Kanawha Institute for Social Research and Action, Inc., DAB No. 3041 (2021)

DECISION

Kanawha Institute for Social Research and Action, Inc. (KISRA) appeals a decision by the Administration for Children and Families (ACF) to disallow $195,763 in federal grant funds awarded to KISRA under the Urban and Rural Economic Development (Community and Economic Development) Health Food Financing Initiative.  ACF based its determination on an independent audit, which found that KISRA's payments to a vendor for special grow lights that it never received was a questioned cost and subject to disallowance.  ACF concluded that KISRA's expenditure of federal funds (in violation of its own disbursement policy) failed to comply with applicable uniform administrative requirements and cost principles.  For the reasons discussed below, we uphold the disallowance.

Legal Background

The Community and Economic Development (CED) program is authorized by Section 680 of the Community Services Block Grant Act, 42 U.S.C. § 9921.  The CED program provides grants to nonprofit community development corporations "to address the economic needs of low-income individuals and families by creating employment and business development opportunities."  Id. § 9921(a)(2)(A).

CED grants are subject to the Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Department of Health and Human Services (HHS) awards at 45 C.F.R. Part 75 ("Part 75").  See 45 C.F.R. §§ 75.101(a), 75.110(a).1  CED grantees are required, among other things, to "[e]stablish and maintain effective internal control over the Federal award that provides reasonable assurance that the non-Federal entity is managing the Federal award in compliance with Federal statutes, regulations, and the

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terms and conditions of the Federal award."  Id. § 75.303(a).  Procurement standards in Part 75 require that grantees, among other things, "maintain oversight to ensure that contractors perform in accordance with the terms, conditions, and specifications of their contracts or purchase orders."  Id. § 75.327(b).

General cost principles under Part 75 are based on the fundamental premises that grantees are "responsible for the efficient and effective administration of the Federal award through the application of sound management practices" and "for administering Federal funds in a manner consistent with underlying agreements, program objectives, and the terms and conditions of the Federal award."  45 C.F.R. § 75.400(a), (b).

For costs to be allowable under a federal award, they must be "reasonable for the performance of the Federal award and be allocable thereto."  45 C.F.R. § 75.403(a).  In determining the reasonableness of a cost, consideration must be given to whether the grantee complied with "sound business practices."  Id. § 75.404(b).  A cost is allocable to a federal award "if the goods or services involved" are chargeable to that federal award "in accordance with relative benefits received."  Id. § 75.405(a).

If a grantee fails to comply with federal laws, regulations, or the terms and conditions of its award, the awarding agency may, as appropriate, disallow the cost of the activity or action not in compliance.  45 C.F.R. § 75.371(b).  When reviewing a disallowance, the Board is "bound by all applicable laws and regulations."  Id. § 16.14.

Case Background

ACF awarded KISRA a CED grant to help fund a project to produce fresh fruits and vegetables in an economically distressed area of Charleston, West Virginia.  See Appellant's Written Statement of Argument (App. Br.) at 1 (¶ 1); Brief of the Respondent, ACF (ACF Br.) at 3.2  KISRA intended to develop an indoor vertical growth farm using a hydroponic system of water and special lighting.  App. Br. at 1 (¶ 1); KISRA Ex. 1, Declaration of Michelle Foster (Foster Decl.) at 1 (¶ 5).  The purpose of the project was to provide fresh produce to local businesses and residents at a reasonable price.  App. Br. at 1-2 (¶ 1). 

In connection with the project planning, KISRA sought the assistance of the West Virginia Department of Agriculture (WVDA).  App. Br. at 2 (¶ 2).  According to KISRA, the Commissioner of the WVDA recommended that KISRA contract with a vendor located in Michigan to provide the "grow lights" necessary for the project.  Id.  Before

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contracting with the vendor, KISRA visited the vendor in Michigan to "personally inspect its operation."  Id. at 2 (¶ 3).

