GAB Decision 763
July 8, 1986
University of California;
Docket No. 85-244
Ford, Cecilia S.; Teitz, Alexander G. Ballard, Judith A.
The University of California appealed a decision by the Public Health
Service (PHS) disallowing $24,541.85 claimed by the University as part
of the indirect costs of a National Cancer Institute grant for the
period July 1, 1978 through June 30, 1980. The University's claim was
based on the application of its indirect cost rate for on-campus
organized research to patient care costs incurred at the UCLA Medical
Center, a facility owned and operated by the University. /1/ PHS
disallowed the costs based on the opinion of the Division of Cost
Allocation (DCA) that the Negotiation Agreement establishing that rate
excluded such patient care costs from the base to which the rate was to
be applied in determining the indirect costs of any grant or contract.
/2/ The University argued that the Agreement excluded from the base only
certain patient care costs purchased from a third party, not patient
care costs incurred at a University-owned facility. Neither party
produced any contemporaneous documentation stating what the language in
the Agreement was intended to mean at the time it was drafted.
(2)$% For the reasons discussed below, we conclude that the
University's
reading of the Negotiation Agreement is more consistent with the
plain
meaning and structure of the Agreement than the reading on which
PHS
based the disallowance. Moreover, the University provided evidence
that
it included patient care costs incurred at University-owned
facilities
in the base at the time the rate specified in the Agreement
was
calculated. PHS provided no evidence that these costs were not
included
in the rate calculation, nor did PHS provide any compelling reason
why
they should not have been. Accordingly, we reverse the
disallowance,
except to the extent noted in footnote 1 above. /3/
Background
An indirect cost rate is the ratio, expressed as a percentage,
between
indirect costs and a direct cost base. The indirect cost rate
is
applied to individual grant and contract awards to determine the
amount
of indirect costs chargeable to the awards. Generally, the
direct costs
of the grant or contract to which the rate is applied are the
same as
the costs included in the base used to calculate the rate. PHS
did not
dispute that this was true in this case, where the Negotiation
Agreement
establishing the rate in question defined the base for application
of
the rate as--
Total Direct Costs Less:
1. expenditures for equipment,
2. expenditures over $50,000 on single Subcontracts with
parties
outside the University,
3. single purchases from third parties over $50,000
for
hospitalization and other expenditures related to patient care, and
4. expenditures for alterations and renovations.
Language of the Agreement
PHS argued that item 3 of the base definition in the Negotiation
Agreement
contained two separate exclusions from total direct costs: (1)
"single
purchases from third parties(3) over $50,000 for
hospitalization," and (2)
"other expenditures related to patient care."
PHS maintained that all but the
first $50,000 of any purchase of patient
care from a third party and all
patient care costs incurred at a
grantee-owned facility were thereby excluded
from the base. The
University disputed this interpretation. In
the University's view, this
provision was properly read to exclude from the
base only the former and
not the latter costs. The University argued
that this provision
paralleled item 2, which also addressed a single cost
element purchased
from a specific source.
We find that the University's reading of item 3 is more consistent
with
the wording of the provision. PHS's attempt to treat "single
purchases
from third parties over $50,000 for hospitalization" and
"other
expenditures related to patient care" as two separate provisions
is
questionable in light of the definition in the 1976 PHS Grants
Policy
Statement of "patient care" as "routine and ancillary medical
services
on either an inpatient or outpatient basis." (Appellant's Ex. G)
Under
this definition, "hospitalization" is a part of "patient care,"
whereas
PHS's reading of item 3 treats "hospitalization" as synonymous
with
"patient care costs." The University's reading of item 3, on the
other
hand, is consistent with this definition, since it
treats
"hospitalization" as a part of "patient care."
Moreover, as the University's argument suggests, the University's
reading
of item 3 as excluding only one cost element from the base is
consistent with
the overall structure of the base definition, since
every other item clearly
excludes only one cost element. The absence of
a comma preceding "and
other expenditures related to patient care" also
indicates that that clause
was not intended as a separate exclusion.
The University's reading of the disputed provision is also consistent
with
the language of the Negotiation Agreement dated may 27, 1973
defining the
base for the year ended June 30, 1975 as excluding from
total direct
costs:
expenditures over $50,000 (for) single purchases from third
parties
of hospitalization and other services related to patient care.
