Village Villa v. Kansas Health Policy Authority

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IN THE SUPREME COURT OF THE STATE OF KANSAS

No. 102,324

VILLAGE VILLA, et al.,
Appellants,

v.

KANSAS HEALTH POLICY AUTHORITY,
Appellee.


SYLLABUS BY THE COURT

1.
Medicaid is a joint federal-state program providing medical assistance to eligible
individuals. Its purpose is to provide medical and rehabilitation assistance to those who
qualify as poor, aged, blind, or disabled. States are not required to participate in the
Medicaid program, but once one elects to do so, it must comply with applicable federal
regulations.

2.
Determining whether an administrative regulation violates the United States
Constitution requires statutory construction, which is a question of law. An appellate
court has unlimited review of such issues.

3.
When a statute or regulation is challenged as an equal protection violation, the first
step is to determine the nature of the classifications at issue and examine whether those
classifications result in arguably indistinguishable classes of individuals being treated
differently. Equal protection is implicated only if there is differing treatment of similarly
2



situated individuals. In the second step, a court examines the rights affected by the
classifications, which dictates the level of scrutiny to be applied—strict scrutiny,
intermediate scrutiny, or the deferential scrutiny of rational basis. The final step requires
determining whether the relationship between the classifications and the object desired to
be obtained withstands the applicable level of scrutiny.

4.
K.A.R. 30-10-1a(a)(7), (9), and (36)(C) are applied when determining whether
there is a change of provider ownership for Medicaid reimbursement purposes. These
regulations distinguish between parties that own or have equity in 5 percent or more of a
provider facility and those who own or have equity in less than 5 percent. The latter are
able to purchase a provider facility in which they own or have equity and be treated as
new owners for the purposes of calculating rates. Those owning 5 percent or more are
not. Thus, these regulations treat similarly situated entities differently.

5.
K.A.R. 30-10-1a(a)(7), (9), and (36)(C) are subject to the rational basis test when
challenged as an equal protection violation. A party attacking these regulations as
unconstitutional for failing to satisfy the rational basis standard has the burden to negate
every conceivable rational basis that might support the classifications these regulations
create.

6.
K.A.R. 30-10-1a(a)(7), (9), and (36)(C) bear a reasonable relationship to a valid
legislative purpose and do not violate equal protection principles.

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7.
Constitutional procedural due process analysis is a two-step process in which the
court first determines whether due process is implicated, and, if it is, then determines
what process is due. At the first level, the claimant must establish some property or
liberty interest such that the protections of the Due Process Clause are invoked. This
property or liberty interest is not inherent in the Due Process Clause but must be rooted in
state law.

8.
Claims made in passing without argument or citations to authority are deemed
waived and abandoned.

Appeal from Shawnee District Court; DAVID E. BRUNS, judge. Opinion filed January 11, 2013.
Affirmed.

Larry G. Karns, of Glenn, Cornish, Hanson & Karns, Chartered, of Topeka, argued the cause and
was on the brief for appellants.

Joann E. Corpstein, chief counsel, of Kansas Department on Aging, argued the cause and R. Greg
Wright and Susan Barker Andrews, of the same department, were with her on the brief for appellee.

The opinion of the court was delivered by

BILES, J.: This is a Medicaid reimbursement appeal under the Act for Judicial
Review and Civil Enforcement of Agency Actions, K.S.A. 77-601 et seq. (now the
Kansas Judicial Review Act, K.S.A. 2011 Supp. 77-601 et seq.). Three corporations, each
of which owns a nursing home facility, want their reimbursement rates recalculated
because they believe there was a change of ownership authorizing the adjustments. The
Kansas Department on Aging (KDOA) and Kansas Health Policy Authority (KHPA)
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denied recalculation because of common ownership between the buyers and sellers,
which they determined barred the rate changes. On review, the district court agreed. On
appeal, the corporations maintain that the agency orders are invalid, violate the Equal
Protection and Due Process Clauses of the United States Constitution, and are vague. We
disagree and affirm.

FACTUAL AND PROCEDURAL BACKGROUND

Prior to January 1, 2005, Virgil Goracke owned 20 percent of three nursing home
facilities—Indian Trails Manor, Inc., d/b/a Indian Trails Mental Health Living Center,
Inc.; Manor of Nortonville, Inc., d/b/a Village Villa; and Flint Hills, Inc., d/b/a Vintage
Manor. There is no dispute these entities were Medicaid-certified nursing facilities.
Goracke signed the 2003 and 2004 Medicaid cost reports for each facility as "Secretary
and Owner." He also solely owned a separate company responsible for managing these
three facilities.

Effective January 1, 2005, three other corporations owned entirely by Goracke
purchased the three nursing homes. Goracke renamed them: Village Villa, Inc., f/k/a
Manor of Nortonville, Inc., d/b/a Village Villa; Providence Living Center, Inc., f/k/a
Indian Trails Manor, Inc., d/b/a Indian Trails Mental Health Living Center; and Flint
Hills Care Center, Inc., f/k/a Flint Hills, Inc., d/b/a Vintage Manor. Goracke signed the
2005 Medicaid cost reports for each facility as "President and Owner."

