UNITED STATES COURT OF APPEALS FOR THE D.C. CIRCUIT


TRANSTN HOSP CORP LA

v.

SHALALA, DONNA E.


99-5166a

D.C. Cir. 2000


*	*	*


Garland, Circuit Judge: The Medicare program reim- burses certain
categories of hospitals on a "reasonable cost"  basis, rather than
under the generally applicable, and less  remunerative, "Prospective
Payment System." Long-term  care hospitals are one such category.
Plaintiffs own two new  facilities for which they sought
classification as long-term care  hospitals before they began
admitting patients. The Depart- ment of Health and Human Services
(HHS) rejected plain- tiffs' request, citing regulations that require
new hospitals to  have six months of experience before they can
qualify as  "long-term." In enacting those regulations, the Secretary
of  HHS took the position that an initial data-collection period is 
statutorily required. Plaintiffs, challenging the regulations in  the
district court, took the opposite position: that the Medi- care
statute does not mandate an initial data-collection period  and in
fact manifestly requires HHS to reimburse them as  long-term hospitals
from the first day of operation. The  district court agreed with


We do not find the statute as clear as either side suggests,  but
rather conclude that Congress intended the Secretary to  exercise
discretion in determining the manner in which a  hospital qualifies as
a long-term care facility. We therefore  reverse the decision of the
district court. However, because  the Secretary mistakenly believed
that she lacked such dis- cretion, we remand the case to permit her to
determine  whether she wishes to retain the existing regulations
knowing  that other options are permissible.


I


Medicare is a federal health insurance program for the  aged and
disabled that is administered by the Health Care 


Financing Administration (HCFA) of HHS. See 42 U.S.C.  ss 1395 et seq.
Under Medicare Part A, institutional health  care providers are
reimbursed for their services to eligible  patients. See id. ss 1395c
to 1395i-5. From its inception  until 1983, Medicare reimbursed
hospitals for the "reasonable  cost" of providing inpatient care,
subject to certain limita- tions. Id. s 1395f(b) (1982); see also id.


By 1983, Congress had become concerned that hospitals  reimbursed on a
reasonable cost basis lacked incentives to  operate efficiently. This
concern led to the revision of the  Medicare payment system in that
year. See Social Security  Amendments of 1983, Pub. L. No. 98-21, s
601, 97 Stat. 65,  149. See generally County of Los Angeles v.
Shalala, 192  F.3d 1005, 1008-09 (D.C. Cir. 1999). In place of the
reason- able cost method, Congress enacted the Prospective Payment 
System (PPS) as the principal method of compensating hospi- tals for
inpatient care provided to eligible patients. Under  PPS, hospitals
are reimbursed according to flat rates estab- lished in advance for
the various categories of patient diag- noses (known as
"diagnosis-related groups" or "DRGs"). 42  U.S.C. s 1395ww(d). The
rates reflect the average cost  associated with treating a patient for
a specific condition, and  encourage hospitals to keep costs within
the anticipated reim- bursement levels. For the care of patients whose
hospitaliza- tions are extraordinarily costly or lengthy, the statute
autho- rizes the Secretary to make "outlier payments" to supplement 
the standard PPS disbursement. Id. s 1395ww(d)(5)(A)(i)- (vi); see


Because PPS was "developed for short-term acute care  general
hospitals," Congress acknowledged that it did not  "adequately take
into account special circumstances of diag- noses requiring long
stays." S. Rep. No. 98-23, at 54 (1983).  Thus, Congress altogether
excluded from PPS certain types  of hospitals that treat atypical
patient populations. These  hospitals instead receive reimbursement
for inpatient care  under the reasonable cost system. See 42 U.S.C.  s
1395ww(d)(1)(B). One type of hospital subject to the statu- tory
exclusion is a long-term care hospital, which the statute 


describes as "a hospital which has an average inpatient length  of stay
(as determined by the Secretary) of greater than 25  days." Id. s
1395ww(d)(1)(B)(iv)(I).1 The availability of this  exclusion is the
central issue in the case before us.