This differed from the language in dispute here in its use of the
phrase
"other services related to patient care" rather than "other
expenditures
related to patient care." (Emphasis added.) The Agency stated
that there
was no evidence that the change from "services" to "expenditures"
was
significant. (Tape of May 6, 1986 telephone conference call) This
tends
to undercut the Agency's position that the reference in the
later
version to "other expenditures related to patient care" is a(4)
separate
exclusion paralleling "single purchases from third parties" since
there
is no such parallel construction in the earlier version, which
the
Agency concedes was essentially the same.
Ambiguities in Language Construed Against Drafter
Both parties argued that, in accordance with general contract
principles,
any ambiguity in the language of the base definition should
be construed
against the drafter, which PHS contended was the University
and the
University contended was DCA. In support of its position, PHS
submitted
a letter dated March 30, 1973 from the University to the
Division of Cost
Policy and Negotiation (now DCA) forwarding a draft
Negotiation Agreement
containing essentially the same language disputed
here. (Respondent's
Ex. F)
The University, however, argued that the draft Agreement was most
likely
the product of on-going negotiations and not submitted without
the
advice of DCA. Without additional evidence showing the context in
which
the draft Negotiation Agreement was sent, we cannot make any finding
as
to which party was the author of the disputed language. Such a
finding
is unnecessary, however, in view of our conclusion, discussed
above,
that the language of the Negotiation Agreement does not support
PHS's
interpretation.
Actual Calculation of Rate
In view of the identity between the base to which the rate is applied
and
the base used to calculate the rate, the Board suggested that it
appeared to
be relevant what direct cost base was used in actually
calculating the rate
shown in the Negotiation Agreement. (Letter to
parties dated February
6, 1986) If patient care costs incurred at the
UCLA Medical Center were
included in the base used to calculate the
rate, the Board believed that this
might indicate that, at the time the
Agreement was entered into, both parties
interpreted the disputed
language as excluding from the base only purchases
of patient care from
a third party in excess of $50,000. Conversely, if
patient care costs
incurred at the UCLA Medical Center were not included in
the base used
to calculate the rate, this would mean that the parties
originally
intended the disputed language to exclude these costs as well.
The University subsequently submitted documentation which showed that
only
third-party patient care costs over $50,000 were specifically
excluded from
the base used to calculate the rate. (University's letter
dated March
4, 1986, Ex. A-C) The documentation also established that
under the
University's accounting system, other patient care costs would
have been
included in the base. (University's letter dated June 17, (5)
1986,
Att. B) In addition, the documentation traced one specific item of
patient
care costs incurred at the UCLA Medical Center from the
University's general
ledger to the costs ultimately included in the
base. (Id., Att. A) The
Agency provided no contradictory evidence.
Instead, the Agency merely stated
that it was not convinced that
$1,206,255 identified in the documentation as
third-party patient care
costs over $50,000, and shown as an exclusion from
the base used to
calculate the rate, did not in fact contain costs incurred
at the UCLA
Medical Center as well. The Agency's basis for questioning
the
composition of the $1,206,255 was the "substantial amount" involved
and
the lack of comparable exclusions from the base for the
University's
contention with respect to how the rate was calculated absent
"cost data
providing a detailed buildup to the $1,206,255 exclusion. . . ."
It
noted that the University had objected to this request as
unduly
burdensome. (Agency's memorandum dated June 23, 1986)
We find that additional information in support of the
University's
contention is unnecessary. The Board initially asked both
parties to
provide evidence regarding whether the patient care costs at issue
here
were included in the direct cost base used to calculate the
applicable
indirect cost rate. (Letter to parties dated February 6, 1986)
The
Agency provided no evidence of its own, merely challenging
the
sufficiency of the University's evidence. In view of the
Agency's
posture with respect to this issue, its unsupported speculation that
the
$1,206,255 exclusion is not what the documentation on its face shows
it
to be does not call that documentation into question. Accordingly,
we
find that patient care costs incurred at the UCLA Medical Center
Care
were included in the base used to calculate the rate. /4/
(6)
The Agency nevertheless argued that even if the disputed patient
care
costs were included in the base used to calculate the rate, this
would
not be probative of the parties' understanding of the base definition
in
the Negotiation Agreement since DCA asserted that it had not been
aware
of the components of the base at the time the rate was calculated
but
had merely accepted the base figure given by the University. (Tape
of
May 6, 1986 telephone conference call) /5/ While the University did
not
rebut DCA's assertion, we think that the actual rate calculation
does
have some bearing on the issues here. As a party to the Agreement,
DCA
clearly bore some responsibility for assuring that the rate
was
calculated in a manner consistent with the Agreement. If including
such
costs in the rate calculation was patently inconsistent with
the
Agreement, it is arguable that DCA would have detected that
before
signing the Agreement. Moreover, the fact that these costs
were
included in the base shows that the University's current
interpretation
of the base definition in the Agreement reflects its original
intent.
