Kalamazoo County Human Services Department, DAB No. 1124 (1990)

DEPARTMENTAL APPEALS BOARD

Department of Health and Human Services

SUBJECT: Kalamazoo County Human

DATE: January 17, 1990
Services Department Docket No. 89-130
Decision No. 1124

DECISION

The Kalamazoo County Human Services Department (KCHSD or Grantee)
appealed a disallowance by the Office of Human Development Services
(OHDS or Agency) of $10,000 charged to the Grantee's Head Start program.
The disallowed funds represented a settlement of a lawsuit filed by a
former employee of the Grantee. The Agency disallowed the claim of the
settlement fee on the grounds: 1) under Office of Management and Budget
Circular A-87 (OMB A-87) a loss which could have been covered by
permissible insurance is unallowable, and 2) the Grantee did not request
specific prior approval in writing from the Agency for paying the
settlement fee, as required by 45 C.F.R. 74.177(b)(3).

The central issue raised by this appeal is whether the $10,000
settlement amount is an allowable cost to the Grantee's Head Start
program. For the reasons discussed below, we find that there is a
reasonable question whether KCHSD fully exhausted the possibility of
recovering the settlement fee from its insurers. Because KCHSD has not
established that the settlement fee is not indemnifiable by its
insurers, we find it unreasonable that the Agency should be required to
fund the settlement fee. We also find that KCHSD did not receive
specific prior approval from the Agency to pay the settlement fee, nor
is the payment for activities for which the grant was awarded.
Accordingly, we sustain the disallowance.

Factual Background

In September 1984 KCHSD discharged an employee from her position as a
clerk/typist with the Head Start program. The employee subsequently
initiated a wrongful discharge suit against KCHSD, charging that KCHSD
failed to follow proper procedures in discharging her. The employee
alleged that she was entitled to an award of damages somewhere in the
range of $80,000 - $120,000. Following extensive pretrial discovery and
with a jury trial imminent, KCHSD became convinced, because of the
uncertainties attendant in any jury trial and the potential fees and
costs of a trial, that it was in its best interests to settle the case
for $10,000. The employee agreed to this settlement offer and her
lawsuit was dismissed on August 16, 1988.

On its final financial status report filed with OHDS for fiscal year
1988, KCHSD listed the settlement fee as a direct cost charged to the
Head Start program.

Applicable Regulations

Recipients of federal grants, such as Head Start funds, are required to
adhere to specific cost principles set forth at 45 C.F.R. Subpart Q.
These principles are to be used in determining what costs are allowable
to a grant. KCHSD, a local government agency, is bound under 45 C.F.R.
74.171 by the cost principles of OMB A-87. OMB A- 87 provides, "Actual
losses which could have been covered by permissible insurance (through
an approved self- insurance program or otherwise) are unallowable unless
expressly provided for in the grant agreement." Attachment B, section
C.4.d.

A grantee is also required to have its budget detail the expenditure of
grant funds approved by the awarding agency. All direct costs must be
approved in advance by the awarding party. 45 C.F.R. 74.177(b)(1). In
regard to the approval of certain costs, the regulations further
provide, at 45 C.F.R. 74.177(b)(3), "If the costs are not specified in
the budget, or there is no approved budget, the recipient shall obtain
specific prior approval in writing from the awarding party. . . ."

Discussion

KCHSD contended that, in light of the large potential liability it faced
from an adverse jury determination on the employee's lawsuit, its
payment of the settlement was prudent and the Agency's decision to
disallow the $10,000 is not supportable under the regulations. KCHSD
argued that its actions met the criteria set forth in OHDS Policy
Interpretative Memo No. 9., referred to in a prior Board decision,
Community Action Commission of the Cincinnati Area, DAB No. 380 (1983).
This Memo set out five specific factors to determine whether settlement
costs in settling personnel litigation would be allowable:

1) A grantee complies with its personnel policies and
procedures; 2) There was no pattern of harassment or other
grossly unfair personnel practices, although the grantee's
personnel policies and procedures were followed; 3) A grantee
notifies the regional office as soon as it learns that a lawsuit is
filed; 4) Legal fees are reasonable in relation to the
services rendered; and 5) A grantee can produce documented
evidence that it attempted to purchase insurance against suits
brought by employees, but the insurance was unavailable or
the cost of the insurance was such that it was unreasonable to
carry such insurance.

KCHSD insisted that it satisfied these criteria. For example, KCHSD
produced correspondence which, it claimed, showed that the Agency was
continually being apprised of the status of the lawsuit. KCHSD Exhibit
(Ex) 3. Additionally, KCHSD presented an affidavit from its attorney in
the lawsuit (Ex. 4, Triemstra affidavit) which detailed his efforts in
settling the lawsuit and in seeking indemnification for the settlement
from three insurance companies with which KCHSD had policies.

