Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: Washington County Opportunities, Inc.
DATE: February 8, 1994
Docket No. A-93-173
Decision No. 1464
DECISION
Washington County Opportunities, Inc. (Washington County) appealed a
determination by the Administration for Children and Families (ACF)
disallowing $107,497.00 charged to Washington County's Head Start
Program for the program year ended July 31, 1992. ACF disallowed
one-time bonus payments made to all full-time Washington County staff
which ACF found were unallowable under the applicable cost principles.
ACF cited the provisions of the Office of Management and Budget (OMB)
Circular A-122, Attachment (Att.) B, 6 and Att. A, A.3. 1/
For the reasons explained below, we conclude that the bonus payments
were, in principle, incentive payments paid pursuant to an agreement
entered into in good faith, as required by OMB Circular A-122. We find
that Washington County reasonably interpreted its personnel policies to
authorize incentive payments. We further find that the mere fact that
the bonuses were organization-wide does not render them unallowable per
se (although it may be a factor in determining their reasonableness).
We find no evidence that Washington County failed to make other
expenditures necessary to carry out its Head Start program in order to
have funds available for bonus payments. Further, Washington County
showed that overall compensation for the employees' was not excessive
and that it was trying to comply with federal requirements.
On the other hand, the fact that Washington County split evenly among
all its employees all of the funds remaining at the end of the budget
period raises a question of the reasonableness of the payments. While
we recognize the potential for mischief arguably inherent in allowing a
grantee to simply spread among its employees all funds remaining at the
end of the year (see ACF Brief at 3), ACF has no published prohibition
against it (and, in fact, may have encouraged the practice here, as we
discuss below). Thus, we do not agree with ACF that distribution of all
remaining sums to all employees alone renders the payment amounts
unreasonable. Since ACF focused on group versus individual bonuses, ACF
did not develop the record in regard to whether simply splitting the
remaining funds produced an unreasonable expenditure. Consequently, we
think that ACF should have a limited opportunity to address whether the
bonus amount meets the requirement in the applicable cost principles
that costs not exceed what a prudent person would pay under the
circumstances. ACF must base any such determination on objective
standards, however.
Background
The following facts are not in dispute. Washington County implemented
its incentive compensation policy in 1989, pursuant to discussions with
ACF regarding the possibility of awarding bonus payments to its staff.
According to Washington County, a representative from ACF told
Washington County staff that bonuses could be awarded only if all
program activities had been completed, excess funds were available at
the end of the year, and Washington County's Personnel Policies and
Procedures manual included a bonus policy provision. Washington County
Brief (Br.) at 2. Accordingly, Washington County added a bonus
provision to its Personnel Policies and Procedures manual which stated
that "[a]t the end of the program year if there are funds that are not
committed - staff will be given a bonus." Washington County Exhibit
(Ex.) 3 at 18. Washington County subsequently submitted the policy to
ACF for approval. There is no indication in the record that ACF either
approved or disapproved the policy. 2/
In 1992, in accordance with a cost savings program implemented by the
Washington County Board of Directors, the staff made a commitment to
work hard and do its best to cut program costs. Washington County Br. at
3. According to Washington County, the employees made an exceptional
effort, and Washington County found itself unexpectedly with $107,497.00
in grant funds remaining at the end of the program year. Id.
Washington County attempted to use these funds to purchase modular
units; however, this was not possible since Washington County did not
receive the supplemental funding necessary to make the purchase. Thus,
in May of 1992, Washington County contacted another ACF representative
to verify that any bonus payments it might decide to make would be
allowable. Washington County asserted that the ACF representative told
the Washington County staff that Washington County could award bonus
payments if program funds were available and if its Personnel Policies
and Procedures manual provided for incentive awards. Washington County
Br. at 3-4. Accordingly, in June of 1992 the Washington County Policy
Council recommended to the Board of Directors that each employee receive
an organization-wide bonus in recognition of the fact that the staff had
"done an outstanding job with [the] children and Headstart as a whole."
Washington County Ex. 4 at 2 (June 23, 1992 Policy Council minutes).
