Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: Virginia Department
DATE: September 14, 1990
of Medical Assistance Docket No. 90-16
Decision No. 1195
DECISION
The Virginia Department of Medical Assistance (State) appealed a
disallowance by the Health Care Financing Administration (HCFA) of
$537,705 in federal funding claimed under Title XIX (Medicaid) of the
Social Security Act. The disallowed amount represented the federal
share of the costs of three contracts the State had with Arthur Young &
Company (AY). HCFA claimed that the contracts were not awarded in
accordance with federal procurement standards because the State had
entered into the contracts with AY through noncompetitive negotiation.
There are two central issues in this appeal: first, whether the State
was required to receive prior approval from HCFA before entering into
the contracts with AY; and second, even if the State was not required to
receive prior approval, whether these noncompetitive contracts were
consistent with the limited circumstances identified by the procurement
standards for noncompetitive negotiation. For the reasons discussed
below, we find that, while the State was not required to seek prior
approval for the contracts from HCFA, the State has failed to establish
that the circumstances here were consistent with the "single source"
and
"emergency" circumstances identified in the procurement standards
for
noncompetitive negotiation. Therefore, we sustain the disallowance of
$537,705 in principle. Nevertheless, since the standards also permit
the federal grantor agency to authorize noncompetitive negotiation even
where other identified circumstances do not apply, we remand this appeal
to HCFA for the purpose of determining if authorization of part or all
of the costs of the disputed contracts would be appropriate. HCFA may
consider the substantial benefit apparently received by the State's
Medicaid program from the contracts and other factors that may support
the reasonableness of the State's decision to use AY in the particular
circumstances of individual contracts.
Factual Background
Between 1982 and 1985 the State entered into five separate contracts
with AY. The last three are the subject of this disallowance. The
first two are relevant only as background.
o Contract 1. In 1982 the State contracted with AY to assist the State
in developing a reimbursement system for the State's Medicaid program
based on prospective payment methodologies for reimbursing hospital and
nursing home Medicaid providers.
o Contract 2. In 1983 the State was sued over the new Medicaid
reimbursement system, Mary Washington Hospital, Inc. v. Fisher, 635 F.
Supp. 891 (E.D.Va. 1985). Because AY had specific familiarity with the
reimbursement system being challenged, the State contracted with AY to
provide litigation support services, including expert testimony. State
Exhibit (Ex.) 1.
o Contract 3. The State sought further assistance from AY in 1984 when
it was faced with additional litigation involving the validity of audits
for a number of cost years for all of the facilities of a large chain
nursing home provider. Under this contract, effective May 1, 1984, AY
received $448,481 to provide the State with assistance in this
litigation. State Ex. 2.
o Contract 4. In another contract, effective January 21, 1985, AY
provided assistance in developing an appropriate provider appeal
procedure to comply with the court's order in the Mary Washington
litigation and received $94,432. State Ex. 3.
o Contract 5. In the last contract, effective August 1, 1985, the
State contracted with AY to provide assistance in the recruitment of a
new administrative head of the Division of Provider Reimbursement and in
the review and modification of the Division's cost audit function; AY
received $532,497 under this contract. State Ex. 4. The State alleged
that the contract represented an "emergency procurement," based on
the
State's realization at the time that its Division of Provider
Reimbursement needed substantial revamping, and that it had a backlog of
approximately 172 audits of nursing home providers.
For the three contracts in dispute (Contracts 3-5), AY received a total
of $1,075,410 ($537,705 in federal funding at the 50% funding rate).
The State did not solicit bids for these contracts, but, rather, awarded
them to AY in noncompetitive negotiation. HCFA disallowed federal
funding because (1) the State did not obtain prior approval from HCFA
for these contracts, and (2) the contracts did not meet any of the
limited circumstances identified in the applicable procurement standards
for noncompetitive negotiation.
Discussion
I. The State was not required to obtain prior approval from HCFA before
contracting with AY.
HCFA's position that the State was required to seek prior approval for
the contracts was based on a provision in the procurement standards
(Paragraph 6 of Appendix G to 45 C.F.R. Part 74) which HCFA applied in
conjunction with a provision in its State Medicaid Manual. Appendix G
to 45 C.F.R. Part 74 consists of Attachment O, "Procurement Standards,"
of Office of Management and Budget Circular A-102, "Uniform
Administrative Requirements of Grants-in- Aid to State and Local
Governments." The Attachment established standards and guidelines for
the procurement of supplies and services for federal assistance
programs, such as Medicaid, to ensure that such supplies and services
are obtained efficiently and economically. The Attachment requires that
all procurement transactions shall be conducted "in a manner that
provides maximum open and free competition," with procurement procedures
that do "not restrict or eliminate competition." Paragraph 10.a.