A


HHS implemented the new PPS reimbursement scheme by  enacting
regulations in 1984. In issuing its final rule, al- though not in the
rule itself, HHS announced that it intended  to apply the statutory
exclusions prospectively only: any  change in a hospital's status
(i.e., whether it was subject to or  excluded from PPS) that occurred
during one cost reporting  period would generally take effect only at
the start of the  next period, with each period typically lasting one
year. See  Medicare Program; Prospective Payment for Medicare In-
patient Hospital Services, 49 Fed. Reg. 234, 243 (1984).  Thus, a new
hospital would not qualify for the exclusion at  least until the
initial reporting period was over. To accom- modate new hospitals, HHS
permitted an abbreviated initial  cost reporting period of six months,
rather than the usual one  year. See 42 C.F.R. s 405.471(c)(5)(i),


__________

n 1 The statute lists the following types of excluded hospitals:


(i) a psychiatric hospital (as defined in section 1395x(f) of  this
title),


(ii) a rehabilitation hospital (as defined by the Secretary),


(iii) a hospital whose inpatients are predominantly individu- als under
18 years of age,


(iv)(I) a hospital which has an average inpatient length  of stay (as
determined by the Secretary) of greater than 25  days ...


... 


(v)(I) a hospital that the Secretary has classified ... for  purposes
of applying exceptions and adjustments to payment  amounts under this
subsection, as a hospital involved extensive- ly in treatment for or
research on cancer....


42 U.S.C. s 1395ww(d)(1)(B).


now codified at 42 C.F.R. s 412.23(e)(1), (e)(3)(ii).2


In 1992, HHS formalized its prospective approach to exclu- sions by
proposing and then adopting the following rule:


For purposes of exclusion from the prospective payment  systems ...,
the status of each currently participating  hospital ... is determined
at the beginning of each cost  reporting period and is effective for
the entire cost  reporting period. Any changes in the status of the 
hospital are made only at the start of a cost reporting  period.


42 C.F.R. s 412.22(d). Thus, a hospital that qualifies for the 
exclusion in the middle of a reporting period will not benefit  until
the next reporting period. By the same token, a  hospital that ceases
to qualify in the midst of a cost reporting  period will nevertheless
be compensated as though it were  exempt for the entire period. See
Medicare Program;  Changes to the Hospital Inpatient Prospective
Payment Sys- tems and Fiscal Year 1993 Rates, 57 Fed. Reg. 23,618,
23,657  (1992). For a new hospital, HHS' rule confirmed that the 
exclusion does not begin until the first six months of data 


In response to the notice of proposed rulemaking, the  National
Association of Long Term Hospitals (NALTH) sug- gested that HHS permit
new long-term care hospitals to self- certify their average length of
stay from the start. See  Letter from NALTH to HCFA at 2 (July 31,
1992) (J.A. at 




__________

n 2 The regulations permit hospitals that experience a change in  their
average length of stay to establish exclusion eligibility by  having
an average length of stay greater than 25 days for the  immediately
preceding six month period. See 42 C.F.R.  s 405.471(c)(5)(i),
(c)(5)(ii)(B) (1983), now codified at 42 C.F.R.  s 412.23(e)(1),
(e)(3)(ii). According to HHS, a new hospital that  treats patients
with an average length of stay greater than 25 days  "will always
experience [a] change in length of stay because its  initial length of
stay is zero inpatient days." HHS Br. at 9 n.5.


53) [hereinafter NALTH Ltr.].3 HHS, however, concluded  that it did not
have the discretion to permit self-certification  by long-term care
hospitals. "We do not believe that the  statute permits us," the
Department said, "to extend the  exclusion for long-term care
hospitals to a hospital which has  not demonstrated actual compliance
with the statutory re- quirement." Medicare Program; Changes to the
Hospital  Inpatient Prospective Payment Systems and Fiscal Year  1993
Rates, 57 Fed. Reg. 39,746, 39,800-01 (1992) [hereinafter  Final
Rule]. The "criterion for exclusion as a long-term care  hospital
(average inpatient length of stay greater than 25  days) can be
assessed only over a period of time. Thus, a  hospital cannot qualify
as a long-term care hospital until it  has been in operation for some
period of time." Id. at 38,801.


