Department of Health and Human Services
DEPARTMENTAL APPEALS BOARD
Appellate Division
SUBJECT: P.R.I.D.E. in Logan County, Inc.
DATE: June 4, 1997
Docket No. A-97-14
Decision No. 1618
DECISION
P.R.I.D.E. in Logan County, Inc. (PRIDE), appealed a
determination by the Administration for Children and
Families (ACF) disallowing $53,559 in rental payments
charged to the Head Start program for the four years
ending December 31, 1995. The basis for the disallowance
was ACF's finding that the rental payments violated cost
principles set forth in Office of Management and Budget
(OMB) Circular A-122 in that the lease agreement pursuant
to which the rental payments were made constituted a
less-than-arms-length transaction.
For the reasons discussed below, we find that the lease
agreement constituted a less-than-arms-length transaction
as set forth in OMB Circular A-122. Accordingly, we
sustain the disallowance.
Background
PRIDE has been the recipient of a grant from ACF to
provide Head Start services to children in Logan County,
West Virginia, since 1964. Beginning in 1980, PRIDE was
allowed to use certain property at no cost by the Logan
County Board of Education. In 1991, PRIDE learned that
the Board of Education property PRIDE was using was going
to be sold at a public auction in February 1992.
On January 27, 1992, PRIDE's Board of Directors
authorized and consented to the creation of a separate
and independent non-profit corporation to be called the
P.R.I.D.E. in Logan County Foundation, Inc. (Foundation).
ACF Exhibit (Ex.) A. The Foundation was established on
February 14, 1992, and formally incorporated by the State
of West Virginia on February 18, 1992. PRIDE Ex. 3. One
of the purposes for which the Foundation was formed was
to buy the Board of Education property used by PRIDE.
PRIDE Brief at 2. Also on February 14, 1992, PRIDE and
the Foundation entered into a ten-year lease, under which
PRIDE would rent the property at a cost of $5,000 per
month. ACF Ex. E. On February 25, 1992, the Foundation
purchased the property for $150,000. ACF Ex. D.
Regulations at 45 C.F.R. § 74.174 (1991) provide that
non-profit organizations such as PRIDE that receive Head
Start funds are subject to the cost principles set forth
in OMB Circular A-122. 1/ OMB Circular A-122 provides
a uniform set of cost principles for determining costs of
grants, contracts, and other agreements and is designed
to promote efficiency and understanding between non-
profit grantees and the federal government. It provides
guidance on allowable direct costs and allocable indirect
costs, as well as guidance on specific cost items.
As applicable to the issue in dispute here, OMB Circular
A-122 provides that --
[r]ental costs under less-than-arms-length leases
are allowable only up to the amount that would be
allowed had the title to the property vested in the
organization. For this purpose, a less-than-arms-
length lease is one under which one party to the
lease agreement is able to control or substantially
influence the actions of the other. Such leases
include, but are not limited to those between (i)
divisions of an organization; (ii) organizations
under common control through common officers,
directors or members; and (iii) an organization and
a director, trustee, or officer or key employee of
the organization or his immediate family either
directly or through corporations, trusts, or similar
arrangements in which they hold a controlling
interest.
OMB Circular A-122, Attachment B., 42.c.
Discussion
In ACF's determination disallowing $53,559 in rental
costs claimed by PRIDE, 2/ ACF pointed to the following
facts for its conclusion that the lease between PRIDE and
the Foundation was a less-than-arms-length transaction as
prohibited by paragraph 42.c of OMB Circular A-122:
o On January 27, 1992, PRIDE's Board of Directors
authorized and consented to the formation of the
Foundation. ACF Ex. A.
o One of the three directors of the Foundation was
the brother of PRIDE's Executive Director.
o The Articles of Incorporation for the Foundation
were prepared by the Deputy Director of PRIDE
and notarized by PRIDE's Executive Director. ACF
Ex. B.
o The Articles of Incorporation for the Foundation
stipulated that the Foundation would promote
social welfare "in a manner directly consistent
with and in support of the goals, objectives,
mission, work, programs and philosophy of [PRIDE]
. . ." Id. at 2.
o On the day the Foundation was formed, but before
it was a legal entity, it entered into a lease
agreement with PRIDE for the property at a
monthly rental of $5,000.
PRIDE Ex. 1, at 1.
In disputing ACF's conclusion, PRIDE argued that under
paragraph 42.c of OMB Circular A-122 the factors which
are determinative of the existence of a less-than-arms-
length transaction are the ability by one organization to
control or substantially influence another organization.
PRIDE asserted that the allegations in ACF's
disallowance determination do not support a finding that
either PRIDE or the Foundation had control of or
substantial influence over the actions of the other.
