DATE: May 4, 1998
SUBJECT: East Missouri Action Agency, Inc.
Docket No. A-97-140
Decision No. 1656
DECISION
The East Missouri Action Agency, Inc. (EMAA) appealed a final decision by the Administration for Children and Families (ACF) disallowing rental costs charged to EMAA's Head Start grant. ACF had included the following special condition in the Head Start Financial Assistance Award granted to EMAA on December 27, 1996:
[S]ubmit a revised budget that reflects: a) Adjusted charges for rental expenses on facilities (owned by the Corporation's Facilities Board) used by Head Start using depreciation or use allowance computations only. See OMB Circular A-122, Section 42(c).
ACF further informed EMAA that its decision to impose this special condition could be appealed to this Board pursuant to 45 C.F.R. . 74.90. The effect of this special condition was to preclude EMAA from charging to the Head Start program all the rental costs it paid to lease buildings owned by East Missouri Action Agency Facilities, Inc. (Facilities). Instead, EMAA was required to charge to the Head Start grant only an amount equal to what EMAA would have been allowed to depreciate if it had owned the buildings. Both parties agreed that the amount in dispute here is $42,694 for EMAA's 1997 fiscal year.
The basis for the imposition of the special condition was ACF's finding that the rental payments violated cost principles set forth in Office of Management and Budget (OMB) Circular A-122, in that the rental agreements between EMAA and Facilities were determined by ACF to be less-than-arms-length transactions.
For the reasons discussed below, we find that the rental agreements between EMAA and Facilities are not less-than-arms-length transactions as set forth in OMB Circular A-122. While it is evident that at one time EMAA effectively controlled the operations of Facilities, EMAA and Facilities have taken steps over the recent years to separate their identities so that they now have an arms-length relationship. Based on the totality of circumstances presented in this case, we conclude that the criterion for a less-than-arms-length relationship proscribed in OMB Circular A-122, the ability to control or substantially influence another party, is no longer present in EMAA's relationship with Facilities. Accordingly, we conclude that the imposition of the special condition in the Financial Assistance Award was not justified, and therefore reverse the disallowance of $42,694.
Background
EMAA was incorporated in 1968 as a not-for-profit community action agency under Missouri law. It serves the residents of eight counties, offering various services to low-income families, including the administration of a Head Start program. Facilities was incorporated in 1977, formed "for the specific purpose of obtaining, holding and managing real property related to the functions of the East Missouri Action Agency, Inc." EMAA Ex. 3, at 1. Under its original bylaws, the Board of Directors of Facilities consisted of three members, the Chairman of the EMAA Board of Directors, a current member of the EMAA Board of Directors, and the EMAA Executive Director. Id. at 2 - 3.
Facilities currently owns four buildings; EMAA is the sole tenant in three of the buildings, and shares the fourth with four other tenants.
Regulations at 45 C.F.R. . 74.27(a) (1996) provide that non-profit organizations such as EMAA that receive Head Start funds are subject to the cost principles set forth in OMB Circular A-122. OMB Circular A-122 provides a uniform set of cost principles for determining costs of grants, contracts, and other agreements and is designed to promote efficiency and understanding between non-profit grantees and the federal government. It provides guidance on allowable direct costs and allocable indirect costs, as well as guidance on specific cost items.
As applicable to the issue in dispute here, OMB Circular A-122 provides that --
[r]ental costs under less-than-arms-length leasesare allowable only up to the amount that would be allowed had the 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 (i) divisions of an organization; (ii) organizations under common control through common officers, directors or members; and (iii) an organization and a director, trustee, or 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. OMB Circular A-122, Attachment B., . 42.c.
Discussion
In ACF's decision imposing the special condition in EMAA's Head Start grant, ACF pointed to the following factors for its conclusion that the rental agreements between EMAA and Facilities were less-than-arms-length transactions as prohibited by paragraph 42.c of OMB Circular A-122:
On appeal, EMAA contended that EMAA and Facilities have a working relationship and engage in business transactions designed to promote each entity's goals, with the relationship taking two forms: 1) EMAA supplies support services to Facilities for a fee; and 2) EMAA leases certain buildings and properties from Facilities for its Head Start program. While admitting that when Facilities was incorporated in 1977 it did not function as an entity separate from EMAA, EMAA argued that in the intervening years, particularly since 1993, Facilities and EMAA have taken steps to develop an arms-length relationship between them.