The Board of Directors subsequently passed a motion to award bonus
payments, "based on performance," to each employee. Washington County
Ex. 5 at 2 (June 30, 1992 Board of Directors minutes). On July 17,
1992, bonuses in the amount of $562.81 were awarded to each of
Washington County's 191 employees. 3/ See Washington County Ex. 5 at
3-12. This amount ($562.81) multiplied by the number of bonuses awarded
(191), when rounded-off, equals the disallowance amount of $107,497.00,
which is all of the funds not expended for other program purposes.
Analysis
The disallowance was based on ACF's determination that the lump-sum
payments which Washington County made to its employees in 1992 were not
allowable incentive compensation. See ACF's disallowance letter dated
May 12, 1993. On appeal, Washington County argued that its incentive
compensation policy complied with all applicable laws and regulations
since the bonus payments were incentive-based and made pursuant to the
bonus policy included in its Personnel Policies and Procedures manual.
Moreover, Washington County contended that it consulted with ACF before
making the bonus payments.
The incentive compensation policy of OMB Circular A-122 states that --
Incentive compensation to employees based on cost reduction, or
efficient performance, suggestion awards, safety awards,
etc., are allowable to the extent that the overall compensation is
determined to be reasonable and such costs are paid or
accrued pursuant to an agreement entered into in good faith
between the organization and the employees before the services
were rendered, or pursuant to an established plan followed
by the organization so consistently as to imply, in effect, an
agreement to make such payment.
OMB Circular A-122, Att. B, 6(h) (emphases added).
In addition, under A-122, costs are also subject to the general
guidelines that they must be reasonable to be allowable. Reasonable cost
is defined in A-122 as follows:
A cost is reasonable if, in its nature or amount, itdoes 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.The
question of the reasonableness of specific costsmust be scrutinized with
particular care inconnection with organizations or separate
divisionsthereof which receive the preponderance of their support from
awards made by Federal agencies.
In determining the reasonableness of a given cost,consideration
shall be given to:
a. Whether the cost is of a type generallyrecognized as ordinary
and necessary for the operation of the organization or the performance
of the award.
b. The restraints or requirements imposed by such factors as
generally accepted sound businesspractices, arms length
bargaining, Federal andState laws and regulations, and terms and
conditions of the award.
c. Whether the individuals concerned acted with prudence in
the circumstances, considering their responsibilities to the
organization, itsmembers, employees, and clients, the public
atlarge, and the Government.
d. Significant deviations from the establishedpractices of the
organization which mayunjustifiably increase the award costs.
OMB Circular A-122, Att. A, A.3.
ACF asserted that the payments Washington County made to its employees
violated A-122 because they were not based on incentive. ACF alleged
that Washington County simply distributed the excess funds remaining at
the end of the program year, without any regard for staff performance,
based on a bonus policy in its Personnel Policies and Procedures manual
which did not include any requirement that bonuses be based on
"efficient performance," or include any method for calculating bonuses
on the basis of employee performance. Moreover, ACF argued that in
general, lump sum payments do not provide incentive since they are
one-time payments which have no effect on employee salaries and
consequently have no effect on the employees' future performance.
In addition, ACF argued that Washington County's payments were not based
on individual performance or achievements since every employee received
the same bonus amount regardless of his or her performance evaluation.
ACF Br. at 4. ACF noted that although Washington County furnished some
employee evaluations with its appeal, performance evaluations for some
employees were missing and other performance evaluations did not include
bonus recommendations. Id. at 3-4. ACF asserted that like the grantees
in Licking County Economic Action Development Study, DAB No. 1159
(1990), and Rural Day Care Association of Northeastern North Carolina,
DAB No. 1384 (1993), Washington County simply discovered at the end of
the program year that excess funds were available and decided to divide
these funds among its employees. According to ACF, Washington County's
actions not only violated the incentive compensation provision of A-122,
but also violated a provision of the Discretionary Grants Administration
Manual (DGAM) which ACF characterized as permitting only ACF, and not
the grantee, to decide what happens to "excess" funds. 4/ Since ACF
focused its analysis on whether the payments were incentive-based, ACF
did not make any finding as to whether the bonus amount was reasonable.
We conclude that the bonuses awarded by Washington County were in fact
incentive-based, as required by OMB Circular A-122. Although Washington
County's Personnel Policies and Procedures manual did not explicitly
require that bonuses be based on employee achievement, Washington
County's interpretation of its policy provision established that all
bonuses were incentive-based. Both the Board of Directors' minutes and
the Policy Council's minutes establish that Washington County decided to
award bonus payments because it believed that the entire staff's
performance merited a reward. Washington County Ex. 4; Ex. 5. ACF did
not dispute Washington County's statement that Washington County's staff
had committed itself at the beginning of the program year, at the
request of the Board of Directors in the wake of federal budget cuts, to
a cost-cutting program to alleviate a predicted funding shortfall.