Based on the recommendation of the WVDA Commissioner and KISRA's inspection of the vendor's operation, KISRA contracted with the vendor to supply "lighting, materials and technical assistance" for the development of its vertical growth farm.  App. Br. at 2 (¶ 4).  In December 2014, KISRA received a purchase order from the vendor for the lighting equipment required by the project.  Foster Decl. at 1-2 (¶¶ 8-9).  The vendor requested payment in the amount of $130,680, which represented 50% of the lighting cost.  Id.  On December 19, 2014, before taking delivery of any lighting equipment, KISRA paid the vendor $130,680 for the lighting.  Id. at 2 (¶ 10).

According to KISRA's former CEO, KISRA subsequently "made efforts" to prepare for the installation of the vertical growth farm throughout 2015.  Foster Decl. at 3 (¶ 14).  As of January 2016, however, no lighting had been delivered by the vendor "despite the payment by KISRA for lighting in December 2014."  Id.  Nevertheless, KISRA's CEO reached out to the vendor in January 2016 and offered to pay the balance owed for the remaining lighting needed for the project.  Id. at 3 (¶ 16) ("We would like to get a check out to you for the balance of the lights.").  By this time, KISRA had decided on having a smaller system than originally planned, which reduced the total lighting cost.  Id.  The vendor submitted another purchase order to KISRA requesting payment in the amount of $92,150 for the remaining lighting.  Id. at 3 (¶¶ 17-18).  On January 21, 2016, KISRA paid the vendor $92,150, again without receiving any lighting.  Id. at 4 (¶ 19).

The vendor did not deliver any of the lighting it agreed to provide and did not return any payments to KISRA.  App. Br. at 3-4 (¶ 6); Foster Decl. at 4 (¶ 19).  In March 2017, after its efforts to recoup the payments from the vendor failed, KISRA filed a lawsuit against the vendor for breach of contract and conversion in the United States District Court for the Southern District of West Virginia.  App. Br. at 3-4 (¶¶ 6-7).3

In December 2017, an independent audit of KISRA's financial statements was completed for the period of January 1, 2016 through December 31, 2016.  Independent Auditors' Report and Financial Statements Prepared by Herman & Cormany (Audit Report) at 3-5.4  Regarding the CED award (No. 90EE108501), the auditors made the following findings:

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Condition and Criteria:  [KISRA] contracted with a vendor to purchase lighting, materials, and technical assistance to develop a vertical farm.  Payment was submitted to the vendor, but the vendor provided no lighting, materials, or technical assistance.  The vendor did not return the payment.

Effect:  The vendor defrauded KISRA and the payment is subject to disallowance.  The payment is considered a questioned cost.

Cause:  [KISRA] did not follow their disbursement policy to pay for items only after they have been ordered, received, and are ready for use.

Questioned Costs:  $195,763.  This is the net amount of the purchase of the lights.^[5^]

Context:  A review of fixed asset additions noted . . . the invoice for lighting.  Upon further discussion, [KISRA] became aware that the lights were not received.

Auditors' Recommendation:  We recommend [KISRA] follow its disbursement policy to only pay for items after they have been ordered, received, and are ready for use.

Views of Responsible Officials and Planned Corrective Actions:  [KISRA] agrees with the finding and the auditors' recommendation.  [KISRA] has filed a lawsuit against the vendor to recover the payment.

Id. at 28.

The corrective action plan, signed by KISRA's CEO on behalf of KISRA, reiterated the findings from the Audit Report regarding the expenditure of federal funds on undelivered lighting.  Id. at 29.  In the corrective action plan, KISRA's management agreed "that the transaction did not follow its disbursement policy."  Id.

By letter dated March 20, 2019, ACF notified KISRA that it was disallowing $195,763 in questioned costs based on the audit findings and KISRA's response in the corrective

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action plan.  Determination Letter at 3.6  ACF observed that KISRA had agreed it did not follow its own disbursement policy when it paid for items before they were received and ready for use.  Id.  ACF concluded that KISRA failed to comply with 45 C.F.R. § 75.404(b), "which requires grantees to follow 'sound business practices' to establish that costs are reasonable," and 45 C.F.R. § 75.405(a), "which requires grantees to limit the amount of grant funds charged 'in accordance with the relative benefits received'" to establish that costs are allocable to the award.  Id. at 3-4.  The notice further advised KISRA that it had a right to appeal the disallowance to the Departmental Appeals Board (Board) under 45 C.F.R. Part 16.  Id. at 4.