B


Plaintiffs Transitional Hospitals Corporation of Louisiana  and
Transitional Hospitals Corporation of Texas (hereinafter  "the THC
plaintiffs") opened two new hospitals at the end of  1992. Both were
intended to treat patients with medically  complex conditions
requiring extended inpatient stays, there- by qualifying for the
long-term care hospital exclusion from  PPS. Before commencing
operations, the THC plaintiffs  wrote HCFA stating that they "only
expect to admit patients  whose medical conditions will result in
lengths of stay in  excess of 25 days." Letter from Counsel for THC to
HCFA  at 2 (Nov. 12, 1992) (J.A. at 57) [hereinafter THC Ltr.]. They 
asked HCFA to exclude them from PPS from the starting  date of their
Medicare provider agreements, rather than  reimburse them under PPS
during their first six months of  operation. See id. at 4 (J.A. at


Kathleen Buto, the Director of HCFA's Bureau of Policy  Development,
wrote back denying plaintiffs' request. Buto  said that the statute
mandates exclusion only for "a hospital 




__________

n 3 NALTH noted that HHS permits new rehabilitation hospitals  to
self-certify that their inpatient populations meet the exclusion 
criteria for that category. See NALTH Ltr. at 1-2 (J.A. at 52-53); 
discussion infra Part III.


which has [emphasis added] an average length of stay (as  determined by
the Secretary) of greater than 25 days."  Letter from HCFA to Counsel
for THC at 2 (Dec. 24, 1992)  (J.A. at 63) (alteration and emphasis in
original) [hereinafter  Buto Ltr.]. Noting that HHS regulations
implement that  mandate by "examining [a hospital's] actual operating
experi- ence in a past period, rather than by relying on its admission
 criteria or other formalized statements of how the hospital is 
intended or expected to operate," Buto concluded that the  THC
plaintiffs could not qualify for the exclusion in advance.  Id. at 2-3
(J.A. at 63-64).


Having had their request turned down, the THC plaintiffs  proceeded
with the six-month cost reporting period. During  that time, they were
reimbursed under PPS, supplemented by  outlier payments. At the end of
the six-month period, both  hospitals demonstrated average inpatient
lengths of stay ex- ceeding 25 days, thereby qualifying for exclusion
from PPS-- and entitling them to payment for "reasonable
costs"--during  the next cost reporting period. See Linville Aff. pp
7, 8, 13  (J.A. at 35, 37). Plaintiffs estimate that their PPS
reimburse- ment during the initial six-month period was approximately 
$1.2 million per hospital less than it would have been under  the
reasonable cost standard. See id. pp 11, 12 (J.A. at 36).


The THC plaintiffs requested a hearing before the Provider 
Reimbursement Review Board, which is authorized by statute  to hear
the complaints of providers dissatisfied with the  compensation they
have received. See 42 U.S.C. s 1395oo(a),  (d). Plaintiffs challenged
the validity of the regulations that  denied them compensation for
reasonable costs during their  first months of operation. The Board,
however, concluded  that it lacked authority to determine the validity
of HHS  regulations.


Plaintiffs then brought suit in the United States District  Court for
the District of Columbia. Ruling on the parties'  cross motions for
summary judgment, the court concluded  that the Medicare statute was
neither silent nor ambiguous  on the question. Rather, the court
concluded that the statute  unambiguously requires HHS to provide a
PPS exclusion  from the beginning of a new long-term care hospital's
partic- ipation in the Medicare program. The court further held that 
even if the statute were ambiguous, the Secretary's regula-


tions did not constitute a permissible interpretation of the 
legislative language. The court therefore declared the regu- lations
invalid insofar as they preclude new long-term care  hospitals from
securing immediate exclusion from PPS. See  Transitional Hosps. Corp.
v. Shalala, 40 F. Supp. 2d 6, 15  (D.D.C. 1999). This appeal by the
Secretary followed.


II


We review de novo the district court's ruling on the mo- tions for
summary judgment. See United Seniors Ass'n v.  Shalala, 182 F.3d 965,
969 (D.C. Cir. 1999). In judging the  validity of the Secretary's
regulations, we apply the familiar  two-step framework of Chevron
U.S.A. Inc. v. Natural Re- sources Defense Council, Inc., 467 U.S.
837, 842-43 (1984).  We first ask "whether Congress has directly
spoken to the  precise question at issue," in which case we "must give
effect  to the unambiguously expressed intent of Congress." Id. If 
the "statute is silent or ambiguous with respect to the specific 
issue," we move to the second step and defer to the agency's 
interpretation as long as it is "based on a permissible con- struction
of the statute." Id. at 843. However, deference is  "only appropriate
when the agency has exercised its own  judgment." Phillips Petroleum
Co. v. FERC, 792 F.2d 1165,  1169 (D.C. Cir. 1986). "When, instead,
the agency's decision  is based on an erroneous view of the law, its


A


We begin with Chevron step one, and with the Secretary's  contention
that Congress unambiguously expressed its intent  to bar the relief
plaintiffs request.


