ORDERS:
FINAL ORDER AND DECISION
I. STATEMENT OF THE
CASE
This
matter is before the Administrative Law Court (“ALC”) for a final order and
decision following a contested case hearing pursuant to S.C. Code Ann. §
44-1-60 (Supp. 2007) and S.C. Code Ann. § 1-23-600(A) (as amended by 2008 S.C.
Act No. 334). Petitioners
MRI at Belfair, LLC (“MRI at Belfair”) and Hilton Head Regional Medical Center
(“Hilton Head Regional”) challenge the decision of Respondent South Carolina
Department of Health and Environmental Control (“Department” or “DHEC”) to issue
a non-applicability determination (“N/A Determination”) for Southern MRI to
purchase and operate a magnetic resonance imaging (“MRI”) unit in Beaufort
County, South Carolina. The
Department granted the N/A Determination based on its finding that the total
project cost of Southern MRI’s MRI project (“MRI Project”) did not exceed the
$600,000 threshold found in 24A S.C. Code Ann. Regs. 61-15 (Supp. 2007), which
triggers the requirement to obtain a certificate of need (“CON”) from the
Department.
In
this matter, the Petitioners challenge the Department’s determination that
Southern MRI’s MRI Project does not require review under the State
Certification of Need and Health Facility Licensure Act, S.C. Code Ann. §§
44-7-110 to 44-7-370 (2002 & Supp. 2007) (“CON Act”); the associated CON regulations,
24A S.C. Code Ann. Regs. 61-15 (Supp. 2007); and the State Health Plan. The
Petitioners contend that a proper application and allocation of the costs for
the MRI Project reflect that the total project costs exceed $600,000. The Respondents
assert that they appropriately allocated costs and that the total project cost
of the project as implemented, based upon those cost allocations, fell below
the $600,000 CON threshold.
After
notice to the parties, the court held a hearing on August 25-29, 2008 and September
15, 2008. All parties appeared at the hearing. Evidence was introduced and
testimony presented. After carefully weighing all of the evidence and applying
the applicable law, the court finds that the Department’s decision to issue an
N/A Determination for the MRI should be upheld.
II. GENERAL FINDINGS OF
FACT
Having
observed the witnesses and exhibits presented at the hearing and closely passed
upon their credibility, and taking into consideration the burden of persuasion
by the parties, the court makes the following Findings of Fact by a
preponderance of the evidence.
Southern MRI was established
in 1998 and has provided imaging services in the Hilton Head area operating as
Southern Open MRI in Bluffton, South Carolina. A separate entity, Southern MRI
of Hilton Head, LLC, has been providing imaging services since the late 1990s
and most recently provided imaging services through an MRI located on Hilton
Head Island.
In the summer of 2007,
Southern MRI decided to offer its referring physicians a more comprehensive
choice of imaging modalities on Hilton Head Island through the establishment of
a full service imaging center. Southern MRI retained Sam Tolbert, a healthcare
consultant, to assist in submitting an N/A Determination request. On August 14,
2007, Southern MRI submitted this request to DHEC seeking an N/A Determination
for the purchase and operation of an MRI as part of an imaging center (the
“Imaging Center”) located at 40 Palmetto Parkway in the Town of Hilton Head
Island in Beaufort County, South Carolina.
The Imaging Center is proposed
to offer imaging services through six different imaging modalities or
equipment, including an MRI unit, a computed tomography (“CT”) unit, an x-ray unit, two ultrasounds, and a Dexa (for bone density testing). In its request, Southern MRI proposed to locate the Imaging
Center in a 7,114 square foot commercial building. It intended to lease a
portion of the building and renovate 4,328 square feet for its Imaging Center and
sublease a smaller area for other uses.
As
part of its request, Southern MRI submitted its projected costs, along with
records, documents, and other information to the Department demonstrating that
the total project cost of the MRI Project was less than $600,000. The
parties appear to agree that the remaining imaging modalities did not require an
N/A Determination because the cost of acquiring and implementing the equipment
did not create any question as to whether CON review was required.
The DHEC staff applied S.C.
Code Ann. Regs. 61-15 § 103.25 to Southern MRI’s request and determined that
the MRI Project had a total project cost under the $600,000 CON threshold set
forth in S.C. Code Ann. Regs. 61-15 § 102.1.f. The DHEC staff issued N/A
Determination (NA-07-48) to Southern MRI for its MRI Project by letter dated
September 19, 2007.
MRI at Belfair and Hilton
Head Regional Medical Center sought administrative review alleging that the
Department erred in determining that the proposed MRI Project did not exceed
the $600,000 regulatory threshold. They allege that the costs of the proposed
project exceeded $600,000 and thus required CON review.
Subsequent to its receipt of
the N/A Determination from the Department, Southern MRI began implementation of
its project, which included construction for the upfit of the Imaging Center
space and acquisition of furniture and equipment. This court issued an Order
lifting the automatic stay then found at S.C. Code Ann. § 1-23-600(G) (Supp.
2007) during the pendency of the case and Southern MRI began performing MRI and
CT imaging in May 2008.
On June 26, 2008, Tolbert, on
behalf of Southern MRI, submitted to DHEC a comprehensive cost report based on
the actual costs incurred to implement the MRI Project.
