DEPARTMENTAL GRANT APPEALS BOARD
Department of Health and Human Services
SUBJECT: Los Angeles County Office of Education
Docket No. 87-3
Decision No. 901
DATE: September 29, 1987
DECISION
The Los Angeles County Office of Education appealed a determination by the Office of Human Development Services (Respondent) disallowing all budgeted rental costs for lease agreements at the Frederick Douglass Child Development Center (Frederick Douglass, Grantee) for the period July 1, 1985 through September 30, 1986. 1/ The Respondent found that the lease agreements at issue were less-than-arms-length, and that the Grantee should therefore be allowed rental costs only up to the amounts that would be allowed if the organization owned the property. In situations of this kind, rental costs are ordinarily limited to depreciation costs or a use allowance. The Respondent disallowed all budgeted rental costs because the Grantee did not submit a depreciation or use allowance schedule for the properties at issue. However, the Respondent stated it was still willing to revise the disallowance on the basis of data submitted showing the amount of these items.
As discussed below, we uphold the disallowance subject to an opportunity for the Grantee to provide documentation of depreciation or use allowance schedules.
Background
The facts in this case are uncontested. In March and April 1983, Frederick Douglass entered into two 5-year leases with unrelated parties for two parcels of property, which encompassed the period at issue, July 1, 1985 through September 30, 1986. In April 1985, the Frederick Douglass Child Development Center Pension Trust (Center Trust) loaned $320,000 to SMD Properties, Inc. (SMD), a corporation unrelated to Frederick Douglass or the Center Trust. However, in July 1985, a deed of trust on the properties was executed by SMD in favor of the Center Trust to secure the earlier loan and, in August 1985, the Center Trust agreed to accept deeds to the properties, in lieu of foreclosure, after SMD defaulted on the loans. This left the Center Trust as the owner of the property leased by Frederick Douglass.
Discussion
The issue to be determined by the Board is whether the leases in question became less-than-arms-length agreements in August 1985 when the Center Trust accepted deeds to the properties in lieu of foreclosure. As discussed below, we find that the lease agreements, by virtue of the parties' ability to terminate the leases, became less-than-arms-length.
We find that the lease agreements were governed by Office of Management and Budget (OMB) Circular A-122, Costs Principles for Nonprofit Organizations, Attachment B, section 42(c) and, indeed, both parties based their arguments on that basis. The relevant portion of section 42(c) states, in part:
Rental costs under less-than-arms-length leases are allowable only up to the amount that would be allowed had title to the property vested in the organization. For this purpose, a less-than-arms-length lease is one under which one party to the lease agreement is able to control or substantially influence the actions of the other. Such leases include, but are not limited to those between . . . organizations under common control through common officers, directors, or members. . . .
In Bullock County Health Services, Inc., Decision No. 360, November 30, 1982, at p. 3, the Board found that "underlying the limitations [in the federal requirement limiting rental costs] is the idea that there should be no possibility that decisions made in management of a grant-supported project could be influenced by conflicts of interest and concerns not related to the best interests of that project."
The Respondent's position, in the disallowance letter, was that the lease agreements in question were less-than-arms-length because the Executive Director of Frederick Douglass (the lessee to the agreements) was also one of two trustees for the Center Trust (the lessor to the agreements), in violation of OMB Circular A-122, Attachment B, section 42(c), noted above. The Respondent concluded that after the Center Trust's acquisition of the properties in question (as authorized by the Frederick Douglass Board of Directors), the Grantee was in effect leasing from itself, i.e., even a minimum amount of separation was not present. Moreover, the Respondent submitted that while ownership of the properties was technically vested in the Center Trust, the ownership should be attributed for all intents and purposes, to the Frederick Douglass Board of Directors, which controls and administers the Trust.
The Grantee argued that the applicable cost principles require more than the mere appearance or possible existence of a less- than-arms-length relationship. The Grantee argued that, as embodied in the provision, the concept of the "ability to control or substantially influence the actions of the other" is not to be mechanical. While the Grantee conceded that the concurrent responsibilities of the Center Trust's trustee and the Frederick Douglass Executive Director created the appearance of the ability to control, the Grantee submitted that from the facts and circumstances of this case it was clear that the leasing arrangement was not in conflict with the applicable cost principles. The Grantee argued that how the properties were acquired is irrelevant. Even if the properties had been purchased directly, instead of through foreclosure, the properties would still be subject to, and burdened by, the pre- existing leases, which had been entered into with an unrelated lessor. The Grantee maintained that the leases cannot be changed or their rent adjusted except in accordance with the lease terms. Thus, the Grantee maintained that the only time the Executive Director as trustee would be in a position to "control or substantially influence" rental costs or other leasehold terms would be when the leases expired in 1988. Alternatively, the Grantee submitted that, if the Board determines that the lease agreements were less-than-arms-length, the Grantee is entitled to rental costs based upon depreciation or use allowance in accordance with OMB Circular A-122, Attachment B, section 42(c) and subsection 9, sections a-g.