The statutory provision at issue is quite brief. It excludes  from PPS
any "hospital which has an average inpatient length  of stay (as
determined by the Secretary) of greater than 25  days." 42 U.S.C. s
1395ww(d)(1)(B)(iv).4 When the Secre-




__________

n 4 Neither side makes an argument based on legislative history.  The
PPS exclusion was passed as part of a large bill enacting 


tary adopted her implementing regulations, she took the  position that
the statute does not permit her to certify a  hospital as long-term in
advance because the criterion for  exclusion, an average inpatient
length of stay greater than 25  days, "can be assessed only over a
period of time." Final  Rule, 57 Fed. Reg. at 39,801. "Thus," she
said, "a hospital  cannot qualify as a long-term care hospital until
it has been in  operation for some period of time." Id. Similarly,
when  HCFA turned down plaintiffs' request for self-certification, it 
stressed that, because under the statute only a hospital that  "has"
the requisite length of stay is eligible, a hospital cannot  qualify
until it makes the requisite showing that it "has" that  average
length of stay. See Buto Ltr. at 2 (J.A. at 63).


The statute seems neither so clear, nor so dictatorial, to us. 
Although it does establish a criterion based on average length  of
stay, the statute is silent as to how and when that length  should be
calculated. Nothing in the language precludes the  Secretary from
determining length of stay based on a predic- tion drawn, as
plaintiffs suggest here, from a hospital's policy  of admitting only
"patients whose medical conditions will  result in lengths of stay in
excess of 25 days." THC Ltr. at 2  (J.A. at 57); cf. County of Los
Angeles, 192 F.2d at 1013-15  (affirming HHS' use of predictions to
determine statutorily- mandated range of outlier payments).


Nor does the statute's use of the present tense verb "has" 
definitively resolve the question. Although to qualify it must  be
true that a hospital "has" the requisite length of stay, that  word
does not tell us how to determine whether that state of  being exists.
The agency has implicitly recognized as much  by adopting a policy of
determining a hospital's status at the  beginning of a cost reporting
period, and then permitting it to  retain that status for the entire
period--even if conditions  change in the interim. See 42 C.F.R. s




__________

n wholesale changes in the Medicare program, and specific references 
to the long-term care exclusion occur only in general passages 
explaining the need for a reasonable costs alternative to PPS for 
certain types of hospitals. See, e.g., H.R. Conf. Rep. No. 98-47, at 
192-93 (1983); S. Rep. No. 98-23, at 53-55 (1983); H.R. Rep. No. 
98-25, at 8-9, 141-42 (1983).


this policy, HHS excludes a hospital for the next period based  on data
derived from the prior period, regardless of whether  the hospital
actually "has" the requisite average on each day  of the next period.
See id.


Moreover, nothing in the statutory language precludes an  alternative
form of relief requested by plaintiffs: retroactive  reimbursement for
reasonable costs incurred during the first  six months if, at the end
of that period, the hospital shows  that it had a 25-day average
during that period. Again, the  word "has" does not unambiguously
decide this question.  Each of plaintiffs' hospitals could have
accurately said on its  six-month anniversary that today it "has" a
greater than 25- day average--referring to the entire period from day
one  through and including day 180. It would therefore have been 
consistent with the literal language to reimburse the hospital  on
that day for all of its reasonable costs incurred to date.


Finally, and perhaps most important, this is not a statute  as to which
we can only infer, from Congress' silence, an  implicit intent to
delegate to the Secretary the authority to  reasonably interpret the
statutory terms. See Chevron, 467  U.S. at 844. Rather, in this case
the statute excludes a  hospital that has an average length of stay of
greater than 25  days, "as determined by the Secretary." 42 U.S.C.  s
1395ww(d)(1)(B)(iv). Thus, Congress has provided "an ex- press
delegation of authority to the agency to elucidate a  specific
provision of the statute by regulation." Chevron, 467  U.S. at 843-44;
see also 42 U.S.C. ss 1302(a), 1395hh(a)  (granting HHS authority to
issue regulations to administer  Medicare program). This means that
the Secretary has  discretion to determine how to calculate the
qualifying length  of stay, and that we are bound to uphold her
determination as  long as she exercises that discretion in a
reasonable way. See  Chevron, 467 U.S. at 843-44.