The cost report included all of the invoices related to the renovation of the
office suite that housed the Imaging Center and documentation of the cost of
the MRI, related equipment, and furniture/equipment in the common spaces. The
project cost report contained an analysis of the total project cost for the MRI
using the methodology that the Department typically applies for imaging
centers.
At the hearing of this
matter, Southern MRI offered extensive testimony and exhibits regarding the
costs that were expended on the MRI Project and the total project costs that
should be allocated to the MRI Project. Southern MRI offered testimony from
Chris Jenkins, Southern MRI’s Director of Operations, regarding the project generally.
He also verified certain expenditures related to the MRI Project. Southern MRI
also offered Jerry Paolucci, who was the construction consultant for the
Imaging Center, to verify construction expenditures. Paolucci was offered as
an expert in general construction, construction management, and specifically
the development and construction of imaging centers. He offered testimony
regarding the renovation costs for the Imaging Center and the square footage
calculations for the MRI Project. Sam Tolbert, a health care administration professor
at Lander University who also operates a health care consulting business,
testified regarding his compilation of the original N/A Determination request, the
final cost report submitted to the Department, and various amendments thereto
that were made for purposes of the contested case hearing following discovery.
Tolbert was qualified as an expert in health planning and offered extensive
testimony regarding his experience with the Department in N/A Determinations
and the proper calculation of costs, as well as the appropriate allocation of
those costs to the MRI Project. Southern MRI also offered testimony and
evidence from Thomas Pietras, a certified public accountant licensed by the
State of South Carolina who practices in Columbia, South Carolina. Pietras was
qualified as an expert in generally accepted accounting principles (“GAAP”).
Pietras reviewed the cost report submitted by Tolbert and made certain
adjustments based on his conclusions that certain costs should not be
considered in the total project cost calculation for the MRI Project under
GAAP. Pietras also testified regarding proper accounting treatment of the
building and land costs for the MRI Project. Tolbert and Pietras both opined that
the total capital costs as submitted by Southern MRI and properly charged under
GAAP was $515,038.
The Petitioners offered
testimony concerning what they alleged was the proper valuation of the existing
land and building and the proper calculation and allocation of costs allegedly
expended on the MRI Project. George “Jake” Knight, a real estate appraiser
licensed by the State of South Carolina, was offered by the Petitioners and
qualified as an expert in real estate appraisal. He testified about the value
of the existing land and building. The Petitioners also offered testimony from
Larry Studdard, who was qualified as an expert in construction cost estimating
and auditing. He testified concerning certain “specialty costs” the Petitioners
allege should have been attributed to the MRI Project. The Petitioners also
offered expert testimony from Donnie Burkett, a certified public accountant
licensed by the State of South Carolina, who was qualified as an expert in GAAP.
Burkett relied on the opinions from Knight and Studdard regarding land and building
value and construction costs and offered opinions on the appropriate capital
costs that should be considered for the MRI Project in accordance with GAAP.
The Petitioners submitted a cost report compiled by Burkett similar in format
to the report submitted by Tolbert and Pietras. Burkett’s cost report
reflected his opinion that the total project cost for the MRI Project was
$716,215 if the court determined there were six modalities in the Imaging
Center or $754,724 if the court determined there were actually only five
modalities that should be considered in allocating costs.
Sarah
“Sallie” Harrell and Victoria Tibshrany, DHEC staff reviewers, testified on
behalf of the Department regarding the Department’s review of the N/A request,
the N/A Determination, and the Department’s position regarding the cost reports
presented at the hearing. Harrell testified that she reviewed the cost reports
submitted by Southern MRI and determined that the total project costs were
calculated properly. She testified that, as the Department staff reviewer for
this project, she determined that the total project cost for the MRI Project is
less than $600,000.
III. GENERAL CONCLUSIONS
OF LAW
A. Jurisdiction,
Review, and Burden of Proof
Jurisdiction
over this case is vested with the South Carolina Administrative Law Court
pursuant to S.C. Code Ann. § 1-23-600(A) (as amended by 2008 S.C. Act No. 334),
S.C. Code Ann. § 44-1-60 (Supp. 2007), and 24A S.C. Code Ann. Regs. 61-15 § 403
(Supp. 2007). The weight and credibility assigned to evidence presented at the
hearing of a matter is within the province of the trier of fact. See S.C.
Cable Television Ass’n v. S. Bell Tel. & Tel. Co., 308 S.C. 216, 222,
417 S.E.2d 586, 589 (1992). Furthermore, a trial judge who observes a witness
is in the best position to judge the witness’s demeanor and veracity and to
evaluate the credibility of his testimony. See, e.g., Woodall
v. Woodall, 322 S.C. 7, 10, 471 S.E.2d 154, 157 (1996); Wallace v.
Milliken & Co., 300 S.C. 553, 556, 389 S.E.2d 448, 450 (Ct. App.
1990). In presiding over this contested case, the court serves as the finder
of fact and makes a de novo determination regarding the matters at
issue. See S.C. Code Ann. § 1-23-600(A); Marlboro Park Hosp. v. S.C.
Dep’t of Health & Envtl. Control, 358 S.C. 573, 577-79, 595 S.E.2d 851,
853-54 (Ct. App. 2004); Brown v. S.C. Dep’t of Health & Envtl. Control,
348 S.C. 507, 512, 560 S.E.2d 410, 413
(2002).
