GAB Decision 297
May 21, 1982 California Department of Social Services; Docket No.
81-182 Garrett,Donald; Teitz,Alexander Settle, Norval
The California Department of Social Services (State) appealed a
disallowance by the Principal Regional Official in Region IX (Agency)
of$11,387 /1/ in interest the State paid on retroactive salary increases
pursuant to a court order and State law. Based on the analysis below,
we sustain the disallowance.
Background.
A California law provided pay increases averaging 11.5 percent to
State employees. The State paid only 7 percent pursuant to a ruling of
the federal Cost of Living Council. The California Supreme Court
ordered the full increase authorized by law.The State paid, and sought
federal participation in the retroactive salary increase and in the
interest the State was required to pay by a State law requiring interest
on money judgments. The Agency did not contest payment of the federal
share of the retroactive salary increase per se, but did disallow the
interest.
The basis of the disallowance.
45 CFR Part 74, Appendix C (1979) /2/ contains cost principles for
grants to state and local governments. Part II, paragraph D included
the following among unallowable costs:
(2) 7. Interest and other financial costs. Interest on borrowings
(however represented), bond discounts, cost of financing and refinancing
operations, and legal and professional fees paid in connection
therewith, are unallowable except when authorized by Federal
legislation.
The Agency took the position in its disallowance letter that the
interest the State had paid in this case was unallowable under the
quoted provision. The State maintained that the interest payment was
actually "compensation for personal services," an allowable cost under
Part II, paragraph B. 10. In the disallowance letter, the Agency said
that it was unpersuaded by the State's position because the sum in
dispute "clearly" was interest.
The sum in question clearly, indeed, was some kind of interest. /3/
The question is whether it represents a cost to the State which is
ineligible for federal participation.
The interest and sovereign immunity.
On appeal, the Agency made only brief mention of the argument that
the interest was unallowable "interest on borrowings" and instead
premised virtually its entire argument on sovereign immunity, arguing
that "interest cannot be assessed against the Federal government in the
absence of a contract or a statute expressly providing for such
interest." Respondent's brief, p. 3. The Agency cited several cases for
the quoted proposition, which appears to be clear and long-standing and,
indeed is reflected in a federal statute (28 U. S. C. 2516(a)).
However, the proposition does not as clearly control the case before us.
Here, the issue is not the precise one of whether interest may be
assessed against the United States, but whether an interest expense
properly incurred by the State (which had effectively waived its own
sovereign immunity to interest on judgments by statute) is an allowable
cost under (3) federal public assistance programs. The cases cited by
the Agency do not reach this issue. /4/
Furthermore, the precedents cited by the Agency, and the rule in 28
U. S. C. 2516(a), apparently would countenance payment of interest if it
was specifically provided for in the "contract" (i.e., the grant
agreement, including applicable rules) between the Agency and the State.
The interest as compensation.
The Agency's sovereign immunity argument does not provide the easy
resolution of this dispute the Agency would have it provide, and (4)
neither does the State's position that the interest expense is
"compensation for services." The State argued that the interest should
be considered compensation because it effectively reflected an increase
in the wage award to employees to "compensate them fairly for the loss
of funds which had been due but were not paid." State's brief, p. 6.
There are three things wrong with this position. First, it takes what
clearly is some sort of interest and strains to make it fit a different
concept. Second, using the State's analysis it would be as easy to call
the interest expense a fine or penalty, which clearly is unallowable.
Finally, the provisions of Appendix C on compensation contemplate
payment for specific services. For example, compensation is allowable
only to the extent that "total compensation for individual employees"
is
determined based on, among other things, "payrolls . . . supported by
time and attendance or equivalent records for individual employes." Part
II, paragraphs B. 10. a. and 10. b. We conclude that the Agency
reasonably determined that the interest was not compensation within the
meaning of Appendix C.
The interest as "interest on borrowings".
The Agency's disallowance letter said that the Agency was unpersuaded
by the State's claim that the sum in issue was compensation, because it
"was computed at a per annum rate and applied to a money judgment as an
interest expense . . . ." p. 2. The letter seems to reflect an
assumption that allowability of interest per se is precluded by Appendix
C. This would be consistent with the Agency's later argument on
sovereign immunity, but would also appear to ignore the modifying words
in the phrase "interest on borrowings (however represented)" in Appendix
C. On appeal the Agency also argues, in a footnote, that "the delay by
the State in paying its employees the full salary provided by state law
(could be construed) as constituting a type of borrowing . . . ." Agency
brief, p. 6.