On March 29, 2019, KISRA timely filed a notice of appeal with the Board, asserting that the audit on which the disallowance was based "contains incorrect and insufficient information regarding the status and mitigating circumstances surrounding the questioned cost."  Notice of Appeal at 1.  KISRA noted that it filed a lawsuit against the vendor, obtained a judgment, and was in the process of pursuing collections.  Id.  KISRA filed with its notice of appeal an executive summary, which provided additional information about the indoor growth facility it intended to develop, how a state official recommended the vendor, how it made two payments to the vendor for lighting equipment it never received, and the judgment it obtained against the vendor.  Executive Summary at 1-2.

KISRA subsequently filed an appeal brief, with three exhibits, including the Declaration of Michelle Foster (former CEO of KISRA) with attachments (Ex. 1); Unsigned Declaration of Carl Chadband (former COO of KISRA) with attachments (Ex. 2); and a copy of the Memorandum Opinion and Order of the United States District Court for the Southern District of West Virginia entering summary judgment in favor of KISRA and against the vendor (Ex. 3).7  KISRA does not dispute that it used federal funds from the CED grant to pay for lighting equipment that it never received, but argues that:  (i) it contracted with the vendor, in good faith, on the recommendation of a "trusted authority" and "after the exercise of due diligence"; (ii) it initiated legal proceedings and obtained a judgment against the vendor; and (iii) requiring repayment of the disallowed amount is "unduly harsh" and will "seriously impede" KISRA's ability to have a sustainable vertical growth farm.  App. Br. at 5.

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In response, ACF argues that KISRA "is ultimately responsible for the misuse of Federal grant funds" and that "grantees must '[e]stablish and maintain effective internal control over the Federal award' and 'ensure that contractors perform in accordance with the terms, conditions, and specifications of their contracts or purchase orders.'"  ACF Br. at 4 (quoting 45 C.F.R. §§ 75.303(a) & 75.327(b)).8  ACF argues that the amount KISRA paid for goods that were never delivered "is clearly an unallowable cost, a point that KISRA does not deny," and that "[i]t is incumbent upon ACF to seek recovery [of] any misused federal funds."  Id.

Analysis

1.  The disallowance is supported by audit findings, and KISRA has not shown those findings are legally or factually unjustified.

When a grantee appeals a federal agency's disallowance determination, the agency "has the initial burden to provide sufficient detail about the basis for its determination to enable the grantee to respond."  E Center, DAB No. 2657, at 5 (2015) (quoting Me. Dep't of Health & Hum. Servs., DAB No. 2292, at 9 (2009), aff'd, Me. Dep't of Hum. Servs. v. U.S. Dep't of Health & Hum. Servs., 766 F. Supp. 2d 288 (D. Me. 2011)).  "If the agency carries this burden, which the Board has called 'minimal,' then the nonfederal party (the grantee, in this case) must demonstrate that the costs are, in fact, allowable."  Id. (citing Mass. Exec. Off. of Health & Hum. Servs., DAB No. 2218, at 11 (2008), aff'd, Massachusetts v. Sebelius, 701 F. Supp. 2d 182 (D. Mass. 2010)).  "When a disallowance is supported by audit findings, the grantee typically has the burden of showing that those findings are legally or factually unjustified."  Id. (quoting Mass. Exec. Off. of Health & Hum. Servs., DAB No. 2218, at 11).  "[W]here a disallowance is authorized by law and the grantee has not disproved its factual basis, the Board must affirm the disallowance."  Cent. Ala. Comprehensive Health, Inc., DAB No. 2625, at 3 (2015) (citation omitted).