The Petitioners, as the parties challenging the Department’s
decision to grant an N/A Determination in this matter, bear the burden of
proof. See Leventis v. S.C. Dep’t of Health & Envtl. Control,
340 S.C. 118, 132-33, 530 S.E.2d 643, 651 (Ct. App. 2000) (holding that the
burden of proof in administrative proceedings generally rests upon the party
asserting the affirmative of an issue). Therefore, MRI at Belfair and Hilton
Head Regional must demonstrate by a preponderance of the evidence that the
Department’s decision to grant Southern MRI an N/A Determination is contrary to
the applicable statutes and regulations. S.C. Code Ann. § 1-23-600(A)(6) (as
amended by 2008 S.C. Act No. 334); S.C. Code Ann. § 44-7-210(E) (2002); S.C.
Code Ann. Regs. 61-15 § 403.1 (Supp. 2007); see also Anonymous v. State Bd. of Med. Exam’rs, 329
S.C. 371, 375, 496 S.E.2d 17, 19 (1998) (holding that the standard of proof in
an administrative proceeding is generally the preponderance of the evidence); Nat’l Health Corp. v. S.C. Dep’t of Health & Envtl. Control, 298
S.C. 373, 380 S.E.2d 841 (Ct. App. 1989) (stating that preponderance of the
evidence standard is applied in CON disputes).
“[T]he Court generally gives deference to an administrative agency’s interpretation of an applicable statute or its own regulation.” Brown v. Bi-Lo, Inc., 354
S.C. 436, 440, 581 S.E.2d 836, 838 (2003) (citing Brown v. South
Carolina Dep’t of Health & Envtl. Control, 348 S.C. 507, 560 S.E.2d 410
(2002)). “The construction of a regulation by the agency
charged with executing the regulations is entitled to the most respectful
consideration and should not be overruled without cogent reasons.” Converse Power Corp. v. S.C.
Dep’t of Health & Envtl. Control, 350 S.C. 39, 48, 564 S.E.2d 341, 346
(Ct. App. 2002). “The
Department, as the sole state agency responsible for administering the CON, is given great
discretion and latitude in administering the terms and conditions of that
program.” Image Trust Florence, Inc. v. S.C. Dep’t of Health & Envtl.
Control & Florence Medical Imaging, 1996 WL 909548, *9, Docket No. 95-ALJ-07-0539-CC (S.C.
ALJD, April 19, 1996) (citing Byerly Hospital v. State Health and Human
Servs. Fin. Comm’n, 319 S.C. 225, 460 S.E. 2d 383 (1995)).
B. CON Review, N/A Determinations, and Generally
Accepted Accounting Principles
This
matter arises under South Carolina’s CON regulatory program for health care
facilities and services, which consists of the State Certification of Need and
Health Facility Licensure Act, S.C. Code Ann. § 44-7-110, et seq. (Supp.
2007), the accompanying CON regulations, 24A S.C. Code Ann. Regs. 61-15 (Supp. 2007),
and the State Health Plan. The
purpose of this regulatory scheme is to “promote cost containment, prevent
unnecessary duplication of health care facilities and services, guide the
establishment of health facilities and services which will best serve public
needs, and ensure high quality services are provided in health facilities in
this State.” S.C. Code Ann. § 44-7-120 (2002).
Pursuant to this regulatory
scheme, a person or health care facility seeking to
acquire medical equipment that is to be used for diagnosis or treatment must
first obtain a CON if the “total project cost” for the acquisition of the
equipment is in excess of that proscribed by regulation. S.C. Code Ann. § 44-7-160(6) (2002). The Department’s regulations
specify the applicable monetary threshold as $600,000. S.C. Code Ann. Regs.
61-15 § 102.1.f. When a question exists as to whether a CON is required
prior to undertaking a particular project, an applicant must submit a letter to
the Department requesting a formal determination as to the applicability of CON
requirements to the project. S.C. Code Regs. 61-15 § 102.3 (Supp. 2007). The
applicant’s letter must contain a detailed description of the project,
including the extent of services to be offered and the total costs of the
project. Id. The Department may request any additional information it
deems reasonably necessary to enable it to make a determination as to the
applicability of CON requirements to the project. Id.
“Total project cost” is defined as “the estimated total capital cost of
a project including land cost, construction, fixed and moveable equipment,
architect’s fee, financing cost, and other capital costs properly charged under
generally accepted accounting principals as a capital cost.” S.C. Code Regs.
61-15 § 103.25. “The determination of project costs involving leased equipment
o[r] buildings will be calculated based on the total value (purchase price) of
the equipment or building being leased.” Id. This sentence in the regulation may be characterized as
the “lease look-through” provision, since the regulation “looks through” a
lease, which would generally be treated as an expense, and includes the value
of the equipment or land being leased as a capital cost to be included in
determining the total project cost for CON review purposes.
Generally
Accepted Accounting Principles (“GAAP”) are a hierarchical set of principles
that guide accountants on accounting issues, including determining when costs
should be recorded on an entity’s accounting books as a “capital cost” versus
an expense. A capital cost is generally considered to be one that
benefits the purchaser for a period of longer that one calendar year. Application
of GAAP may require an exercise of judgment or discretion on the part of the
accountant.
Higher level GAAP is found in
various pronouncements, statements of position, and bulletins published by
professional accounting bodies like the Financial Accounting Standards Board
(“FASB”). Lower level GAAP is found, inter alia, in textbooks and
treatises. The widely held practices of accountants are also lower level
GAAP. Capitalization and cost allocation rules are the two main areas of GAAP
most relevant to this matter.
