Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: Salt Lake Community Action Program
DATE: June 26, 1991
Docket No. 91-16
Decision No. 1261
DECISION
Salt Lake Community Action Program (SLCAP) appealed a determination by
the
Office of Human Development Services (OHDS) disallowing $40,323
charged to
the Head Start program for rental payments made for two
buildings. OHDS
found that the lease agreements for the buildings were
less-than-arms-length
transactions, and that the applicable cost
principles allowed only
depreciation expenses and operating expenses
under such circumstances.
1/ For the reasons discussed below, we find
that SLCAP
substantially controlled or influenced the actions of the
lessor
organization, Captive, Inc. (Captive), making the lease
agreements
less-than-arms-length transactions. Accordingly, we uphold
the
disallowance. However, as discussed later, OHDS may consider
whether a
deviation from the applicable cost principles is appropriate
here in light of
SLCAP's allegation that such a deviation was granted in
the case of another
grantee.
Applicable Law
The cost principles for nonprofit organizations are contained in Office
of
Management and Budget (OMB) Circular A-122, which is made applicable
to SLCAP
by 45 C.F.R. 74.174. Attachment B, para. 42 of the Circular
provides
that rental costs are generally allowable if reasonable in
light of market
rates and conditions, as well as alternatives available
and the nature of the
property leased. If, however, the lease agreement
is entered into
between parties when "one party to the lease agreement
is able to control or
substantially influence the actions of the other,"
then the rental costs are
treated under a special rule for
"less-than-arms-length leases".
Allowable rental costs for a
less-than-arms-length lease are limited to the
amount which would be
allowable if the grantee held title to the property,
under a
depreciation or use allowance method of calculation. Attachment
B,
para. 9. The Circular gives as examples of less-than-arms-length
leases
--
those between (i) divisions of an organization;
(ii)
organizations under common control through common
officers,
directors, or members; and (iii) an organization and a
director,
trustee, officer, or key employee of the organization or
his
immediate family either directly or through
corporations,
trusts, or similar arrangements in which they hold a
controlling
interest.
Case Background
SLCAP was incorporated in 1965 as a community action agency, and
operated
a number of programs, including a Head Start program. On
9/22/80, SLCAP
purchased Building #1, which it used as its main office.
On 10/31/88, SLCAP
purchased Building #2, which it used as a Head Start
center. SLCAP
assigned the contracts for these buildings to Captive on
6/26/89 (Building
#1) and on 11/16/88 (Building #2) for consideration of
$10 each.
Captive in turn entered into lease agreements with SLCAP for
each of these
buildings on 12/27/89. The lease agreement for Building
#2 provided
that it was effective 11/15/88 (the day before the
assignment of the building
to Captive). SLCAP made rental payments to
Captive for the period
beginning 12/15/89 for Building #1 and for the
period beginning 7/1/89 for
Building #2 (in both cases before the leases
were executed). 2/ The
lease agreements provided that taxes, utilities
and maintenance costs were
the responsibility of the lessee, and
payments for these costs were made
separately from the rental payments
disallowed here.
Captive was incorporated on October 28, 1988, as a
non-profit
corporation. Its articles of incorporation listed a number
of
objectives, including "to acquire and maintain, building and
property
for community centers. . . ." OHDS Ex. 2, p. 2. The
three
incorporators named in Captive's articles of incorporation were all
on
SLCAP's board of trustees. Two of Captive's five trustees --
including
its president, who executed the leases for the buildings in
question --
were also members of SLCAP's board of trustees. Captive's
only assets
were the assignments and lease agreements it entered into with
SLCAP.
Discussion
SLCAP admitted that the facts showed that SLCAP and Captive were
"two
organizations working closely together" and that there was
"some
indication of 'coordination of activities' to affect the
purchase/lease
transaction. . . ." SLCAP brief dated 4/5/91, pp. 5,
9. However, SLCAP
denied that Captive was under the control of or
substantially influenced
by SLCAP. SLCAP argued that there was no
"common control" within the
meaning of OMB Circular A-122 since less than 50%
of the members of the
board of Captive were also on SLCAP's board.
SLCAP also argued that the
disallowance should be waived because the amount
charged to the Head
Start grant for rental of the buildings was not only
reasonable, but was
in fact a very favorable rate.
We find that SLCAP's position has no merit. Looking at the record as
a
whole, it is clear that SLCAP and Captive were never
distinct
organizations with truly independent identities and that they
had
substantial influence over each other.
In a prior decision raising the issue whether a lease agreement was
a
less-than-arms-length transaction, the Board found as one
factor
indicating substantial influence the fact that three of seven
directors
of one organization were also directors of the other
organization,
specifically stating, "[i]t is not necessary for MFHS to
control an
absolute majority, however, for MFHS to exercise 'substantial
influence'
over HMA." Maternal and Family Health Services, Inc.,
DAB No. 839
(1987), p. 3. We reaffirm this view, and reject SLCAP's
contention that
OMB Circular A-122 is ambiguous and that we should therefore
find that
"common control" did not exist where only two of Captive's five
board
members were on the board of SLCAP. Surely in this situation the
two
common members were in a position to exert "substantial influence"
on
the remaining Captive board members, even if they did not control
a
majority of the votes.
