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New Mexico Dep't of Information Technology v. United States Dep't of Health and Human Services

September 22, 2008


The opinion of the court was delivered by: Colleen Kollar-kotelly United States District Judge


New Mexico and other states receive federal funds for costs that are incurred in the administration of federal programs, but only to the extent that the costs are allowable (i.e., necessary and reasonable for the proper and efficient performance of a federal award) or allocable (i.e., assignable to a cost objective in accordance with the relative benefits received). Federal funds that are improperly awarded may be subject to a disallowance determination and a refund by the state. In this Administrative Procedure Act ("APA") case, the New Mexico Department of Information Technology ("New Mexico") has brought suit against the United States Department of Health and Human Services and Michael O. Leavitt, in his official capacity as Secretary of the Department of Health and Human Services (collectively, "HHS"), arguing that HHS's Division of Cost Allocation improperly calculated a disallowance amount by failing to offset overcharges associated with certain fiscal year 2004 services with undercharges occurring during the same period. The disallowance determination was upheld by HHS's Departmental Appeals Board ("DAB") on May 17, 2007, resulting in a decision that New Mexico challenges in this case as arbitrary and capricious. After a searching review of the parties' submissions, applicable case law, statutory authority, regulations, and the administrative record, the Court finds that the DAB's decision was not arbitrary and capricious, and quite to the contrary, was consistent with all applicable regulations and with a prior decision issued by the DAB against New Mexico that rejected the same arguments that New Mexico has once again raised before the DAB and before this Court. Accordingly, the Court shall GRANT Defendant's [11] Motion for Summary Judgment and DENY Plaintiff's [14] Motion for Summary Judgment, for the reasons that follow.


A. Regulatory Framework

The procedures governing the receipt and payment of federal funds to states for the administration of federal programs are contained in the Office of Management and Budget Circular A-87, located at 60 Fed. Reg. 26,484 - 26,507 (May 17, 1995) ("Circular A-87").*fn1 This case concerns the disposition of federal funds that New Mexico claimed for "central service costs," which are "the costs of services provided by a state on a centralized basis to its various departments and agencies . . ." Circular A-87, Attach. A, ¶ B.4. A state receives funds for central service costs pursuant to a negotiated Cost Allocation Plan (a "CAP," or on a statewide basis, an "SWCAP"). Id., Attach. C, ¶ A.1. An SWCAP has numerous requirements that a state must follow in order to receive federal funds. For example, an SWCAP must identify, accumulate, and allocate allowable costs of services and include a formal accounting and other records that support the propriety of the costs assigned to the federal funds. Id., ¶¶ A.1, D.4. An SWCAP must include a projection of the central service costs for the following year, and a reconciliation of actual allocated central service costs with the estimated costs for the year most recently completed or the year preceding the year that was most recently completed. Id. ¶ D.1. All SWCAPs must be submitted to the cognizant agency*fn2 within six months prior to the beginning of each of the governmental unit's fiscal year, id. ¶ D.4, and must include a certification that the costs are allowable and properly allocable for federal funds in accordance with federal requirements. Id. ¶ E.4. A state must comply with its SWCAP that has been approved by the cognizant agency. See Circular A-87, Attach. A, ¶ C.1.d (explaining that costs are only allowable when they "[c]onform to any limitations or exclusions set forth in [Circular A-87], Federal laws, terms and conditions of the Federal award, or other governing regulations . . ."); id., Attach. C, ¶ A (explaining that states must adopt and conform to CAPs that support claimed central service costs); id., ¶ C (explaining that "[c]osts of central services omitted from the plan will not be reimbursed").