A question arises as to the interpretation of § 103.25 with
regard to the application of GAAP to the calculation of total project cost. The
regulation is ambiguous as to whether GAAP must be applied to every component
listed in the regulation as comprising “total project cost,” or rather whether
GAAP only is required to be applied in determining the component immediately
preceding the regulation’s reference to GAAP—“other capital costs.” The
parties took varying positions as to this issue.
The court finds, based on the grammatical construction of
the sentence and mindful of the legislative purposes behind the CON Act and its
accompanying regulations, that the regulation is intended to list the common
capital costs associated with health care projects—i.e., land, construction,
equipment, architect’s fee, and financing costs—but also to include a catch-all
component of “other capital costs” that may be associated with the project but
not among those specifically listed in the regulation. Because the catch-all
provision is by nature unspecific, the regulation provides instruction as to
how to determine whether a cost is an “other capital cost” rather than an
expendable cost by requiring the Department, with respect to those unlisted
costs, to apply GAAP. This interpretation of the regulation—that GAAP is
required to be applied only with regard to “other capital costs”—allows the
Department flexibility in calculating the specifically listed costs where a
strict application GAAP may not be consistent with the purposes of the CON
Act.
The court finds support for its construction of the
regulation in the “lease look-through” provision. That provision suggests that
accounting principles regarding “capital costs,” which would call for a lease
to be treated as an expendable cost rather than a capital cost, may not always be
appropriate for regulatory purposes. The regulation includes a specific
provision to prevent applicants from
circumventing the CON Act by leasing rather than purchasing and specifically
captures leases as part of the “estimated total capital cost of a
project.” S.C. Code Regs. 61-15 § 103.25 (emphasis added). Accordingly, the court finds that the
regulation defines the components of the
“estimated total capital cost of a project” as: land (whether leased or
purchased); construction; fixed and moveable equipment (whether leased or
purchased); architect’s fee; and financing cost. In addition, “other capital
costs properly charged under generally accepted accounting principles as a
capital cost” must also be included. Id.
The court further finds that, in determining the costs of
the land, construction, equipment, architect’s fee, and financing costs, the
Department can certainly look to GAAP for guidance as long as the application of
GAAP in the particular instance at hand is consistent with the purposes of the
CON Act. However, with
regard to “other capital costs” that may be associated with the project, the
Department is required by the plain language of the regulation to apply
GAAP.
Turning specifically to the
project at issue, the evidence shows that one of the principles of GAAP that
the Department could look to in determining land and construction costs is “FASB
67: Accounting for Costs and Initial Rental Operations of Real Estate Projects.”
The parties’ GAAP experts agreed that FASB 67 is not directly on point, as it
applies to real estate projects. However, both Burkett and Pietras appeared to
agree that it can provide guidance to the situation at hand. According to the
principles of FASB 67, the first step in calculating costs is the concept of “specific
identification”; that is, specifically identifying costs directly attributable to
the MRI Project in this case. Costs can be specifically identified based on
the use for which they were incurred. Section 7 of FASB 67 states: “Project
costs clearly associated with the acquisition, development, and construction of
a real estate project shall be capitalized as a cost of that project. Indirect
project costs that relate to several projects shall be capitalized and
allocated to the projects to which the costs relate. Indirect costs that do
not clearly relate to projects under development or construction, including
general and administrative expenses, shall be charged to expenses as
incurred.” FASB 67 further states that if costs cannot be specifically
identified, they must be allocated pursuant to another method. Section 11(B)
of FASB 67 provides: “Construction costs shall be allocated to individual units
in the phase on the basis of relative sales value of each unit. If allocation
based on relative sales value is impracticable, capitalized costs shall be
allocated based on area methods, for example, square footage, or other value
methods as appropriate under the circumstances.”
As
stated above, while FASB 67 may provide guidance to the Department in
determining land and construction costs attributable to the MRI Project, the
Department is not bound to follow it. It is bound, however, to apply the
regulation defining “total project cost” in a manner consistent with the
purposes of the CON Act. The evidence shows that to that end, the Department
has developed an allocation methodology specific to imaging centers. Pursuant
to that methodology, the Department allocates certain costs of an imaging
center by dividing those costs by the number of modalities to be implemented,
since all of the costs being allocated are being used for imaging purposes. The
court finds it appropriate to defer to the Department’s interpretation of the regulation
in applying its allocation methodology by modality for imaging centers. Cf. Anderson v. Baptist Med. Center, 343 S.C. 487, 495, 541 S.E.2d 526, 529-30 (2001) (“Construction of a statute by an agency charged with its administration will be accorded the most respectful
consideration and will not be overruled absent compelling reasons.”). The court further finds that the
agency’s construction of this portion of the regulation as it applies to
imaging centers is reasonable and does not conflict with the purposes of the
CON Act. Accordingly, the court finds no compelling reason to reject the
agency’s interpretation of this ambiguous regulation.
