Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: Iowa Department of Human Services
DATE: June 19, 1992
Docket No. 91-161
Decision No. 1340
DECISION
The Iowa Department of Human Services (State) appealed a disallowance
by
the Health Care Financing Administration (HCFA) of federal
financial
participation (FFP) in the amount of $395,579 claimed under title
XIX of
the Social Security Act (Act). The State's claim was for costs
incurred
for Medicaid drug utilization review (DUR) services provided by the
Iowa
Pharmacists Association (originally the Iowa Pharmacy Foundation)
under
six successive contracts with the State during the period August 1,
1984
through February 28, 1990. 1/ Each of the contracts exceeded
$10,000
and was awarded without competition and without prior approval
from
HCFA. HCFA disallowed the contract costs on the ground that the
State
had not obtained prior approval in accordance with the
applicable
regulations. HCFA also denied the State's requests for
retroactive
approval of the contracts. HCFA later determined that the
contract
costs were also unallowable because the State failed to follow its
own
procedures for non-competitive procurements.
I. Summary of Decision
This dispute arises in the context of requirements related to
state
procurement processes, where federal policies give states
considerable
latitude and afford federal agencies relatively narrow authority
to
intrude. While sole-source contracting is an area where
federal
oversight through an approval mechanism is authorized, sole-sourcing
is
nevertheless a common procurement mechanism in the federal
government
and, presumably, among states as well. HCFA's approval
requirement
obviously is meant to give HCFA a means to assure that
sole-source
procurement is not used abusively, rather than to forestall
use
altogether.
The record here shows undisputed benefits and cost savings to HCFA
from
the contracts, an apparent lack of other likely bidders, and
HCFA's
approval of similar contracts after the period in question
here.
Furthermore, the State has made a persuasive case that there was
no
violation of its own procurement procedures.
Our parsing of the applicable regulations and policies discloses that
the
state was required to obtain prior approval for at least some of
the
sole-source contracts. The Stat failed to meet this
requirement.
However, HCFA had discretion to give retroactive approval of
the
contracts. As we have held in the past, where an HHS agency
has
authority to grant approval after-the-fact, the agency may not
merely
rely on the lack of prior approval per se to deny retroactive
approval;
the agency must articulate a reasonably persuasive substantive
basis for
denying such approval.
Here, HCFA has presented no such substantive basis. If the record
had
displayed any substantive abuse arising from the sole-source
procurement
here -- such as elimination of likely bidders, unfair
preference,
pass-through of substantially higher costs to HCFA, or some
other
substantial abuse of the procurement process -- then HCFA might
prevail.
But in the absence of any such evidence, HCFA's denial of
approval
renders its retroactive approval authority meaningless, elevates
form
over substance, and appears arbitrary. Thus, we conclude that
the
disallowance should be reversed.
II. HCFA's approval of all the contracts was required.
HCFA originally took the position that prior approval was required by
45
C.F.R. Part 74, Appendix G, . 6 and by 42 C.F.R. . 434.6(a)(1).
2/
Paragraph 6 of Appendix G states that:
Federal grantor pre-award review and approval of the
grantee's
proposed contracts . . . is permitted only under the
following
circumstances:
(a) The procurement is expected to exceed $10,000 and is to
be
awarded without competition . . . .
This language allows a federal agency to impose a prior
approval
requirement under certain circumstances. It does not by its
own terms
require prior approval, however. Section 434.6(a)(1) of 42
C.F.R.
provides that certain contracts, including contracts for DUR
services,
must:
[i]nclude provisions that define a sound and
complete
procurement contract, as required by 45 C.F.R. Part 74,
Appendix
G.
Since there is no prior approval requirement in paragraph 6 of Appendix
G,
however, this provision cannot impose a prior approval requirement by
merely
incorporating Appendix G by reference.
HCFA later contended that the State Medicaid Manual (which was issued
by
HCFA to provide guidance to the states concerning the administration
of
their Medicaid programs) contained a requirement for prior
approval.