B


The THC plaintiffs also see the statute as clear and unam-
biguous--although in precisely the opposite way as that per- ceived by
HHS. In their view, and in the view of the district  court, the use of
the present tense "has" requires that if 


during any given period the hospital "has" a 25-day average,  it must
be considered exempt for the entire period. See THC  Br. at 22-23. The
use of the present tense, plaintiffs contend,  requires that the
exclusion "be applied on a current basis,"  and "allows no alternative
temporal reading." Id. Or, as the  district court put it, "the plain
language of the statute indi- cates that a long-term care hospital may
obtain an exemption  from the Prospective Payment System whenever it
'has' an  average inpatient length of stay greater than 25 days." 
Transitional Hosps., 40 F. Supp. 2d at 10.5


Again we disagree, this time for the mirror image of our  reasoning
with respect to HHS' interpretation. Because the  statute does not
tell us how to determine whether a hospital  "has" the required
average length of stay, it cannot be read  as requiring the agency to
make that determination constant- ly and instantaneously--any more
than it can be read (as  HHS would have it) as requiring the agency to
make that  determination prospectively only. In Methodist Hospital v. 
Shalala, 38 F.3d 1225 (D.C. Cir. 1994), we considered a  similar
argument regarding the wage index used to determine  reimbursement
rates under PPS. In that case, the plaintiff  hospitals contended that
the Medicare statute required retro- active application of corrections
made to the index to ensure  that the Secretary was not employing an
incorrect index in  the period prior to the next correction. We
rejected that  claim, noting that it "would require the Secretary to
make  virtually continuous adjustments in the wage index." Id. at 
1230. "The statute," we said, "does not specify how the  Secretary
should construct the index, nor how often she must  revise it....
Congress through its silence delegated these  decisions to the




__________

n 5 Plaintiffs also proffer an argument they describe as based on 
statutory purpose, contending that they are entitled to an exemp- tion
from their first day of operation because Congress' exclusion of 
long-term care hospitals from PPS demonstrates its recognition  that
PPS is an inadequate method for reimbursing such hospitals.  But this
simply begs the question discussed in the text: were  plaintiffs'
hospitals "long-term," within the meaning of the statute,  from that


But, plaintiffs argue, if Congress had intended the exclu- sion to
apply prospectively, it could have drafted the statute  to provide a
PPS exclusion for a hospital that "had" an  average inpatient length
of stay greater than 25 days "during  its most recent cost reporting
period." Transitional Hosps.,  40 F. Supp. 2d at 11 (quoting Pls.'
Mot. for Summ. J. at 15)  (emphasis omitted). Frankly, we do not see
such a revised  statute as particularly less ambiguous. Indeed, we do
not see  why HHS could not have proffered the same editorial sugges-
tion and then made the opposite argument: If Congress had  intended
hospitals to receive retroactive reimbursement as  plaintiffs contend,
wouldn't it have defined the exclusion as  covering hospitals that
"had" the requisite average during  their "most recent cost reporting
period"? In any event,  while positing a "clearer" way to write a
statute may suggest  that an existing statute is ambiguous, it surely
does not  establish that it is unambiguous. And if the statute is not 
unambiguous, Chevron requires us to defer to a reasonable  reading by


We also must take care to read the word "has" in the  context of the
entire phrase of which it is a part. Two  elements of that context are
important here. First, the  statutory exclusion is for a hospital that
has "an average"  inpatient length of stay of greater than 25 days.
The criteri- on of "an average" strongly militates against plaintiffs'
view  that a hospital's status must be measured at every moment in 
time. As HHS correctly points out, an average is a criterion  that can
only be assessed over a period of time. Moreover,  the statute refers
not to an average "over" a period of 25  days, but to an average "of"
25 days--necessarily indicating  that the period of measurement must
be more than 25 days in  order reasonably to determine whether the
"average" during  that period was at least 25 days. Hence, the use of
the word  "has" in conjunction with the word "average" would not 
preclude waiting until six months have passed to determine  whether,
at that point, the hospital "has" an average of 25  days over a