Thus, the fact that the rate calculation included these patient
care
costs further supports our conclusion that the
University's
interpretation of the disputed language is the one that ought to
be
applied here.
In addition, given that the rate was calculated initially by
including
the disputed patient care costs, it would be inequitable to
preclude the
University from applying that rate to direct costs which
included these
patient care costs; otherwise, the University could not
fully recover
its indirect costs.
Rationale for Exclusion of Patient Care Costs
PHS also contended that it was appropriate to exclude most patient
care
costs from the base used to calculate the rate, and hence from the
base
to which the rate is applied, because these costs did not generate
a
significant amount of indirect costs. According to PHS, the
first
$50,000 of patient care services purchased from a third party
could
reasonably be(7) included in the base because of the
administrative
effort associated with the negotiation, execution and
administration of
a contract for such services. PHS asserted, however, that
the inclusion
of any additional patient care costs in the base would distort
the
indirect cost allocation process by drawing a disproportionate amount
of
indirect costs to patient care.
PHS did not specifically relate its argument to the interpretation of
the
Negotiation Agreement; however, if there had been some rationale
for
excluding the costs in question from the base at the time the rate
was
negotiated, this would tend to support PHS's interpretation of the
Agreement
as excluding the costs. The University responded that there
was no
evidence supporting PHS's contention that patient care costs
generated no
significant indirect costs. It argued, moreover, that it
is inherent in
the indirect cost allocation process that some projects
will be allocated
more than the amount of indirect costs they actually
generated while other
projects will be allocated less.
The rationale advanced by PHS for the exclusion from the base of
patient
care costs -- except those associated with single purchases from
third
parties up to $50,000 -- has some merit. While indirect cost
rates are
useful precisely because the amount of indirect costs generated by
each
project cannot be specifically identified, the cost principles
state
that indirect costs must be distributed to various activities
"in
reasonable proportions consistent with the nature and extent of the
use
of the institution's resources. . . ." Federal Management Circular
73-8,
(now OMB Circular A-21), Attachment A, E.2.b) Thus, the exclusion
of
patient care costs from the base used to calculate the rate would
have
been appropriate if DCA had determined that including them would
result
in their being allocated a disproportionate share of indirect
costs.
There has been no showing that DCA made any such determination
before
the Negotiation Agreement was entered into, however. We cannot
find
that the Agreement excluded the patient care costs at issue
simply
because their exclusion might have been appropriate under
circumstances
not found by DCA to exist at the time the Agreement was entered
into.
PHS further noted, however, that the University was reimbursed through
its
patient care rate for certain overhead costs associated with patient
care
provided at the UCLA Medical Center. PHS took the position that
this
showed that patient care costs received more than their fair share
of
indirect costs, although it acknowledged that the indirect costs in
dispute
here did not duplicate costs recovered through application of
the patient
care rate. (Tape recording of May 6, 1986 telephone
conference call)
However, since there was no duplication, the fact that
the University
recovered overhead costs for patient care through both a
patient care rate
and an(8) indirect cost rate does not show that
patient care received a
disproportionate amount of indirect costs. The
existence of the patient
care rate thus fails to show that there was a
reasonable basis for excluding
the disputed patient care costs from the
base at the time the Negotiation
Agreement was entered into (which would
have supported PHS's interpretation
of the Agreement).