Medicaid is a joint federal-state program providing medical assistance to eligible
individuals. Its purpose is to provide medical and rehabilitation assistance to those who
qualify as poor, aged, blind, or disabled. See 42 U.S.C. § 1396 et seq. (2006); State v.
McWilliams, 295 Kan. 92, 96, 283 P.3d 187 (2012). States are not required to participate
in the Medicaid program, but once one elects to do so, it must comply with applicable
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federal regulations. See 42 U.S.C. § 1396a(1) (2006); Country Club Home, Inc. v.
Harder, 228 Kan. 756, 763, 620 P.2d 1140 (1980), modified 228 Kan. 802, 623 P.2d 505
(1981). Kansas made this election for the relevant time period.

Effective July 1, 2006, KHPA became responsible for the state Medicaid plan's
supervision and administration. K.S.A. 2006 Supp. 75-7409. At that time certain
"powers, duties and functions of the division of health policy and finance within the
department of administration and the director of health policy and finance [were]
transferred to and imposed upon the [KHPA]." K.S.A. 2006 Supp. 75-7413. At the time
the present matter arose, KHPA was responsible for defending the regulations now
questioned, which were promulgated by the Secretary of Social and Rehabilitation
Services. See K.S.A. 39-708c.

Since then, mergers within Kansas government altered the agencies responsible
for the state's Medicaid program administration. Through Executive Reorganization
Order No. 38, effective July 1, 2011, Governor Sam Brownback abolished KHPA and
established the Kansas Division of Health Care Finance within the Kansas Department of
Health and Environment. This order transferred all KHPA statutory powers, duties, and
functions to the Kansas Department of Health and Environment, the Division of Health
Care Finance, the Secretary, and the Director. As such, the responsibility for the
supervision and administration of the Kansas Medicaid program is now with the Kansas
Department of Health and Environment. See L. 2012, ch. 102, sec. 40.

A Medicaid services provider does not bill eligible patients for covered services.
Rather, the provider is reimbursed by the government according to preestablished rates.
See 42 U.S.C. § 1396a(30)(A) (2006); K.S.A. 39-708a; K.S.A. 39-708c(s), (x). A
statutory amendment enacted during the 2006 Kansas legislative session changed the
base year for computing the Medicaid reimbursement rates at issue in this case.
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Specifically, the law stated that beginning with fiscal year 2007, base year rates would be
calculated by averaging together 2003, 2004, and 2005 cost reports. K.S.A. 2006 Supp.
75-5958.

KDOA, which under K.S.A. 2006 Supp. 75-5903(a) and K.S.A. 2006 Supp. 75-
5908(d) was responsible for receiving and disbursing funds made available under any
federal program for the aging including the Medicaid program, published a notice in the
Kansas Register about this change in the base year. Additionally, in notifying providers
operating a facility for 12 or more months on December 31 that they were to file a
calendar year cost report, KDOA's notice told providers that if a "non-arms length change
of provider takes place . . . the facility will be treated as an ongoing operation."

KDOA sent letters to Village Villa, Providence Living Center, and Flint Hills Care
Center (collectively Village Villa) announcing the new Medicaid per diem rate for each
facility effective July 1, 2006. The letters indicated that the base data for calculating the
new rates was the combined cost data from each facility's calendar year costs reports for
2003, 2004, and 2005. The letters also alerted the recipients to their right to request a fair
hearing if they disagreed with the new rates. This notice was in compliance with K.A.R.
30-7-65.

In response, Village Villa requested a hearing with the Kansas Department of
Administration challenging the new reimbursement rates for each facility. It argued that
because the facilities underwent a change of ownership in 2005, the rates should be based
exclusively on the new owner's first calendar year cost reports, i.e., only the 2005 cost
reports, which presumably would have generated more Medicaid revenue.

KDOA moved for summary judgment, arguing the applicable regulations
prevented it from applying anything other than the average of the 2003, 2004, and 2005
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cost reports because Village Villa had not undergone a "change of ownership" as defined
in K.A.R. 30-10-1a(a)(7).Village Villa countered that KDOA was misapplying the
regulations and that such application was unconstitutional because it did not require the
agency to evaluate the arm's length legitimacy of each transaction.

The hearing officer rejected Village Villa's arguments, finding that the parties to
each transaction were "related" under K.A.R. 30-10-1a(36)(C) because Goracke had
owned 20 percent of the facilities being sold to corporations owned entirely by Goracke,
constituting "common ownership" under K.A.R. 30-10-1a(9). Thus, "by operation of law
for Medicaid reimbursement purposes—there was no change of ownership and no arms-
length transaction," and the correct method for calculating the reimbursement rate was
averaging the 2003, 2004, and 2005 cost reports.

The hearing officer also correctly noted there was no administrative authority to
address Village Villa's claim that the reimbursement regulations were unconstitutional.
See Zarda v. State, 250 Kan. 364, Syl. 3, 826 P.2d 1365, cert. denied 504 U.S. 973
(1992); Kaufman v. State Dept. of SRS, 248 Kan. 951, 954, 811 P.2d 876 (1991)
("Administrative boards and agencies may not rule on constitutional questions; therefore,
the issue of the constitutionality of a state statute or an administrative regulation must be
raised when the case is appealed to a court of law.").

Village Villa appealed the hearing officer's initial order to KHPA, which agreed
with the ruling that the parties to the January 2005 transaction were "related." And it too
noted it had no authority to address the constitutional claims.