Washington County Br. at 2-3. Thus, although the Board of Directors'
minutes simply express general approval of the staff's performance, it
is clear in context that the incentive awards were based in part on the
staff's successful cost-cutting efforts. Consequently, we conclude that
Washington County's bonus payments were in fact based on "efficient
performance," within the meaning of A-122.
We further conclude that the policy in Washington County's personnel
manual constituted a good faith agreement to pay incentive bonuses,
entered into before the services were rendered, as required by A-122.
Washington County clearly applied its policy in authorizing the
incentive payments. 5/ Although its incentive policy did not explicitly
provide a written formula for determining bonus eligibility and for
calculating bonus amounts, this was not significant here. The cost
principles do not require formula-based bonuses; since Washington County
paid every employee the same amount, it did not need to use a formula.
Furthermore, ACF's argument that lump-sum payments do not provide
incentive is without merit. A one-time payment which rewards employees
for their past performance is clearly incentive-based since anticipation
of similar awards can provide incentive for future performance. There
is no regulatory requirement that bonuses must be paid in increments in
order to be incentive-based. In addition, ACF's reliance on a statement
in one of our previous Board decisions, Licking County Economic Action
Development Study, DAB No. 1159 (1990), is misplaced. ACF relied on the
Agency's finding in Licking County that "a one-time lump-sum payment
would not have a practical positive effect on the compensation level of
the Grantee's employees in ensuing years." This statement, however,
must be read in the context of the parties' arguments in that case.
Licking County argued that it gave one-time payments to its employees in
order to attract qualified staff, and the Agency made the above
statement in response, in order to point out that because one-time
lump-sum payments did not affect employee salaries, they were not
necessary to attract qualified employees. Thus, it is clear that ACF's
reliance on the statement in Licking County was misguided.
We also find that because Washington County gave organization-wide
bonuses based on the staff's overall performance, individual performance
evaluations were irrelevant. The personnel policy did not require
consideration of individual performance evaluations. As discussed
above, Washington County gave organization-wide bonus payments to reward
the staff for its cost-cutting achievements and for its overall
performance with the Head Start children. It was reasonable, therefore,
that each employee bonus was for the same dollar amount, without regard
to individual performance evaluations.
Moreover, we disagree with ACF's apparent position that an
organization-wide bonus cannot constitute incentive compensation. 6/
There is nothing in the language of the incentive compensation provision
of OMB Circular A-122 which specifically requires that bonus payments be
based only on individual performance. Also, ACF never cited any
regulation or published policy interpretation which stated that bonus
payments had to be based on individual performance. Indeed, during the
telephone hearing in this case, counsel for ACF mentioned that some
group bonus awards may have been allowable if they had been based on the
performance of individual facilities in Washington County's Head Start
program. This position is consistent with our conclusion that A-122
does not limit incentive payments to payments recognizing individual
achievements. We see no basis for a distinction between awards to
employees of individual facilities operated by Washington County and
awards to all Washington County employees.
Even if it were reasonable to interpret A-122 as permitting only
incentive compensation based on individual performance, ACF cannot
disallow the incentive payments in question here based on such an
interpretation, since it is well-established that a grantee cannot
fairly be held to an agency interpretation of which it does not have
timely notice where there is another reasonable interpretation relied on
by the grantee. 7/ Illinois Department of Children and Family Services,
DAB No. 1335 (1992); see California Department of Health Services, DAB
No. 1285 (1991), at 9, citing Commonwealth of Pennsylvania, Dept. of
Public Welfare v. The United States Department of Health and Human
Services, 928 F.2d 1378 (3d Cir. 1991); see also the Administrative
Procedure Act, 5 U.S.C. 552(a)(1) (1970) (which provides that if an
agency interpretation of general applicability has not been published in
the Federal Register, it may adversely affect a party (other than the
agency), only if "the party has actual and timely notice of the terms
thereof").
