On June 22, 2017, the New York State Appellate Division, Third Department issued a decision in LeadingAge New York v. Shah on the validity of regulations promulgated by the Department of Health (“DOH”), pursuant to Executive Order 38 (“EO 38”), that limit executive compensation and administrative costs for certain State-funded providers.  The Third Department affirmed the decision of the court below and upheld the “hard” cap imposed by the DOH -- capping state dollars for executive compensation at $199,000 -- but determined that the DOH exceeded its authority with respect to the “soft” cap -- regulating executive compensation from all sources of funding.  This decision is in conflict with earlier decisions rendered by the Appellate Division, Second Department upholding the soft cap as well as the hard cap, and sets up a possible appeal to the New York State Court of Appeals. Previously issued Clients & Friends Memoranda discuss the regulations at issue in detail and the litigation challenging them.  

Hard Cap

The Third Department held that DOH acted within its rulemaking authority by imposing the hard cap; the hard cap places a limit on administrative costs and executive compensation at $199,000 paid for by Medicaid or other state funds and state-authorized payments.  The court relied on the DOH’s statutory obligation to ensure that “scarce taxpayer dollars” are used efficiently and for the benefit of recipients of government-funded services.  The court concluded that the DOH properly analyzed the societal costs and benefits of the “hard cap” regulation.  The court rejected the providers’ contention that the regulations violate the State constitutional “separation of powers” doctrine.  In so holding, the court explained that DOH was properly exerting its authority to fill in the details of “broad legislation” requiring it to “administer taxpayer funding programs efficiently,” and that the hard cap reflected DOH’s “special expertise in regulating public health care spending.” 

Furthermore, the Third Department reasoned, the hard cap was not arbitrary or capricious because it was adopted after a task force investigation revealed that certain service providers had used state funds to pay themselves excessive compensation instead of using such funds in furtherance of public health programs.  Notably, one justice dissented, concluding that the hard cap exceeded the DOH’s regulatory authority.

Soft Cap

However, the Third Department ruled that DOH had exceeded its rulemaking authority in promulgating the soft cap, which restricts executive compensation paid from all sources, including non-Medicaid or -State funds, with limited exceptions.  The court explained that by attempting to regulate executive compensation from all sources, DOH was adopting its “own ideas of sound public policy,” a power reserved to lawmakers, and was acting outside DOH’s legislative mandate to manage the efficient and effective use of taxpayer money for health care and related services.  The court further explained that DOH has “no special expertise in administering regulations governing the overall executive compensation or competence in regulating corporate governance,” noting that the soft cap regulations “meddles significantly in the decision-making processes of corporations’ governing bodies.”  There were no dissenting opinions on this portion of the court’s decision.

Next Steps?

Either party may seek leave to appeal the decision to the New York Court of Appeals, with the petitioners possibly relying on the dissent, which found the hard cap infirm as well; and the State relying on the Second Department’s earlier decision, which upheld the EO 38 regulations in their entirety.