Village Villa then petitioned the Shawnee County District Court for judicial
review of KHPA's final order under the Act for Judicial Review and Civil Enforcement
of Agency Actions. The district court affirmed KHPA's holding that there had not been a
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"change of ownership" from the January 2005 transaction even if there had been an
"arm's length transaction" for other purposes. The court also concluded the
reimbursement regulations were constitutional. Village Villa timely appealed the district
court's decision. This court transferred the case on its own motion under K.S.A. 20-
3018(c).
DISCUSSION

The Secretary of Social and Rehabilitation Services promulgated the regulation for
determining whether the January 2005 acquisition by Goracke's corporations constituted
a change of ownership for Medicaid reimbursement purposes under the authority granted
by K.S.A. 39-708c. The relevant subsections of that regulation are K.A.R. 30-10-
1a(a)(7), (9), and (36)(C). These provisions have the force and effect of law. K.S.A. 77-
425.

Regulations

K.A.R. 30-10-1a defines words and terms used in Article 10 (Adult Care Home
Program) of the Kansas Administrative Regulations. A "change of ownership" is defined
in K.A.R. 30-10-la(a)(7) as "a transfer of rights and interests in real and personal property
used for nursing facility services through an arm's-length transaction between unrelated
persons or legal entities." (Emphasis added.)

"Related parties" are defined as:

" two or more parties with a relationship in which one party has the ability to influence
another party to the transaction in the following manner:
. . . .
(C) when any party considered a related party to a previous owner or operator
becomes the employee, or otherwise functions in any capacity on behalf of a subsequent
9



owner or operator. Related parties shall include parties related by family, business, or
financial association, or by common ownership or control. Transactions between related
parties shall not be considered to have arisen through arm's-length negotiations."
(Emphasis added.) K.A.R. 30-10-la(a)(36)(C).

Notably for this appeal, "'Common ownership' means that an entity holds a
minimum of five percent ownership or equity in the provider facility or in a company
engaged in business with the provider facility." K.A.R. 30-10-la(a)(9).

KHPA's actions under K.S.A. 77-621(c)(3), (4), (7), and (8)

Village Villa's overarching argument is that KHPA's reliance on "the 5% rule" and
its refusal to investigate or recognize the "otherwise fully arm's length business
transaction" is shocking, arbitrary, and capricious. K.S.A. 77-621 governs judicial review
of agency actions. The burden of proving the invalidity of an agency's action falls on the
party making that claim. K.S.A. 77-621(a)(1).

At the outset, we note Village Villa incorrectly asserts that the 2009 amendments
to K.S.A. 77-621 apply to our analysis. See Redd v. Kansas Truck Center, 291 Kan. 176,
Syl. ¶ 1, 239 P.3d 66 (2010) ("[T]he 2009 Kansas Judicial Review Act amendments to
the standard of review apply only prospectively to agency decisions issued on or after
July 1, 2009."). We apply the law applicable at the time of the agency action under
review. K.S.A. 77-621(a)(2),

Village Villa appears to argue invalidity under K.S.A. 77-621(c)(1), (3), (4), (7),
and (8). At the time of KHPA's decision, K.S.A. 77-621 stated in pertinent part:

(c) The court shall grant relief only if it determines any one or more of the
following:
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(1) The agency action, or the statute or rule and regulation on which the agency
action is based, is unconstitutional on its face or as applied;
. . . .
(3) the agency has not decided an issue requiring resolution;
(4) the agency has erroneously interpreted or applied the law;
. . . .
(7) the agency action is based on a determination of fact, made or implied by the
agency, that is not supported by evidence that is substantial when viewed in light of the
record as a whole, which includes the agency record for judicial review, supplemented by
any additional evidence received by the court under this act; or
(8) the agency action is otherwise unreasonable, arbitrary or capricious."

With regard to K.S.A. 77-621(c)(3), (4), and (8), Village Villa contends KHPA
ignored the language of K.A.R. 30-10-1a(a)(36), which it interprets to require "one party
[having] the ability to influence another party to the transaction." Village Villa likewise
challenges KHPA's failure to make findings on the ability to influence under K.A.R. 30-
10-1a(a)(10), which defines "control" as meaning that "an individual or organization has
the power . . . to significantly influence or direct the action . . . of an organization or
facility." When a party contends an agency erroneously interpreted or applied the law, we
exercise unlimited review and need not give deference to the agency's interpretation.
Saylor v. Westar Energy, Inc., 292 Kan. 610, 614, 256 P.3d 828 (2011).

Village Villa incorrectly reads K.A.R. 30-10-1a(a)(36). The regulation sets forth
that "'related parties'" are those in which one party to the transaction has the ability to
influence another party "in the following manner." And under subsection (C) of K.A.R.
30-10-1a(a)(36), "common ownership" is one way in which a party to a transaction may
have the ability to influence the other. In addition, K.A.R. 30-10-1a(a)(36)(C) provides
that "related parties" include those related by "common ownership or control." (Emphasis
added). And because the term "or" separates "common ownership" and "control," only
one of those conditions need be met for parties to be deemed related. For these reasons,
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we reject Village Villa's arguments that KHPA failed to decide an issue requiring
resolution, erroneously interpreted or applied the regulation, and took action that was
arbitrary or capricious.

Village Villa further asserts that factual support for KHPA's action is lacking. But
the basic facts are not in dispute—Village Villa concedes the three corporations that
purchased the nursing facilities were solely owned by Goracke and that he previously
owned 20 percent of the corporations that sold the nursing facilities to the three
purchasing companies. These concessions defeat any argument Village Villa makes
regarding the nature of the evidence supporting KHPA's decision. Accordingly, Village
Villa's argument under K.S.A. 77-621(c)(7) fails as well.

