GAB Decision 714
December 27, 1985
Economic Opportunity Council of Suffolk, Inc.;
Ford, Cecilia Sparks; Teitz, Alexander G. Ballard, Judith A.
Docket No. 85-68; ACN 02-55007
The Economic Opportunity Council of Suffolk, Inc. (EOCS, Grantee)
appealed a decision by the Office of Human Development Services (OHDS,
Agency) disallowing $21,929 in expenditures charged to Grantee's Head
Start grant for the period February 1, 1983 through November 30, 1983.
Grantee conceded $4,120 of the disallowed costs and OHDS reduced its
disallowance by $5,532 as a result of information contained in Grantee's
briefing. The amount remaining in dispute is $12,277. This amount
was
disallowed because the items were either (1) purchased without Grantee's
obtaining the required prior approval from OHDS ($12,158), or (2) an
unallowable late payment penalty ($119).
For the reasons discussed below, we uphold the disallowance in the
reduced
amount.
Items purchased without approval $12,158)
Grantee purchased equipment and paid for renovations of its building
with
Head Start grant funds. These items were not included in the
approved
budget. Grantee admitted that Agency prior approval for
such
expenditures was required but not sought or obtained. Grantee
(1)
asserted that the Agency is permitted to waive the prior
approval
requirement, and (2) argued that the Agency should have
granted
retroactive approval here because the Agency had approved
the
expenditure of grant funds for similar items in the past.
Grantee also argued that it would be unreasonable for the Agency to
refuse
the waiver in light of an agreement negotiated between the
parties.
Grantee stated that the agreement would terminate Grantee's
operation and
form a new grantee that would "inherit" all the property
of Grantee's Head
Start program including the equipment and renovated
building subject to this
appeal. Grantee's reasoning was that it would
be an(2) abuse of
discretion by the Agency to require Grantee to repay
the money for these
items and then take the items from Grantee without
cost to the Agency.
OMB Circular A-122, Attachment B, sections 13a, b, and d provide that
the
purchase of general purpose equipment with a cost of more than $500
and
capital expenditures for building improvements are allowable only
with the
prior approval of the awarding agency. /1/ Section 74.177(c) of
45 CFR
provides that the Agency may waive or conditionally waive the
requirement for
its approval of costs. The preambles to the proposed
and final versions
of the waiver provision indicate that the purpose of
this provision is to
enable an awarding agency to waive in advance for a
particular grantee the
general requirement to obtain prior approval
whenever incurring a cost in a
category for which such approval is
specified. See 42 Fed. Reg. 4157
(January 24, 1977); 43 Fed. Reg.
34080 (August 2, 1978). Such a
waiver is normally granted only to
grantees which have established their own
internal procedures which
obviate the need for close oversight by the
awarding agency. Here,
Grantee did not receive such a waiver and was
subject to the requirement
at the time the costs were incurred, so the real
issue is whether
approval should have been given retroactively for a specific
cost item.
Chapter 1-105-60 B.1 of the Department of Health and Human
Services
Grants Administration Manual (HHS GAM) covers retroactive approval
by
the Agency. /2/ The HHS GAM provides that the "transaction may
be
approved retroactively" if "the transaction would have been approved
had
the organization requested approval in advance." In applying this
HHS(3)
GAM provision in a previous decision, Economic Opportunity
Atlanta,
Inc., Decision No. 313, June 24, 1982, the Board interpreted it
as
follows:
Since the language of this provision is permissive, i.e., may,
it
does not preclude the Agency's consideration of all other
relevant
factors, such as a grantee's fiscal management history, in
deciding
whether or not to ultimately grant retroactive approval where
prior
approval was required but not obtained. In making its
determination on
a request for retroactive approval, the Agency has
considerable, but not
completely unbounded, discretion. Although the
Board will not interfere
when the Agency appropriately exercises its
discretion, the Agency must
state the basis for its decision and may not deny
retroactive approval
based on unsubstantiated conclusions or on bases so
insubstantial that
the decision fairly can be described as capricious.
(p. 3)
In Economic Opportunity Atlanta, Inc., the Board reversed
the
disallowance, rejecting the Agency's unsupported argument that
the
Grantee's continual fiscal management problems justified the
Agency's
denial of retroactive approval.
In this appeal, however, the Agency has supported its denial
of
retroactive approval. The Agency based its denial on
Grantee's
insolvent financial condition, history of poor fiscal management,
and
uncertain viability both as an entity and as a Head Start
grantee.
(Agency's brief, p. 7) The Agency pointed out (1) that Grantee had
been
funded as a high-risk grantee since December 1, 1983, and (2) that
the
bases for this status included Grantee's:
* Failure to repay $659,593 owed to the Office of Community Services
and
$38,842 in Head Start disallowances.