Paragraph 6 of Appendix G sets out standards for grantor review of
proposed contracts:
Federal grantor pre-award review and approval of the grantee's
proposed contracts and related procurement documents, such as
requests for proposals and invitations for bids, is permitted only
under the following circumstances:
a. The procurement is expected to exceed $10,000 and is to be
awarded without competition or only one bid or offer is received in
response to solicitation.
* * *
HCFA contended that it had exercised the discretion afforded to it by
Paragraph 6 to formally require, through its State Medicaid Manual, that
all contracts exceeding $10,000 must receive HCFA's prior approval.
(HCFA issues the Manual to states to provide regulatory interpretation
and policy guidelines concerning the Medicaid program.)
The Manual states that Paragraph 6 requires written prior approval for
proposed contracts where the procurement:
- Is expected to exceed $10,000 and be awarded without competition
or only one bid or offer was received in response to the
solicitation.
Section 2500(13).
The primary difficulty with HCFA's position is that this section of the
Manual was not issued until 1987. The contracts in dispute here were
executed in 1984 and 1985. The State cannot be held to revised
provisions of the Manual that were not in effect when the contracts were
executed. The provisions of the Manual that were in effect during the
period at issue contain no requirement that a state must get HCFA's
approval before entering into contracts such as the ones at issue here.
In fact, the Manual provision in effect, Section 2500(14), specifically
declared that the regulations at 45 C.F.R. Part 74 allowed states to
enter into contracts without prior federal approval except for contracts
involving automatic data processing equipment and Medicaid Management
Information Systems.
HCFA has not referred the Board to any other program rule or policy
giving notice to states at the time these contracts were executed that
HCFA had invoked the discretion afforded by Paragraph 6 to require prior
approval of all contracts in excess of $10,000. We therefore find that
HCFA's position that the funding associated with the contracts should be
disallowed solely on the basis of the State's failure to get HCFA's
prior approval of the contracts is without merit.
II. The questioned contracts did not meet the single source and
emergency circumstances for noncompetitive negotiation.
While we have rejected HCFA's assertion that prior approval was needed
for the contracts at issue, the State still has the burden to show that
the contracts met one of the circumstances for noncompetitive
negotiation contracts listed at Paragraph 11.d. of Appendix G to 45
C.F.R. Part 74. Paragraph 11 sets forth standards for methods of
procurement under grants. Specifically, Paragraph 11.d. provides:
Noncompetitive negotiation is procurement through solicitation of a
proposal from only one source, or after solicitation of a number of
sources, competition is determined inadequate. Noncompetitive
negotiation may be used when the award of a contract is infeasible
under small purchase, competitive bidding (formal advertising) or
competitive negotiation procedures. Circumstances under which a
contract may be awarded by noncompetitive negotiation are limited
to the following:
(1) The item is available only from a single source; (2) Public
exigency or emergency when the urgency for the requirement will not
permit a delay incident to competitive solicitation; (3) The
Federal grantor agency authorizes noncompetitive negotiation; or
(4) After solicitation of a number of sources, competition is
determined inadequate.
The State here relied on the "single source" and the public "exigency
or
emergency" provisions.
A. The contracts for litigation assistance (Contracts 3 and 4) do
not qualify as single source contracts under Paragraph 11.d.
As noted above, the State had initially contracted with AY to assist in
the development of its Medicaid reimbursement system and to provide
litigation support in a lawsuit. (Contracts 1 and 2.) Contracts 3 and
4, which are at issue here, were to provide further assistance to the
State in litigation concerning various aspects of the State's Medicaid
reimbursement system. The decision to retain AY as a single source
procurement for the later contracts was, according to the State,
"logical," in that AY's "unique position" enabled it to
respond to the
State's needs quickly and with personnel already either on-site or
familiar with the State's Medicaid Program and its reimbursement
systems. Additionally, the State cited section 11-45.B. of the Code of
Virginia:
Any public body may enter into contracts without competition for .
. . expert witnesses and other services associated with litigation
or regulatory procedures.