Here, there is no dispute ACF met its initial burden in disallowing the questioned costs.  In its determination letter, ACF explained that it was disallowing questioned costs in the amount of $195,763 based on the audit finding that KISRA, in violation of its own disbursement policy, used federal funds to pay a vendor for lighting equipment that it never received.  Determination Letter at 3.  ACF concluded that KISRA failed to comply with 45 C.F.R. § 75.404(b), "which requires grantees to follow 'sound business practices'" and 45 C.F.R. § 75.405(a), "which requires grantees to limit the amount of

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grant funds charged [to a federal award] 'in accordance with the relative benefits received.'"  Id. at 3-4.  KISRA does not argue that the determination letter contained insufficient detail to enable it to respond.  We conclude that ACF carried its initial burden to provide sufficient detail about the basis for the disallowance.

Having found that ACF carried its initial burden, the burden shifts to KISRA to demonstrate that the questioned costs are allowable.  See E Center at 5.  Moreover, since ACF's disallowance determination is supported by audit findings, KISRA must show that the auditor's findings "are legally or factually unjustified."  Id. (citations omitted).

Although KISRA's notice of appeal alleged that the Audit Report "contains incorrect and insufficient information," KISRA made no attempt to refute the audit findings on appeal.  KISRA presented no evidence that anything in the Audit Report about its expenditure of federal funds was incorrect.9  We find the facts relevant to the disallowance determination, as reported by the auditor, are undisputed.  KISRA concedes that it used federal funds in connection with its CED grant to pay for lighting equipment that it never received.  App. Br. at 1 (¶ 1); Audit Report/Corrective Action Plan at 29.  KISRA further concedes that the payments made to its vendor violated its own disbursement policy.  Audit Report/Corrective Action Plan at 29.  KISRA does not argue that the payments complied with sound business practices or benefitted the CED award in any way.

We find the costs KISRA charged to the CED grant for lighting equipment it never received are not reasonable because KISRA did not adhere to "sound business practices" when it made payments to the vendor in violation of its own disbursement policy.  See 45 C.F.R. § 75.404(b).  Moreover, the costs incurred by KISRA are not allocable to the CED award because the costs conferred no benefit on the federal award or the vertical growth farm KISRA had intended to develop with federal funds.  See id. § 75.405(a).

Still further, KISRA made no attempt to respond to ACF's contention that "grantees must '[e]stablish and maintain effective internal control over the Federal award' and 'ensure that contractors perform in accordance with the terms, conditions, and specifications of their contracts or purchase orders.'"  ACF Br. at 4 (quoting 45 C.F.R. §§ 75.303(a) & 75.327(b)).  The contract at issue here obligated the vendor to supply lighting, materials, and technical assistance for KISRA's vertical growth farm.  Although KISRA contends it performed due diligence in selecting the vendor, that fact, even if true, does not excuse KISRA from ensuring that the vendor performed in accordance with its contractual obligations.  KISRA acknowledges that it paid the vendor $130,680 in December 2014 without receiving any lighting and, more than one year later, initiated an additional $92,150 payment to the vendor, again without receiving any lighting.  Foster Decl. at 2

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(¶¶ 9-10), 3 (¶¶ 14-16), 4 (¶ 19).  KISRA presented no evidence that it questioned the vendor or insisted on the delivery of any lighting between the time of the initial payment in December 2014 and the subsequent payment in January 2016.  KISRA provided no explanation for its decision to use federal funds to pay for 100% of the lighting equipment in violation of its disbursement policy and without requiring the delivery of any lighting equipment from the vendor.

Accordingly, we further find that KISRA failed to show:  (i) that it established and maintained "effective internal control" over the CED award; or (ii) that it maintained oversight to ensure that its vendor performed "in accordance with the terms, conditions, and specifications of [the vendor's] contracts or purchase orders."  See 45 C.F.R. §§ 75.303(a) & 75.327(b).

Based on the foregoing, we conclude that KISRA failed to carry its burden of showing that the audit findings are legally or factually unjustified and that the questioned costs are, in fact, allowable.