* Faulty management practices of:
(a) persistent lending of Head Start funds to other grant programs;
(b) failing to liquidate long outstanding receivables; and
(c) failing to establish adequate fiscal controls and
property
management system.
* Uncertain viability as a result of the above described faults.(4)
The Agency pointed out that Grantee's management had been so deficient
as
to cause the Agency to take actions to terminate Grantee's Head
Start
grant.
Grantee disputed generally the Agency's statement that Grantee
was
"unworthy" of being granted retroactive approval. Grantee also
pointed
out that it was disputing some of the specific findings of the
Agency.
We conclude, however, that enough of the Agency's findings
are
undisputed, or have been established previously before this Board,
to
provide a reasonable basis for the Agency's denial of
retroactive
approval. (For a discussion of Grantee's practice of
lending Head Start
funds to other programs and failing to timely liquidate
the resulting
accounts receivable, see Economic Opportunity Council of
Suffolk, Inc.,
Decision No. 679, August 12, 1985.)
We are not persuaded by Grantee's argument that retroactive
approval
should be given because these costs have been regularly approved
when
timely application for approval has been sought. That similar
costs
have been approved in the past does not compel the Agency to
approve
retroactively the costs involved in this appeal when, considering
the
particular circumstances, the Agency decides that these costs should
not
be approved. One reason why prior approval by the Agency is
required is
so the Agency can use its judgment with regard to certain types
of
expenditures before deciding whether the expenditures are
justified
under the particular circumstances of a grantee at the time.
If
approval were automatic, there would be no need for requiring
Agency
review of the costs.
Grantee submitted a copy of its agreement to transfer all of
Grantee's
property to the Office of Human Development Services (OHDS) and
the
Office of Community Services (OCS) of the Department of Health and
Human
Services. We do not think, however, that this agreement renders
the
Agency's denial of retroactive approval unreasonable, as Grantee
argued.
Paragraphs 4 and 6 of the agreement between Grantee and the Agency
state
that Grantee agrees to transfer all its property to OHDS and
OCS.
However, paragraph 6 states that the property shall be transferred
"as
satisfaction of EOCS's debt due to the degree EOCS is able to
satisfy
these debts out of presently available assets." Therefore, the
equipment
and renovations subject to this appeal were to be used to satisfy
all
debts of Grantee owed to the Agency, not specifically to reimburse
OHDS
for the funds used to purchase the equipment and renovations. If
the
equipment and renovations were being transferred for the
specific
purpose of (5) satisfying the disallowance involved here,
perhaps
Grantee would be entitled to a partial credit for the reasonable
value
of the equipment and renovations. However, here the property is
being
transferred as a result of negotiations arising from a
proposed
termination action, which is separate from the action here.
Moreover,
the agreement does not clearly encompass the amount disallowed
here.
Grantee must account for the federal funds entrusted to it and
the
Agency demonstrated that its decision to deny retroactive approval
was
reasonable and conscientious grants administration.
Accordingly, we uphold the Agency's disallowance of $12,158
in
expenditures for equipment and renovations made without the
required
Agency approval.
Late Mortgage Payment Penalty ($119)
The disallowance letter indicated that Grantee's auditor described
this
cost as "rent payment-late charges." During the telephone
conference
conducted in this appeal, Grantee indicated that the $119 was
a
percentage allocation, to the grant, of a late mortgage payment
penalty
on the building rented by Grantee to its Head Start program.
The Agency disallowed the cost because it found that the payment of
this
cost was an unreasonable charge to the grant. The Agency's
position was
that penalty charges for late payments are not the kind of
expenses
incurred by a prudent person nor the kind generally recognized
as
ordinary and necessary for the performance of a Head Start grant and
are
therefore unreasonable charges. Unreasonable charges, argued
the
Agency, are unallowable. The Agency also based its position on
the
premise that late payment penalties are unallowable as interest.
Grantee argued that the late fee should be considered a reasonable
and
allowable charge to the grant, stating that the $119
represented
additional rent charged to the Head Start grant pursuant to the
lease.
(Grantee's brief, p. 2) Grantee stated that it had
financial
difficulties related to its high-risk status and since Grantee paid
its
payroll first, sometimes late mortgage payment penalties had to be
paid,
and when incurred, payment of the late payment penalties was prudent
to
avoid eviction. Grantee said the late penalties were allocated to
the
grant at the same rate (27%) as other costs of maintaining the
building
as provided in a written memorandum. Grantee asserted that the
27% was
a bargain because Head Start occupied 80% of the building.
(Telephone
conference, August 22, 1985) Grantee argued that the late
payment
penalty was not interest but an ordinary cost of doing business
that
inevitably occurs in the course of even a well managed business.