The State contended that the two contracts on their face recite the
specific litigation involved and the tasks to be performed in assisting
the State's defense to the litigation. Therefore, according to the
State, the contracts, although noncompetitive, were nevertheless valid
and lawful under Virginia law. The State accused HCFA, by issuing a
disallowance, of attempting to override Paragraph 2.b. of Appendix G,
which provides:
Grantees shall use their own procurement procedures which reflect
applicable State and local laws and regulations, provided that
procurements for Federal Assistance Programs conform to the
standards set forth in this attachment and applicable Federal law.
The State interpreted this language as requiring deference to state law
if the state law is consistent with the Appendix. The State insisted
that its laws are consistent with the Paragraph 11.d. authorization for
noncompetitive negotiation of single source contracts. 1/ The State
argued that contracts for litigation support must be treated as single
source procurements since trial counsel must have the discretion to
select their own expert witnesses and to protect their litigation
strategy from being disclosed prematurely.
In our view, the clear thrust of Appendix G is that procurement
activities should wherever possible be conducted in a competitive
environment. Moreover, Paragraph 2.b., cited by the State, limits
deference to State law to the extent that the state law conforms with
the standards set forth in the Appendix.
While the State argued that contracts 3 and 4 qualified for
noncompetitive negotiation as single source contracts under Paragraph
11.d(1), the State actually followed the procedures for noncompetitive
negotiation under its own law for services associated with litigation.
2/ Thus, the State here did not follow procedures that would otherwise
have been necessary under State law for single source contracts, such as
a written determination and public notice that only one source was
"practicably available." The State nevertheless argued before the
Board
that the two contracts qualified as "single source." Even if we use
the
State's own standard that only one source must be "practicably
available," however, we find that the State has failed to establish that
the circumstances here met that standard.
While the State might be correct in asserting that AY had familiarity
with the State's Medicaid reimbursement system and thus qualified as
experts for purposes of litigation, we do not find that factor
determinative in establishing that AY was practicably the "single
source" for the contracted services. HCFA argued that other major
accounting firms had the capability and resources to accomplish the
stated goals of contracts 3 and 4. Based on the record before us, we
have no reason to dispute this assertion. AY holds no monopoly on
expertise in the provider reimbursement field, and the State did not
argue that its reimbursement system was so unique that other firms would
have been unable to provide the necessary assistance. While it could be
argued that, due to its familiarity with this State's Medicaid program,
AY could perform the contracted services more efficiently, and hence at
a lesser cost, than other accounting firms, that factor would not
conclusively demonstrate that AY was the only firm practicably available
to provide the service.
Accordingly, we find that the first two questioned contracts with AY do
not meet the "single source" requirements of Paragraph 11.d. for
permissible noncompetitive negotiation.
B. The circumstances surrounding Contract 5 did not constitute a
"public exigency or emergency" as provided for in Paragraph
11.d.
The State contended that in 1985 its Medicaid program was faced with an
"emergency." The director of the newly created Virginia Department
of
Medical Assistance initiated a priority evaluation of all aspects of the
State's Medicaid program. The evaluation uncovered what the State
termed a critical problem in the division responsible for the provider
audit and rate-setting function. The director of the division
responsible for this function was removed for incompetence and the
division had a backlog of approximately 172 audits covering
approximately $1 billion of Medicaid expenditures. The State determined
that a new head of the division had to be recruited and a plan developed
to deal with the audit backlog. These were the circumstances that led
the State to contract once again with AY.
The Director of the Virginia Department of Medical Assistance made a
written determination that an emergency existed "because of the actual
large financial and legal risk" to the State. State Ex. 4A. AY was
chosen because "[n]o other firm could acquire [the] knowledge in the
required time frame for implementation of the recommenda- tions to
preclude further potential grave harm" to the State's Medicaid program.
Id. The contract was entered into as an emergency procurement under the
authority of section 11-41.E. of the Code of Virginia. 3/
The State asserted that this contract, executed in accordance with this
State law, thus met a Paragraph 11.d. circumstance for noncompetitive
negotiation, involving a public "exigency or emergency."
Paragraph 11.d(2) permits noncompetitive negotiation for a public
exigency or emergency "when the urgency for the requirement will not
permit a delay incident to competitive solicitation." As we noted
above, the State procurement standards also provide for noncompetitive
negotiation in the case of emergency but do require competition "as is
practicable under the circumstances." Although we would generally defer
to a state's determination under its own procedures where the state is
applying standards that are consistent with federal standards, we
question whether the State here has fully followed its own procedures
and whether the record here is in any event sufficient to demonstrate
that the State's determination was justifiable.