2.  The Board may not overturn or waive a disallowance based on "mitigating circumstances" or other equitable arguments.

KISRA does not contend the questioned costs are allowable, but challenges the disallowance based on "mitigating circumstances" and other equitable arguments.  Notice of Appeal at 1.  Specifically, KISRA contends it was the unwitting victim of a "fraudulent scheme" perpetrated by its vendor.  App. Br. at 3 (¶ 5).  KISRA further argues that:  (i) it contracted with the vendor in good faith; (ii) it initiated legal proceedings and obtained a judgment against the vendor; and (iii) the disallowance is "unduly harsh" and would "seriously impede" KISRA's ability to fulfill its goal of having a sustainable vertical growth farm.  App. Br. at 5.  None of these arguments provides a basis to overturn or waive the disallowance.

KISRA's argument that it should not be responsible for the disallowed amount because it was the victim of fraud has no merit.  The Board previously considered and rejected a similar argument in Central Alabama Comprehensive Health, Inc., DAB No. 2625 (2015).  The disallowances in Central Alabama arose from the alleged misappropriation of federal funds by a "management contractor" hired by the grantee.  Id. at 3-4.  The auditors and relevant federal agency determined, among other things, that the grantee "failed to develop and implement procedures to ensure adequate internal control over the administration of federal assistance and adequately safeguard assets."  Id. at 3-4.  The grantee did not dispute the audit findings or the federal agency's authority to disallow the funds.  Id. at 5.  Instead, it argued that its contractor, not the grantee, should be held responsible for the disallowance.  Id.  The grantee argued that it had no knowledge of the contractor's misappropriation of funds and, when it became aware of the financial irregularities, it promptly terminated the management contract and filed a civil action

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against the contractor.  Id. at 5-6.  In addition to documentation of the civil action, the grantee presented evidence that an employee of the contractor had pled guilty to fraud against the grantee in a pending federal criminal case.  Id. at 6-7.

Rejecting the grantee's contentions, the Board stated that "[t]he ultimate responsibility that all grant funds are properly expended . . . lies with the grantee because the legal relationship created by a grant award is between the Agency and the Grantee."  Id. at 6 (citations and internal quotations omitted).  The Board explained that when the grantee applied for and received the federal award, it "became a fiduciary of federal funds . . . and [therefore,] was responsible for ensuring that those funds were properly spent and accounted for."  Id. at 7 (citation and internal quotations omitted).  The Board found "no reasonable basis" for concluding that the grantee was not responsible for its contractor's misconduct and for repaying the disallowed costs.  Id.  The Board upheld the disallowances because they were supported by the record evidence and consistent with applicable statutes and regulations.  Id.

For the same reasons, there is no basis for the Board to overturn or waive the disallowance in this case based on a breach of contract (or alleged fraud) by KISRA's vendor.10  As the grantee, KISRA bears the ultimate responsibility for ensuring that federal funds awarded to it are properly spent in accordance with the applicable statutes and regulations.  See Cent. Ala. at 6-7.  Moreover, the civil action KISRA filed against its vendor is not relevant to any issue before the Board.  Id. at 7.  As explained in Central Alabama, KISRA may seek relief from its vendor in private litigation, but it "remains responsible for the commitments it made in accepting federal grant funds."  Id. (concluding that civil action against contractor and pending federal criminal case were not relevant to the Board's decision).

KISRA further argues that it should not be required to repay the disallowed amount because it contracted with its vendor in "good faith."  App. Br. at 5.  This amounts to an argument that the disallowance should be waived on equitable grounds.  "The Board is bound by all applicable laws and regulations and has no authority to waive a disallowance."  River E. Econ. Revitalization Corp., DAB No. 2087, at 12 (2007) (citing 45 C.F.R. § 16.14); see also Econ. Opportunity Comm'n of Nassau Cnty., Inc., DAB No. 2731, at 7 (2016) ("The Board has consistently held that it 'has no authority to waive a disallowance based on equitable principles.'" (quoting Mun. of Santa Isabel, DAB No. 2230, at 11 (2009)).  Thus, "[a] party's good faith, honest efforts, or financial hardship do not provide a legal basis for the Board to overturn a disallowance."  River E. Econ. Revitalization at 12 (citing New Century Dev. Corp., DAB No. 1438, at 11 (1993)).

