Health Law Daily Wrap Up, DISPROPORTIONATE SHARE HOSPITALS—N.D. Tex.: Texas hospital wins challenge to HHS rule affecting Medicare DSH calculations, (Jul 30, 2026)

By Patricia K. Ruiz, J.D.

The court vacated a regulation excluding certain demonstration-project patient days and denied a request for permanent injunction.

A federal court in Texas granted summary judgment to Covenant Medical Center, holding unlawful an HHS regulation that excluded certain patient days associated with uncompensated-care funding pools from calculations used to determine Medicare disproportionate share hospital payments. The court declared the regulation invalid and vacated it, concluding that it conflicted with the governing statute and binding Fifth Circuit precedent. The court, however, denied the hospital's request for a permanent injunction, finding that the plaintiff had not established irreparable harm (Covenant Medical Center v. Kennedy, No. 4:26-cv-00077-P (N.D. Tex. July 27, 2026)).

Background. The dispute concerned Medicare reimbursement calculations for disproportionate share hospitals, which serve significant numbers of low-income patients. Eligibility for enhanced payments is determined in part by a hospital's disproportionate share hospital percentage, which includes a Medicaid fraction based on patient days attributable to Medicaid-eligible individuals. Congress amended the statute in 2005 to allow the HHS secretary to include patient days for individuals who are not otherwise Medicaid eligible but are treated as such because they receive benefits through Medicaid demonstration projects approved under Section 1115 of the Social Security Act.

Texas' Healthcare Transformation and Quality Improvement Program is a Section 1115 demonstration project that was approved by the secretary in 2021. Under the program, hospitals could receive payments from uncompensated care cost pools to offset the cost of providing indigent care. According to the court, hospitals viewed approval of the program as allowing patient days associated with those benefits to be included in the Medicaid fraction calculation.

In 2023, HHS adopted what the court referred to as the "Exclusion Rule," codified at 42 C.F.R. § 412.106(b)(4)(iii). The rule provided that patients whose healthcare costs were claimed for payment from certain uncompensated-care funding pools authorized under Section 1115 were not regarded as Medicaid eligible for purposes of the Medicaid fraction and that their patient days could not be included in the calculation.

Previous litigation. The litigation began in 2024, when a group of Texas disproportionate share hospitals challenged the rule. The district court initially held that it had jurisdiction, declared the rule unlawful, and vacated it, concluding that the regulation conflicted with the Medicare statute and the Fifth Circuit's decision in Forrest General Hospital v. Azar (seeTexas hospitals serving the indigent secure vacatur of HHS 'Exclusion Rule', Aug. 20, 2024).

On appeal, however, the Fifth Circuit reversed without addressing the merits, holding that the hospitals had failed to satisfy Medicare's channeling requirements because they had not first presented reimbursement claims to HHS through the administrative process and obtained a final agency determination (see District court had no jurisdiction to hear case arising out of Medicare channeling scheme, Dec. 15, 2025). After the hospitals submitted the relevant cost reports, pursued administrative review, and obtained authorization for judicial review, the case returned to the district court for a merits determination.

Conflict with statute. Considering the merits of the case, the instant court concluded that the Exclusion Rule was unlawful because it was inconsistent with the text of 42 U.S.C. § 1395ww(d)(5)(F)(vi)(II) and with the Fifth Circuit's decision in Forrest General Hospital v. Azar. According to the court, Forrest established that the Medicaid fraction's numerator includes both days associated with Medicaid-eligible patients and days attributable to patients treated as Medicaid eligible through a Section 1115 demonstration project approved by the secretary. The court said the secretary had already exercised any relevant discretion when approving Texas' demonstration project and could not subsequently exclude those patient days through regulation.

The court rejected HHS's reliance on the Supreme Court's 2025 decision in Advocate Christ Medical Center v. Kennedy, finding that the case involved a different statutory provision and did not alter the Fifth Circuit's analysis of the Medicaid-fraction statute at issue. While acknowledging that HHS's interpretation was "far from an implausible interpretation" of the statute, the court stated that it was bound by Fifth Circuit precedent. The court therefore declared 42 C.F.R. § 412.106(b)(4)(iii) unlawful and declined to address the plaintiff's separate argument that the rulemaking process was arbitrary and capricious under the APA.

Injunction denied. The court next considered the plaintiff's request for a permanent injunction barring enforcement of the rule. Applying the traditional four-factor test for injunctive relief, the court found that the hospital satisfied the requirements concerning inadequate legal remedies, balance of hardships and public interest. However, the court determined that the plaintiff had not demonstrated irreparable harm. Although monetary damages were unavailable against the government, the court said the hospital could return to the administrative process and recover any reimbursements to which it was entitled. Because that avenue of relief remained available, the court found the plaintiff had not carried its burden on the irreparable-harm requirement and denied the injunction request.

Vacatur granted. The court nevertheless ruled that vacatur was the appropriate remedy. It noted Fifth Circuit precedent describing vacatur as the ordinary remedy for unlawful agency action and as less severe than an injunction. Finding that the Exclusion Rule was unlawful, the court concluded that vacatur would remedy the plaintiff's injury while imposing a lesser burden on HHS. The court therefore granted the plaintiff's request to vacate the regulation under the APA.

The case is No. 4:26-cv-00077-P.

Judge: Pittman, M.

Attorneys: Robert M. Hill (King & Spalding LLP) for Covenant Medical Center. Brian Walters Stoltz, U.S. Department of Justice, for Robert F. Kennedy, Jr.

Companies: Covenant Medical Center

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