..."
7Graham Hospital Ass'n. v. Sullivan, 832 F.Supp. 1235, 145 (N.D.Ill.1993); Baptist Hospital
East v. Sullivan, 767 F.Supp. 139 (W.D.Ky.1991); Mercy Hospital v. Sullivan, Civil No. 90-

discussed and the Secretary's arguments were rejected by the Sixth Circuit in Guernsey Memorial
Hosp. v. Secretary of Health and Human Services8, 996 F.2d 830 (6th Cir.1993).
In Guernsey, a case on all fours with the case sub judice, the Sixth Circuit determined that
the language and structure of the Medicare regulations unambiguously provide that reimbursement
will be made on the basis indicated by GAAP. Id. at 835. Specifically, the court found that
[w]ere it not for § 233 of the Provider Reimbursement Manual, any fair minded person
reading the regulations in the light of generally accepted accounting principles would have to
conclude that [the hospital] was entitled to reimbursement for its advance refunding costs in
the year in which, under GAAP, the costs were deemed to have been incurred.
Id. at 834.
As to section 233, the Guernsey court concluded that it was invalid. Id. at 835. This is
because issuance of the Provider Reimbursement Manual was not preceded by the formal rulemaking
requirements of 5 U.S.C. § 5539 and thus it does not carry the force and effect of law or regulation.
National Medical Enterprises v. Bowen, 851 F.2d 291, 293 (9th Cir.1988). Lacking these formal
requisites, section 233 could only be valid if it were an "interpretive" rule as opposed to a
"substantive" rule.10 See 5 U.S.C. § 553(b)(A).
Accordingly, the Secretary argued in Guernsey, as she argues herein, that section 233 merely
interprets the regulations. The Guernsey court, however, disagreed. It found that as opposed to
merely interpreting existing regulations, section 233 impermissibly changed the meaning of the
properly promulgated regulations. Id. at 835; See also Graham, 832 F.Supp. at 1243. Hence, the
0024 P, 1991 WL 104090 (D.Me. April 25, 1991); Ravenswood Hospital Medical Ctr. v.
Schweiker, 622 F.Supp. 338 (N.D.Ill.1985); Methodist-Evangelical Hospital, Inc. v. Shalala,
Civil No. 92-2887-LFO. 1993 WL 548830 (D.D.C. Dec. 22, 1993); Grant Medical Center v.
Shalala, Civil No. 93-0470-LFO, 1993 WL 548830 (D.D.C. Dec. 22, 1993).
8The district court in the Guernsey case had ruled in favor of the Secretary, but that decision
was reversed by the Sixth Circuit.
9These requirements include advance notice of the terms or substance of a proposed rule under
§ 553(b) and an opportunity for interested persons to comment through the submission of written
data, views or argument under § 553(c).
10Interpretive rules clarify or explain existing law or regulations; substantive rules grant rights,
impose obligations or produce other significant effects on private interests. American Hospital
Association v. Bowen, 834 F.2d 1037, 1045 (D.C.Cir.1987).

