South Carolina              
Administrative Law Court
Edgar A. Brown building 1205 Pendleton St., Suite 224 Columbia, SC 29201 Voice: (803) 734-0550

SC Administrative Law Court Decisions

CAPTION:
MRI at Belfair, LLC and Hilton Head Regional Medical Center vs. SCDHEC, et al

AGENCY:
South Carolina Department of Health and Environmental Control

PARTIES:
Petitioners:
MRI at Belfair, LLC and Hilton Head Regional Medical Center

Respondents:
South Carolina Department of Health and Environmental Control and Southern MRI
 
DOCKET NUMBER:
07-ALJ-07-0538-CC

APPEARANCES:
M. Elizabeth Crum, Esquire
Kelly M. Jolley, Esquire
For Petitioner MRI at Belfair, LLC

Daniel J. Westbrook, Esquire
Travis Dayhuff, Esquire
Holly G. Gillespie, Esquire
For Petitioner Hilton Head Regional Medical Center

Ashley C. Biggers, Esquire
For Respondent South Carolina Department of Health and Environmental Control

E. Wade Mullins, III, Esquire
For Respondent Southern MRI
 

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).[1] 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.[2] 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.[3]

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,[4] 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;[5] 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.[6] 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.[7] Therefore, Southern MRI leases 71.45% of the building. The court therefore finds that $58,303 (71.45% * $81,599)[8] 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[9] 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.[10] 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.[11] 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:[12] $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



[1] The Administrative Procedures Act (“APA”) was amended and renumbered via 2008 S.C. Act No. 334 (eff. June 16, 2008). Accordingly, all citations to the APA in this Order are to the recently amended and renumbered sections enacted by 2008 S.C. Act No. 334 unless otherwise stated.

[2] By Order dated March 18, 2008, Hilton Head Imaging, Inc. intervened as a Petitioner in this case. However, prior to the contested case hearing, Hilton Head Imaging, Inc. was dismissed as a party by consent of the parties.

[3] For the purposes of the contested case hearing and the Final Order and Decision, the project for which the court must determine the total project cost is the portion of the Imaging Center relating to the MRI.

[4] The CT was previously challenged as part of this contested case; however, the Petitioners consented to dismissal of this issue prior to the contested case hearing.

[5] A portion of Southern MRI’s leased space will not be used for the Imaging Center and therefore is not included in the square footage for the Imaging Center. The court’s references in the Order therefore distinguish between “Leased Space” and the space occupied by the “Imaging Center.”

[6] “MAI” stands for Member of the Appraisal Institute. The Appraisal Institute is a trade organization which monitors appraisers and holds them to a particular standard.

[7] The remaining square footage of the building is leased by a Huddle House restaurant.

[8] Calculations may not be exact to the penny due to rounding.

[9] “CAD” stands for “computer-aided design.”

[10] In the initial N/A request, Southern MRI planned to have two ultrasounds and did not intend to offer mammography. However, based on the evidence presented at the hearing, Southern MRI has decided to have only one ultrasound and has entered into a contract for a mammography unit in its place.

[11] The court is aware that there is testimony in the record that various Department reviewers have allocated renovation costs in a slightly different manner. However, the Record reflects that the Department has allocated renovation costs in different ways depending on the staff reviewer. Harrell testified that she believed that allocating the renovation costs by dividing by the number of modalities was reasonable and consistent with the regulation and the court so finds.

[12] Even if the court were to determine that GAAP is required to be applied to every component listed in the regulation, the court is persuaded by Pietras’s testimony that allocating by the number of modalities does not violate GAAP. Thus, even under such a legal analysis, the court’s conclusion would not change because the total project cost for the MRI Project would be $531,214, well under the regulatory threshold. The difference in this total is the result of applying GAAP to determine the fair market value of the land and building. Applying GAAP to Beaver’s appraisal may bring into question its reliability. In that event, the court is persuaded by Pietras’s land valuation, which he determined by capitalizing the purchase option contained in the lease executed between Southern MRI and its landlord. The market value of the land and building would then be $634,500. Therefore, the cost per square foot would increase from $109.84 to $136.30 per square foot.


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