In denying that either organization had control over the
other, PRIDE contended that none of the three situations
described in paragraph 42.c which indicate such control
were present in this case: 1) PRIDE and the Foundation
were not divisions of the same organization, but rather
two separate corporate entities; 2) PRIDE and the
Foundation had separate corporate structures, with no
common officers, directors, or members; and 3) while one
of the three directors of the Foundation was the brother
of PRIDE's Executive Director, there is no evidence that
the brother controlled the Foundation.
PRIDE further discounted the import of the fact that
PRIDE's Executive Director signed the incorporation
papers of the Foundation. PRIDE stated that under West
Virginia law an incorporator of an organization has a
minor role, limited to signing and delivering the
articles of incorporation to the Secretary of State.
Similarly, PRIDE argued, the fact that an officer of
PRIDE and a director of the Foundation were brothers is
not evidence that one organization could control the
other. PRIDE additionally disputed that any of the other
"facts" cited by ACF, such as the wording of the
Foundation's Articles of Incorporation, constitutes
evidence that PRIDE controls the Foundation.
As to the question of whether PRIDE exerted substantial
influence over the Foundation, PRIDE asserted that the
facts alleged by ACF are not pertinent to the issue of
"substantial influence." PRIDE asserted that there is no
evidence that the relationship of the brothers led to any
intimate involvement by either brother in the activities
of the other brother's organization. PRIDE further
contended that, notwithstanding the minimum clerical
support PRIDE provided the Foundation in completing the
incorporation procedures of the Foundation, ACF has not
provided any evidence that PRIDE continued to provide
assistance to the Foundation or exerted any influence
over it. PRIDE disputed that it had influence over the
Foundation simply because the Foundation's Articles of
Incorporation state its goals as being identical to those
of PRIDE's, arguing that any social welfare program could
receive support from the Foundation.
PRIDE summarized its position by contending that ACF,
both in its disallowance determination and in its brief,
failed to allege any relevant facts to support its
finding regarding the disallowance. PRIDE accordingly
requested that the Board dismiss this appeal for failure
by ACF to state a claim.
We decline to grant PRIDE's request. It is evident that
ACF, in reaching its conclusion that the lease between
PRIDE and the Foundation was a less-than-arms-length
transaction, did not base its determination on any single
uncontroverted fact that established that one
organization had the ability to control or substantially
influence the other, but rather on a series of events
concerning the relationship between PRIDE and the
Foundation. Such an approach was sanctioned by the Board
in Enterprise for Progress in the Community, Inc., DAB
No. 1558 (1996) (EPIC), in which the Board found that the
"totality of the overall relationship" between two
organizations supported a finding of substantial
influence. EPIC at 7. In EPIC, as is the case here, a
Head Start grantee helped in the establishment of a
foundation, which subsequently purchased property and
leased the property to the Head Start grantee. In
examining the relationship between the Head Start grantee
and the foundation, the Board looked at such items as the
minutes of the foundation, the coordination of activities
between the organizations, the foundation's sources of
income, and the use of the grantee's personnel to perform
many of the foundation's functions. 3/
Here we do not have any minutes of the Foundation in the
record before us or any evidence about the sources of the
Foundation's income. ACF has asserted that PRIDE
personnel played a role in the incorporation of the
Foundation, but we do not consider that particularly
probative of whether PRIDE personnel played a role in the
daily management of the Foundation. We do, however, have
the Foundation's Articles of Incorporation. PRIDE Ex. 3.
These Articles of Incorporation state that one of the
purposes of the Foundation is --
F. TO promote and support the social welfare of
needy and poor people by undertaking all of the
above-described purposes in a manner directly
consistent with and in support of the goals,
objectives, mission, work, programs and philosophy,
of P.R.I.D.E. IN LOGAN COUNTY, INC. . . . and its
community action programs in Logan County, West
Virginia, exclusively.
Emphasis added. The Articles of Incorporation further
provide that the Foundation "shall exclusively use
[PRIDE] . . . as the vehicle of execution and delivery,
in its service to the public." II. B. Additionally,
the Articles of Incorporation provide that, if the
Foundation dissolves, all of its assets should be donated
exclusively to PRIDE. II. E.
These provisions of the Foundation's Articles of
Incorporation call into question PRIDE's assertion that
it could not control or have substantial influence over
the Foundation. The Foundation bound itself to the goals
and work of PRIDE exclusively. The Foundation declared
that PRIDE would be the exclusive means of its delivery
of services to the public. Again, if the Foundation were
to cease operations, all its assets would go PRIDE
exclusively. In other words, without PRIDE, the
Foundation would have no independent basis for its
existence. Under these provisions, it is difficult to
conceive that PRIDE would not have substantial influence
over the Foundation.