Indeed, were we to read the statute as literally as plaintiffs  and the
district court suggest, plaintiffs' own contention--that 


they "met the 25-day requirement at all times during their  operation"
and so were entitled to payment from the first  day--would be plainly
incorrect. THC Br. at 4. On day one,  the hospitals could not have had
a 25-day average because 25  days had not yet passed. If a hospital
must be, and may only  be, paid for days on which it "has" a 25-day
average, plain- tiffs could not have qualified earlier than the 25th
day. Even  then, they could have done so only if every patient present
on  day one were still at the hospital 25 days later.


The second element of context that is important here is the  statute's
parenthetical phrase, "as determined by the Secre- tary." As we have
discussed above, by employing this phrase  Congress has made "an
express delegation of authority to the  agency to elucidate [the]
specific provision of the statute by  regulation." Chevron, 467 U.S.
at 843-44. This further takes  the case out of the realm of Chevron
step one's de novo  review, and into the realm of Chevron step
two--which asks  only whether the agency's interpretation is
reasonable. See  id. And that gives the agency considerable leeway to
deter- mine how "has" is to be defined, and whether to require 
prospective, contemporaneous, or retrospective evaluation  and
payment. See San Bernardino Mountains Community  Hosp. Dist. v.
Secretary of Health & Human Servs., 63 F.3d  882, 886-87 (9th Cir.
1995) (holding that inclusion of phrase  "as determined by the
Secretary" in Medicare Act's definition  of "sole community hospital"
"make[s] clear that Congress  intended to delegate to the Secretary
the task of outlining  and defining the criteria for attaining sole


Plaintiffs resist the conclusion that Congress has delegated 
definitional authority to HHS. They argue that the fact that  the
parenthetical "as determined by the Secretary" follows  the phrase "an
average inpatient length of stay," means that  Congress has only given
the agency "discretion to determine  how the average length of stay
will be calculated"--and not  whether the hospital "has" that average.
THC Br. at 26.  This is far too sophistic a reading. First, the
concession that  the agency has discretion to determine how to


average necessarily means it has discretion to determine  whether a
hospital "has" that average--since a hospital can- not have a
qualifying average unless it satisfies the agency's  calculation
methodology. Second, even if word placement  were decisive, it is as
true that the delegating parenthetical  follows the phrase "has an
average inpatient length of stay"  as that it follows the phrase "an
average inpatient length of  stay." At most this renders the scope of
Congress' delega- tion ambiguous, which again moves us to Chevron's
second  step. See Chevron, 467 U.S. at 844.6


C


In reaching the conclusion that the statute unambiguously  requires
retroactive reimbursement for the hospitals' initial 




__________

n 6 Plaintiffs assert that Congress confirmed their reading of the 
long-term care exclusion in its 1997 amendments to the Medicare 
statute, which place payment limits on newly participating long- term
care hospitals. Those amendments provide that:


in the case of a hospital or unit that is within a class of hospital 
described in subparagraph (B) which first receives payments  under
this section on or after October 1, 1997--


(i) for each of the first 2 cost reporting periods for which the 
hospital has a settled cost report, the amount of the payment  with
respect to operating costs ... [shall be] equal to the  lesser of ...
[the amount of operating costs or a national  limit.]


42 U.S.C. s 1395ww(b)(7)(A). Plaintiffs contend that this language 
indicates that Congress intended newly participating long-term care 
hospitals to receive reimbursement for reasonable costs from the  date
of their first reporting period. But as the Secretary points  out,
this provision does not materially advance the analysis. By its 
terms, it applies only to a "subparagraph (B)" hospital. A subpara-
graph (B) hospital, in turn, is defined as including a hospital that 
comes within subsection (d)(1)(B)(iv)--the precise subsection that is 
in dispute in this case. See id. s 1395ww(b)(7)(B); cf. Methodist 
Hosp., 38 F.3d at 1231 (noting, in the context of the Medicare 
statute, that "the views of a subsequent Congress form a hazardous 
basis for inferring the intent of an earlier one") (internal quotation


