Court Nixes Challenge to Limits on Physician-Owned Hospitals

August 21, 2012

August 21, 2012 — A federal appeals court in Houston, Texas, has struck down a challenge to part of the Affordable Care Act (ACA) that essentially prevents physician-owned hospitals from expanding.

A trade group called Physician Hospitals of America (PHA) and the Texas Spine & Joint Hospital sued the Obama administration to have that portion of the law overturned as unconstitutional. In an opinion issued August 16, however, the appeals court did not rule on the merits of the case, but instead dismissed it on technical grounds. Nevertheless, the case has stoked the debate about the pros and cons of physician-owned hospitals, many of which are organized around particular specialties.

The roots of the case lay in federal restrictions on physician self-referral in the Medicare program. In 1989, Congress passed the so-called Stark law that denies Medicare payment when a patient receives care at a healthcare facility owned in whole or part by a referring physician. Lawmakers acted on evidence showing that an ownership stake could influence physicians to refer patients for medically unnecessary services.

The ban was extended in 1993 to hospitals in situations in which a referring physician had invested in a particular subdivision or department. However, the ban did not apply if the physicians had an ownership interest in the entire hospital, a loophole called "the whole-hospital exception."

In response to a rapid rise in physician-owned hospitals, in 2003 Congress enacted an 18-month moratorium on Medicare payments for self-referrals to these hospitals while the government studied their cost, quality, and effect on competitors. Existing physician-owned hospitals and those under development were exempt from the moratorium, which effectively discouraged new ones from starting up. Subsequent government studies found that physician-owned hospitals generally provided efficient, high-quality care, but did not rule out eliminating the whole-hospital exception in the future. Two studies in particular noted that physician-owned hospitals generally treated less severe cases than community hospitals — cherry-picking, in the eyes of critics — although community hospitals "were not suffering financially as a result," according to one report.

Congress, however, still had its doubts about the worthiness of physician-owned hospitals, and it expressed them in the ACA. The healthcare reform legislation, enacted in March 2010, limits the whole-hospital exception to hospitals that were owned by physician as of December 31, 2010, and that were enrolled in Medicare at that time. Any physician-owned hospitals that sprang up afterward could not receive Medicare or Medicaid reimbursement for self-referrals. Furthermore, existing physician-owned hospitals grandfathered under the law would lose their "whole-hospital exception" — and forego Medicare and Medicaid payment — if they expanded their facilities without first getting an exemption from the Department of Health and Human Services (HHS).

Stuck in the Middle of Expansion

That restriction on expansion prompted the suit heard by the federal appeals court in Houston. The physician-owned Texas Spine & Joint Hospital in Tyler, Texas, had launched a $30 million expansion in 2008, but halted construction in 2010 when Congress passed the ACA because it could not finish by the law's cut-off date of December 31, 2010. At the time, the hospital had already invested $3 million. Several dozen other specialty hospitals with construction projects underway were caught in a similar bind.

In June 2010, Texas Spine & Joint Hospital, joined by the PHA, asked a federal district court in Texas to block enforcement of the new limits on physician-owned hospitals so it could expand and still receive Medicare and Medicaid reimbursement. The plaintiffs said that the law's sole purpose was to protect hospitals not owned by physicians from "unwanted competition."

By unfairly diminishing the investment that physicians had in Texas Spine & Joint Hospital, the plaintiffs asserted, the law violated the guarantee of due process found in the Constitution's Fifth Amendment. They also said the law violates the amendment's equal protection clause by favoring hospitals not owned by physicians, and amounts to an improper "taking" of the physician-owners' property.

Siding with the plaintiffs were the Texas Medical Association (TMA) and a group called the Physicians Foundation, which includes the TMA and 16 other state medical societies. In a friend-of-the-court brief, the TMA and the Physicians Foundation said physician-owned hospitals earn the highest marks for quality of care and patient satisfaction, undercut competitors on cost, and serve the needy, all on top of paying taxes — unlike their not-for-profit counterparts.

Obama Administration Won First Round of Legal Battle

The Obama administration asked the district court to dismiss the suit, saying that the law was a constitutional, rational response to problems associated with physician-owned hospitals. Physician ownership, the administration said, leads to overuse of services and greater healthcare spending. By scooping up the easiest and best-paying patients, such hospitals also undermine public and community hospitals, which provide uncompensated care and services not typically found at their competitors. In addition, the administration said, physician-owned hospitals do not provide adequate emergency care.

Aside from defending the law, the Obama administration argued that the district court lacked jurisdiction in the case. It said Texas Spine & Joint Hospital was not entitled to challenge a Medicare statute in federal court until it had exhausted 2 preliminary options for justice. One option, administrative in nature, was asking the secretary of HHS to review the hospital's grievance. An alternative option is seeking compensation in the special Court of Federal Claims. Because the hospital had taken neither of these steps, the district court should throw out the case simply on jurisdictional grounds, according to the Obama administration.

In March 2011, the federal district court ruled that, contrary to the government's position, it did have jurisdiction in the case. Nevertheless, it agreed with the government that the ACA provisions were constitutional and dismissed the lawsuit. Although the plaintiffs marshalled "considerable evidence that questioned the wisdom and judgment of the legislature," the court ruled, Congress had not enacted the restrictions on physician-owned hospitals arbitrarily — it had a rational, if not necessarily correct, case for doing so.

"That Isn't the American Way"

Defeated in federal district court, Texas Spine & Joint Hospital and the PHA went upstairs to the federal appellate court in Houston. Although the plaintiffs had won in district court on the jurisdictional issue, they continued to defend their case as ripe for judicial review. They said it was unfair to make the hospital first press its claim through other channels, because it would have to complete its massive expansion, treat a single self-referred Medicare patient, and then wait for a denied claim before it could proceed.

That argument, however, did not sway the appellate court, which dismissed the lawsuit on the jurisdictional grounds laid out by the Obama administration and vacated the lower court's decision. The appellate court acknowledged that the hospital probably would experience a "delay-related hardship" by exhausting other options to qualify for its day in court. However, in the context of a massive program such Medicare, it said, "paying this price may seem justified."

Scott Oostdyk, an attorney who represented Texas Spine & Joint Hospital and the PHA in the litigation, said that his clients are "disappointed that the court closed the procedural avenue in a situation where it would cost [millions of dollars] before your situation became ripe."

"The appellate court said you have to break the law in order to appeal the law," Oostdyk told Medscape Medical News. "That isn't the American way to proceed.

"There should be a better remedy for physicians and patients who were promised that their voices would be retained in the new healthcare paradigm."

Oostdyk said his clients are considering whether they will appeal to the US Supreme Court. "All options are on the table."

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