KCHSD's reliance on the Memo's criteria is misplaced. As the Agency
pointed out, the Board in the Cincinnati decision found that the Memo
was an internal OHDS document that was non-binding. The Agency added
that it no longer uses the Memo and the Memo therefore has no present
validity or relevance to this appeal. Moreover, in Cincinnati the Board
upheld the disallowance of a settlement of a personnel lawsuit because
the grantee there produced no evidence that it ever sought to obtain
insurance for a contingency that was reasonably foreseeable, as required
by federal cost principles. The Board specifically rejected the
argument that settlement of the lawsuit was the prudent course of
action:

While it may have been true that the Grantee saved itself a
considerable amount of money by settling the suit out of court,
this is not necessarily sufficient to demonstrate
allowability of the costs. As a charge to federal funds, this
expenditure must also be consistent with the applicable cost
principles. . . .

Cincinnati, p. 3.

Unlike the situation in Cincinnati where the grantee had no insurance
for personnel lawsuits, the record of this appeal contains evidence that
KCHSD did have insurance to cover the settlement fee. One of its
insurance policies, the one issued by The Home Indemnity Company
(Insurer), 1/ entitled Public Officials Errors and Omission Liability
Insurance (Exhibit B of the Triemstra affidavit), provided, "The company
will pay on behalf of the insured all sums which the insured shall
become legally obligated to pay as damages because of any wrongful act
act which occurs during the policy period and arises out of the
discharge of duties by an insured, on behalf of a public entity." The
policy defines "wrongful act" as "any actual or alleged error,
misstatement, act, omission, neglect or breach of duty including
misfeasance, malfeasance and nonfeasance by an insured."

It can reasonably be asserted that the discharge of the employee and the
alleged failure to follow proper procedures constituted a "wrongful act"
by KCHSD within the meaning of its policy with the Insurer. As such the
cost of any potential liability would have been covered by the Insurer's
policy as required by OMB A-87. Yet the record is clear that KCHSD has
not exhaustively pursued this matter with the Insurer. The Insurer has
not yet answered an outstanding KCHSD inquiry whether or not there was
coverage under its policy and is still in the process of looking at the
claim. Triemstra affidavit, pp. 2-3. Thus the Insurer has not yet
determined that it will not pay the settlement fee. Until KCHSD has
received a definitive rejection of its claim, it is patently unfair to
expect the Agency to "foot the bill" for the settlement. And even if
the Insurer does reject the claim, KCHSD can still challenge the
nonpayment of the claim in court. KCHSD argued that this would be an
expensive proposition as the costs of an action and attorneys' fees
would not be recoverable as damages under Michigan law. Such
speculation, however, does not justify the position that the Agency is
responsible for payment of the settlement fee.

The fact remains, moreover, despite KCHSD's protestations, that there is
no indication in the record that KCHSD ever received the Agency's
specific written approval to charge the settlement fee to its Head Start
grant as required by 45 C.F.R. 74.177(b)(3). KCHSD pointed out that it
kept the Agency informed of the status of the lawsuit. Mere updates on
the status of the suit, however, cannot be assumed to constitute
approval of KCHSD's action. There is nothing in the record to indicate
that KCHSD ever specifically sought or received approval from the Agency
to make the settlement it did. 2/

The cost principles require that grant funds be used only for the
activities for which the grant was awarded. 45 C.F.R. 74.170. See
Community Action Agency of Chambers- Tallapoosa-Coosa, Inc., DAB No.
1066 (1989). The grant funds were never awarded to pay the settlement,
nor was there any subsequent approval to use the grant funds for that
purpose. Under these circumstances, we find no merit in KCHSD's
position.

Conclusion

For the reasons discussed above, we sustain the Agency's decision to
disallow the $10,000 settlement fee claimed by the Grantee as a cost to
its Head Start grant.

________________________ Donald F.
Garrett


_________________________ Norval D.
(John) Settle


________________________ Alexander G.
Teitz Presiding Board Member

1. KCHSD referred to this policy as being issued by the Home Insurance
Company of Indiana. The policy indicates, however, that the insurance
was issued by the Home Indemnity Company.


2. The Board has at times considered whether an agency should consider
granting "retroactive prior approval," where prior approval was required
but not requested prior to incurring a particular cost. We have in some
cases said that the grantor agency has to articulate a substantive basis
for denying retroactive approval. See Alabama Dept. of Human Resources,
DAB No. 939 (1988). Here there was a clear substantive reason for
denying approval, namely, the OMB A-87 provision that losses which could
have been covered by permissible insurance are