The excerpt from the 1982 version of the Manual, which HCFA
provided,
does not contain any express reference to prior approval, and
states
that "HCFA's authority to prescribe additional procurement,
contractual
or review procedures" beyond those in Appendix G is
"severely
limit[ed]." HCFA ex. 6. 3/ Thus, HCFA's reliance
on this version of
the Manual is misplaced.
The 1986 version of the Medicaid Manual, however, can reasonably be
read
as stating a requirement for prior approval. It states in
pertinent
part that "[r]egulations at 45 CFR Part 74 allow you to enter
into
contracts without prior Federal approval with three general
exceptions."
One of the exceptions is in the case of sole source contracts
where the
procurement:
o Is expected to exceed $10,000 and to be awarded
without
competition or only one bid or offer was received in response
to
solicitation; or
o Is expected to exceed $10,000 and specifies a "brand
name"
product; or
o Procedure or operation fails to comply with one or
more
significant aspects of 42 CFR Part 74 Appendix G.
This language appears to assume, incorrectly, that Appendix G
itself
requires prior approval of sole source contracts under the
circumstances
specified. Nevertheless, since Appendix G authorizes a
federal agency
to require prior approval, we conclude that HCFA exercised
its
discretion to do so when it issued this version of the Medicaid
Manual.
Accordingly, the State was subject to a prior approval requirement
with
respect to the last three contracts at issue here (beginning July
1,
1987).
In an Order to Develop the Record issued in this case, moreover, the
Board
suggested that HCFA approval might be required under 45 C.F.R.
Part 74,
Appendix G, . 11.d. Paragraph 11.d. provides in pertinent
part:
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.
Under this provision, a sole source contract is permitted only if a
state
obtains federal agency approval or shows that one of several
other
circumstances existed. The State did not take the position
that
paragraph 11.d.(1), (2), or (4) applied here. Thus, HCFA approval
was
required pursuant to paragraph 11.d.(3) in order for the cost of
the
contract to be allowable. 4/
At the risk of stating the obvious, the approval requirement here is
not
an end in itself, but exists for a purpose: to assure that
a
sole-source procurement does not, by by-passing the
self-policing
effects of competition, introduce abuses such as unfair
preferences and
higher costs. We take notice of the fact, however, that
sole sourcing,
when adequately justified, is an acceptable procurement
practice.
III. Retroactive approval of the contracts was authorized.
There is no dispute that the State did not seek HCFA's authorization
prior
to executing any of the contracts. We find, however, that HCFA
had
discretion to approve the contracts on a retroactive basis.
Paragraph 11.d.(3) of Appendix G does not specifically require
that
federal grantor agency authorization be given in advance. Thus,
such
authorization may be given retroactively under the terms of
this
provision itself. Moreover, while the 1986 version of the
Medicaid
Manual specifically requires HCFA's prior approval, retroactive
approval
was authorized in the case of the contracts subject to this
requirement
pursuant to the Department of Health and Human Services (HHS)
Grants
Administration Manual (GAM), Chapter 1-105-60 B.1, which 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." 5/
HCFA nevertheless argued that it had no discretion to grant
retroactive
approval here because the HHS GAM authorizes retroactive approval
only
where prior approval is required by an OMB circular, not where it
is
required by regulation. As noted previously, however, the
requirement
for prior approval in the 1986 version of the Medicaid Manual is
based
on 45 C.F.R. Part 74, Appendix G, which in turn is derived from
OMB
Circular A-102. Thus, the HHS GAM authorizes retroactive approval
in
lieu of the prior approval required by this version of the
Medicaid
Manual. Moreover, as we found above, there is no other prior
approval
requirement in the regulations which applies to any of the
contracts.
Accordingly, we conclude that HCFA had discretion to grant
retroactive
approval of all of the contracts.
IV.
HCFA improperly denied retroactive approval of the
contract.
By letter dated January 23, 1990, the State requested that HCFA
approve
the contract for the period July 1, 1989 through June 30, 1990 on
a
retroactive basis. State ex. 9. On February 8, 1991, the
State
reiterated its request for retroactive approval of this contract
and
also requested retroactive approval of all prior DUR contracts.
