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11.01.2008 Update: CON Cost Allocation Issue Determined in May 30, 2008 Final Agency Decision but Remains Subject to Appeal.
11.01.2008
(See below for related articles from March 2008 and January 2007)

A final agency decision issued 30 May 2008 by the new Acting Director of the North Carolina Department of Health and Human Services, Division of Facility Services (“DFS”) held that certain construction costs borne by unrelated third parties should not be included in cost thresholds in determining whether a Certificate of Need (“CON”) is required for certain projects.  Mission Hospitals, Inc. et al v. N.C. D.H.H.S., et al., 05 DHR 1369 (Final Agency Decision May 30, 2008).  This new final agency decision departs from a previously issued final agency decision in the same case.  Mission Hospitals, Inc. et al v. N.C. D.H.H.S., et al., 05 DHR 1369 (Final Agency Decision 7 August 2006).

This case originated from the issuance of a “no-review” determination granted to Asheville Hematology by the CON Section in February 2005, which permitted Asheville Hematology to relocate and expand an existing medical oncology treatment center and acquire a linear accelerator, CT scanner/ simulator, and treatment planning software and equipment without obtaining a CON.  Competing health service providers Mission Hospitals, Inc. and 21st Century Oncology appealed the no-review determination, contending that the costs of the proposed project exceeded the thresholds that require Asheville Hematology to obtain a CON.  The director of DFS at that time, Robert Fitzgerald, agreed and reversed the CON Section’s no-review determination in a final agency decision issued August 7, 2006.  Mr. Fitzgerald’s decision forbade Asheville Hematology from undertaking the relocation/expansion or the acquisition of the proposed equipment until it first applied for and obtained a CON.  Asheville Hematology appealed to the Court of Appeals, which on March 18, 2008 reversed the final agency decision on procedural grounds and sent the case back to the director of DFS for the issuance of a new final agency decision.  On May 30, 2008, a new final agency decision was issued by new Acting Director of DFS Jeff Horton, and the new final agency decision upheld the initial no-review determination made by the CON Section and permitted Asheville Hematology to proceed without obtaining a CON. 

Costs for building construction and up-fit.

The May 30, 2008 final agency decision held that the relocation and expansion of the oncology center by Asheville Hematology did not require a CON because total project costs were below the threshold of $2 million, and thus the proposed center was not a “new institutional health service” requiring a CON under G.S. 131E-176(16)b.  In calculating total project costs, the final agency decision determined that the developer’s base costs for constructing the building should not be included as part of the total project costs.  If the builder is unrelated to the entity which will be providing the health service and is leasing space to the health service, the CON Section will only look at the actual costs incurred to specifically upfit or transform the office building into a health service facility.  However, if a builder is a party related to the provider of the health service, the CON Section considers the builder to be developing the health service facility, and therefore the entire cost of the facility would be considered when determining total project costs.

The final agency decision further held that none of the equipment acquisitions constituted “major medical equipment” pursuant to G.S. 131E-176(14f), since the costs associated with each piece of equipment should be treated separately, and the costs for each piece of equipment were below the applicable $750 thousand cost threshold.

The CON law seeks to control capital expenditures for health services and facilities.  Therefore, the final agency decision is more consistent with the purpose of CON law than Mr. Fitzgerald’s previous final agency decision.  Costs for construction of space leased in existing buildings or in buildings that are not specific to medical uses and which costs are borne by unrelated third parties should not count towards cost thresholds for purposes of obtaining a CON. 

It is important to note that the final agency decision has been appealed and ultimately could be reversed by the Court of Appeals.  Unless the Court of Appeals rules otherwise, the CON Section is expected to follow the final agency decision and will likely exclude these unrelated construction costs when calculating cost thresholds for determining whether a CON is required.  Any decision by the Court of Appeals will likely not be issued in 2008.  Entities proposing new health services should therefore carefully analyze and consider all project costs, including construction costs, before going forward.
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 Update: 18 March 2008 – CON Cost Allocation Issue Not Resolved by Court 
(See below for original article)

A much anticipated decision was issued today by the N.C. Court of Appeals in a case that impacts which proposed health care projects in N.C. are required to have state approval in the form of a Certificate of Need (“CON”).  Unfortunately, the Court addressed only procedural aspects of the case, and did not resolve underlying issues of the proper interpretation of the CON law.

The Court of Appeals issued an opinion in the case of Mission Hospitals, Inc. et al v. N.C. D.H.H.S., et al., 05 DHR 1369, COA06-1642.  The Court held that the Director of the Division of Health Service Regulation (formerly Division of Facility Services) made procedural errors (a) by communicating with one party ex parte (outside the presence of the other parties) during the drafting of the final agency decision, and (b) by failing to give specific reasons for rejecting numerous findings of fact from the recommended decision by the administrative law judge who heard the case.  As a result, the court vacated the final agency decision and sent the case back to the Division of Health Service Regulation for a second hearing and a new final agency decision.

Since the agency’s decision in 2006, when analyzing whether a proposed project meets cost thresholds that determine whether a CON must be obtained, the CON Section has followed the direction of the DHSR Director by counting construction costs for the building space in which a proposed project would be developed, even when those construction costs are incurred by a separate entity. 

