On December 30, 2015, the New York State Appellate Division, Second Department issued a decision in Agencies for Children’s Therapy Servs., Inc. v. N.Y. St. Dep’t of Health,1 upholding the regulations promulgated by the Department of Health (“DOH”) pursuant to Executive Order 38 limiting executive compensation and administrative costs for certain State-funded providers.2  The Court’s decision resolves a lower court split within the Second Department3 by reversing the Supreme Court, Nassau County’s prior ruling that adoption of the regulations had exceeded DOH’s statutory authority and violated the separation of powers doctrine, and upholding a Supreme Court, Suffolk County decision that found Executive Order 38 and the regulations to be constitutional.  Previously issued Clients & Friends Memoranda discuss the regulations and litigation challenging them in greater detail.4 

The Court cited several provisions of the Public Health Law and State Finance Law granting the Department of Health broad authority to:

  • “regulate the financial assistance granted by the [S]tate in connection with all public health activities” (N.Y. Pub. Health Law § 201[1][o]);
  • “receive and expend funds made available for public health purposes pursuant to law” (N.Y. Pub. Health Law § 201[1][p]);
  • “enter into contracts and agreements with individuals, associations, and corporations as may be deemed necessary and advisable to carry out the general intent and purposes of the Public Health Law. . . within the limit of funds available, for materials, equipment or services” (N.Y. Pub. Health Law § 206[3]);
  • “make a determination of responsibility of the proposed contractor” for health care services (N.Y. State Fin. Law § 163[9][f]), including its “financial ability,” “integrity,” and “past performance’” (N.Y. State Fin. Law § 163[1][c]); and
  • “make its service contract awards . . . in a manner that “optimizes quality, cost and efficiency’” (N.Y. State Fin. § 163[1][j]). 

In upholding the regulations, the Court concluded that the regulations pass constitutional muster on the ground that they are “not inconsistent with the . . . statutory provisions or their underlying purposes of obtaining high-quality services with limited available funds,” and “directly furthers the purposes of those statutory provisions by ensuing that . . . DOH awards service contracts to agencies that will use most of the tax dollars they receive directly on the provision of services rather than upon administrative overhead and executive compensation.”5

The Court then discussed the four factors enunciated by the Court of Appeals in Boreali v. Axelrod6 for analyzing separation-of-powers challenges to executive action.  With respect to the first Boreali factor – “‘whether the agency did more than balanc[e] costs and benefits according to preexisting guidelines, but instead made value judgments entail[ing] difficult and complex choices between broad policy goals to resolve social problems’”7 -- the Court concluded that DOH did not create a regulatory scheme “‘laden with exceptions based solely upon economic and social concerns’ and ‘based on its own conclusions about the appropriate balance of trade-offs between health and cost to particular industries in the private sector.’”8  In so concluding, however, the Court did not address the fact that the regulations apply to some, but not all, types of State-funded health care entities.9

With regard to the second Boreali factor – “‘whether the agency merely filled in details of a broad policy or if it wrote on a clean slate, creating its own comprehensive set of rules without benefit of legislative guidance’” 10 -- the Court held that “DOH’s determination to establish executive compensation and administrative cost limits in order to guide its own spending and contracting decisions represents a means to achieve the Legislature’s express ends.”11  However, none of the provisions of the Public Health Law and State Finance Law relied on by the Court address the level of compensation a health care provider or State contractor may decide to pay its executives. 

With regard to the third Boreali  factor – “‘whether the [L]egislature has unsuccessfully tried to reach agreement on the issue’”12 -- the Court noted that the Legislature had failed to adopt the Governor’s own 2012 budget-bill proposal to limit executive compensation and administrative costs, or that two similar pieces of legislation were unsuccessful.  Nevertheless, the Court was not persuaded that this track record was sufficient evidence of “prolonged legislative deadlock”13 on the issue. 

With regard to the fourth Boreali factor – “‘whether the agency used special expertise or competence in the field to develop the challenged regulations’”14 -- the Court held that the regulations “clearly reflect[] that it is the product of the DOH’s independent research into average levels of executive compensation and administrative expenses, its industry and program management expertise, and multiple revisions based on stakeholders’ concerns.”15  Notably, the Court did not reference any record evidence to support this assertion.  The Court’s holding is also difficult to reconcile with the fact that virtually identical regulatory limits were adopted by thirteen different agencies and applied to a host of State-funded entities other than health care providers. 

The Second Department’s decision does not separately analyze the executive compensation and administrative cost limits, but addresses their validity in one fell swoop.  Likewise, the Court did not explain how the statutes conferring authority on DOH to limit expenditures of public funds would authorize the regulations’ “soft cap” on executive compensation, which limits compensation paid by all sources – including non-State sources – and specifically requires providers to satisfy a regulatory “safe harbor” in order to justify compensating “covered executives” from all sources in excess of $199,000.  In this connection, the Court did not discuss the recent decision of Supreme Court, Albany County, which invalidated the “soft cap” as beyond DOH’s statutory authority.16

Nassau County Providers?  Following the April 8, 2014 issuance of the Agencies for Children’s Therapy Services decision in Supreme Court, Nassau County, the State’s Executive Order 38 Website posted Guidance indicating that providers conducting business in Nassau County were not required to file Executive Order 38 disclosures:

Based upon the April 8, 2014 decision in Agencies for Children’s Therapy Services, Inc. v. New York State Department of Health, et al. (“ACTS”), covered providers conducting business in Nassau County need not file Executive Order 38 disclosures. For purposes of this notice, “conducting business” means having a place of business within Nassau County, providing program services or administrative services involving the use or receipt of State funds or State-authorized payments within Nassau County, or otherwise conducting business within Nassau County in relation to which executive compensation is paid. Please note that the ACTS decision is under appeal. Those affected by the ACTS’ decision should periodically check the EO 38 website for updates regarding any changes to this notice.17

As of the date of this memorandum, the Guidance remains posted on the Executive Order 38 Website.  In light of a possible appeal of the Second Department's decision to the Court of Appeals, it is unclear whether or when the State will update the Guidance to require covered providers in Nassau County to comply with the regulations.  As Nassau County providers to date were not required to comply with the reporting and other requirements in the regulations, any revised Guidance should specify in what reporting period Nassau County providers will be expected to come into compliance, going forward.

The ultimate fate of Executive Order 38 and related regulations remains uncertain.  We anticipate that Agencies for Children’s Therapy Services will seek to appeal the Second Department decision to the Court of Appeals.18  Likewise, either the petitioners or the State may also pursue an appeal of the Supreme Court, Albany County decision to the Appellate Division, Third Department.