Economic Opportunity Council of Suffolk, Inc., DAB No. 714 (1985)

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