State
ex. 22. The earlier request was denied by HCFA on the ground that
the
State had not complied with what HCFA viewed as a requirement for
prior
approval at 45 C.F.R. Part 434. State ex. 10. There is no
indication
in the record that HCFA responded to the later request prior to
the
State's appeal of the disallowance; however, HCFA specifically
addressed
the issue of retroactive approval in briefs filed in the
proceeding
before this Board.
On appeal to the Board, the State asserted that retroactive approval
was
appropriate for a number of reasons, including that (1) HCFA
granted
prior approval of two later contracts (beginning July 1, 1990)
which
were substantially the same as the contracts in question; 6/ (2)
The
dollar amount of each of the later contracts approved by HCFA was
as
high or higher (and, for fiscal years 1991 and 1992, reimbursed at
a
higher rate of FFP) than the dollar amount of the contracts in
question;
and (3) The contracts in question were effective, resulting
in
significant direct savings to the Medicaid program from changes
in
recipients' drug therapy following DUR review. The State later
asserted
as an additional ground for retroactive approval that the same
or
greater costs would have been incurred if there had been competition
for
the contracts in question. The State based this assertion on the
fact
that the Iowa Pharmacists Association was the sole bidder for
a
competitive contract for DUR services advertised by the State in
early
1990, and that its bid was approximately 10% above the costs for
the
same services charged under the non-competitive contracts.
In response, HCFA took the position that, even if it had discretion
to
grant retroactive approval, it did not abuse this discretion in
refusing
to approve the contracts "when the State knew or should have known
from
various sources that prior federal approval was required and it
failed
to ever attempt to obtain such approval." HCFA brief dated
4/16/92, at
8. HCFA agreed that the contracts benefitted the Medicaid
program. Id.
at 9. In addition, HCFA did not deny the State's
assertion that the DUR
services were provided at less cost than if the State
had obtained the
services through competitive bidding. However, HCFA
asserted that
competitive bidding was generally required to ensure that
"procurements
are obtained fairly and efficiently," and argued that "[t]o
allow
non-competitive selection any time a state asserts that it was
cheaper
to do so, would render those objectives meaningless." Id.
This Board has previously held that, while the HHS GAM gives the
federal
grantor agency 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." Virginia Dept.
of
Medical Assistance, DAB No. 1195 (1990), at 11, quoting Alabama Dept.
of
Human Resources, DAB No. 939 (1988), at 7. Thus, "the grantor
agency
must articulate a substantive basis for denying retroactive
approval."
Id. The Board specifically indicated in Virginia that HCFA
could not
deny retroactive approval under paragraph 11.d.(3) based on the
fact
that a sole source contract was not justified under paragraph
11.d.(1),
(2), or (4), and that it was appropriate to consider issues such as
the
general reasonableness and necessity of the contract activities
in
determining whether to grant retroactive approval. Based on
these
standards, we conclude that HCFA did not properly exercise
its
discretion in denying retroactive approval of the contracts in
question
here.
HCFA's assertion that retroactive approval was not appropriate in
this
case because the State failed to seek prior approval of the contracts
is
not a substantive basis for denying retroactive approval, in the face
of
unrebutted evidence of benefit to the Medicaid program, a lack
of
indicia of sole-source abuse, and HCFA approval of subsequent
similar
contracts. As the Board stated in Economic Opportunity of
Atlanta,
Inc., DAB No. 313 (1982), "[f]or the Agency to now rely on the
same
prior approval requirement as a basis for not granting
retroactive
approval renders the consideration of retroactive approval
meaningless."
HCFA also took the position that it was not a valid basis for
granting
retroactive approval that the sole source contracts were cheaper
than a
competitive contract would have been. We agree with HCFA that
this fact
alone would not necessarily warrant granting retroactive approval,
since
the purpose of competitive bidding is not solely to obtain the
lowest
price. However, the State also advanced other reasons for
granting
retroactive approval which appear reasonable on their face, i.e.,
that
HCFA approved later, similar non-competitive State contracts and
that
the contracts benefitted the Medicaid program. Since a state
is
entitled under section 1903(a)(7) of the Act to funding for costs
which
are necessary for the proper and efficient administration of
its
Medicaid plan, it would be unfair to deny federal funding, based
solely
on the lack of prior approval, for contracts which benefitted
the
Medicaid program and cost no more than if the contracts had
been
competed. The fact that HCFA subsequently approved similar
contracts
with higher costs confirms that the contracts in question
were
beneficial and their costs not excessive. 7/
Accordingly, we conclude that HCFA did not properly exercise
its
discretion when it refused to grant retroactive approval of
the
contracts.