cost reporting period, the district court relied on another  district
court opinion, County of Los Angeles v. Shalala, 992  F. Supp. 26
(D.D.C. 1998), which held that a provision of the  Medicare statute
required HHS to make retroactive adjust- ments to outlier payments.7
County of Los Angeles held that  the provision, which set a range for
the "total amount of the  additional payments made," 42 U.S.C. s
1395ww(d)(5)(A)(iv)  (emphasis added), unambiguously required the
Secretary to  adjust the additional payments retroactively to ensure
that  the total fell within the range. See County of Los Angeles,  992
F. Supp. at 36. It thus rejected the Secretary's interpre- tation of
the provision as merely instructing her as to where  to set outlier
thresholds for the coming year. The district  court in the instant
case followed that line of reasoning, and  held that HHS could not use
prior-period experience merely  to determine how to reimburse the
plaintiff hospitals in the  future, but rather had to reimburse the
hospitals for their  reasonable costs from the first date of their
operation. See  Transitional Hosps., 40 F. Supp. 2d at 12.


Although the district court's reliance on the opinion in  County of Los
Angeles cannot be faulted, this court reversed  that decision seven
months later. See County of Los Angeles  v. Shalala, 192 F.3d 1005
(D.C. Cir. 1999). Rejecting an  argument based on verb tense, we held
that "instead of  embodying a retrospective inquiry into the amount of
outlier  payments that have been made," "the phrase 'payments made 
under this subparagraph' might just as plausibly reflect a 
prospective command to the Secretary about how to structure  outlier
thresholds for payments to be made in advance of each  fiscal year."
Id. at 1013. In so holding, we cited the Su- preme Court's decision in
Regions Hospital v. Shalala, 118  S. Ct. 909 (1998). There, the Court
held that the statutory  phrase, "recognized as reasonable," "by
itself[ ] does not tell  us whether Congress means to refer the
Secretary to action  already taken or to give directions on actions




__________

n 7 As discussed in Part I above, outlier payments are a supple- ment
to PPS reimbursement for hospitals with patients that stay  for
unusually long periods. See 42 C.F.R. ss 412.80 et seq.


taken." Id. at 916 (quoting Administrators of the Tulane  Educ. Fund v.
Shalala, 987 F.2d 790, 796 (D.C. Cir. 1993)).  "In other words," the
Court said, "the phrase 'recognized as  reasonable' might mean costs
the Secretary (1) has recog- nized as reasonable for [prior
reimbursement] purposes, or  (2) will recognize as reasonable as a
base for future ...  calculations." Id. By the same token, we conclude
that the  phrase at issue here--"has an average inpatient length of 
stay (as determined by the Secretary) of greater than 25  days"--is
ambiguous and may refer to the hospital's status at  the beginning of,
during, or at the close of a cost reporting  period. Cf. United States
Dep't of the Treasury v. FLRA, 960  F.2d 1068, 1072 (D.C. Cir. 1992)
(holding that statutory  phrase "adversely affected" is ambiguous and
permits "alter- native temporal readings").


III


Having concluded that the analysis of Chevron step one  does not
resolve the case, we would ordinarily move to step  two and ask
whether the Secretary's interpretation of the  meaning of the statute
is reasonable. Plaintiffs argue that  the Secretary's interpretation
is not reasonable, contending  that HHS has no justification for not
permitting self- certification, for not utilizing the alternative of
retroactive  reimbursement, and for denying both options to long-term 
care hospitals while making them available to another catego- ry of
PPS-excluded institutions: rehabilitation hospitals. See  42 C.F.R. s
412.23(b)(8), (b)(9).


HHS replies that it is perfectly reasonable to rely on actual  data
regarding length of stay rather than on a hospital's self- interested
prediction. The Department explains that it per- mits
self-certification by rehabilitation hospitals because the  criteria
for qualification of such hospitals are based on the  "characteristics
of the patients and the types of services that  the facility
furnishes," Final Rule, 57 Fed. Reg. at 39,801,8 