Regarding the meaning which should be given the "interest on
borrowings" preclusion, the State argued:
. . . the underlying premise of the Social Security Act is that
States will fully fund their share of the programs in return for their
receipt of federal funds. If States have to borrow money to do so, the
cost of borrowing that money does not go to fund programs, but to a
third party. The federal government gets no benefit from the money
spent. It follows that FFP would be prohibited in the cost of money
acquisition . . . interest is a "hidden" component of many costs,
e.g.,
the purchase of equipment. It can also be a routine part of employee
compensation (5) (e.g., interest earned on retained pension of profit
sharing funds). Thus, it should be clear that the term "interest"
is
not a magic word which precludes FFP. It is the cost of borrowing money
(whether denominated "interest" or not) which is noncompensable.
State's brief, pp. 5-6. (Emphasis added).
The State's argument has a counterpart in federal procurement
practice, where the same preclusion on interest on borrowings is found
(and may be more apt); /5/ here, however, the argument suffers two
flaws. First, the federal program gets no more benefit from payment of
interest on a judgment than it would get from payment of interest on a
loan, so that the State effectively condemned its own argument. Second,
if the interest here is not an unallowable fine, penalty or donation,
and not allowable compensation, then it either is a peculiar creature
which is not covered by the cost principles in Appendix C (we discuss
this further below), or it is interest the State earned (or at least
owed) on the funds it improperly withheld from its employees: a
constructive borrowing which reasonably would fall within the ambit of a
borrowing "however represented." In a telephone conference held in
this
case, the State argued that the concept of borrowing implies an element
of "volition" on the part of the borrower which did not exist here.
But
that does not necessarily follow from the face of the cost principle,
and the emphatic modifier "however represented" would appear capable
of
covering the point. Furthermore, one could also find that the State's
refusal to pay the full amount of salary mandated by State law
constituted the volitional "borrowing."
Although we believe the foregoing is a reasonable construction of the
term "interest on borrowings (however represented)," we cannot conclude
definitively that the interest here is interest on borrowings because
the record contains nothing on the purpose and history of the California
statue which required the interest. But given our conclusion below, we
need not deal with this construction in greater depth.
(6) The interest as something simply not covered by the cost
principles.
If the interest here did not fall within a specifically allowable
category under the cost principles in Appendix C, but also arguably did
not fall neatly within any of the several unallowable categories
discussed above, should the Agency then be obligated to share the
expense? We conclude not.
The cost principles in Appendix C provide:
Failure to mention a particular item of cost in the standards is not
intended to imply that it is either allowable or unallowable, rather
determination of allowability in each case should be based on the
treatment of standards provided for similar or related items of cost.
Part II, A. 2.
Under this provision, the Agency reasonably could treat the interest
in question here the same way it would treat the "similar or related"
item of interest on borrowings. The cost principles also establish a
general federal standard that costs must be "necessary and reasonable"
in order to be allowable. Part I, . 1. a.
Otherwise unspecified administrative expenses incurred by a state in
running a Medicaid program are allowable under the Social Security Act
to the extent "found necessary by the Secretary for the proper and
efficient administration of the State plan." Section 1903(a)(7), 42 U.
S. C. 1396b(a)(7). A similar provision is applicable to the program of
Aid to Families with Dependent Children. See, section 403(a)(3) of the
Act, 42 U. S. C. 603(a)(3). /6/ Other than the cost principle on
compensation, the State has shown no regulation which might be
interpreted to mean the Secretary has chosen to pay for this type of
interest.
Furthermore, if the expense in question here was clearly a legitimate
cost of running the State's federally-assisted programs, the (7) State
might have a basis for arguing that the Agency had arbitrarily and
unreasonably denied payment, and abused its discretion. The State did
not argue this, and in any event we would not agree, for the
circumstances are not quite as equitably compelling as may appear at
first reading.
It was California legislative action which initiated the higher
salary provisions, it was California executive action (albeit
interactive with the Cost of Living Council) which limited the salary,
it was a California court which determined the State erred, and the
interest was imposed under California law. While the State bore an
unavoidable expense, the expenditure benefits the HHS public assistance
programs only very remotely. It is true that the federal Cost of Living
Council helped cause the problem, but that does not necessarily mean
that the HHS public assistance programs ought to underwrite the expense
merely because they coincidentally also are federal programs. And,
while we have concluded that federal sovereign immunity does not
directly control the interest allowability issue as presented in this
case, the basic principle is a collateral reason not to find the
Agency's denial of participation in interest unreasonable.