As a result of the Court of Appeals’ decision, DHSR will be required to issue another decision, but the impact of the decision on the CON Section and providers is not likely to change.  The new decision could again be appealed, and if so the issue will not likely be resolved during 2008. ______________________________________________________________________________________________
2006 Decision by DFS Effectively Lowers Cost Thresholds for Projects Requiring CON’s

Article Summary:

A recent decision by the North Carolina Department of Health and Human Services, Division of Facility Services (“DFS”) has far-reaching implications for health service providers’ future projects by affecting whether projects are below the cost thresholds in the law that trigger the requirement for a Certificate of Need. 

The DFS decision changes previous agency policy by requiring providers to include certain construction costs incurred by another party for space to be leased for purposes of a project.  As a result, additional construction costs must now be considered (even if incurred by entities other than the health service provider) and CON’s may now be required for projects involving leased space that were not previously regulated.  Mission Hospitals, Inc. et al v. N.C. D.H.H.S., et al., 05 DHR 1369 (Final Agency Decision 7 August 2006).
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2006 Decision by DFS Effectively Lowers Cost Thresholds for Projects Requiring CON’s

A recent final agency decision by the director of the North Carolina Department of Health and Human Services, Division of Facility Services (“DFS”) has far-reaching implications for health service providers by requiring a Certificate of Need (“CON”) for projects that were previously below cost thresholds that trigger the requirement for a CON.  Mission Hospitals, Inc. et al v. N.C. D.H.H.S., et al., 05 DHR 1369 (Final Agency Decision 7 August 2006).

The subject of the decision, Asheville Hematology, is an existing medical oncology treatment center providing chemotherapy services that wished relocate to a larger building in Asheville and add radiation oncology services.  It proposed to acquire a linear accelerator, CT scanner/ simulator, treatment planning software and equipment, and to relocate and expand its existing facility to a new, larger building. 

In February 2005, Asheville Hematology requested a determination from the CON Section that no CON was required for the project.  The CON Section granted the requested determination in August 2005, finding that no CON was required under GS 131E-176(16)b, since total project costs were below $2,000,000.  The CON Section also found that none of the equipment acquisitions constituted “major medical equipment” pursuant to GS 131E-176(14f), since the costs associated with each system were below $750,000.

Mission Hospitals, Inc. and 21st Century Oncology, a competing oncology practice, appealed the no-review determinations, contending among other things that costs had been omitted from the representations made by Asheville Hematology, and that the true costs of the project exceeded the thresholds that require Asheville Hematology to obtain a CON.  The director of DFS agreed and reversed the CON Section.  The director’s final agency decision forbade Asheville Hematology from undertaking the relocation/expansion or the acquisition of the proposed equipment until it first applied for and obtained a CON.

Among the other reasons for which a CON was required, the Director departed from previous agency practice by concluding that Asheville Hematology improperly failed to include costs for the construction of the building space that would house the new equipment.  Although Asheville Hematology had included “upfit costs” to customize certain space within the proposed building to house the new equipment, the building itself was to be constructed by a different entity and leased to Asheville Hematology.  As a result, Asheville Hematology did not include the cost to construct the necessary parts of the building itself.

The decision noted that the cost thresholds set by the CON statutes are not limited to costs incurred by Asheville Hematology.  Therefore, even if the building was to be built and paid for by another entity, the construction costs for space “essential for making [the proposed equipment] operational” must be counted toward the applicable thresholds for major medical equipment (under GS 131E-176(14f)) and the development of a diagnostic center (under GS 131E-176(7a)).

Applying this logic, DFS derived an additional cost to be allocated by multiplying the average construction cost per square foot for the building by the square footage to be used for the proposed equipment.  After adding this additional cost, the proposed project exceeded the $750,000 cost threshold and therefore constituted the acquisition of major medical equipment, which requires a CON.  The project as a whole also exceeded the $2,000,000 threshold and thus required a CON pursuant to GS 131E-176(16)b.

In so holding, the decision relied upon a 1999 declaratory ruling by DFS concerning the acquisition of diagnostic equipment by Onslow Memorial Hospital, and the installation of the equipment in existing space in the hospital.  The 1999 decision found that Onslow Memorial failed to include the costs necessary to add shielding and otherwise make the space suitable for the diagnostic equipment.

However, in the 2006 Asheville Hematology decision, DFS went a step further by applying this rationale to the construction of new space by a separate entity, instead of the cost to convert existing space by the same entity.  This extension could affect any project in which a provider wishes to lease space (either newly constructed or existing) in which a health service will be located. 

This Final Agency Decision is arguably counter to the purpose of the CON Law to the extent that it counts the costs for construction of space leased in existing buildings or in a new office or retail buildings that are not specific to medical uses.  The primary purpose of the CON Law is to limit the construction of health care facilities in this state to those that the public needs and that can be operated efficiently and economically for their benefit.  However, counting the construction costs of buildings that could just as easily be used as office space or a coffee shop does not further this legislative purpose.  Instead, by including costs unrelated to medical uses, the decision unjustifiably lowers the cost thresholds that were set by the legislature to specifically allow smaller projects to proceed unregulated.

The Final Agency Decision has been appealed by Asheville Hematology, and could be reversed by the Court of Appeals.  However, while the appeal is pending, the CON Section has indicated that it will follow the decision and count construction costs incurred by unrelated parties when analyzing whether a CON must be obtained for a proposed project.  Since the decision is recent, it is unclear how far the CON Section will extend the requirement to include construction costs incurred by third parties.  As a result, anyone planning a project subject to the CON cost thresholds must give this issue careful consideration.