Below we will discuss the bases for upholding the disallowance of the
$119
late payment charge:
* The late payment charge was unallowable as interest;
* The late payment charge was unallowable because it was
an
unreasonable cost.
Late Payment Charge as Interest
OMB Circular A-122, Attachment B, Section 19.a states that costs
incurred
for interest on borrowed capital, however represented, are
unallowable.
The Board has found that a late payment charge constituted an
unallowable
interest charge. In Marshalls Community Action Agency,
Decision No.
328, June 30, 1982, the Board held that the Agency's
argument that the
payment of a late charge "constituted a constructive
borrowing" was a
"reasonable construction of the term 'interest on
borrowed capital . . .
however represented'". (p. 3) The Board concluded
"that the late payment
charge . . . was interest on borrowed capital, an
unallowable cost." (p. 3)
We find no reason to treat the late payment
penalty in this appeal
differently.
Grantee's argument that this late payment charge was not interest
but
simply a cost of doing business is not persuasive. The reason the
cost
is assessed is in substance to compensate the mortgagor for loss of
the
use of funds; in other words, the charge constitutes
interest.
Furthermore, while the sustaining of interest charges may well be a
cost
of doing business, such charges are specifically unallowable under
the
Head Start grant.
Late Payment Charge as Unreasonable
OMB Circular A-122, Attachment A, Paragraph A.2.a. provides that, for
a
cost to be allowable, it must be reasonable for the performance of
the
grant. Reasonable costs are defined in Paragraph A.3 which
provides:
Reasonable Costs. A cost is reasonable if, in its nature
or amount,
it does not exceed that which would be incurred by a prudent
person
under the circumstances prevailing at the time the decision was made
to
incur the cost.(7)
Paragraph A.3.a. provides that in determining the reasonableness of
a
given cost, consideration shall be given to:
Whether the cost is of a type generally recognized as ordinary
and
necessary for the operation of the organization or the performance
of
the award.
Although Grantee argued that the payment of a share of the late
payment
charge by the Head Start program should be considered a reasonable
cost
as part of the rent, Grantee has not provided the Board with any
written
document that demonstrates that, as a part of its rent payment, the
Head
Start program was required to pay part of any late mortgage
payment
charge. Therefore, we find that a prudent person would not
have
incurred this cost under the circumstances prevailing at the time.
Even
if Grantee had been able to produce a lease with such language, it
is
not clear that the Board would find that a prudent person would
have
agreed to the inclusion of such a late payment penalty in its
rental
payments. Typically, rent is paid at a fixed rate each month or
year
and does not provide for additional payments for late mortgage
payment
penalties which are beyond the control of the lessee.
Grantee has an obligation to document the allowability of its
costs.
(Neighborhood Services Department, Decision No. 110, July 15, 1980;
New
York State Department of Social Services, Decision No. 204, August
7,
1981) We find that Grantee has not documented the reasonableness of
the
late mortgage payment penalty.
That the rent charged the Head Start program may have been a bargain
(27%
of the cost for 80% of the space) does not make the payment of a
late
mortgage payment charge reasonable. In Marshalls Community
Action
Agency the Board upheld the Agency determination that any late
payment
charge arising from the failure to pay a bill on time was not a
cost
that would be incurred by a prudent person or considered to be
"ordinary
and necessary" for the performance of a grant. (p. 4)
High risk status may have caused Grantee to sustain late
payment
penalties, as the Grantee argued. However, while it may have
been
"prudent" in one sense to pay the penalty to avoid eviction, this
does
not render the cost one that a prudent business person would
have
incurred; if Grantee had avoided high risk status to begin with,
it
could have avoided the charge.
For these reasons, we find that the late payment charge was
an
unreasonable cost and the Agency correctly disallowed the cost.(8)
Conclusion
For the reasons discussed above, we uphold the disallowance in the
amount
of $12,277. /1/ Section 74.174 of 45 CFR Part 74 makes
OMB
Circular A-122 applicable to
nonprofit grantees such as Economic
Opportunity Council of
Suffolk. /2/ One requirement
that must be
met for retroactive approval under HHS GAM 1-105-60B.1 is that
the
grantee agrees to institute controls to ensure that prior
approval
requirements are met in the future. Grantee argued that
retroactive
approval should be granted because of assurances that it will not
be
requested again by Grantee. The Agency said that Grantee's
assurances
are disingenuous because Grantee's operation is being
terminated. We do
not necessarily agree with this
characterization. However, because such
assurances have been made does
not compel the granting of retroactive
approval where the Agency properly
finds that other circumstances
warrant denial of retroactive approval.
MARCH 28, 1987