Conclusion.
We uphold the disallowance in the amount of $11,387. /7/
/1/ The original disallowance of $13,811 was later reduced by
$2,424, which represented funds under a program of the U. S. Department
of Agriculture. See, memorandum of December 14, 1981, from George E.
Miller, HHS Regional Director, to a representative of this Board and the
letter attached to that memorandum. /2/ Although we refer to the
1979 codification of the cost principles, as the Agency did, provisions
relevant here were in effect from 1973. See, 38 Fed. Reg. 26275,
September 9, 1973. /3/ "Under California law, pre-judgment
interest at the rate of 7 percent simple annual interest is required to
be paid whenever a sum certain or capable of being made certain by
computation is found to have been payable on a date prior to judgment.
Post-judgment interest at the same rate is also due on all money
judgments." State's brief, p. 2. /4/ U. S. ex rel. Angarica De
La Rua v. Bayard, 127 U. S. 251 (1888) involved a claim against the U.
S. Secretary of State for interest earned on funds held by the U. S.
pursuant to an award of the Spanish-American Claims Commission pending
their disbursement to the petitioner. Under the Commission's process,
the claim (against Spain) was made by the U. S. and the award was to
the U. S., although based on the petitioner's claim. The U. S. invested
the funds pending disbursement, and refused to pay the interest earned
when payment of principal was finally made to the petitioner. The
Supreme Court upheld the refusal based on sovereign immunity. In U. S.
v. North Carolina, 136 U. S. 211 (1890), the U. S. sued for interest
earned on certain State bonds after maturity. The Court extended the
principle of sovereign immunity in the interest context to the State as
a sovereign entity. Smyth v. U. S., 302 U. S. 329 (1937) stands for the
proposition that the U. S. was not liable for interest on U. S. bonds
after the date of a properly advertised accelerated recall date. U. S.
v. N. Y. Rayon Importing Co., 329 U. S. 654 (1947) involved a suit for
excessive customs duties paid to the U. S. on imported yarn. The U. S.
Customs Court held for the claimant, but payment was delayed while the
U. S. Court of Claims reviewed the status of a successor to the original
claimant and awarded interest. The Supreme Court would not sustain the
award of interest. U. S. v. Mescalero Apache Tribe, 518 F. 2d 1309 (U.
S. Ct. Cl. 1975) cert. denied 425 U. S. 911 (1976), involved an award by
the Indian Claims Commission of interest for a 47-year period on certain
Indian moneys held by the U. S. in trust for three tribes. The court
held that the U.S. was justified in denying payment of the interest, no
matter how equitably compelling the circumstances were. /5/ "The
principal rationale behind disallowance of interest on contractor
borrowings has been to assure equal treatment of contractors, since to
allow a contractor who relies heavily upon borrowed capital to be
reimbursed for allocable interest costs is regarded as inequitable to
companies which use internally generated funds to finance their
operations." Nash and Cibinic, Federal Procurement Law, 3rd Ed., pp.
1546-7 (Washington, D. C., The George Washington University, 1980).
This proposition is of questionable applicability to federal formula
grant programs such as those under the Social Security Act, where states
compete for funds, if at all, on a much different basis than firms
bidding for a contract. /6/ The record does not make it clear
what programs are involved in this dispute. See the letter of December
14, 1981 from the Regional Director of the Division of Cost Allocation
to a State representative, in which the Regional Director explained that
there were "over 20" programs affected by the audit finding on the
interest involved here, and that "most" were HHS programs. The State
did not contest the $11,387 amount, and we note that the State's
argument appears predicated on the Social Security Act (see the quoted
material on p. 4 above), so that reference to the Medicaid and AFDC
programs is particularly apt. We mention the two cited statutory
provisions as further specific examples of the express or implied
responsibility and discretion on the part of the Secretary to determine
reasonableness and allowability of costs generally. See also, Appendix
C, Part I, C. and Part II, d. 2. (quoted above). /7/ The record in this
case contains a suggestion that the Agency may have originally viewed
the interest preclusion in the cost principles to reach all interest,
rather than the ambiguously narrower category of interest on borrowings.
Further, we conclude above that the Agency appeared to consider the
doctrine of sovereign immunity as more stringently controlling this case
than is warranted by the precedents the Agency cited. Therefore,
although we uphold the disallowance as reasonable, nothing precludes the
Agency from reconsidering the matter.
OCTOBER 22, 1983