Constitutionality of K.A.R. 30-10-1a(a)(7), (9), and (36)

We next consider Village Villa's claim that K.A.R. 30-10-1a(a)(7), (9), and (36)
are unconstitutional. This court may grant relief only if "[t]he agency action, or the
statute or rule and regulation on which the agency action is based, is unconstitutional on
its face or as applied." K.S.A. 77-621(c)(1).

Determining whether a regulation meets constitutional muster requires statutory
interpretation, which is a question of law over which this court has unlimited review. See
National Council on Compensation Ins. v. Todd, 258 Kan. 535, 539, 905 P.2d 114
(1995). And as stated above, an agency's interpretation of a statute or regulation is not
afforded any significant deference on judicial review. Kansas One-Call System, Inc. v.
State, 294 Kan. 220, 225-26, 274 P.3d 625 (2012) (citing Ft. Hays St. Univ. v. University
Ch., Am. Ass'n of Univ. Profs, 290 Kan. 446, 457, 228 P.3d 403 [2010]).

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Equal Protection

Village Villa argues the regulations at issue violate the Equal Protection Clause of
the United States Constitution because they treat an owner of nursing facilities who
previously owned at least 5 percent of the facilities he or she purchased but had no
control or significant influence over the facilities differently from a new owner who
similarly had no control or significant influence over the facilities. Village Villa contends
that to comply with the Equal Protection Clause, the agency should be required to make
findings of fact as to whether each individual sale is an arm's-length and valid business
transaction despite having been between "related parties," as that term is defined in the
regulation. The Fourteenth Amendment to the United States Constitution provides in part:
"No State shall . . . deny to any person within its jurisdiction the equal protection of the
laws."

An equal protection analysis has three steps. First, a court must determine the
nature of the statutory classifications and examine whether these classifications result in
disparate treatment of arguably indistinguishable classes of individuals. Board of Miami
County Comm'rs v. Kanza Rail-Trails Conservancy, Inc., 292 Kan. 285, 315, 255 P.3d
1186 (2011). If so, the Equal Protection Clause is implicated. In the second step, a court
examines which rights the classifications affect because the nature of those rights dictates
the scrutiny applied when the statute or regulation is reviewed. There are three levels of
scrutiny: (1) the rational basis standard to determine whether a statutory classification
bears some reasonable relationship to a valid legislative purpose; (2) the heightened or
intermediate scrutiny standard to determine whether a statutory classification
substantially furthers a legitimate legislative purpose; and (3) the strict scrutiny standard
to determine whether a statutory classification is necessary to serve some compelling
state interest. Miller v. Johnson, 295 Kan. 636, 2012 WL 4773559, at *21 (citing Kanza
Rail-Trails Conservancy, 292 Kan. at 316). In the final step of analysis, a court
13



determines whether the relationship between the classifications and the object desired to
be obtained withstands the applicable level of scrutiny. Miller, 295 Kan. at __, 2012 WL
4773559, at *21 (citing Kanza Rail-Trails Conservancy, 292 Kan. at 316).

The first question is whether K.A.R. 30-10-1a(a)(7), (9), and (36) create disparate
treatment of similarly situated individuals. The party challenging constitutionality has the
burden of demonstrating that he or she is similarly situated to others treated differently.
State v. Huerta, 291 Kan. 831, 834, 247 P.3d 1043 (2011). As such, "the parameters of a
court's consideration of whether individuals are similarly situated is set by the
distinctions argued by the complaining party." State v. Salas, 289 Kan. 245, 249, 210
P.3d 635 (2009) (citing Heller v. Doe, 509 U.S. 312, 319-21, 113 S. Ct. 2637, 125 L. Ed.
2d 257 [1993]).

The regulations distinguish between parties that own or have equity in 5 percent or
more of a provider facility and those who own or have equity in less than 5 percent.
Unlike the former, the latter are able to purchase a provider facility in which they own or
have equity and be treated as a new owner for the purposes of calculating Medicaid
reimbursement rates. KHPA argues there is no disparate treatment because "related party
transactions are not similarly situated to those transactions involving truly arm's-length
bonafide unrelated entities."

Village Villa counters that the regulations treat similarly situated parties
differently, e.g., an owner with a 4 percent interest is treated differently from one who
owns 5 percent though their actual control over the provider facility may be nearly
identical. On this point, we agree with Village Villa. One who owns 4 percent of a
provider facility is similarly situated to one who owns 5 percent, and these regulations
treat these two groups differently. Therefore, we move to the next step and determine
what level of scrutiny applies.
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Village Villa correctly concedes that the appropriate scrutiny level is the rational
basis test. See In re Tax Appeal of Weisgerber, 285 Kan. 98, 104, 169 P.3d 321 (2007)
(when complaint is that a law causes economic disparity, the rational basis test or
"reasonable basis test" is used to determine if the law violates the Equal Protection
Clause); see also Downtown Bar and Grill v. State, 294 Kan. 188, 194, 273 P.3d 709
(2012) (if legislative classification does not target a suspect class or burden a
fundamental right, court applies rational basis test).