__________

n 8 The statute excludes from PPS "a rehabilitation hospital (as 
defined by the Secretary)." 42 U.S.C. s 1395ww(d)(1)(B)(ii). The 
Secretary's implementing regulation defines such a hospital as one 


criteria which--unlike length of stay--a hospital can "virtual- ly
guarantee[ ]" from the first day of operations, HHS Reply  Br. at 12.
With respect to the alternative of retroactive  adjustment, HHS points
out that no one suggested such an  option until after the district
court litigation began in this  case.9 Moreover, HHS argues that
retroactive adjustments  are as likely to hurt hospitals that slip
below the average  during a period for which they have been
prospectively  qualified, as it is to help them by providing
reimbursement  for a prior period in which they became qualified along
the  way. By setting reimbursement rates "that are not later  subject
to retroactive correction," HHS contends, "the Secre- tary promotes
certainty and predictability of payment for not  only hospitals but
the federal government." HHS Br. at 41  (quoting County of Los


Although we ordinarily would now proceed to evaluate  these various
arguments under the standards of Chevron's  second step, we cannot do
so in this case. While the Secre- tary has discretion to establish a
reasonable mechanism for  determining whether a hospital has the
requisite average  length of inpatient stay, that discretion must be
exercised  through the eyes of one who realizes she possesses it. At 
several points, the Department's briefs suggest that the  Secretary
did realize that she had such discretion.10 At other  points, the
briefs suggest quite the opposite.11 Most relevant, 




__________

n that, inter alia, serves an inpatient population of whom at least 75 
percent require intensive rehabilitative services for the treatment of
 specified conditions including stroke, spinal cord or brain injury, 
major multiple trauma, and amputation. See 42 C.F.R.  s
412.23(b)(2).


9 Neither NALTH in its comments on the 1992 proposed rule,  nor the THC
plaintiffs themselves in their 1992 request to HCFA,  proposed
retroactive reimbursement. See HHS Reply Br. at 14 n.7.


10 See, e.g., HHS Br. at 25, 28.


11 See, e.g., HHS Br. at 12 (stating that in promulgating 1992 
regulations, "HHS concluded that a self-certification procedure for 
long-term care hospitals would violate its statutory mandate"); id. 
at 15 (stating that in rejecting THC plaintiffs' request for self-


however, is that the notice issued at the time the final rule  was
promulgated makes it quite clear the Secretary did not  believe that
she had the discretion to do what the plaintiffs  request. See, e.g.,
Final Rule, 57 Fed. Reg. at 39,800-01  ("We do not believe that the
statute permits us to extend the  exclusion for long-term care
hospitals to a hospital which has  not demonstrated actual compliance
with the statutory re- quirement.") (emphasis added); id. at 39,800
(declaring the  Secretary's doubt that "the law would support such a
policy");  id. at 39,801 ("[T]he [statutory] criterion for exclusion
... can  be assessed only over a period of time. Thus, a hospital 
cannot qualify as a long-term care hospital until it has been  in
operation for some period of time.") (emphasis added).12


As the Supreme Court has instructed, an agency "order  may not stand if
the agency has misconceived the law." SEC  v. Chenery Corp., 318 U.S.
80, 94 (1943); see Phillips Petrole- um, 792 F.2d at 1169-70. Applying
that principle, this court  has held that "an agency regulation must
be declared invalid,  even though the agency might be able to adopt
the regulation  in the exercise of its discretion, if it was not based
on the  [agency's] own judgment but rather on the unjustified as-
sumption that it was Congress' judgment that such [a regula- tion is]
desirable" or required. Prill v. NLRB, 755 F.2d 941,  948 (D.C. Cir.
1985) (internal quotations omitted) (alterations  in original).
Because the Secretary evaluated the various  reimbursement
alternatives on the assumption that "a hospi- tal cannot qualify as a
long-term care hospital until it has  been in operation for some
period of time," Final Rule, 57  Fed. Reg. at 39,801, and because that




__________

n certification, HCFA explained "that nothing in the statute or regu-
lations would allow it to grant the hospitals an immediate exclusion 
from the PPS").


12 The Buto letter, although somewhat more equivocal, reflects  a
similar understanding. See Buto Ltr. at 2 (J.A. at 63) (denying 
plaintiffs' request because statute mandates exclusion only for "a 
hospital which has [emphasis added] an average length of stay (as 
determined by the Secretary) of greater than 25 days") (alteration 
and emphasis in original).


the Secretary must make a fresh determination as to whether  she wishes
to adopt the self-certification or retroactive adjust- ment options.


IV


For the foregoing reasons, the judgment of the district  court is
reversed. The case is remanded to that court with  instructions to
remand it to HHS for further consideration  consistent with this