On September 30, 2025, Judge Loren Alikhan of the D.C. District Court issued a decision holding that a rule CMS adopted in 2023 to address the treatment of Part C days in the calculation of the Medicare DSH payment for periods prior to 2013 was impermissibly retroactive and arbitrary and capricious. Montefiore Medical Center v. Kennedy, No. CV 24-cv-1810-LLA, 2025 WL 2801237 (D.D.C. Sept. 30, 2025). The Court’s decision marks the latest development in the now decades-old legal brawl between hospitals and CMS over the treatment of Part C days in the Medicare DSH payment formula.
Background
The Medicare DSH payment is derived from the sum of two fractions: a Medicare and a Medicaid fraction. The Medicare faction asks what percentage of a hospital’s patient days attributable to patients who are “entitled to benefits under Part A” are also entitled to supplemental security income (SSI). The Medicaid fraction asks what percentage of the hospital’s non-Medicare patient days are attributable to patients who are eligible for Medicaid. The higher the sum of these fractions, the greater the DSH payment.
In the inpatient prospective payment system (IPPS) proposed rule for FY 2004, CMS proposed to “clarify” its “practice” concerning the treatment of Part C days in the Medicare fraction. At that time, CMS did not regard Part C patients as “entitled to . . . Part A” and therefore did not include Part C days in the Medicare fraction. In the FY 2005 final rule, based on the comments solicited the year before, CMS reversed course and adopted a policy of including Part C days in the Medicare fraction. This shift was generally expected to reduce the Medicare fraction (and consequently, DSH payments) because Part C patients are less likely to be on SSI.
The D.C. Circuit held that CMS’s “surprise switcheroo” in 2005 violated the notice and comment rulemaking requirements of the Administrative Procedure Act (APA). Allina Health Services v. Sebelius, 746 F.3d 1102, 1106 (D.C. Cir. 2014) (Allina I). Perhaps expecting that result, while Allina I was still pending, CMS readopted its policy of including Part C days in the Medicare fraction in the IPPS final rule for 2014. For periods prior to 2013, the agency attempted to implement the same policy without formal rulemaking. But the Supreme Court crushed that attempt in Allina II, holding that the agency could not adopt its Part C policy for periods prior to 2013 without notice and comment rulemaking. Azar v. Allina Health Services, 139 S. Ct. 1804 (2019) (Allina II).
The Supreme Court addressed DSH again in Becerra v. Empire Health Foundation, 142 S. Ct. 2354, 1368 (2022) (Empire). In Empire, the court held that Medicare beneficiaries who had exhausted their Part A coverage were “entitled to . . . Part A.” While the Empire court did not address Part C days directly, it held that one’s entitlement to Part A turns on whether they meet Medicare’s eligibility requirements—not on whether Medicare is paying for their stay.
In 2023, CMS published a final rule adopting its Part C policy for periods prior to 2013. The Medicare statute generally prohibits retroactive rulemaking except where necessary to comply with statutory requirements, or failure to apply the change retroactively would be contrary to public interest. But CMS alleged that retroactive rulemaking was not strictly necessary because, in the agency’s view, the Supreme Court held in Empire that the only reasonable interpretation of the statute was to treat patients who had met Medicare’s eligibility criteria as being “entitled to . . . Part A.”
CMS opined in its 2023 rule that retroactive rulemaking would be appropriate even absent the Empire decision. The agency contended retroactive rulemaking was necessary to comply with its statutory requirement to calculate DSH payments because for the period between 2005 and 2013 there was no regulation in effect governing the treatment of Part C days (since the Allina I court vacated that regulation). CMS also argued that retroactive rulemaking was in the public interest so that hospitals could receive their DSH payments for the period between 2005 and 2013.
Montefiore Medical Center v. Kennedy
Acting on CMS’s instruction in the 2023 rule, a Medicare contractor finalized a hospital’s DSH payment for its 2006 cost reporting period using a Medicare fraction that included Part C days. The hospital appealed that calculation to the Provider Reimbursement Review Board and to D.C. District Court. Before the court, the hospital filed a motion for summary judgment in which it argued that the Medicare statute requires excluding Part C days from the Medicare fraction, and that the 2023 rule was impermissibly retroactive and otherwise arbitrary and capricious.
In its decision, the Court applied the newly minted Loper Bright test to conclude that including Part C days in the Medicare fraction is consistent with the “best reading” of the statute. Relying principally on Empire, the Court held that entitlement to Part A turns on whether the patient meets the eligibility requirements for Medicare coverage—not on whether Part A (or Part C) is paying for the patient’s care during a given hospital stay.
The Court found that under the hospital’s theory that Part C patients are categorically not “entitled to . . . Part A,” Part C patients would not be able to avail themselves of many of the benefits available under the statute to individuals, including Medicare Part D’s prescription-drug benefits, or even switching back from Part C to Part A. “This disruptive view of Part A entitlement is untenable, and it frustrates the statute's design . . . .”
The Court’s work was not finished there. The question remained whether the 2023 rule was nonetheless impermissibly retroactive. CMS argued that should the Court agree with its interpretation of “entitled to . . . Part A,” it need not address whether the rule was retroactive because the agency was simply giving effect to the intent of the statute. The Court disagreed that its decision affirming CMS’s interpretation of the statute mooted the question of retroactivity.
[T]he Secretary offers no support for the notion that once a court interprets a statute, an agency has an automatic license to apply that interpretation retroactively through the rulemaking process. The court declines the Secretary's invitation to read a Loper Bright-sized hole into the . . . retroactivity precedent.
The Court ruled that the 2023 rule was “quintessentially retroactive” because it “departs from established practice” and “alters the past legal consequences of past actions” at least as applied to periods preceding the 2008 IPPS rule since it was not until that rulemaking that CMS.
Next, the Court proceeded to consider whether the 2023 rule fell within the exceptions to the statutory bar against retroactive rulemaking. With regard to the first exception, the Court found that CMS did not need to adopt a retroactive rulemaking to comply with its statutory directive to calculate DSH payments because the agency could simply revert back to its historical practice of excluding Part C days from the Medicare fraction. The Court found that Allina I resurrected that policy when it vacated the 2005 rule.
As for the second exception, the Court determined that CMS failed to demonstrate that failing to apply the 2023 rule retroactively would be contrary to the public interest. CMS had argued that applying the rule retroactively advances the public interest by allowing CMS to make DSH payments and administer the DSH statute. But these rationales were too close to the “statutory compliance” exception for the Court’s comfort. “[A]s a matter of statutory interpretation, the public interest exception cannot be read in such a way that makes the statutory compliance exception altogether redundant.”
Finally, the Court found that the 2023 rule is arbitrary and capricious because the agency failed to fully consider and address the financial impact of the rule. In particular, the Court noted that CMS’s estimated impact in the 2023 rule cannot be reconciled with its past statements. CMS said in the 2023 rule that the impact would be between $0 and $0.6 billion annually. But in Allina II, CMS represented before the Court that the impact of reversing its Part C policy would be between $3 and $4 billion between 2005 and 2013.
Despite finding multiple flaws in the 2023 rule, the Court declined to vacate it just yet and has instead ordered the parties to file briefs to address whether vacatur is the appropriate remedy.