The rational basis standard requires only that a statutory classification bear some
reasonable relationship to a valid legislative purpose. Miller, 295 Kan. at __, 2012 WL
4773559, at *21 (citing Kanza Rail-Trails Conservancy, 292 Kan. at 316). As a result, the
standard is a lenient one. Weisgerber, 285 Kan. at 105. A statute or regulation fails the
rational basis test only if the classification at issue "'rests on grounds wholly irrelevant to
the achievement of the State's legitimate objective.'" Weisgerber, 285 Kan. at 105
(quoting Leiker v. Gafford, 245 Kan. 325, 363-64, 778 P.2d 823 [1989]). And the
complaining party has the burden to negate every conceivable rational basis that might
support the classification challenged. Miller, 295 Kan. at __, 2012 WL 4773559, at *22
(citing Downtown Bar and Grill, 294 Kan. 188, Syl. ¶ 10). "'[T]he party must
demonstrate that "no set of circumstances exist" that survive constitutional muster.
[Citation omitted.]'" Downtown Bar and Grill, 294 Kan. at 195.

KHPA argues there is a valid legislative purpose for the regulations at issue
because they ensure the Kansas Medicaid program does not incur artificially inflated
costs due to related parties engaging in self-dealing. This, it argues, keeps the
government's costs as low as possible and makes care more widely available to those in
need. And for its part, Village Villa makes no arguments as to whether the State has a
legitimate purpose justifying the regulations other than to state: "[T]he costs to the State
15



would be no different if a third party purchased these facilities for the same consideration
paid by [Village Villa]. As long as the price paid was fair and reasonable, the State's
interest is protected."

Village Villa instead focuses on the State's method for achieving its goal.
Specifically, it argues the State could prevent fraud and control escalating prices by
making a factual inquiry of every transaction regarding the ability of control and
possibility of unfair self-dealing. It cites South Boston General Hosp. v. Blue Cross of
Va., 409 F. Supp. 1380 (W.D. Va. 1976). In that case, the Secretary of Health, Education,
and Welfare refused to reimburse a qualified provider of Medicare services for costs paid
to the facility's prior owner on the basis of a federal related-parties rule (see 20 C.F.R. §§
405.415, 405.419, and 405.427). On appeal, the district court found the regulations did
not further the purpose of a federal Medicare statute, 42 U.S.C. § 1395x(v)(1)(A), which
required the Secretary to reimburse providers of "needed health services." The court cut
from whole cloth a requirement that the Secretary scrutinize each related-party
transaction to ensure above-board related-party transactions were not being treated
inequitably when compared to unrelated-party transactions. South Boston General Hosp.,
409 F. Supp. at 1384-85.

But numerous courts have declined to follow South Boston. See, e.g., Sid Peterson
Memorial Hosp. v. Thompson, 274 F.3d 301, 312-13 (5th Cir. 2001) (rejecting South
Boston's reasoning because "[t]he need for broad prophylactic rules [such as the related-
party rule] is particularly apparent in a program as complex and ripe with the potential for
abuse as the Medicare reimbursement scheme"); American Hospital Management Corp.
v. Harris, 638 F.2d 1208, 1213 n.9 (9th Cir. 1981) ("[South Boston] cited no case
authority for its conclusion that the Secretary must individually scrutinize transactions
involving related entities for fairness."). And these courts found related-party regulations
promote valid legislative purposes in support of federal Medicare law. We agree.
16




In Sid Peterson and American Hospital, both the Fifth and the Ninth Circuit
Courts of Appeals upheld federal regulations disallowing Medicare reimbursements when
transactions were between related parties. The regulations at issue in both cases, in part,
identified parties as being related when one had control of another because of significant
influence. Sid Peterson, 274 F.3d at 304, 311-12; American Hospital, 638 F.2d at 1209,
1212-13 (finding the exception in the regulation allowing related parties to demonstrate
that they conducted a bona fide arms-length transaction helped establish the lawfulness of
the regulation). And in identifying the valid purpose of these regulations, the Sid
Peterson court described the "related-party rule" as "'prophylactic'" in that it

"involves a judgment that the probability of abuse in related transactions is high enough
that it is more efficient to prevent the opportunity for abuse from arising by prohibiting
certain provider/lender relationships that are likely to give rise to self-dealing
transactions, rather than to try to detect actual incidents of abuse. [Citation omitted.]" Sid
Peterson, 274 F.3d at 304.

Similarly, the American Hospital court held the regulation at issue in that case was
validly designed to prevent "seemingly separate entities from engaging in what is in fact
self-dealing at the expense of the Medicare program." American Hospital, 638 F.2d at
1212. The court noted the regulation may not achieve its objective with mathematical
precision, but it upheld the regulation nonetheless because it had a reasonable
relationship to the enabling legislation, 42 U.S.C. § 1395x(v)(1)(A), it was designed to
implement. American Hospital, 638 F.2d at 1212-13.

More pertinently, the American Hospital court also considered the argument that
the regulation violated equal protection principles and held there was no constitutional
infirmity. The court concluded the classification of "'related entity'" was a reasonable
17



method of achieving the valid legislative purpose of preventing reimbursement of
excessive charges resulting from self-dealing. American Hospital, 638 F.2d at 1213.
Similarly, in Fairfax Hospital Ass'n, Inc. v. Califano, 585 F.2d 602 (4th Cir. 1978), the
Fourth Circuit Court of Appeals had previously addressed the constitutionality of the
same regulation at issue in American Hospital and found no violation of the Equal
Protection Clause. The court held:

"Particularly in a program as complex as the Medicare program, with its large numbers of
providers and suppliers . . . , the Secretary, in his regulations may make, indeed he must
make, '"rough accommodations illogical, it may be, and unscientific,"' using generalized
classifications governing the methods of calculating 'reasonable cost' when it is obvious
that individualized cost calculations are both not administratively practical and unduly
expensive." Fairfax, 585 F.2d at 606 (quoting Dandridge v. Williams, 397 U.S. 471, 485,
90 S. Ct. 1153, 25 L. Ed. 2d 491 [1970]; Weinberger v. Salfi, 422 U.S. 749, 773-80, 95 S.
Ct. 2457, 45 L. Ed. 2d 522 [1975]).