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Finally, KISRA argues that the disallowance is "unduly harsh" and will "seriously impede" its ability to have a vertical growth farm.  App. Br. at 5.  These arguments, again based on equitable principles, provide no basis for overturning a legally justified disallowance.  See, e.g., Econ. Opportunity Comm'n of Nassau Cnty. at 7 (rejecting argument that disallowance should be overturned based on grantee's contention that it was "unduly harsh" and "patently unfair").  When, as here, "a disallowance is authorized by law and the grantee has not disproved its factual basis, the Board must affirm the disallowance."  Cent. Ala. at 3 (citation omitted).

Conclusion

For the foregoing reasons, we sustain ACF's disallowance of $195,763.

• 1. We cite to the HHS regulations at 45 C.F.R. Part 75 in effect at the time of the award at issue.  The Part 75 regulations implement the language in 2 C.F.R. Part 200 (Uniform Administrative Requirements, Cost Principles and Audit Requirements for Federal Awards) and supersede OMB circulars and earlier regulations in Title 2 of the Code of Federal Regulations and HHS regulations at 45 C.F.R. Parts 74 and 92.  See 45 C.F.R. §§ 75.104, 75.106.
• 2. The factual contentions in KISRA's brief are verified by its current CEO, Reginald Jones, who executed a sworn written statement that the facts described in the brief "are true" or "believed to be true."  App. Br. at 6.  ACF does not dispute KISRA's "recounting of the facts" as set forth in KISRA's brief.  ACF Br. at 3.
• 3. In January 2019, KISRA obtained a judgment against the vendor for breach of contract.  App. Br. at 4 (¶ 8); KISRA Ex. 3, Memorandum Opinion and Order.  KISRA states that it has retained Michigan counsel to collect the judgment.  App. Br. at 4 (¶ 9).  KISRA, however, presented no evidence that it collected any part of the judgment or returned any funds to ACF.
• 4. ACF filed the Audit Report and Corrective Action Plan as a single exhibit, in PDF format, with its response brief.  We cite the page numbers of the PDF because not all the page numbers of the exhibit are numbered.
• 5. There is an apparent discrepancy between the total amount KISRA contends it paid the vendor ($222,830) and the "net amount" paid for the lights ($195,763) as determined by the auditor.  We found no explanation for this discrepancy in the record.  In any event, the differing amounts do not affect our decision because neither party disputes the amount of the questioned costs ($195,763) as determined by the auditor.
• 6. A copy of the determination letter was filed with KISRA's notice of appeal as attachment 1a.  The determination letter replaced an earlier September 24, 2018 letter, which had incorrectly identified the program and grant number.  Determination Letter at 1.
• 7. The Unsigned Declaration of Carl Chadband (KISRA Ex. 2) describes KISRA's efforts to recoup the payments made to the vendor prior to filing suit.  Although we give the unsigned declaration no weight, we accept the representations in KISRA's verified brief that, prior to filing suit, KISRA attempted to obtain a refund of all payments made to the vendor for the lighting.  App. Br. at 3-4 (¶¶ 6-7).
• 8. ACF's reliance on 45 C.F.R. § 75.303(a) and § 75.327(b) is an additional basis for the disallowance not referenced in the determination letter.  The Board has consistently held that a federal agency may raise new grounds for a disallowance during the appeal process provided the appellant has an opportunity to respond.  See W. Va. Dep't of Health & Hum. Res., DAB No. 2017, at 2 n.1 (2006); see also Philadelphia Parent Child Ctr. Inc., DAB No. 2356, at 4 (2010) (citing Recovery Res. Ctr., DAB No. 2063, at 7-8 (2007)).  KISRA had an opportunity to respond by filing a reply, but it did not do so.
• 9. As further explained below, KISRA challenges the disallowance based on "mitigating circumstances" and other equitable arguments.  See infra at 8-10.  KISRA does not argue that the questioned costs are allowable.
• 10. The judgment entered against the vendor in KISRA's civil action was for breach of contract only.  KISRA Ex. 3, at 2, 4.