In the present case, the cognizant agency responsible for reviewing and approving New Mexico's fiscal year 2004 SWCAP was HHS's Division of Cost Allocation ("DCA"). A.R. 3-4 (5/17/07 DAB Decision). DCA disallowed overcharges for central service costs involving New Mexico's Internal Service Fund ("ISF"), a financing mechanism that allows a state to charge rates to recover the costs of services, and an additional margin permitting a reasonable level of working capital reserves. Circular A-87, Attach. C, ¶¶ E.3.b, G.2. Just as a state must produce certain information related to an SWCAP, a state must also provide the cognizant agency with certain information related to an ISF. For example, a state must provide a fiscal year-end reconciliation and an explanation as to how variances will be handled. Id. ¶ E.3.b.1. Although an ISF may cover more than one category of service provided by a central services agency, "[e]ach billed central service activity must separately account for all revenues . . . generated by the service, expenses incurred to furnish the service, and profit/loss." Id. ¶ G.1.

Of particular significance to the present litigation, Circular A-87 provides that revenues resulting from these billed central services must be compared to the actual allowable costs at least annually so that adjustments can be made:

Billing rates used to charge Federal awards shall be based on the estimated costs of providing the services, including an estimate of the allocable central service costs. A comparison of the revenue generated by each billed service (including total revenues whether or not billed or collected) to the actual allowable costs of the service will be made at least annually, and an adjustment will be made for the difference between the revenue and the allowable costs.

Id. ¶ G.4. Circular A-87 identifies four possible "Adjustment Methods":

(a) a cash refund to the Federal Government for the Federal share of the adjustment,

(b) credits to the amounts charged to the individual programs,

(c) adjustments to future billing rates, or

(d) adjustments to the allocated central services costs. Id.*fn3

HHS's interpretation of Circular A-87, including its interpretation of the Adjustment Methods quoted immediately above, is embodied in an implementation guide titled "ASMB C-10." A.R. 168-192. ASMB C-10 explains (through a question and answer format) that Adjustment Method (b) may only be used for billed costs within a fiscal year:

Attachment C, paragraph G.4 establishes four methods for adjusting internal service funds (billed central services) for profits or losses realized from operations. Alternative (b) allows credits to amounts charged to the individual programs. This method would only cover profits. If losses occur, why can't individual programs be debited?

Effectively, alternative (b) is correcting billed costs in the current year, whereas alternative (c) is carrying forward the profit/loss into the next open fiscal period. The failure of the Circular to note how losses are to be treated in alternative (b) is an editing error. For consistency purposes, both alternative (b) and (c) cover profit and loss situations. However, only one method can be used in a given fiscal year.

A.R. 191-92 (ASMB C-10, Part 4, § 4.8, Question 4-12) (emphasis added).

DCA may initiate a disallowance action if costs are not claimed in accordance with a state's approved SWCAP. 45 C.F.R. § 92.51; Circular A-87, Attach. C, ¶ F.3. The state may request reconsideration of a disallowance determination, and may file an appeal with the Department of Appeals Board ("DAB"). 45 C.F.R. Part 16, App'x A, ¶ D. A final disallowance determination is subject to judicial review as a final agency action under 5 U.S.C. § 704.

B. Factual Background

This case is best understood against the background of New Mexico's repeated failures to comply with its SWCAP requirements and with Circular A-87. In March and April 2001, DCA issued determinations for fiscal years 1995 through 1999 that disallowed more than $8,000,000 in federal funds for costs associated with central computer services billed by New Mexico. See New Mexico Gen'l Svcs. Dep't, DAB 1876 at 1, 2003 WL 21043171 (H.H.S. Apr. 30, 2002). New Mexico appealed this disallowance determination, arguing that the amount should be offset with costs that were never billed to state agencies for federal programs but that, according to New Mexico, could have been billed. Id. at 1, 5. The DAB found that, although it might sometimes be appropriate to reevaluate prior costs that were never billed, a disallowance action is "not the right place to determine that." Id. at 6. Instead, if New Mexico believed that it billed inadequately for some of its services: its remedy would be to adjust its billing to the state agencies for the past periods.

Those agencies could then verify whether the bills reflect necessary costs for services actually ordered and delivered and allocate the correct amounts to any participating federal programs in accordance with the CAP and the rules applicable to those program grants.

Id. The disallowance action was the improper place to raise New Mexico's offset arguments because "[n]one of these processes are part of the evaluation normally done by DCA in its review of the bases for the internal service funds amounts." Id. The DAB concluded that New Mexico's position, if ...

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