The court concluded that given the potential for abuse in charges between related
parties, regulations formulated "to prescribe reasonable classifications to prevent such
abuse" were proper. Fairfax, 585 F.2d at 607.

Both Sid Peterson and American Hospital held that the related-party regulations
were consistent with the Secretary's rule-making authority under 42 U.S.C. §
1395x(v)(1)(A), which, as stated, required the Secretary to adopt regulations resulting in
reimbursement of actual costs. Sid Peterson, 274 F.3d at 307, 313; American Hospital,
638 F.2d at 1212. A comparable federal Medicaid statute offers compelling support for
KHPA's arguments regarding the legislative purpose behind the 5 percent rule. 42 U.S.C.
§ 1396a(30)(A) (2006) states:

18



"A State plan for medical assistance must

. . . .

"(30)(A) provide such methods and procedures relating to the utilization of, and
the payment for, care and services available under the plan (including but not limited to
utilization review plans as provided for in section 1396b(i)(4) of this title) as may be
necessary to safeguard against unnecessary utilization of such care and services and to
assure that payments are consistent with efficiency, economy, and quality of care and are
sufficient to enlist enough providers so that care and services are available under the plan
at least to the extent that such care and services are available to the general population in
the geographic area." (Emphasis added.)

As to what would make a state plan inefficient and uneconomical, the Third
Circuit Court of Appeals has held that provider payments that are too high make a
program noncompliant with the federal requirement. Pennsylvania Pharmacists Ass'n v.
Houstoun, 283 F.3d 531, 537 (3d Cir. 2002). And other jurisdictions have recognized that
a state has a legitimate interest in controlling Medicaid costs. See St. Louis South Park v.
Missouri DSS, 857 S.W. 2d 304, 307 (Mo. App. 1993) (controlling the costs of its
Medicaid program in setting reimbursement rates for participating nursing homes is a
legitimate state interest); In re NYAHSA Litigation, 318 F. Supp. 2d 30, 42 (N.D.N.Y.
2004) ("Preserving the financial integrity of welfare programs is a legitimate state
interest."). The United States Supreme Court has also emphasized that a state has "broad
discretion" when financing Medicaid benefits. Pharmaceutical Research and Mfrs. of
America v. Walsh, 538 U.S. 644, 666, 123 S. Ct. 1855, 155 L. Ed. 2d 889 (2003).

While the classification at issue in South Boston, Sid Peterson, American Hospital,
and Fairfax was "related parties" and the classification Village Villa challenges concerns
parties that own or have equity in 5 percent or more of a provider facility, the legislative
purpose is the same. The district court in rejecting Village Villa's argument found the
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purpose of Kansas' 5 percent rule/common ownership regulations to be "controlling and
preserving the financial integrity of the Medicaid program." We agree and hold that this
is a valid legislative purpose.

The remaining question is whether the classification created by the 5 percent rule
bears a reasonable relationship to this valid legislative purpose we have just identified.
And we find support for the 5 percent rule within K.A.R. 30-10-1a(a)(9) is found in 42
C.F.R. § 455.1 et seq. (2006), which sets forth requirements for a state fraud detection
and investigation program and for disclosure of information on ownership and control. 42
C.F.R. § 455.101 (2006), which is the definitions section of the subpart on provider
disclosure, recites that a person with an ownership or control interest means a person or
organization that has ownership, indirect ownership, or a combination of direct and
indirect ownership totaling 5 percent or more in a disclosing entity. And although it is
unclear why the federal government chose to require disclosure at the 5 percent level, that
requirement is evident in the original legislation, prior public law, and the legislative
history. See 44 Fed. Reg. 41,644, July 17, 1979; H.R. 3, P.L. 95-142, October, 25, 1977,
as reprinted in 1977 U.S.C.C.A.N. at 91 Stat. 1175-78; H.R. No. 95-393 (Pt. II), at 39-40
(1977), as reprinted in 1977 U.S.C.C.A.N. at 3042.

In addition, comments at the beginning of the published final regulation address
public suggestions that the reporting requirements for a "significant business transaction"
be changed from $25,000 and 5 percent to $100,000 and 10 percent. The agency's
response was that many small providers would be engaged in business transactions
amounting to less than $25,000—which was statutorily required—but the transactions
would still account for a substantial amount of business. And to monitor those
transactions the 5 percent rule was implemented. The agency's stated goal in
promulgating a $25,000 and 5 percent requirement was to reduce the probability of
Medicaid fraud. 44 Fed. Reg. 41,638, July, 17, 1979.
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Village Villa contends this regulation is not binding and is an inappropriate
comparison as its purpose, which is disclosure of all shareholders to ensure convicted
criminals are not participating in federal health care programs, has nothing to do with
who controls an organization for purposes of sale transactions. But we disagree.
Medicaid's integrity—and specifically the goal of preventing fraud—is a valid purpose
for Kansas' 5 percent rule/common ownership regulation. The federal government's 5
percent disclosure requirement, implemented to help prevent fraud, is a reasonable
method for the state to draw upon in attempting to prevent fraud within its own program.