IV. SPECIFIC FINDINGS OF
FACT
A. Value of the
Land and Building
Southern MRI leases the land
and building for the Imaging Center. Accordingly, the “lease look-through”
provision applies. Thus, pursuant to 24A
S.C. Code Regs. 61-15 § 103.25, the court must determine “the total
value (purchase price)” of the land and building, including repairs made by the
landlord; determine a cost per square foot for the Leased Space; and then attribute a portion of the total value of the land and building to the
MRI Project by multiplying the cost per square foot by the number of square
feet specifically identified with the MRI Project. Further, a portion of the
common area of the Imaging Center must be allocated to the MRI Project.
1. Total
Value of Existing Land and Building
The parties disagree about
several issues relating to land and building cost, including the appraised
value of the land and building, the amount of the landlord repairs that should
be included in the value of the land and building, and the square footage of
the leased space for the Imaging Center.
a. Appraised Value
of Leased Space
With the N/A request, Southern
MRI submitted an appraisal dated May 10, 2007 prepared by Gary Beaver, an
appraiser licensed in South Carolina, who valued the land and building at
$500,000. The Petitioners assert that this appraisal is unreliable based on the
number of adjustments he made, the comparable properties he used, and the fact
that he did not have at the time of his appraisal the benefit of the actual
lease that was subsequently signed by Southern MRI and its landlord. Furthermore,
the Petitioners assert that Beaver’s appraisal lacks credibility based on
professional licensure issues and a default judgment entered against Beaver in
another state. In response, Southern MRI contends that Beaver is a licensed
appraiser in the state of South Carolina who issued an appraisal based on the
information available to him at the time of the N/A request. The Department accepts
the usage of Beaver’s valuation.
At the hearing, Southern MRI
also offered $634,500 as an alternative value for the land and building in the
event that the court found Beaver’s appraisal to be unreliable. Pietras
derived this valuation based upon a purchase option contained in the lease
agreement. The Petitioners contend that the
proper valuation for the land and building is $775,000 based on an appraisal
prepared by George Knight, a South Carolina licensed and MAI-certified
appraiser. Knight
attempted to appraise the property as of the time that the lease was entered
into. However, Knight actually conducted the appraisal much later in time,
after the landlord had made the repairs to the roof, siding, and parking lot,
and after Southern MRI completed extensive renovation of the leased portion of
the property. Knight did not have the benefit of viewing the property in the
“as is” condition at the inception of the lease. The undisputed testimony is
that the premises, at that time, were in such a state of disrepair as to be
uninhabitable. The Leased Space was contaminated with mold and suffered from plumbing
problems. The carpet had been ripped out and there were holes in the roof such
that daylight could be seen. Southern MRI engaged in substantial renovations,
including tearing out damaged walls, inserting walls, adding carpet, installing
a ceiling, and other major repairs.
The evidence shows that appraisals
involve subjective judgments. For example, it is within the judgment of the
appraiser to determine which comparable sales properties to analyze in using the
direct sales comparison approach. It is not unusual for two different
appraisers to appraise the same property and get two different values. Southern
MRI argues that Knight’s appraisal is not as reliable as Beaver’s and is
overvalued based on the fact that he did not have the benefit of viewing the
“as is” condition of the Leased Space, and because he used comparables that
were later in time and were inappropriate based on the condition of the Leased
Space. The court agrees.
The court finds that the
Petitioners did not prove by a preponderance of the evidence that it was contrary
to the applicable regulations to rely on Beaver’s appraisal. Therefore, the
court finds that the value of the existing land and building of the Leased
Space that should be used to determine the total project cost of the MRI
Project is $500,000.
b. Value of the
Landlord Repairs
As part of the lease
agreement, prior to Southern MRI occupying the Leased Space, the landlord was
required to repair several items. The landlord’s obligations included
replacing the roof, repairing the exterior siding, and repairing the parking
lot. The total cost for these repairs was $108,799. Of that amount, $27,200
was expended in repairing the parking lot. Based on the testimony presented,
the court finds that the cost expended for the parking lot is more in the
nature of repair and maintenance and is not a capital expenditure. Therefore,
it should not be included in determining the total project cost of the MRI
Project. However, a portion of the monies spent on the roof and the siding, amounting
to $81,599, should be allocated to the MRI Project.
As more fully discussed
below, Southern MRI leases 5,083 square feet of space in a building that, based
on the only evidence presented at trial, is approximately 7,114 square feet.
Therefore, Southern MRI leases 71.45% of the building. The court therefore
finds that $58,303 (71.45% * $81,599) of the
landlord repairs should be included in the total value of the land and building
of the Leased Space for the purposes of determining the total project costs of
the MRI Project.
c. Square Footage
of the Leased Space
Much of the evidence
presented at trial centered around the square footage of the leased space and
the individual rooms. Several measurements were offered by the experts and
included in the documents submitted. The lease signed by Southern MRI states
that the Leased Space is 5,224 square feet. Southern MRI asserts that the Leased
Space is actually 5,016 square feet. It bases this assertion on measurements
taken by Chris Jenkins, the Director of Operations for Southern MRI. Jenkins
measured the rooms with the assistance of his wife based on instructions he
received from Paolucci, who assisted Southern MRI with its construction and
design and was found by the court to be an expert in the design and
construction of MRI facilities. Jenkins measured each room three times.
Paolucci then averaged Jenkins’s measurements and entered that data into a CAD program to determine the total square footage for each room, the Imaging
Center, and the Leased Space.