PRIDE's contention that none of the three types of a
less-than-arms-length transaction listed in paragraph
42.c was present in its relationship with the Foundation
overlooks the fact that these are examples of less-than-
arms-length leases cited in that paragraph and are not
exclusive. The paragraph plainly states that "[s]uch
leases include, but are not limited to" the cited three
examples. EPIC at 7. An organization such as the
Foundation whose Articles of Incorporation clearly tie
the organization to another organization exclusively
would certainly fall within the parameters of paragraph
42.c.
Additionally, other factors establish the influence PRIDE
could have over the Foundation. In Salt Lake City
Community Action Program, DAB No. 1261 (1991) (SLCAP),
the Board examined a Head Start grantee's leases for two
buildings. Among the factors the Board found as
indications that the leases were less-than-arms-length
transactions were the lack of independent organizational
purpose of the lessor ("The record contains no evidence
that [the lessor] had any purposes or interest
independent of [the grantee].") and the coordination of
activities between the two organizations. SLCAP at 4.
In regard to the latter factor, the Board noted that the
lessor was incorporated three days before the purchase of
a building, the grantee assigned the building to the
lessor less than a month after it purchased the property,
and then entered into a lease agreement less than two
months after the assignment. The Board found that
"[t]hese activities were unlikely to have been so closely
timed unless they were part of a coordinated plan by the
organizations which exerted substantial influence over
each other." Id.
Both of these factors are present in this case. As noted
above, the Foundation's purpose, as stated in its
Articles of Incorporation, was to promote social welfare
"in a manner directly consistent with . . . [PRIDE] . . .
exclusively." Moreover, here the timeframe for the
creation of the Foundation, the purchase of the property,
and the lease agreement with PRIDE was even more
compressed than in SLCAP. The Foundation was established
on February 14, 1992, and that very day the Foundation
entered into a lease agreement with PRIDE, some 11 days
before the Foundation even purchased the property that
was the subject of the lease. It is reasonable to infer
from these circumstances that there existed, as in SLCAP,
a "coordinated plan" by PRIDE and the Foundation.
Throughout this proceeding, PRIDE contended that the test
ACF was obliged to meet was whether ACF provided evidence
that one organization controlled or substantially
influenced the other. However, OMB Circular A-122 states
the standard as one where one organization "is able to
control or substantially influence" the other. The Board
noted in EPIC that "[t]he cost principles are designed
not merely to cover situations where there has been
abuse, but also situations where there would be potential
for abuse." EPIC at 10.
PRIDE argued that the fact that two organizations engage
in business transactions designed to foster the goals of
each organization is not convincing evidence that a less-
than-arms-length relationship exists between the
organizations. For this proposition, PRIDE cited Home
Education Livelihood Program, Inc., DAB No. 1598, at 9
(1996) (HELP). In HELP, the Board found that a Head
Start grantee and a lessor had not engaged in a less-
than-arms-length transaction. What distinguished that
case from EPIC and SLCAP, where the organizations
providing facilities for lease to the Head Start programs
had no other purpose other than to supply facilities to
Head Start, was that the lessor in HELP was an
independent organization whose leasing of Head Start
facilities was a very minimal part of its business. HELP
at 13. Here we have no record of any activity undertaken
by the Foundation other than its leasing of the property
to PRIDE. PRIDE did not develop any facts showing that,
for the four years at issue here, the Foundation became
more independent or fostered a broader corporate purpose.
Thus, the Board's decision in HELP is clearly not
applicable to the facts of this appeal.
Conclusion
For the reasons discussed above, we find that a less-
than-arms-length relationship existed between PRIDE and
the Foundation, and we accordingly sustain the
disallowance of $53,559.
________________________
Cecilia Sparks Ford
________________________
Donald F. Garrett
________________________
M. Terry Johnson
Presiding Board Member
* * * Footnotes * * *
1. This regulation was amended in 1994 and the comparable
provision now appears at 45 C.F.R. § 74.27(a).
2. The disallowance amount was based on ACF's calculation
of what PRIDE would have been able to claim for the costs of the
property allocable to the Head Start program in the years 1992
through 1995 if PRIDE had actually owned the property and
depreciated it at the allowable rate of 31.5 years. PRIDE did not
challenge ACF's calculation.
3. In EPIC, the Board further stated that the issue of the
reasonableness of the rental costs on the leased property was not a
determinative factor under the cost principles of OMB A-122. In
EPIC the grantee had argued that the rent for the property was well
below fair market value. There has been no argument in the instant
case on whether the rental costs charged by the Foundation to PRIDE
were in excess of fair market value.