We also find that this appeal is factually distinguishable from Licking
County and Rural Day Care, in which the Board upheld the disallowances
at issue. Unlike Washington County, the grantee in Rural Day Care did
not have any incentive compensation policy in effect when it paid bonus
payments to its employees. In Licking County, the grantee did have a
bonus policy in effect; however, its bonus payments were based on
position and seniority, rather than incentive. In contrast, Washington
County gave bonuses to all of its employees, regardless of position or
seniority, in reward for the staff's overall performance. This case is
also distinguishable from Seaford Community Action Agency, DAB No. 1433
(1993). In Seaford, a portion of the disallowance was upheld because
some of the grantee's bonus awards did not conform to its incentive
compensation policy. Unlike the bonuses in Seaford, however, all of
Washington County's bonus payments were consistent with a reasonable
reading of its bonus policy. 8/
We also find unpersuasive ACF's argument that pursuant to certain HDS
manual provisions, Washington County did not have any authority to
decide how to use the "excess" funds which it spent for the incentive
payments. The provisions which ACF cited (2 and 3 of section I of the
DGAM at 1-7, 1-8) are inapplicable to the facts of this case because
they address the expenditure of funds that remain unobligated after the
end of a program year. The funds at issue here were bonuses approved by
Washington County's Board of Directors in accordance with its personnel
policy prior to the end of its program year. The provisions cited by
ACF make it clear that expenditures for personnel compensation are
allocable to the time the services are rendered. Consequently, whether
the bonus expenditure was allowable is governed by the applicable cost
principles of OMB Circular A-122, which ACF cited in its disallowance
letter, not the provisions for excess funds.
ACF also argued that the bonus payments did not comply with A-122's
requirement that all costs must be "reasonable, ordinary and necessary"
because there were other, more important uses for these funds. See OMB
Circular A-122, Att. A, A.3. ACF argued that Washington County should
have used the excess funds to improve its services to the children or to
enhance its facilities.
There is no evidence in the record, however, to support this argument.
Employee performance is critical to operation of a good Head Start
program, and the cost principles recognize incentive compensation
generally as an allowable cost. Thus, we conclude that payments of
bonuses generally can be considered to be reasonable, ordinary and
necessary for a Head Start grantee. Moreover, ACF did not allege that it
had suggested to Washington County, before the employee bonuses were
authorized by the Board of Directors, that there were other, more
important, uses for these funds. Although, as previously indicated,
Washington County tried to use the money to purchase modular units for
its program, ACF apparently decided that such a purchase was not
sufficiently important to warrant supplemental funding at that time. In
addition, the record indicated -- and ACF did not dispute -- that the
funds were available as a result of Washington County's efforts to
operate its program more efficiently, and thus were not attributable to
any failure by Washington County to expend all grant funds necessary to
carry out its program. See Washington County Br. at 2-3; Transcript of
12/6/93 Hearing at 34. Moreover, although Washington County had an
incentive compensation policy in effect in 1989, it did not make any
incentive payments until 1992. There was no evidence here of a pattern
of Washington County awarding bonus payments at the end of the year,
which might suggest that it deliberately failed to expend all program
funds for budgeted items.
On the other hand, while there is no indication in the record here that
Washington County shortchanged its program in order to have a large pool
of money to fund bonuses, the fact that the amount of the bonuses was
apparently determined by dividing the available funds calls into
question whether the amount of the bonuses was reasonable. Since the
ACF representative whom Washington County contacted before issuing the
bonus payments simply stated that bonuses could be paid as long as there
were program funds available and the Personnel Policies and Procedures
manual provided for incentive awards, it is not surprising that
Washington County distributed all of the funds remaining at the end of
the program year equally among its employees. The record does not
contain any evidence as to the factors which Washington County
considered, if any, in arriving at the $562.81 bonus amount. Since ACF
based its disallowance determination primarily on its position that the
cost principles prohibit organization-wide bonuses, it failed to focus
on whether the bonuses were reasonable in amount. Washington County
argued that the amounts paid were reasonable since the level of pay that
comparable workers in the geographic area earned was not exceeded. ACF
did not dispute the allegation that the total compensation amount was
not excessive. There is no indication, however, that ACF considered
whether a prudent person would have paid a bonus of $562.81 under the
same circumstances, in accordance with OMB Circular A-122, Att. A, A.3.