V. The State complied with its own procurement
procedures in
awarding the contracts on a non-competitive basis.
HCFA also took the position that the contract costs were
unallowable
because the State did not comply with its own procurement
procedures.
Title 45 C.F.R. Part 74, Appendix G, . 2.b., requires grantees to
"use
their own procurement procedures which reflect applicable State
and
local laws and regulations." In addition, the cost principles for
state
and local governments in OMB Circular A-87 (made applicable to
grant
programs administered by HHS by 45 C.F.R. . 74.171) require that,
in
order to be allowable, costs must "[b]e authorized or not
prohibited
under State or local laws or regulations." This Board has
previously
upheld a disallowance based on the grantee's failure to follow its
own
procurement procedures. Virgin Islands Dept. of Human Services, DAB
No.
1067 (1989) at 7-9.
According to the State, the applicable State procurement procedures
were
those issued by the Financial Management Division of the
State
Comptroller and incorporated in the Department of Human
Services'
Management Manual. 8/ The State asserted that "[a]ll of the
DUR
contracts were approved as personal service contracts pursuant to
the
state procedures in effect at the time." State brief dated 4/16/92,
at
11, quoting Supplemental Affidavit of Joe Mahrenholz. The State
also
asserted that --
Even if the state procedures had not otherwise
allowed
noncompetitive procurement, the Iowa legislature
specifically
directed the Department of Human Services to contract with
the
Iowa Pharmacists Association (then referred to as the
Iowa
Pharmacy Foundation) in 1984. . . . As the Board noted in
its
order to develop the record, a state law specifying the
Iowa
Pharmacists Association as the contractor for DUR services
would
not override federal procurement standards. However, a
specific
state law would override general state procedures
requiring
competitive procurement.
Id. at 11-12. HCFA responded that there was no documentation in
the
contract files showing that the State complied with the procedures
which
the State claimed were applicable. HCFA also contended that the
statute
cited by the State merely gave the Department of Human
Services
discretion to contract with the Iowa Pharmacists Association, and
thus
could not override the procurement procedures in the Department of
Human
Services' Management Manual.
We conclude that the State statute overrode the otherwise applicable
State
procurement procedures. The statutory provision relied on by the
State
provided:
If the department reasonably expects that savings from
the
implementation of a drug utilization review program will
cover
the department's share of the costs of a contract for
the
development and implementation of such a program, the
department
may contract with the Iowa pharmacy foundation for
the
development and implementation of such a program.
1984 Iowa Acts ch. 1310 . 3(2) (State ex. 27, attachment E at 4).
In
our view, the State's reading of this statute as mandating that
any
contract for DUR services be with the Iowa Pharmacists Association
may
overstate the case. However, it seems reasonable to read the
statute as
specifically authorizing a sole source procurement with the
Association.
Even if this is not the only reasonable interpretation of the
statute,
the Board has previously held that a state's reasonable
interpretation
of its own law is entitled to deference. See New York
State Dept. of
Social Services, DAB No. 1235 (1991). We therefore
conclude that the
statute overrode the general procurement procedures adopted
by the State
agency. 9/ Thus, the State used "procurement procedures
which reflect
applicable State and local laws . . . ," as required by
Appendix G, .
2.b. 10/
We note that the statutory language relied on by the State appears in
an
act appropriating funds for human services programs for the
year
beginning July 1, 1984. HCFA did not argue that the statute was
limited
in its application to that year, however, nor does the statute
contain
any direct expression of such a limitation. Moreover, we see no
reason
to infer such a limitation since it is unlikely that the
State
legislature would have authorized a sole source contract for an
initial
year only to require competition in successive years.