Guernsey court found that section 233 worked a substantive change in the regulations and was thus
an invalid attempt to make a substantive rule without the formalities of the Administrative Procedures
Act.11 Guernsey, 996 F.2d at 832.
We agree with the reasoning of Guernsey and adopt its holding that the Medicare regulations
provide for the use of GAAP in determining the timing of Medicare reimbursement in advance
refunding transactions and that section 233, which provides to the contrary, is an invalid attempt to
promulgate a substantive rule without complying with the rulemaking formalities. Moreover, we see
nothing contrary to this holding in our decision in Sun Towers, Inc. v. Heckler, 725 F.2d 315 (5th
Cir.), cert. denied, 469 U.S. 823, 105 S.Ct. 100, 83 L.Ed.2d 45 (1984).
In Sun Towers, this Court was called on to decide whether certain costs were allowable under
the Medicare program. Among these costs were "stock maintenance costs."12 Id. at 326. The
Secretary disallowed reimbursement for these costs finding that they were only tangentially related
to the care of Medicare beneficiaries.13 The district court, however, reversed the Secretary's
determination.
Among the arguments the district court presented to support its decision in Sun Towers was
an argument based on GAAP. Id. at 328. Under GAAP, stock maintenance costs are recognized as
general and administrative expenses. Thus, the district court argued that these costs were allowable
11Also, the Guernsey court rejected the Secretary's attempted distinction between the
Hospital's reporting of its costs and the reimbursement for those costs. The Secretary argued that
the regulations mandated the use of GAAP only for the Hospital's internal cost reporting and that
§ 233 was sufficient to establish a different accounting system for cost reimbursement. In
rejecting this argument, the court noted that the purpose of cost reporting was to enable the
Hospital's costs to be known so that reimbursement could be calculated. For that reason, the
court felt that there should be a nexus between the fundamental principles of cost reporting and
cost reimbursement. Accordingly, the Guernsey Court found that § 223 was ineffective because
"[t]he "nexus' that exists in the regulations between cost reporting and cost reimbursement is too
strong ... to be broken by a rule not adopted in accordance with the rulemaking requirements of
the Administrative Procedures Act." Id. at 836. We agree with this statement.
12These costs consisted of 1) stock transfer and registration fees; 2) reports to stockholders;
3) stockholders' meetings; 4) legal and accounting fees incurred through the SEC filings and
stockholders' meetings; and 5) public relations aimed at institutional investors.
13Medicare does not reimburse all expenses, but only those that are reasonably related to
patient care. Id. at 328 n. 25; 42 U.S.C. § 1395x(v)(1)(A).

because 42 C.F.R. § 405.40614 required GAAP to be applied in determining reasonable costs. Id.
We rejected this argument holding that GAAP was not necessarily to be used in determining
if a particular cost was allowable. Id. at 328-29. In particular, we found that section 405.406 was
not designed to determine the "costs allowable under the Medicare Act. The regulation is directed
at the type of financial data and reports required of providers; it is not a regulation affecting the
substantive provisions of the program as to what constitutes reimbursable costs." Id. at 329 (quoting
American Medical International, Inc. v. Secretary of Health, Education and Welfare, 466 F.Supp.
605, 623 (D.D.C.1979), aff'd 677 F.2d 118 (D.C.Cir.1981) (emphasis added). Hence, we reversed
the decision of the district court and held that the Secretary's determination was neither arbitrary nor
capricious. Sun Towers, 725 F.2d at 330.
In Sun Towers, the issue was whether a particular cost was allowable at all. In the case at bar,
as it was in the Guernsey case, the issue is when a cost that was clearly allowable should have been
reimbursed. These are different questions and we do not believe that Sun Towers speaks to the issue
of when reimbursement is to be made.
Accordingly, we adhere to our decision in Sun Towers as to whether a particular cost is
allowable. However, we follow Guernsey as to when advance refunding costs are to be reimbursed.
III.
CONCLUSION
For the reasons stated above, we hold that, under the applicable Medicare regulations, the
Hospital was entitled to reimbursement for the full amount of its advance refunding loss in 1987 plus
interest. Therefore, we REVERSE the decision of the district court and REMAND this case for a
determination of the exact amount of the advance refunding loss and the amount reimburseable under
Medicare plus interest from 1987.15
14This section was the precursor to § 413.20.
15The Hospital argues that we should hold that the fiscal intermediary's figure of $11,671,393
is correct as to the amount of the advance refunding loss. However, this factual issue was not
decided by the PRRB or the Secretary, it was not before the district court, and we do not address
it. See Presbyterian Hospital of Dallas v. Harris, 638 F.2d 1381, 1389 (5th Cir.), cert. denied,
454 U.S. 940, 102 S.Ct. 476, 70 L.Ed.2d 248 (1981).