The Petitioners contend that
the space leased by Southern MRI is 5,083 square feet. They rely on
measurements taken by Studdard, who was qualified as an expert in construction
costing and cost auditing. Studdard testified that he has over thirty years of
experience in the construction business and routinely measures interior
spaces.
Both sets of measurements
offered by the parties seem to be reliable in that the witnesses carefully
measured and/or have substantial experience in measuring. The court observes
that two experts can measure (or direct the measurements for) the same room and
obtain two different sets of dimensions. The court must choose one of these
measurements to calculate the total project cost of the MRI Project. The court
finds Studdard’s evidence to be slightly more reliable on this issue because he
conducted the measurements personally and has extensive experience, and, most
compellingly, because his measurements of the overall Leased Space almost
precisely match those contained in an early construction drawing of the
building in the records of the town of Hilton Head. Therefore, the court finds
that the exterior of the Leased Space measures approximately 5,083 square feet.
d. Cost
per Square Foot of the Leased Space
Therefore, the cost per
square foot of the Imaging Center is $109.84 (value of the Leased Space divided
by the total square footage of the Leased Space or $558,303/5,083).
2. Land
and Building Cost of the MRI Project
a. Square
Footage and Identification of the Imaging Center Space by Use
As noted above, the parties
disagree on the proper interior square footage measurements for the Imaging
Center. Southern MRI asserts that the total interior square footage for the
Imaging Center is 4,283.53 square feet. As discussed above, Southern MRI bases
this assertion on measurements taken by Jenkins and calculated by Paolucci. By
contrast, the Petitioners contend that the proper square footage for the
Imaging Center is 4,179.11 based on measurements taken by Studdard. For the
same reasons as stated above, the court finds Studdard’s evidence to be
slightly more reliable. Therefore, the court finds that the total square
footage for the Imaging Center is 4,179.11 square feet.
Based on the evidence
submitted at the hearing, the court finds that the Imaging Center will have six
modalities: an MRI, a CT, an ultrasound, a Dexa, an x-ray, and a mammography
unit. The space
of the Imaging Center can be divided into three categories: (1) Common Area;
(2) MRI-Dedicated Area; and (3) Other Clinical Area. The parties agree as to how
to identify the use of space for most of the rooms. However, they disagree on
the rooms listed on the plans as the radiologist’s office or “rad room,” the
general dressing and sub-waiting rooms, and the control room.
While the first room is labeled as
a “radiologist’s office,” testimony revealed that this office is being used
primarily by Jenkins as his office since there is not a radiologist on staff.
Staff members also use this room as well as physicians who may be onsite during
procedures that require contrast injections.
With regard to the dressing and
waiting rooms, the Petitioners assert that, based on their proximity to the MRI
and CT rooms and the fact that they were labeled in early plans as being
specifically for use by CT and MRI patients, the cost of those rooms should be specifically
designated to those modalities. However, the testimony presented at the
hearing reveals that these rooms are in fact being used by all patients
regardless of the modality they are using.
Finally, the Petitioners argue
that the costs of the control room should be divided equally between the CT
unit and the MRI unit because the MRI and the CT are controlled from this
room. However, while the evidence showed that the CT and MRI are controlled
from this room, it also demonstrated that there is a printer that prints film
for other modalities and a desk for the physicians to use. Therefore, the
court finds that this area is actually used for the benefit of all modalities
and should be considered common space.
Common area consists of area
that benefits all of the modalities or is utilized by patients for all of the
modalities. The court finds that the “rad room,” control room, and waiting and
dressing areas are most appropriately identified as common area. Therefore,
the court finds that the total square footage of the space of the Imaging Center
should be designated as follows: (1) Common Area: 2,276.53 square feet; (2)
MRI-Dedicated Area: 616.86 square feet; and (3) Other Clinical Area: 1,285.72
square feet.
Land and Building Costs Specifically
Identifiable to MRI Project (MRI-Dedicated Area)
Based on the findings above,
the cost per square foot of the Imaging Center is $109.84 (value of the leased
space divided by the total square footage of the leased space or
$558,303/5,083). Accordingly, the value of the MRI-Dedicated Space is $67,754
(616.86 * $109.84).
Allocation of Common Area
To
allocate the appropriate amount of the costs of the common area to the MRI
Project, Southern MRI divided the total cost of the renovations by six, the
total number of modalities proposed for the Imaging Center. This was the same
allocation methodology that Harrell, the DHEC reviewer for the project,
testified is appropriate for imaging centers. Tolbert testified that there are
various ways to allocate costs in the health care industry. He believed that dividing
these costs based on the number of modalities in the Imaging Center was a
reasonable method for allocating cost. Pietras further testified that dividing
costs by the number of modalities was a GAAP-compliant method of allocating
costs. As discussed above, the court finds that allocating the costs of the
common areas of the Imaging Center by the number of modalities is consistent
with the regulation and the CON Act.
Therefore,
the Common Area that should be allocated to the MRI Project is 379.42 square
feet (2,276.53/6 (square footage of the Common Area divided by the number of
modalities)). The value of the Common Area allocation for the MRI Project is
$41,675, which is arrived at by multiplying the Common Area allocation by the cost
per square foot of the Imaging Center (379.42 * $109.84).
Thus, the court finds that
the total value of the existing land and building that should be included in
determining the total project cost of the MRI Project is $109,429 ($67,755 (MRI-Dedicated)
+ $41,674 (Common Area Allocation)).
