Health Law Daily Wrap Up, MEDICARE OVERPAYMENTS AND UNDERPAYMENTS—D.D.C.: Michigan loses appeal of decades-old CMS disallowances of $195 million in Medicaid payments, (Sep 29, 2026)

By Justin Marcus Smith, J.D.

The court acknowledged that analyzing Michigan’s challenge to the psychiatric facility exception for disproportionate share hospital payments required “swinging vine to vine through a jungle of statutory and regulatory provisions.”

Disproportionate share hospital (DSH) Medicaid payments to two psychiatric hospitals owned and operated by the State of Michigan were subject, without exception, to the institutions for mental diseases (IMD) exclusion from eligibility for Medicaid funding, held the federal district court in Washington, D.C. Disallowances of $195 million in DSH payments and a long-awaited decision of the U.S. Department of Health and Human Services Departmental Appeals Board (DAB) upholding them were consistent with the Medicaid statute and regulations. That was so regardless of other potential grounds for the disallowances, for example, whether the hospitals were required to have provider agreements with the Michigan Medicaid agency; whether the hospitals met the minimum threshold of Medicaid-eligible patients to qualify for DSH payments; whether DSH payments were additionally barred by the inmate exception; or whether those payments violated a hospital specific DSH limit. Because the court did not need to reach those other potential grounds for the disallowances, the court declined to consider the parties’ arguments about them. Independent of the Medicaid law analysis, the court declined to cut short the federal government’s right of recoupment where there was no clear statutory deadline for the Centers for Medicare & Medicaid Services (CMSs) to make the disallowance decisions under the Single Audit Act. Last, sovereign immunity barred Michigan’s unjust enrichment claim, but the court found unjust enrichment would have failed on the merits anyway because the accrued interest in dispute accrued on money that did not belong to Michigan (Michigan Department of Health and Human Services v. U.S. Department of Health and Human Services, No. 24-2264 (JEB) (D.D.C. Sept. 21, 2026)).

Background. There are two streams of Medicaid “federal financial participation” (FFP) contributions: (1) payments directly tied to the cost of providing covered services; and (2) supplemental payments distributed among so-called “disproportionate share hospitals” that serve poor communities.

Federal law categorically excludes from Medicaid any payments for inpatient hospital services in IMDs, except to individuals under 21 or over 64. Even within those age exceptions, funding only goes to certified psychiatric facilities. If CMS determines that Medicaid FFP has been paid in disregard of these limits, it will disallow the payments. The state must pay them back.

At issue here were Medicaid DSH payments that the Michigan Department of Community Health (DCH), predecessor to the Michigan Department of Health and Human Services (Michigan), made to two IMDs between federal fiscal years 2001 and 2009. The State of Michigan owned and operated both IMDs (collectively, the hospitals). One, the Center for Forensic Pathology (CFP), treated those deemed incompetent to stand trial or acquitted by reason of insanity. The other treated prisoners. At relevant times, both were accredited as hospitals and met the statutory definition of IMDs. However, neither had a provider agreement with the state to participate in Medicaid or billed it directly for providing services under Michigan’s Medicaid plan, and neither was certified as meeting the special requirements for psychiatric facilities relevant to IMD exclusion. Although neither hospital met the certification requirement, the state understood the certification to apply only to payments for covered services that neither hospital received. The claimed FFP in the payments came to a total of more than $195 million paid to the state of Michigan.

A series of state and federal audits raised questions about the payments. Michigan brought them to the attention of CMS, but CMS continued to make DSH payments to CFP and continued to approve FFP in those payments. In 2010, after more audits, HHS amended the state Medicaid plan to expressly require IMDs receiving DSH funds to have provider agreements with the state and meet the requirements for hospital participation under Medicaid regulations that in turn incorporated the “requirements for participation in Medicare.” CFP was certified as meeting the Medicare special conditions of participation (CoPs) for psychiatric hospitals later that same year.

However, in June 2018, CMS issued a “final determination” on the audit findings that disallowed the full amount of FFP claimed for the hospitals in the period the audits covered. The disallowance decisions were based on the same grounds raised by the state auditor, plus several additional ones. CMS determined Michigan was not entitled to FFP in the DSH payments because (1) both hospitals lacked a provider agreement as required by 42 U.S.C. § 1396a(a)(27); (2) both hospitals fell within the IMD exclusion at § 1396d(a)(1) and could not qualify for any exception because they lacked the required certification as psychiatric hospitals; (3) the prison hospital additionally fell within the inmate exclusion at 1396d(a)(32)(A); (4) neither hospital served the minimum percentage of Medicaid-eligible patients (MUIR threshold) at § 1396r-4(d)(3); and (5) the prison hospital also ran afoul of the hospital-specific cap on DSH funds. CMS asserted each as an independent ground for disallowance.

Michigan moved timely for reconsideration and elected to retain the disputed funds in the interim, as permitted by statute. After CMS denied reconsideration, Michigan appealed to the DAB. However, the DAB did not rule for more than five years, until 2024, when it upheld the disallowances on the same grounds CMS cited. The DAB also rejected Michigan’s laches argument.

Michigan then filed the instant judicial complaint in August 2024. The complaint asserted the CMS disallowances and the DAB decision upholding them violated the Medicaid Act, the Single Audit Act, and the implementing regulations of both statutes, such that the court should set the disallowances aside for violation of the Administrative Procedure Act (APA). The Michigan complaint also included an unjust enrichment claim for the accrued interest during the DAB delay in adjudicating the appeal.