Applicability of the Cost Principles
PHS asserted that it has been the long-standing policy of the
government,
as codified in the cost principles, to exclude patient care
costs from the
base for calculating the indirect cost rate (and hence
from the base to which
the rate is applied). Since it is unlikely that
the Negotiation
Agreement in question here would have defined the base
in a manner
inconsistent with the cost principles, the Agency's
assertion, if true, would
tend to support its interpretation of the
Agreement. PHS noted that
from 1967 through March 1979, the cost
principles specified a base of
salaries and wages, which would by
definition exclude patient care
costs. (See Federal Management Circular
73-8, Attachment A, G.2) PHS
further noted that the cost principles in
effect since March 1979 specify a
base of modified total direct costs,
consisting of salaries and wages, fringe
benefits, materials and
supplies, services, travel, and subgrants and
subcontracts up to $25,000
each. (See OMB Circular A-21, Attachment
A. G.2.) An interpretation of
this provision issued by the Department
of Health, Education and Welfare
(the predecessor of HHS) on December 11,
1979 stated that the term
"services" includes all services "except those that
would cause a
significant distortion . . . in the allocations," and provided
further
that "(generally)," patient care charges "cause significant
distortions
and should not be included in the base." (Respondent's Ex. D)
The Agency failed to note, however, that the earlier cost
principles
provided that "bases other than salaries and wages may be used
provided
it can be demonstrated that they produce equitable results," and
that
the Negotiation Agreement in question here provided for a modified
total
direct cost base. Moreover, the Negotiation Agreement's inclusion
of
the first $50,000 of patient care costs purchased from third parties
is
inconsistent with PHS's claim that only a salaries and wages base
was
permissible. Thus, the cost principles in effect through March 1979
did
not require the exclusion of the disputed patient care costs.
PHS is also mistaken in its claim that the cost principles in effect
after
March 1979 prohibited the inclusion of the disputed patient care
costs.
The modified direct cost base as(9) defined by the cost
principles includes
"services," and there is no dispute that this
covered patient care.
Thus, PHS's claim really rests on the
Department's interpretation of the cost
principles, which does not
exclude patient care costs from "services" under
all circumstances but
only when the inclusion of such costs would distort the
indirect cost
rate. Since PHS provided no evidence that the inclusion
of the
questioned patient care costs would in fact have distorted the
indirect
cost rate, the inclusion of such costs in the base is not
inconsistent
with the HEW interpretation of the cost principles.
(Moreover, since,
as noted by the University, the HEW interpretation had not
been issued
when the rate was negotiated, it has no bearing on our
interpretation of
the Negotiation Agreement. Similarly, the fact, noted
by PHS, that the
Negotiation Agreement for periods after the time in question
here
excluded all the care costs from the base has no bearing on this
case
since the parties were guided by the HEW interpretation in
concluding
that Agreement.)
Conclusion
For the foregoing reasons, we conclude that the Negotiation
Agreement
included patient care costs incurred at University-owned facilities
in
the base for application of the rate and that such patient care
costs
were thus appropriately included in the direct costs of the
National
Cancer Institute grant for purposes of calculating the
applicable
indirect costs. Accordingly, we reverse the Agency's
determination
disallowing $24,541.85 charged as indirect costs of the grant
on that
basis, subject to the caveat noted in footnote 1 on page 1. /1/
It
appears from the record that
the amount of applicable indirect
costs was incorrectly calculated. An
earlier decision by PHS disallowed
all patient care costs charged as direct
costs of the grant as well as
the applicable indirect costs of
$24,541.85. (Appellant's Ex. A) PHS
subsequently allowed all but
$4,454.85 of the direct patient care costs.
(Appellant's Ex. K) Since the
University did not appeal the disallowance
of the $4,454.85, PHS may consider
whether that part of the $24,451.85
in dispute here which is applicable to
the $4,454.85 in unallowable
patient care costs is unallowable regardless of
our conclusion that the
indirect cost rate was properly applied to patient
care costs generally.
/2/ A series of Negotiation Agreements covered the
period in question.
The relevant language in all of the Agreements was the
same. /3/
The Board's review
in this case was not restricted to whether the PHS
decision was clearly
erroneous since that restriction applies only when
there has been a decision
by a preliminary review authority (45 CFR
16.12(d)(1)); here, the
University was instructed by PHS to submit any
appeal of its initial decision
directly to this Board.
/4/
Although the University's evidence that the base included patient
care
costs incurred at University-owned facilities is sufficient to
prevail
in this case, it is not conclusive in the sense that it does not
trace
every item of patient care cost to show its ultimate
treatment.
Accordingly, the Agency is not precluded from finding in another
case
not involving the indirect costs claimed in this appeal, and based
on
additional evidence not in the record for this appeal, that the base
did
not include all patient care costs incurred at
University-owned
facilities.
/5/ The Agency also asserted that it would be
justified in revising the
indirect cost rate for the period in question
since the calculation of the
rate did not reflect its understanding of
the Negotiation Agreement.
(Tape recording of May 6, 1986 conference
call) Since this matter arose
before us as an appeal from a disallowance
of indirect costs under only one
of the University's many grant
projects, however, we do not have authority in
this proceeding to
determine whether the rate was equitable or whether it
could properly be
renegotiated at this juncture.
MARCH 28, 1987