The pertinent facts surrounding the lease agreements and acquisition of the properties in this case are not at issue. The uncontested facts require the Board to determine what effect, if any, the August 1, 1985 Center Trust's acquisition of the properties had on the two 5-year leases entered into in March and April 1983. While we agree with the Grantee's position that the applicable authority envisions more than an appearance of control, we find that much more than an "appearance" is present in this case. We do not accept the argument that the parties involved could not change or adjust the lease agreements until their natural expiration in 1988.
The Grantee's main focus in its argument was that the leases in question had to remain intact until their expiration in 1988. Therefore, according to the Grantee, even though the Executive Director of Frederick Douglass was also one of the two Center Trust's trustees, he had no opportunity to "control or substantially influence" rental costs or other leasehold terms.
We agree with the Grantee that the relevant question in this case is when a lease may be terminated and under what circumstances. However, it is clear that ample precedent exists for the conclusion that a written lease may be terminated by mutual agreement, and as between the parties, it is not necessary that such agreement to cancel be evidenced by a writing signed by the parties. 49 Am. Jur. 2d, Landlord & Tenant, section 991. For example, in Geortz v. Wodzisz, 70 N.E. 2d 776 (Ohio Ct. App. 1946), at p. 777, the court said:
There are many ways in which a lease for years may be terminated. A written lease may be terminated by mutual agreement and as between the parties it is not necessary that such agreement to cancel be evidenced by a writing signed by the parties. The courts have uniformly held this view. (emphasis added)
Therefore, the Grantee's entire argument is based on a faulty foundation. Once the Center Trust accepted the deeds from SMD, the Executive Director of Frederick Douglass, who was also one of the two Center Trust's trustees, could have controlled or substantially influenced the lease agreements from that time on, including agreeing to terminate the leases entirely, let alone modifying their terms. We believe that the Executive Director/trustee relationship is enough in and of itself to find that the lessee could have controlled the leases, and that the lessor could have substantially influenced the lease agreements. Even if it were not, the lessee has the power to remove the trustees and appoint successors, so that the lessee can completely control the lessor. See Respondent's Ex. A, Articles 1.12 and 2.3 (a); Grantee's Ex. 13, sections 7.9 (b) and (c). In fact, minutes of a meeting of the Frederick Douglass Board of Directors (lessee) show that it voted to authorize the Center Trust to purchase the building and thereby became the lessor. See Respondent's Ex. F. 2/
Both parties agree that in less-than-arms-length transactions applicable authority allows for rental costs up to the amount that would be allowed had legal title to the property been vested in the lessee. The Grantee has requested an opportunity to present such documentation. In the disallowance letter, the Respondent indicated a willingness to allow such a presentation. Therefore, within 30 days (or such other time as permitted by the Respondent) the Grantee should provide such information to the Respondent.
Conclusion
Based on the foregoing reasons, we uphold the Respondent's disallowance subject to reduction as indicated above.
________________________________ Donald F.
Garrett
________________________________ Norval D.
(John) Settle
________________________________ Alexander G.
Teitz Presiding Board Member
1. Initially, the Respondent disallowed a total amount of $51,971 for two centers, the Frederick Douglass Child Development Center and the ABC Child Development Center, on the same basis. However, after settlement negotiations, Los Angeles County Office of Education, as the grant recipient, decided not to appeal the portion of the disallowance for the ABC Child Development Center. The parties have not yet determined what portion of the disallowance amount should be allocated to each center. Frederick Douglass, as the real party in interest, engaged an attorney to present the case before the Board; both parties agreed to this procedure. Therefore, throughout this decision we refer to Frederick Douglass as the Grantee.
2. We do not believe it necessary for our decision to consider the extensive documents submitted by the Respondent pertaining to a pending civil action brought by the Department of Labor against Frederick Douglass for alleged improprieties dealing with the Center Trust pension