EMAA stated that in 1993 Facilities amended its bylaws, so that the purpose of Facilities is now stated as:
The corporation is organized and shall be operated exclusively for charitable and educational purposes, and it is formed for the specific purpose of obtaining, holding, managing, and renting real property to East Missouri Action Agency, Inc and/or other nonprofit, civic or charitable organizations, whose functions include assistance to help alleviate the cause of poverty or to better the lives of the disadvantaged in the area.
EMAA Ex. 20, at 1 (emphasis added by EMAA). EMAA further pointed out that the 1993 bylaws revision increased the Facilities Board of Directors to seven members, with six voting members to be drawn from local government or other civic or charitable organizations, with the non-voting member designated as the Chairperson of the EMAA Board of Directors. Id. at 2 - 3. EMAA noted that the revised Facilities bylaws did not provide for an executive director, and removed the EMAA executive director from the Facilities Board.
As further evidence of Facilities' independence from EMAA, EMAA also pointed out that since 1994 EMAA and Facilities have been represented by different counsel.
EMAA further denied that, as stated in ACF's final decision, it and Facilities are under the management of the same executive director, noting that Facilities does not even have an executive director. EMAA stated that since 1993 EMAA staff have provided staff support for Facilities under a consulting agreement entered into between EMAA and Facilities, for which EMAA receives a monthly fee. EMAA Ex. 21. According to EMAA, its executive director only supervises personnel in the performance of the consulting agreement.
EMAA further disputed the assertion in the ACF decision that its Board Chairperson (erroneously called "President" by ACF) exerts "considerable influence over the Facilities Board." EMAA maintained that its Board Chairperson has attended only one Facilities Board meeting, in January 1995, after becoming EMAA Chairperson in October 1994, and questioned how a non-voting member could exert "considerable influence" in meetings he did not attend.
EMAA also pointed to a number of continuing steps (addressing some of the points made in the ACF final decision) taken by EMAA and Facilities since ACF issued its decision to demonstrate the independence between the two organizations:
EMAA sought to distinguish its case from SLCAP, EPIC, and PRIDE, while likening its factual situation to the factual situation in HELP. Upon review of the record, we agree.
ACF correctly pointed out that the finding of a less-than-arms-length relationship does not necessarily depend on any single uncontroverted fact that establishes that one organization has the ability to control or substantially influence another organization, but that a series of events or facts can establish the existence of such a relationship. ACF cited EPIC, in which the Board found that the "totality of the overall relationship" between two organizations supported a finding of substantial influence. EPIC at 7. In EPIC, as is the case here, a Head Start grantee helped in the establishment of another entity, a foundation, which subsequently purchased property and leased the property to the Head Start grantee. In examining the relationship between the Head Start grantee and the foundation, the Board looked at such items as the minutes of the meetings of the foundation's board of directors, the coordination of activities between the organizations, the foundation's sources of income, and the use of the grantee's personnel to perform many of the foundation's functions.
ACF argued that the situation presented here resembled that in EPIC in that the principal purpose of Facilities, despite having four additional tenants in one of its four buildings, is to provide EMAA with rental property, with EMAA being the only one of the tenants having its executive director attend and participate in Facilities Board meetings. Furthermore, according to ACF, the minutes of the meetings of the Facilities Board disclose that EMAA's executive director attended 10 out of 14 Facilities Board meetings from January 31, 1995 through August 28, 1997, with the executive director integrally involved in such matters as the recruitment of new Board members, bids for insurance packages, and refinancing building loans. Although this alleged influence of EMAA's executive director at Facilities Board meetings was not mentioned in the ACF final decision as one of the indications of a less-than-arms-length relationship, ACF nevertheless cited the influence of the EMAA executive director as prime evidence of a less-than-arms-length relationship, quoting from EPIC:
The Minutes, so far as they reflect the routine business activities of the Foundation, support a conclusion that the Executive Director was in a position to, and often times did, exert substantial influence over the Foundation's actions. This factor alone supports a conclusion that the organizations' relationship was less-than-arms-length. EPIC at 7 (emphasis added by ACF).
We find, however, that the factors that were critical to the Board's conclusion that a less-than-arms-length relationship existed in EPIC are either not present here or present in a much lesser degree than was the case in EPIC.
First, a review of the minutes of the meetings of the Facilities Board does not reveal the type of involvement by the Head Start grantee's executive director that was present in EPIC nor support ACF's contention that EMAA's executive director exercised undue influence over the Facilities Board. ACF supplied the minutes of 15 meetings of the Facilities Board during the period January 31, 1995 through August 28, 1997. ACF Ex. 1. While subjects involving EMAA were discussed at each of the meetings, most of the discussion involved Facilities Board members reviewing routine maintenance items at buildings where EMAA was a tenant, with no or minimal input from EMAA's executive director. See, e.g., ACF Ex. 1, at 7 and 13 (roof repairs), 10 (grass mowing), 19 (safety doors), 23 (drain problems), and 34 (parking lots).
