By Jonathan Stempel

NEW YORK (Reuters) - The federal appeals court in New York struck down a U.S. regulation that made it harder for hospitals to provide better medical care at lower cost by claiming they were "rural" for some purposes and "urban" for others.

Thursday's decision by the 2nd U.S. Circuit Court of Appeals is a victory for hospitals in urban areas including the acute care Lawrence + Memorial Hospital of New London, Connecticut, which said the Department of Health and Human Services' "reclassification rule" forced it to overpay for drugs that patients needed.

Writing for the appeals court, Judge Jed Rakoff said the 2000 regulation conflicted with the plain meaning of the federal Medicare statute, and that HHS lacked authority to implement it.

Medicare lets hospitals be reimbursed for the cost of providing services. It allows some hospitals to be classified simultaneously as "rural" to get lower drug pricing and "urban" to ensure they can attract and pay qualified staff.

But under the HHS rule, according to Rakoff, urban hospitals classified as "rural" to reduce drug prices could not be deemed "urban" by the agency's Medicare Geographic Classification Review Board, unless they first canceled their rural status for the years in which they sought reclassification.

In December 2014, a federal judge rejected the New London hospital's challenge to the rule, which she said reflected a "deliberate, logical, and considered" effort at HHS to implement an ambiguous Medicare statute.

But Rakoff, who normally sits on the federal district court in Manhattan, said the statute was clear and downplayed concern that hospitals might seek classifications they do not deserve.

The law "simply increases the number of situations in which hospitals can be treated as rural for some purposes and urban for others, but there is nothing 'absurd' about such a measured approach," he wrote. "An agency may not rewrite clear statutory terms to suit its own sense of how the statute should operate."

A spokesman for U.S. Attorney Deirdre Daly in Connecticut, who defended the HHS regulation, said: "The Justice Department and HHS are reviewing the decision to determine how best to proceed."

Joseph Glazer, the hospital's lawyer, in an email said his client is pleased with the decision. He said the dual classification saves hospitals millions of dollars annually through greater Medicare reimbursements or cost savings.

The case is Lawrence + Memorial Hospital v Burwell et al, 2nd U.S. Circuit Court of Appeals, No. 15-164.

To Learn More:

Closing of Rural Hospitals across U.S. Upends Communities (by Noel Brinkerhoff and Steve Straehley, AllGov)