B. Construction Costs (Tenant Upfit)
Significant renovations were
performed to the Leased Space by Southern MRI prior to its opening. There is
no dispute as to the total renovation costs, which were $359,200; however, the
parties disagree as to which costs should be specifically identified as part of
the MRI Project. They further disagree as to how other costs should be
allocated to the MRI Project.
The
majority of the renovation costs were incurred through a lump-sum contract with
a general contractor, Breeze Builders. Southern MRI allocated $59,867 of the
cost of the renovations to the MRI Project. Southern MRI calculated these
costs by dividing the total cost of the renovations by six, the total number of
modalities proposed for the Imaging Center. Harrell testified that she
believed it was reasonable to divide the renovation costs by the number of
modalities because the renovations were necessary to upfit the Imaging Center to
service the six modalities.
The
Petitioners contend that Southern MRI’s allocation of the renovation costs violates
GAAP because it failed to specifically identify “specialty costs” that it
contends were incurred solely for the MRI Project. The Petitioners presented
evidence through their construction expert, Studdard, as to the value of the
specialty costs associated with the project. Studdard defined as specialty
costs “everything over and above what you might find in a State Farm Insurance
Office.” To assist Studdard in breaking out the specialty costs, he retained
the services of an electrical expert, Daryl Wood, and a mechanical expert, Ray
Fine. He reviewed certain source documents produced by Breeze and estimated
the balance of the work based on the plans he obtained. He concluded that
there were specialty costs required for three of the six modalities: (1) CT –
$39,665; (2) MRI – $55,262; and (3) X-Ray – $14,100. Burkett then attributed
the MRI specialty costs identified by Studdard directly to the project. The
remaining “non-specialty” costs were considered common costs, a portion of which
were allocated to the MRI Project on a square footage basis.
Harrell
testified that applicants requesting an N/A Determination typically break out
specialty costs associated with the MRI such as costs related to freight,
rigging, and installation, in addition to the unit price. She also stated that
typical costs for an MRI project include shielding and a pro-rated portion of
the land and building value. In addition, Tibshrany stated that applicants
requesting an N/A Determination typically break out specialty costs associated
with the MRI such as the heating, ventilating, and air conditioning device
(“HVAC”), MRI shielding, lights, and electrical equipment.
Southern
MRI contends that neither the Department regulations nor GAAP requires that the
“specialty costs” be segregated as suggested by the Petitioners. Southern MRI argues
that because it had a lump-sum contract for the renovation work, it was not
practicable or feasible to undertake the cost and effort to separately identify
the costs in this context. Southern MRI did directly attribute certain costs
that were clearly associated with the MRI to the MRI Project, including the MRI
shielding and other costs that were not included in the lump-sum contract.
Tolbert testified that in his experience he had never been asked to break out
specialty costs from a lump-sum contract. He further testified that he had
reviewed between twenty or thirty N/A project files over the last several years
and did not see any situation where the Department asked an applicant to break
out specialty costs from a lump-sum contract.
Specific
Identification of Construction Costs
The
question in this case is whether it violated the regulation for Southern MRI to
fail to specifically identify the so-called specialty costs in its total
project cost calculation rather than allocating them among the modalities. The
evidence is uncontroverted that if specialty costs are specifically
identifiable they should be directly charged to the project. The Department
appears to expect certain specialty costs to be broken out but does not always
require that it be done. Southern MRI specifically identified a majority of
the costs that the Department staff stated were commonly included in a request
for an N/A Determination. The court finds that in this particular case the
reliable and probative evidence suggests that a specialty cost breakout could
only be done with significant time and expense. The costs were presented in
such a fashion that would prohibit this court from making such a determination
on a majority of the specialty costs asserted by the Petitioners. However, one
item that the Department specifically stated was typically identified that
Southern MRI failed to include was the HVAC that cools the equipment room of
the MRI unit.
At
the hearing Paolucci testified that he believed the accurate cost for the HVAC
specifically installed to “super chill” the MRI equipment room was
approximately $4,000. The Petitioners presented estimated costs of the HVAC
determined by Fine to be significantly larger than Paolucci’s. Based on Paolucci’s
direct involvement and knowledge of the construction of Southern MRI’s Imaging
Center, the court finds Paolucci’s cost to be more reliable and accurate. Therefore,
of the $359,200 lump-sum contract, the court finds $4,000 should be
specifically identified to the MRI Project for the HVAC.
Allocation
of Construction Costs
The
court finds that, with the exception of the HVAC unit specifically used to
chill the equipment room for the MRI, allocating the upfit and renovation costs
by dividing by the number of modalities as done by Southern MRI is reasonable,
appropriate, and does not violate the regulation. Therefore, after deducting
$4,000 from the lump-sum contract, the total upfit and renovation costs to be
allocated equal $355,200. The amount to be attributed to the MRI Project is
$59,200 ($355,200/6), in addition to the $4,000 for the HVAC, for a total of $63,200.
C. Equipment Costs
Specific Identification of Equipment
Costs
Both the Petitioners and
Southern MRI included the following items and costs in their respective
calculations of the MRI Project’s equipment costs: MRI $275,000, sales tax on
MRI $19,250, MRI shielding $28,000, electrical disconnect $4,000, fire
extinguisher $199, and MRI chiller $550. As there is agreement upon the
inclusion of these items at these amounts, the court finds that these items,
totaling $326,999, are properly included in the MRI Project’s total project
cost.