Our conclusion that the State statute authorizing a sole source
contract
for DUR services superseded general State procurement raises the
further
question whether the State statute was inconsistent with the
general
federal policy, expressed in (cite), favoring the use of
competitive
procedures. The State's procurement procedures were
required by
paragraph 2.b. of Appendix G to "conform to the standards set
forth in
this attachment and applicable Federal law." However, while
federal
policy favors competition, sole source contracts are an
accepted
contracting technique where they are shown to be justified.
As
previously discussed, the use of sole source contracts was
justified
here on the grounds that the contracts benefitted the Medicaid
program
and did not result in higher costs (and a larger federal share)
than
would have been incurred had the contract been competed.
Accordingly,
the mere fact that the State entered into a sole source
contract
pursuant to a State statute is not a sufficient basis for
a
disallowance.
Conclusion
For the foregoing reasons, we conclude that the disallowance should
be
reversed in full.
_____________________________ Cecilia Sparks Ford
_____________________________ Donald F. Garrett
_____________________________ Norval D. (John) Settle
Presiding
Board Member
1. The starting dates of the six contracts at issue here were
August 1,
1984, July 1, 1985, July 1, 1986, July 1, 1987, July 1, 1988 and
July 1,
1989. State ex. 3-8.
2. Appendix G sets out in its entirety the "Procurement Standards"
in
Attachment O of the 1981 version of Office of Management and
Budget
(OMB) Circular A-102, "Uniform Administrative Requirements
for
Grants-in-Aid to State and Local Governments." Although OMB
Circular
A-102 was revised in 1988, HHS did not change Appendix G, which is
made
applicable to contracts implementing a state's Medicaid program by
42
C.F.R. . 434.6(a)(1).
3. Moreover, in Virginia Dept. of Medical Assistance, DAB No.
1195
(1990), the Board found that the Medicaid Manual did not contain
any
requirement for prior approval of contracts which were executed in
1984
and 1985.
4. Section 434.70(a)(2) of 42 C.F.R. provides for FFP in
expenditures
for payments to contractors only if the contract meets the
appropriate
requirements of 45 C.F.R. Part 74.
5. The chapter in which this statement appears deals
with
determinations of allowable costs in the context of
audit
determinations. Although this appeal arose out of a HCFA review
of the
contracts rather than a formal audit, it is a parallel circumstance
in
that HCFA determined that a claimed cost was unallowable.
Accordingly,
there is no reason to doubt that HCFA had discretion under the
HHS GAM
to grant retroactive approval here. See Virginia Dept. of
Medical
Assistance, DAB No. 1195 (1990), at 11.
6. These two contracts were with the State's peer review
organization,
which in turn subcontracted with the Iowa Pharmacists
Association for
DUR services. HCFA did not dispute that these contracts
were
substantially the same as the State's earlier contracts with the
Iowa
Pharmacists Association.
7. HCFA asserted that the approval of these later contracts was not
a
legitimate consideration in determining whether retroactive
approval
should be granted, citing Tennessee Dept. of Health and Environment,
DAB
No. 1136 (1990), and Economic Opportunity Council of Suffolk, Inc.,
DAB
No. 714 (1984). In these decisions, the Board rejected the
argument
that retroactive approval should have been granted because the
federal
agency had given prior approval of similar costs incurred before
the
disputed costs. These decisions are inapposite here, where the
State
relied on HCFA's approval of later, not earlier, contracts.
8. The procedures which the State contended were applicable
allowed
non-competitive procurement only if one of several specified
conditions
were met. The procedures further stated that "[t]he
justification for
use of sole source or emergency selection and the basis
upon which a
particular source is selected shall be documented in the
contract file."
State ex. 28, Attachment K. In addition, for
professional service
contracts in excess of $10,000, the procedures required
the preparation
of "Advance Planning Documents" to be approved by the
appropriate
division director prior to solicitation and development of the
contract.
Id. HCFA's financial management report cited state procedures
stating
different criteria for non-competitive procurements. However,
the State
contended that the procedures cited by HCFA applied only to
Department
of General Services procurements and not to the personal
service
contracts in question here.
9. There is no indication in the record that the condition
precedent
stated in the statute (i.e., that the department reasonably
expects
savings to cover state costs) was not met here.
10. In view of this conclusion, we need not address the
question
whether the State complied with the general procurement
procedures
adopted by the State