This provision states that a cost is reasonable, either in nature or
amount, if "it does not exceed that which would be incurred by a prudent
person under the circumstances."
Accordingly, while we overturn the disallowance as it is currently
framed, our decision does not preclude ACF from examining further the
reasonableness of the $562.81 bonus amount, using the standard set out
in OMB Circular A-122, Att. A, A.3, i.e., whether the bonus payment was
an amount which a prudent person would pay under the same circumstances.
ACF may consider, among other factors, Washington County's compensation
levels, the compensation levels of comparable workers in the same
geographic area, bonuses of similarly situated organizations, and
whether Washington County paid any other bonuses to its employees.
Conclusion
Based on the foregoing analysis, we find that Washington County's
payments to its employees were, in principle, bonus payments which
satisfied the cost principles on incentive compensation. We also find
that ACF is not precluded from considering whether it was reasonable for
Washington County to award bonuses in the amount of $562.81 from
end-of-year funds to all persons in the organization. Accordingly, we
reverse the entire disallowance of $107,497.00, without prejudice to
ACF's further consideration of whether the bonus amount was reasonable.
ACF is not precluded from finding that a portion of the bonus is
unreasonable, but ACF should explain the basis for such a finding. ACF
should complete its assessment and issue any revised disallowance within
60 days; Washington County may appeal any disallowance determination
within 30 days of its receipt.
___________________________ Judith A.
Ballard
___________________________ Cecilia
Sparks Ford
___________________________ M. Terry
Johnson Presiding Board Member
1. OMB Circular A-122 sets out the cost principles for non-profit
organizations such as Washington County. The Circular is made
applicable to Department of Health and Human Services (DHHS) grants by
45 C.F.R. 74.174(a) (1992), and by Head Start regulations at 45 C.F.R.
1301.10.
2. Washington County did not state whether it specifically asked for
approval of its changed policy or whether it simply submitted the entire
personnel policy manual with its annual application for refunding.
Although ACF stated that it did not usually approve or disapprove a
grantee's personnel policies, we expect that ACF could assist Washington
County in clarifying its policy, if Washington County should decide to
do so as a result of this disallowance proceeding.
3. The minutes of the Board of Directors' June 30, 1992 meeting
indicated that there were two recommended bonus amounts: $562.81 and
$565.81. The Board adopted the recommendation for a $565.81 bonus;
however, the list of employee incentive awards indicates that the
employees received awards for $562.81. This discrepancy was brought to
the attention of a Washington County representative during the telephone
hearing in this case; however, since he was not clear which bonus amount
was awarded, we have accepted the $562.81 amount in the list of employee
incentive awards as the amount awarded to each employee.
4. The DGAM was issued by the Office of Human Development Services
(OHDS), one of the DHHS agencies combined in 1991 to form ACF.
5. Washington County also argued that it had a good faith agreement
with its employees to award bonuses when funds were available, apart
from the written policy in its personnel manual. There is no evidence
that Washington County's long-standing promise to award such bonuses was
any more explicit than its written policy, however.
6. In our view, organization-wide bonuses can reasonably qualify as
incentive compensation since efficient performance and cost reduction
can be achieved through group as well as individual efforts. In fact,
many organizations, including the federal government, have policies
authorizing awards to all members of a group based on the group's
overall performance.
7. Washington County argued that ACF could not disallow the bonus
payments because it approved Washington County's incentive compensation
plan on more than one occasion. ACF contended that even if it did tell
Washington County's staff that its bonus provision was acceptable,
estoppel against the government would not work in this instance. It is
not necessary for us to consider this estoppel argument, however, since
we find that Washington County's payment of an organization-wide bonus
complied with applicable cost principles and was a reasonable
interpretation of its written incentive policy. It is worth noting,
however, that there is generally no estoppel against the federal
government. See Office of Personnel Management v. Richmond, 496 U.S.
414 (1990), reh'g denied 497 U.S. 1046 (1990); see also Heckler v.
Community Health Services of Crawford County, Inc., 467 U.S. 51 (1984).
8. ACF distinguished this case from Seaford as well; however, it
based its distinction on the fact that the grantee in Seaford, unlike
Washington County, based its allowable bonus payments on a formula which
took employee performance ratings, salary and length of employment into
account. As noted earlier, however, since Washington County's payments
are allowable organization-wide bonuses, there was no need for them to
be based on an incentive