At the outset we are reluctant to find a "public exigency or emergency"
in circumstances that were entirely under the State's control and that
were not demonstrated to have been unavoidable. The State never argued
here that it was unable to provide closer surveillance of the
performance of the division director and of the increasing backlog in
audits that apparently occurred over several years. See State Ex. 14.
If the State had monitored the situation more closely, it presumably
could have corrected the problem before it reached such serious
proportions and it would have had more breathing space for competitive
negotiation. An emergency has been defined to be "a situation which has
suddenly and unexpectedly arisen." 64 AM. JUR. 2D Public Works and
Contracts, Sec. 39 (1972). The State did not demonstrate that the
circumstances here were sudden or unexpected.
Moreover, we do not see in the State's situation the sense of "urgency"
required by Paragraph 11.d. and State procurement standards that would
necessitate the complete abandonment of competitive solicitation. The
State was not faced with anything like a court ordered deadline or a
natural catastrophe that required it to act in so short a time frame
that competitive solicitation was impossible. The State did not allege
that it would not have been feasible to procure other bids during the
time the State actually took to execute its contract with AY after it
had decided that it would be necessary to hire a consultant. (Indeed,
the State did not provide the Board with any time frames customarily
required for full or limited competitive solicitation for this type of
service.) Even under its own procedures, the State was supposed to
provide such competition as is practicable under the circumstances. The
State in our view has failed to demonstrate that absolutely no
competition was practicable.
Moreover, HCFA argued that the State failed to comply with its own
procurement law because there was no "written notice" as required
by
section 11-41.E. The State argued that this was a technical deficiency
only. We question whether the absence of notice can be viewed as a
technical deficiency since notice presumably was required to apprise
other potential competitors of the State's intentions so that they might
protest or intervene if they were so inclined.
Accordingly, we find that the record does not show that Contract 5 meets
the "emergency" provision of Paragraph 11.d. or the State's own
procurement standards.
III. HCFA should examine the contracts to determine if retroactive
authorization is warranted.
Although the contracts in question do not qualify under the single
source or emergency standards for noncompetitive negotiation,
noncompetitive solicitation is nevertheless permitted under Paragraph
11.d. if the federal grantor agency authorizes it. Prior to executing
the contracts, the State did not seek HCFA's authorization. The
Department of Health and Human Services Grants Administration Manual
(HHS GAM) provides that a "transaction may be approved retroactively"
if, among other things, "the transaction would have been approved had
the organization requested approval in advance." HHS GAM Chapter
1-105-60 B.1. 4/ Moreover, the Board has held under circumstances
comparable to those raised here that, although HCFA has considerable
discretion in determining whether to grant retroactive approval, it "may
not deny retroactive approval based on unsubstantiated conclusions or on
bases so insubstantial that the decision fairly can be described as
capricious." Alabama Dept. of Human Resources, DAB No. 939 (1988), at 7,
citing Economic Opportunity Atlanta, Inc., DAB No. 313 (1982); see also
Virgin Islands Dept. of Justice, DAB No. 1067 (1989). The Board also
reiterated in Alabama its view that "the grantor agency must articulate
a substantive basis for denying retroactive approval." Alabama, at 7.
In response to a Board inquiry concerning the possibility of retroactive
approval here, HCFA stated that it would not grant retroactive approval
of the costs of these contracts since there is no way of adequately
measuring the costs that would have been incurred if the contracts had
been negotiated competitively. HCFA additionally stated, however, that
the basis for its disallowance was the State's failure to obtain prior
approval, and that the reasonableness of the contracts' amounts and
activities was not a consideration in the disallowance determination.
Since, as we have found in Part I above, that the authority on which
HCFA relied for its position that prior approval was mandatory was not
in existence at the time of the contracts, it appears that HCFA may not
have properly considered whether it can give retroactive authorization
for the costs associated with the contracts. Moreover, it is readily
apparent from the record that, at the time of its disallowance
determination, HCFA did not have a complete and accurate picture of the
scope of the contracts. 5/
We believe that HCFA thus has not sufficiently examined the contracts
and their accomplishments to make a determination, based on standards
that were actually in effect, whether retroactive authorization might be
warranted. While, as HCFA argued, the precise cost of competitively
negotiated contracts may never be known, the State's Medicaid program
presumably benefitted from the contracts and the State should be given
the opportunity to demonstrate that some, if not all, of the costs would
have been incurred even if there had been competitive negotiation. A
state is entitled to funding for costs which are necessary for the
proper and efficient administration of its Medicaid plan. Section
1903(a)(7) of the Social Security Act. It is also significant that even
if the State had followed competitive solicitation procedures, it would
not necessarily have been bound to select the lowest priced offeror if
other factors reasonably supported the selection of a higher offeror.