At length, both parties moved for summary judgment. The district court, sitting as an appellate tribunal, applied de novo review to statutory interpretation without any deference to HHS.

Medicaid law. The court found one relatively straightforward basis for affirmance: the hospitals did not comply with the specific conditions that federal law places on IMDs to receive federal Medicaid funding, including DSH payments. The court concluded the DAB decision upholding the disallowances rested on the “best reading” of the Medicaid statute and regulations, was “reasonably explained,” and was not contrary to law, arbitrary, or capricious under the APA.

The court found both hospitals met the definition of an IMD, so any “medical assistance” to them fell within the IMD exclusion. As for exceptions to the IMD exclusion, Michigan offered a perfunctory, undeveloped, and consequently waived challenge that the regulatory definition of the 65-and-over exception was inconsistent with the Medicaid statute. In any event, the argument was unpersuasive on the merits because the HHS Secretary has express authority to make rules as may be necessary to administer the Medicaid program efficiently. Michigan also did not show any actual inconsistency with the Medicaid statute.

As for the under-21 IMD exception, Michigan did not maintain that either hospital specifically qualified. Neither hospital met the special conditions of participation (CoPs) for psychiatric hospitals. During the relevant period, they were accredited as hospitals, but they were never certified as psychiatric hospitals that met the special CoPs applicable to that distinct provider type. Michigan did not dispute this.

Falling outside those exceptions, the hospitals were fully subject to the IMD exclusion. That barred them from receiving medical assistance under not only the statute, but also the state Medicaid plan. That was dispositive. As the DAB explained, because ineligibility for “medical assistance” necessarily meant ineligibility for DSH payments, the lack of certification sufficed to uphold the disallowances of those payments to the two hospitals.

Michigan also advanced a contrary theory that the IMD exclusion only applied to payments for services, not DSH payments. This theory attempted to divide two sections of the Medicaid statute. The court said the theory was wrong because DSH payments also count as “medical assistance.” DSH payments are an adjustment to the standard rates for furnishing “inpatient hospital services.” The federal government could not be expected to pay any share of a DSH adjustment to inpatient hospital services falling within the IMD exception. The court explained its reasoning at length. The court noted that Michigan elsewhere appeared to accept that the general exclusions from “medical assistance” applied to DSH payments. The court said the DAB also clearly explained this.

Michigan’s next argument that the Medicaid statute specifically foreclosed making eligibility for DSH payments contingent on the Medicare special CoPs for psychiatric hospitals misconstrued the DSH provisions. That some IMDs may qualify to receive Medicaid DSH did not make all IMDs qualified.

Nor did requiring certification with Medicare special CoPs run afoul of the provision that the HHS Secretary may not restrict a state’s authority to designate hospitals as DSH hospitals. As the DAB explained, state discretion in directing DSH payments to qualified hospitals did not mean they may direct DSH payments to hospitals not qualified to participate in Medicaid.

Notice. Despite Michigan’s attempts to imply that application of Medicare CoPs as the criteria for DSH payment eligibility under Medicaid came as a surprise, the court noted the rules for the two programs were closely intertwined, with commonplace cross-references, including in the state’s own Medicaid plan.

The only affirmative conduct Michigan pointed to was continued CMS approval of FFP in the DSH payments after the first audit raised the certification issue. CMS failed to make its disallowance decisions promptly, but the court said that was not a notice problem. The first audit happened after most of the payments at issue here were made. As for DSH payments after the first audit reports, Michigan did not explain how it was deprived of notice. Federal law reasonably allows for retroactive disallowance decisions after further review, which is what happened here. FFP is often paid and later disallowed, hence it would have been unreasonable for Michigan to assume ratification.

Single Audit Act. The Single Audit Act (SAA) itself did not impose any time limit on CMS to issue the disallowances, but Office of Management and Budget (OMB) guidance did direct CMS to issue a management decision within six months of the audit report. The argument that missing the deadline was “arbitrary, capricious, and inconsistent with law” was tantamount to arguing for converting OMB guidance into a limitations period for the federal government to recoup improperly claimed Medicaid payments. The court declined to cut short the federal government’s right of recoupment in the absence of a clear statutory deadline. Only Congress could make a call like that. The court may have been empathetic toward Michigan, but Michigan did not make any denial of due process argument and expressly disclaimed equitable estoppel.

Unjust enrichment. Last, the court held sovereign immunity barred the unjust enrichment claim. The APA waiver of sovereign immunity extends only to suits against the United States “seeking relief other than money damages.” The court already determined that the CMS disallowances were lawful, so unjust enrichment could not be predicated on reversal. Absent statutory entitlement to return of fund, Michigan’s unjust enrichment claim was for money damages for the interest injury incurred due to DAB delay. The court reasoned that ordering payment of money for interest would have amounted to awarding compensatory damages regardless of the fact Michigan sought a sum certain more akin to money damages. The court found the unjust enrichment claim would have failed on the merits anyway because the interest accrued on money that never belonged to Michigan.

The case is Civil Action No. 24-2264 (JEB).

Judge: Boasberg, J. Attorneys: Kendra Doty (Brown & Peisch PLLC) for Michigan Department of Health and Human Services. William Thanhauser, U.S. Department of Justice, for U.S. Department of Health and Human Services.

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