Commonwealth of Pennsylvania D v. United States, 897 F.3d 497

Background

Pennsylvania operated the Pennsylvania Restraint Reduction Initiative (PARRI) from 1996–2011 to train nursing-home staff to reduce use of restraints; it contracted with Kendal and claimed the contract costs as Medicaid administrative expenses.
CMS reimbursed about $3,001,536 for those claims but, following an OIG audit, disallowed the payments as non-reimbursable because provider training is not an administrative cost under 42 U.S.C. § 1396b(a)(7), relying on a 1994 State Medicaid Director Letter (1994 SMDL).
The HHS Departmental Appeals Board affirmed CMS’s disallowance, citing the 1994 SMDL and prior Board precedent that provider training is not an administrative cost and should instead be recovered via provider payment rates.
The District Court granted summary judgment to the agency, holding the 1994 SMDL is an interpretive guidance entitled to Skidmore deference and that the agency’s disallowance complied with the APA.
On appeal, the Third Circuit applied APA review, affirmed the District Court and Appeals Board, and rejected Pennsylvania’s challenges to the SMDL, its application to PARRI, discovery denial, GAM time-limit argument, and the request to take judicial notice of a 2015 CMS Q&A.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Validity of 1994 SMDL (interpretive vs substantive rule)	SMDL is a substantive (legislative) rule that required notice-and-comment under APA	SMDL is interpretive guidance clarifying §1396b(a)(7) and thus not subject to notice-and-comment	SMDL is an interpretive rule; notice-and-comment not required; Skidmore deference appropriate
Application of SMDL to PARRI training (overhead vs admin)	PARRI costs are not "overhead"; providers didn’t incur the cost so it isn’t disallowable	Training is provider-related and thus not an administrative cost; proper reimbursement route is provider rate-setting	Agency reasonably concluded PARRI is provider training/overhead and not an administrative cost; decision upheld under APA
Ambiguous spending condition (Pennhurst/notice)	SMDL created ambiguous grant condition depriving Pennsylvania of notice	The controlling statute/regulation supply the standard; SMDL is an interpretation of that standard and did not create an unauthorized condition	Rejection: state had notice from statute/regulation and Secretary’s discretion; no Pennhurst defect
Denial of discovery before the Appeals Board	Pennsylvania sought discovery to show CMS promised to reimburse PARRI costs	Board reasonably denied speculative discovery; no factual basis to believe such promise existed	Denial was not an abuse of discretion
GAM time limit for disallowance (three-year lookback)	GAM limits disallowance to three years based on records-retention rule	GAM is an internal, non-binding manual and agency may disallow earlier claims when records exist	GAM is not binding regulatory law; Board permissibly disallowed full period because records existed
Judicial notice of 2015 CMS Q&A (post-decision statement)	District Court should have taken judicial notice of CMS’s later Q&A supporting reimbursement	Q&A was published after the agency decision and is reasonably disputable; could represent a policy change, not an interpretation controlling at the time	Court did not abuse discretion in refusing judicial notice or record supplementation

Key Cases Cited

Douglas v. Independent Living Center of Southern California, 565 U.S. 606 (statement on Medicaid as federal-state cooperative program)
Skidmore v. Swift & Co., 323 U.S. 134 (guidance on weight of agency interpretations)
Motor Vehicle Manufacturers Ass'n v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29 (arbitrary and capricious standard)
S.E.C. v. Chenery Corp., 332 U.S. 194 (Chenery doctrine on review limited to agency grounds)
Elizabeth Blackwell Health Center for Women v. Knoll, 61 F.3d 170 (treating HCFA state-director letters as interpretive guidance)
New Hampshire Hospital Ass'n v. Azar, 887 F.3d 62 (First Circuit on when CMS Q&A/FAQ can be a substantive rule)
Revak v. National Mines Corp., 808 F.2d 996 (agency policy change and reasoned analysis requirement)