Reduced to its essence, Village Villa's overall contention is that there is a better
way to achieve the objective of fraud prevention than the State's chosen approach. But
whether there is a better way is not the question. See Dandridge, 397 U.S. at 485 ("In the
area of economics and social welfare, a State does not violate the Equal Protection Clause
merely because the classifications made by its laws are imperfect. If the classification has
some 'reasonable basis,' it does not offend the Constitution simply because the
classification 'is not made with mathematical nicety or because in practice it results in
some inequality.' [Citation omitted.]"). This court is obligated to determine whether there
is a rational basis for the regulation in place.

We hold that the common-ownership classification of K.A.R. 30-10-1a(a)(9) bears
a reasonable relationship to a valid legislative purpose of controlling Medicaid costs.
Village Villa failed to meet its burden to negate this rational basis. K.A.R. 30-10-a(a)(7),
(9), and (36) do not violate equal protection principles.

21



Due Process

Village Villa next argues the regulations violate both procedural and substantive
due process requirements and are void for vagueness. We consider first procedural due
process, which requires notice and an opportunity to be heard at a meaningful time and in
a meaningful manner. Winston v. Kansas Dept. of SRS, 274 Kan. 396, 409, 49 P.3d 1274
(2002). The first determination a court must make when reviewing a procedural due
process claim is whether a protected liberty or property interest is involved. It is only
when a court finds a protected interest is implicated that it must then determine the nature
and extent of the process that is due. Winston, 274 Kan. at 409.

Property interests are not created by the Constitution, rather they "are created and
their dimensions are defined by existing rules or understandings that stem from an
independent source such as state law—rules or understandings that secure certain
benefits and that support claims of entitlement to those benefits." (Emphasis added.)
Board of Regents v. Roth, 408 U.S. 564, 577, 92 S. Ct. 2701, 33 L. Ed. 2d 548 (1972); see
Brown v. U.S.D. No. 333, 261 Kan. 134, 150, 928 P.2d 57 (1996) (property or liberty
interest not inherent in Due Process Clause but must be rooted in state law); Harrison v.
Long, 241 Kan. 174, 178, 734 P.2d 1155 (1987) (same).

Village Villa contends it has a property interest in reimbursement and its 2005
calendar year cost reports should have been the basis of its rate of reimbursement.
According to Village Villa, "[w]hen KDOA made its adjustment to [Village Villa's] costs
reports, it deprived [Village Villa] of [its] property interests without due process of law."
But it fails to identify what statute or regulations it relies on for this contention. Instead, it
asserts only that "the Kansas regulations constitute the rules and form the basis of the
mutually explicit understanding that supports [Village Villa's] claims of entitlement to
22



reimbursement." This is a woefully insufficient platform upon which to launch a due
process attack.

Village Villa relies on Furlong v. Shalala, 156 F.3d 384, 393 (2d Cir. 1998), to
support its contention. The Furlong court had to decide whether physicians who had
chosen to provide one kind of Medicare services were entitled to the same due process
received by physicians who had chosen to provide another kind of Medicare services.
The first step in this process was to determine if the physicians had a property interest in
their reimbursements. The Furlong court rejected the providers' argument that a property
right arose from the Medicare Manual, the accompanying agency regulations, or the
Administrative Procedures Act, but it approved the physicians' argument that previous
administrative law judge decisions created a property interest for all physician providers,
not just ones who participated in one type of Medicare services. 156 F.3d at 394-95.

But Furlong is distinguishable from Village Villa's claim. First, Village Villa fails
to cite the regulations it claims give birth to its property interest. Second, Furlong merely
held a provider group had the same property interest that ALJs had already interpreted as
an entitlement for a second group of providers—and regardless of their classification, the
two groups had the same interest. Village Villa does not offer another instance in which
Kansas regulations were interpreted to give a provider a property interest in
reimbursement.

At least one federal circuit has suggested that some form of property interest may
exist in Medicaid reimbursement. Under New York law, the Second Circuit Court of
Appeals determined that while Medicaid providers have no property interest in future
reimbursements, they have a property interest in Medicaid reimbursement for "services
already performed in reliance on a duly promulgated reimbursement rate." Oberlander v.
Perales, 740 F.2d 116, 120 (2d Cir. 1984), superseded by statute on other grounds as
23



stated in Senape v. Constantino, 936 F.2d 687, 690 n.4 (2d Cir. 1991); but see Yorktown
Medical Laboratory, Inc. v. Perales, 948 F.2d 84, 89 (2d Cir. 1991) (holding Medicaid
provider did not have property interest in Medicaid payments that were pending
investigation); but see also Personal Care Products, Inc. v. Hawkins, 635 F.3d 155, 159
(5th Cir. 2011) (Texas statutory scheme does not create property interest in present
reimbursement claims while past claims are under investigation for fraud).

And based in part on Oberlander, in Painter v. Shalala, 97 F.3d 1351, 1357-58
(10th Cir. 1996), the Tenth Circuit Court of Appeals assumed, "without deciding," that
physicians have a property interest in receiving payment for Medicare services rendered.
But the court concluded that physicians do not hold a property interest in having their
reimbursement rates calculated in a particular manner. 97 F.3d at 1358.