In any event, the authorization by the federal grantor agency cited by
the procurement standards is not limited to consideration of any
particular circumstance. It presumably was added to the procurement
standards to permit the grantor agency to consider circumstances other
than the circumstances already identified in the standards. Thus, HCFA
may consider, among other things, the substantive relationship of these
contracts with earlier contracts with AY that may have been
competitively awarded. HCFA may also consider during its review other
issues which have previously been deferred, such as the general
reasonableness and necessity of the contract activities and amounts and
the allowability of contract overrides of approximately $200,000.
Accordingly, we conclude that it is appropriate to remand this appeal to
HCFA to determine whether it will grant retroactive authorization for
any of the costs associated with the contracts. That determination may
be based on further information and documentation submitted by the State
following consultation with HCFA as appropriate. The State's submission
should be made within 30 days of receipt of this decision or such longer
period as allowed by HCFA. If HCFA decides not to grant retroactive
authorization for the contract costs at issue, it should provide a
written statement of its reasons to the State. The State may, within 30
days of receipt, appeal that decision to this Board.
Conclusion
For the reasons stated above, we uphold in principle the disallowance of
$537,705, but remand the appeal to HCFA for a determination of whether
retroactive authorization of the contracts is warranted.
_____________________________ Judith A. Ballard
_____________________________ Cecilia Sparks
Ford
_____________________________ Donald F. Garrett
Presiding Board Member
1. Sole source contracts are permitted under section 11-41.D. of the
Code of Virginia:
Upon a determination in writing that there is
only one source practicably available for that
which is to be procured, a contract may be
negotiated and awarded to that source without
competitive sealed bidding or competitive
negotiation. The writing shall document the
basis for this determination. The public body
shall issue a written notice stating that only
one source was determined to be practicably
available, and identifying that which is being
procured, the contractor selected, and the date
on which the contract was or will be awarded.
This notice shall be posted in a designated
public area or published in a newspaper of
general circulation on the day the public body
awards or announces its decision to award the
contract, whichever comes first.
2. This circumstance is not specifically identified in Paragraph 11.d,
and therefore would not be a basis in itself for noncompetitive
negotiation under the federal procurement standards, although it might
be a factor HCFA might consider in determining whether to authorize the
contracts. In any event, HCFA alleged that the State procurement law
has a carefully defined procedure for procurement of professional
services, and that the State provided no documentation showing that it
followed those procedures, i.e., that it held discussion with more than
one accounting firm, or that there was a written determination made that
AY was the only offeror fully qualified to handle the litigation
contracts. The State did not refute this allegation.
3. Section 11-41.E. provides:
In case of emergency, a contract may be awarded without
competitive sealed bidding or competitive negotiation; however,
such procurement shall be made with such competition as is
practicable under the circumstances. A written determination of
the basis for the emergency and for the selection of the
particular contractor shall be included in the contract file.
The public body shall issue a written notice stating that
the contract is being awarded on an emergency basis, and
identifying that which is being procured, the contractor selected,
and the date on which the contract was or will be awarded. This
notice shall be posted in a designated public area or
published in a newspaper of general circulation on the day the
public body awards or announces its decision to award the
contract, whichever comes first, or as soon thereafter as
practicable.
4. This statement appears in the HHS GAM chapter on audit resolution
in the context of determinations of allowable costs. Although this
appeal arose out of a HCFA review of the contracts rather than a formal
audit, it is a parallel circumstance involving a determination that a
claimed cost is unallowable, and there is no reason to doubt that HCFA
has the same discretionary ability to grant retroactive approval.
5. HCFA's disallowance determination referred to only one contract
with AY involving the whole $537,705 in funding at issue. However,
during the course of this appeal, the State furnished HCFA copies of
other contracts with AY relevant to disallowed expenditures. We need not
determine which party may have been at fault for the incomplete
information reflected in the disallowance letter in order to resolve any
of the substantive issues. Nevertheless, it is clear that HCFA was not
in possession of all the relevant information and documents when it
conducted its