As in DAB No. 839, supra, however, we do not rely solely on the
existence
of "common control" for our conclusion that the leases in
question here
constituted less-than-arms-length transactions. Other
factors which
support this conclusion include the following:
o Lack of independent organizational purpose: The
record
contains no evidence that Captive had any purposes or
interests
independent of SLCAP. Despite the fact that Captive's
articles
of incorporation state other purposes in addition to
the
acquisition of property for community centers, SLCAP did
not
dispute that Captive's only assets were the buildings which
were
assigned to it by SLCAP and that the leases for these
properties
were its only source of income.
o Less than adequate consideration: SLCAP assigned Building
#1
to Captive more than eight years after it purchased
the
property. During that time, SLCAP must have accumulated
equity
in the building which far exceeded the $10 of
consideration
which Captive paid for the assignment.
o Coordination of activities: Captive was incorporated
three
days before the purchase of Building #2. SLCAP
assigned
Building #2 to Captive less than a month after it purchased
the
property, and entered into the lease agreement less than
two
months after the assignment. These activities were unlikely
to
have been so closely timed unless they were part of
a
coordinated plan by organizations which exerted
substantial
influence over each other.
o Unusual business practices: Although SLCAP entered
into
lease agreements for both buildings on 12/27/89, it
claimed
rental costs for a period beginning prior to that date.
This
indicates that Captive permitted SLCAP to occupy the
buildings
without lease agreements, an unusual business practice which
is
indicative of the substantial influence that SLCAP
exercised
over Captive. In addition, the lease agreement for
Building #2
was entered into one day before SLCAP assigned that
property to
Captive, also an unusual business practice.
Accordingly, we conclude that the lease agreements
were
less-than-arms-length transactions. As noted previously, however,
SLCAP
argued that even if the transactions had this nature, the
disallowance
should be reversed because the rental costs were
reasonable. SLCAP
requested a hearing if OHDS disputed its assertion of
reasonableness.
In response, OHDS noted that the Board held in DAB No. 839,
supra, that
the reasonableness of the rental costs was not adequate
justification
for disregarding regulatory requirements. OHDS also
appeared to dispute
SLCAP's position that the rental costs were
reasonable. See OHDS brief,
p. 9.
We conclude that no purpose would be served by a hearing on
the
reasonableness of the rental costs. The Board is bound by
all
applicable regulations. 45 C.F.R. 16.14. Since we find that
the lease
agreements at issue here constituted less-than-arms-length
transactions
within the meaning of OMB Circular A-122, we must uphold
the
disallowance regardless of whether the rental costs were
reasonable.
See DAB No. 839, supra, p. 6.
SLCAP argued, however, that OHDS had discretion to grant a deviation
from
the limitation on rental costs in OMB Circular A-122. It alleged
that
OHDS had in fact granted a deviation for another grantee under
similar
circumstances while refusing to consider a request for a
deviation (or
waiver) from SLCAP which pointed this out. (OHDS
responded to an
earlier request by SLCAP for a waiver by stating that
all non-profit grantees
were bound by the requirements of OMB Circular
A-122, Attachment B, para.
42. SLCAP brief dated 5/31/91, Ex. 3.)
It is arguable that OHDS has discretion under 45 C.F.R. 74.6 to grant
a
deviation from the applicable cost principles. 3/ However, it is
the
function of the Board to decide disputes. That function ends here
with
the determination that the lease agreements were
less-than-arms-length
transactions within the meaning of OMB Circular A-122,
Attachment B,
para. 42. The Board has no power to direct OHDS to waive
a disallowance
which is clearly authorized by these cost principles or even
to consider
a request for such a waiver. The whole purpose of the
waiver authority
conferred by 45 C.F.R. 74.6 is to allow the agency to
exercise its
discretion, taking into consideration all the facts and
circumstances of
each case. Thus, we are limited here to stating our
opinion that, as a
matter of sound administrative practice, it may be
advisable for OHDS to
at least respond to SLCAP's second waiver request.
4/
Conclusion
For the reasons described above, we uphold the $40,323 disallowance
in
full.
____________________________ Donald F. Garrett
_____________________________ Norval D. (John) Settle
_____________________________ Alexander G. Teitz Presiding
Board
Member
1. The disallowance represents the difference between the
rental
payments and allowable depreciation plus operating expenses for each
of
the two buildings. SLCAP did not argue that the disallowance
was
improperly calculated.
2. Payments made through 4/30/90 were disallowed in the case of
each
building. It appears that rental payments were also made for
Building
#2 for the period 6/26/91 - 7/1/91 but were not included in
the
disallowance. See disallowance letter dated 1/9/91, p. 3; OHDS
brief
dated 5/13/91, p. 4.
3. SLCAP also cited 45 C.F.R. Part 30, Subpart C, as giving
HHS
authority to waive the disallowance. However, this subpart allows
the
compromise of claims where the Department's ability to collect the
full
amount is uncertain, and is not applicable here where SLCAP contends
a
waiver is warranted on the merits of its case.
4. SLCAP cited Action, Inc. v. Donovan, 789 F.2d 1453 (10th Cir.
1986),
as authority for the proposition that an agency is required to
respond
to a request to exercise discretion whether or not to recoup
a
disallowance. However, the program involved in that case was
authorized
by the Comprehensive Employment and Training Act and administered
by the
Department of Labor, and thus entirely different from the program
in
question