To have a property interest in a governmental benefit, "a person clearly must have
more than an abstract need or desire for it. He must have more than a unilateral
expectation of it. He must, instead, have a legitimate claim of entitlement to it." Roth, 408
U.S. at 577. A person's interest in a governmental benefit becomes a property interest for
due process purposes "if there are rules or mutually explicit understandings that support
his claim of entitlement to the benefit and that he may invoke at a hearing." Perry v.
Sindermann, 408 U.S. 593, 601, 92 S. Ct. 2694, 33 L. Ed. 2d 570 (1972).

While Kansas providers may be entitled to reimbursement, i.e., to get paid for
services provided, Village Villa fails to identify any "rules or understandings" that create
entitlement to a specific methodology for calculating rates of reimbursement year after
year. And the federal government provides states with the authority to modify rates as
needed so long as specific goals are met. See generally 42 U.S.C. § 1396a(30)(A).

24



Whether Medicaid reimbursement is a protected property interest is a question of
first impression for this court, which we will not decide in the absence of clearly
articulable claims regarding the entitlements at issue and the statutory or regulatory
provisions that give rise to them. We conclude that Village Villa has failed to establish a
property interest in reimbursement rates calculated in a particular manner in the context
of this case. Without such a property interest, its claim must fail.

As to its substantive due process claim, the United States Supreme Court has held
that substantive due process does not protect economic liberties. Stop the Beach
Renourishment, Inc. v. Florida Dept. of Environmental Protection, 560 U.S. __, 130 S.
Ct. 2592, 2606, 177 L. Ed. 2d 184 (2010) (citing Lincoln Fed. Labor Union v.
Northwestern Iron & Metal Co., 335 U.S. 525, 536, 69 S. Ct. 251, 93 L. Ed. 212 [1949]).
Because Village Villa asserts an economic liberty was violated, i.e., that reimbursement
rates were improperly calculated, it has no substantive due process claim.

Village Villa next complains the district court erred by finding K.A.R. 30-10-1a
(a)(7), (9), and (36) do not violate due process due to vagueness. Village Villa's chief
complaint is that "any undefined degree of association by family, business, or financial
association would appear to be prohibited unless the term 'or control' is also a
requirement." It maintains such an interpretation is overly vague and, therefore, reasons
that a related party's "ability to influence" or "control" a transaction must be considered.

The test for vagueness is a common-sense determination based on fundamental
fairness. "A statute that 'either requires or forbids the doing of an act in terms so vague
that persons of common intelligence must necessarily guess at its meaning and differ as
to its application' violates the Fourteenth Amendment to the United States Constitution
and is thus void for vagueness." State v. Richardson, 289 Kan. 118, 124, 209 P.3d 696
(2009) (quoting State v. Dunn, 233 Kan. 411, 418, 662 P.2d 1286 [1983]). Statutes
25



regulating business are given greater leeway than those proscribing criminal conduct.
Kaufman v. Kansas Dept. of SRS, 248 Kan. 951, 956, 811 P.2d 876 (1991). And "'[a]
statute will not be declared void for vagueness when it employs words commonly used,
previously judicially defined, or having a settled meaning in law.'" Kaufman, 248 Kan. at
958 (quoting Kansas City Millwright Co., Inc. v. Kalb, 221 Kan. 658, 663, 562 P.2d 65
[1977]).

The pertinent part of K.A.R. 30-10-la(a)(36)(C) states: "Related parties shall
include parties related by family, business, or financial association, or by common
ownership or control." These are commonly used words. Village Villa fails to elaborate
as to why it argues vagueness other than its bald allegation that the regulation is vague.
Without any substance behind it, we deem the argument to be abandoned. See Miller v.
Johnson, 295 Kan. 636, 2012 WL 4773559, at *36 (2012) (citing Frick Farm Properties
v. Kansas Dept. of Agriculture, 289 Kan. 690, 714, 216 P.3d 170 [2009]) (claims made in
passing without argument or support deemed waived and abandoned).

Compliance with federal regulations

Village Villa lastly asserts K.A.R. 30-10-1a(a)(7), (9), and (36)(C) contravene a
purpose of the federal Medicaid regulations: encouraging provider participation by
making sufficient payments "to enlist enough providers so that services under the plan are
available to recipients at least to the extent that those services are available to the general
population." See 42 C.F.R. § 447.204 (2006). KHPA provides statistics demonstrating
that it is meeting that purpose.

The appropriate supervisory federal agency—the Centers for Medicare and
Medicaid Services (CMS)—has approved Kansas' Medicaid plan. Village Villa fails to
address why CMS would approve the state plan if the Kansas regulations contravened
26



this federal purpose or otherwise elaborate on its argument. Given this failure, we
similarly deem this issue abandoned.

We conclude the district court correctly affirmed KHPA's final order regarding the
application of K.A.R. 30-10-1a(a)(7), (9), and (36)(C) and appropriately rejected Village
Villa's constitutional claims.

Affirmed.

LUCKERT, J. not participating.
1

MARQUARDT, J. assigned.
CAPLINGER, J. assigned.

1
REPORTER'S NOTE: Pursuant to the authority vested in the Supreme Court by
K.S.A. 20-3002(c), Judge Marquardt, of the Kansas Court of Appeals, was appointed to
hear case No. 102,324 vice Justice Luckert, and Judge Nancy L. Caplinger (now Justice
Nancy L. Moritz), of the Kansas Court of Appeals, was appointed to hear the same case
to fill the vacancy on the court created by the retirement of Chief Justice Robert E. Davis.