Iowa Department of Human Services, DAB No. 1340 (1992)

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