EMAA pointed out that its executive director was present at only ten of the Facilities Board meetings, mainly in his capacity as supervisor of contract employees performing services for Facilities. The executive director took part in discussions involving major items such as finding a new location for the EMAA central office and purchasing insurance coverage, but these projects were clearly undertaken by him at the Facilities Board's request. EMAA pointed to two instances where the Facilities Board rejected the executive director's proposals. ACF Ex. 1, at 45 - 46 and 50. In short, the situation here is distinguishable from EPIC; the record there indicated that the grantee's executive director had a preeminent role in running the meetings of the lessor's board.
In addition, unlike EPIC, there is substantial evidence here of independent organizational purposes for EMAA and Facilities. In EPIC, the Board found that the minutes of the foundation's meetings revealed no evidence of any significant business conducted by the foundation other than serving EPIC. Here Facilities Board members also discussed non-EMAA business at their meetings, e.g., renting Facilities buildings to non-EMAA tenants and seeking additional non-EMAA tenants. ACF Ex. 1, at 18, 24, and 32.
This case is also readily distinguishable from PRIDE, where the foundation's Articles of Incorporation expressly bound the foundation in its goals and delivery of services to the Head Start grantee exclusively. PRIDE at 5. Here, while the original bylaws of Facilities adopted a similar exclusive relationship with EMAA, the 1993 revision of the bylaws effectively removed Facilities from a shared identity with EMAA.
In EPIC, the Board found that the activities of EPIC and the foundation were so intertwined, with the foundation following EPIC's lead in the acquisition of property, that an arms-length relationship did not exist. Furthermore, without EPIC, the foundation did not have any independent economic viability. The fact that two organizations engage in business transactions designed to foster the goals of each organization, however, is not conclusive evidence that a less-than-arms-length relationship exists between the organizations. HELP at 9. In HELP, the Board found that a Head Start grantee and a lessor had not engaged in a less-than-arms-length transaction. What distinguished that case from EPIC and SLCAP, where the organizations providing facilities for lease to the Head Start programs had virtually no purpose other than to supply facilities to Head Start, was that the lessor in HELP was an independent organization whose leasing of Head Start facilities was a very minor part of its business, some two percent of its total income. HELP at 9 and 13.
Unlike the situations in EPIC and SLCAP, where the lessors had no tenants other than the Head Start grantees, Facilities has had tenants other than EMAA since at least 1994. ACF Ex. 2, at 5. Facilities currently has four other tenants which pay a total monthly rent of $2,134. EMAA Ex. 34. This amounts to $25,608 yearly, or approximately 30 per cent of Facilities' total income. While this does not approach the situation presented in HELP where the lessor's business with the Head Start grantee was a minimal portion of its total income, we nevertheless do not consider Facilities' non-EMAA income to be an insignificant amount. It is an indication that Facilities was not completely dependent on EMAA, as it had a source of income other than EMAA.
ACF additionally argued in its brief that EMAA's rental arrangements with Facilities do not comply with 45 C.F.R. . 74.43, which requires that all procurement transactions be conducted in a competitive fashion, and with 45 C.F.R. . 74.45, which requires some form of cost analysis for every procurement action. We do not find ACF's reliance on these regulations convincing. First, there is evidence that the price EMAA paid Facilities in rental costs, $0.70 per square foot, was considered to be within, if not below, the competitive rates for commercial real estate within the area served by EMAA. EMAA Ex. 10. Second, if by invoking 45 C.F.R. . 74.45, ACF is suggesting that EMAA should have undertaken a cost analysis to determine whether it was more financially sound to purchase rather than lease buildings for the operation of its Head Start program, ACF has not shown that funds for such a large capital expenditure were readily available to EMAA. Moreover, ACF has not adopted a policy favoring ownership over leasing for Head Start grantees since that option became available in 1994. We question whether it is realistic to demand that a grantee in EMAA's position complete what amounts to a paper exercise in exploring a purchase option when it lacks the funds to execute that option. Accordingly, we do not find that 45 C.F.R. . 74.45 supports the disallowance in this case.
Conclusion
For the reasons discussed above, we find that there was not a less-than-arms-length relationship between EMAA and Facilities, and we accordingly reverse the disallowance of $42,694.
________________________
Cecilia Sparks Ford
________________________
Donald F. Garrett
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M. Terry Johnson
Presiding Board Member