Allocation of Common Furniture, Fixture,
and Equipment
The parties diverged with
regard to the appropriate valuation of furniture, fixture, and equipment
(“FF&E”). Southern MRI allocated $616 to the project for MRI-Dedicated FF&E
and $2,558 for FF&E in common areas. Hilton Head Regional contends that $8,423
(less the fire extinguisher and the chiller, which the parties agreed upon) is attributable
as dedicated FF&E and $6,104 is allocable for FF&E in common area. MRI
at Belfair contends that $8,224 is attributable as dedicated FF&E and $6,184
is allocable for FF&E in common area. The differences between Southern
MRI’s values and the Petitioners’ relate to four general issues.
The
Petitioners include certain FF&E as direct costs based on adjustments made
to the space allocation, including the radiologist office and the sub-waiting
and general dressing rooms. Because the court finds that Southern MRI properly
considered those rooms to be common areas, the court finds that Southern MRI properly
treated the FF&E in those rooms as common FF&E.
The
Petitioners include $2,900 identified as calibration for the MRI injector as a
direct cost under FF&E. Burkett testified that this expenditure should be
capitalized under GAAP because he believed it was incurred to prepare the
equipment to operate at its new location. Jenkins testified that the invoice
was for a preventive maintenance service call to perform service on the MRI
injector that was transferred from the old facility. In other words, a vendor
had a yearly service contract to perform preventive maintenance on this
injector. Therefore, the court finds that the $2,900 cost was for annual
preventive maintenance on a piece of equipment that was transferred to Southern
MRI’s imaging center. It was not a cost required to bring the MRI into service
at its new location and, thus, not a capital cost. Southern MRI properly
excluded it from the total project cost.
Southern
MRI’s initial cost report included the fair market value of FF&E that was
transferred from a related entity with some overlapping ownership, Southern MRI
Hilton Head. Pietras testified that under GAAP, if there is a transfer of
assets between related entities, the assets should be transferred at book
value. Because those assets transferred had been fully depreciated, Pietras
adjusted the FF&E costs to remove the value of those assets from the cost
report in order to comply with GAAP. The Petitioners’ allocation of FF&E
costs included the fair market value of the transferred FF&E. As stated
above, the Department is only required to apply GAAP when determining
“other capital costs.” GAAP does not necessarily have to be applied to
determine FF&E costs. However, the Department may look to GAAP in
determining the appropriate method to calculate and allocate FF&E.
Further, the Department is given deference in interpreting its regulations.
Therefore, the court finds that the Petitioners have not proven that this treatment
of FF&E violates the regulation.
Southern
MRI allocated the costs of common FF&E by dividing by the number of
modalities as it did with other common costs. The Petitioners allocated the
cost of the common FF&E based on square footage. As stated above, because the
court finds that the allocation of common costs by modality is reasonable in
this case and not in violation of the regulation, the court finds that the
Petitioners have failed to satisfy their burden of proof.
Accordingly,
based on the above findings, the total equipment costs that should be included
in determining the total project costs of the MRI Project are $330,174.
D. Architect’s Fee
No architect’s fees are at
issue in this case.
E. Financing
The parties agree that
financing costs should be included in the total project cost of the project;
however, they disagree as to how they should be allocated. Southern MRI
divided the total financing costs by the number of modalities, arriving at
$2,049 attributable to the MRI Project. The Petitioners argue that these costs
should be allocated on a square footage basis. Based on the discussion above,
the court concludes that dividing by the number of modalities is an appropriate
method and therefore, $2,049 of the total financing costs should be included in
determining the total project cost of the MRI Project.
F. “Other
Capital Costs” Under GAAP
As discussed above, the
“other capital costs” component of total project cost mandates application of
GAAP. Within this component, the parties disagree about the proper accounting
treatment of fees paid by Southern MRI for an appraisal and consultation on
DHEC’s N/A Determination procedure. Southern MRI included $4,965 of these fees
in its total project cost calculation. Pietras did not adjust Southern MRI’s
total project cost calculation to remove these fees, and opined that they are
properly capitalized. However, the Petitioners’ accounting expert, Burkett,
opined that these fees are not properly capitalized under GAAP. The court
concludes that these fees are not properly capitalized under GAAP, and thus
they are not properly included in total project cost.
V. CONCLUSION
OF LAW REGARDING CALCULATION OF TOTAL PROJECT COST
Viewing
all of the facts in the record as a whole, the court finds that the total
project cost of the MRI Project is $504,852, calculated as follows:
Land
and Building: $109,429
Construction: $63,200
Fixed
and Moveable Equipment: $330,174
Architect’s
Fee: $0
Financing
Cost: $2,049
“Other
Capital Costs” under GAAP: $0
Total: $504,852
Therefore, since
this project is below the $600,000 threshold, the Petitioners did not meet their
burden to prove by a preponderance of the evidence that DHEC erred in granting
Southern MRI the N/A Determination at issue.
VI. ORDER
For
all the foregoing reasons, it is
ORDERED that the decision of the South Carolina Department of Health and
Environmental Control to issue NA-07-48 to Southern MRI is upheld.
IT
IS SO ORDERED.
___________________________________
PAIGE
J. GOSSETT
Administrative
Law Judge
October 22, 2008
Columbia, South Carolina
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