Cnty. of Fresno v. Azar, 1:18-cv-00320-LJO-BAM

CourtUnited States District Courts. 9th Circuit. United States District Courts. 9th Circuit. Eastern District of California
Writing for the CourtLawrence J. O'Neill, UNITED STATES CHIEF DISTRICT JUDGE
Citation384 F.Supp.3d 1164
Parties COUNTY OF FRESNO, Plaintiff, v. Alex AZAR II, Secretary of the Department of Health and Human Services, Defendant.
Decision Date30 April 2019
Docket Number1:18-cv-00320-LJO-BAM

384 F.Supp.3d 1164

COUNTY OF FRESNO, Plaintiff,
v.
Alex AZAR II, Secretary of the Department of Health and Human Services, Defendant.

1:18-cv-00320-LJO-BAM

United States District Court, E.D. California.

Signed April 30, 2019


384 F.Supp.3d 1166

Brian Lee Melikian, Daniel Carl Cederborg, Fresno County Counsel, Fresno, CA, Robert E. Wanerman, Pro Hac Vice, John W. Eriksen, Pro Hac Vice, Etein Becker & Green, P.C., Washington, DC, for Plaintiff.

Philip A. Scarborough, Office of the United States Attorney Eastern District of California, Sacramento, CA, for Defendant.

MEMORANDUM DECISION AND ORDER RE PARTIES' CROSS-MOTIONS FOR SUMMARY JUDGMENT

Lawrence J. O'Neill, UNITED STATES CHIEF DISTRICT JUDGE

384 F.Supp.3d 1167

I. INTRODUCTION

The County of Fresno (the "County") filed this action in March 2018 challenging a final decision of the Secretary of Health and Human Services (the "Secretary" or "HHS"), acting through the Departmental Appeals Board ("Appeals Board"), disallowing certain pension obligation bond costs incurred by the County in performing services that benefit federally funded programs. The parties filed cross-motions for summary judgment; upon completion of the parties' briefing, the matter was taken under submission, and the hearing on the parties' motions was vacated. For the reasons set forth below, the Secretary's motion for summary judgment is GRANTED, and the County's motion for summary judgment is DENIED.

II. BACKGROUND1

A. Federal Grant Costs and OMB Circular A-87

Local governmental entities, including the County, perform a range of tasks that support programs funded by the Federal Government, such as food and nutrition services, adult and children's health and human services programs, housing and urban development programs, and justice service programs. The costs incurred by the County for work performed by its employees on these federal programs are reimbursable through the Federal Government. The principles for determining allowable costs of programs under grants from the Federal Government were originally set forth in a circular issued by the United States Bureau of the Budget, "Budget Bureau Circular A-87." In 1981, the Office of Budget Management ("OMB") reissued the circular as "OMB Circular A-87" (Circular A-87") which is currently codified at 2 C.F.R. Part 200.2 Under Circular A-87, a single federal agency is designated as a "cognizant agency" and bears responsibility for reviewing, negotiating, and approving cost allocation plans of individual non-federal entities who receive federal grant funding. 2 C.F.R. § 200.19 ; 2 C.F.R. Part 22, App. V(F)(1) (the "cognizant agency" is generally the federal agency with the largest dollar value of total federal awards with a governmental unit). These plans control the non-federal entity's billing of central service costs, which includes fringe benefit costs of all federal grants received by the non-federal entity. HHS is the cognizant agency for the County's cost allocation plan that is disputed in this case. (AR 112.)

To be allowable under Circular A-87, costs must be necessary and reasonable for the proper and efficient administration of the federal program, be allocable to the Program, and be net of all applicable credits. 2 C.F.R. § 200.403(a) (2016) ; 2 C.F.R. Part 225, Appx. A(C)(1)(a) (2015).3 Employee

384 F.Supp.3d 1168

compensation, including the cost of fringe benefits such as pensions, is generally an allowable cost, but only to the extent it satisfies the specific requirements of Circular A-87. 2 C.F.R. §§ 200.430, 200.431. In this case, the parties' dispute centers around the allowability of pension funding costs.

B. Underfunded Pension Plans and Catch-Up Payments

Some non-federal entities, like the County, pay retired former employees a benefit that is set by a defined formula – i.e. , defined benefit pensions. During an employee's career with the employer, he or she accrues a benefit under the plan that will be payable upon retirement; there is often a long period between when an employee accrues a benefit and when the benefit is ultimately paid (at retirement). To assess the total liabilities of a pension plan at any specific point in time, plan actuaries must project the value of the benefits the plan is obligated to pay in the future. These actuarial calculations are based on certain known factors such as an employee's years of service to date and predictions of future occurrences such as an employee's retirement date, lifespans, and the rate of return on invested assets. When the plan liabilities, measured at a particular moment in time, exceed the assets held by the plan at that point, this shortfall is called an unfunded accrued liability ("UAL").

A pension plan may have a UAL for a variety of reasons: the employer has created a new pension plan that credits an employee for service that pre-dates the plan creation, the employee was awarded additional benefits under an existing plan, the employer failed to deposit sufficient funds in prior years to fund the benefits that accrued in that particular year, there was a lower-than-expected return on plan investments, or assumptions made by actuaries in assessing plan liabilities proved incorrect – e.g. , the retirees live longer than expected. When a UAL occurs, the sponsoring employer generally amortizes the UAL and pays an actuarially-determined amount each year to correct the shortfall over time. The Governmental Accounting Standards Board ("GASB") issues Generally Accepted Accounting Principles ("GAAP"). To be eligible for reimbursement under Circular A-87, pension costs must be calculated using GAAP. Under GASB principles, a pension plan's annual required contribution includes costs related to pension benefits accrued in that year and payment for any amortized portion of an existing UAL. (AR 586, GASB No. 27, ¶ 10(f).) The amortized UAL costs include payment on the UAL and "interest" that is an actuarily-assumed percentage typically corresponding to the actuary's projected rate of investment return on the pension plan assets. (AR 634, GASB No. 27, ¶ C-5 (defining amortization payment); AR 1029-30, GASB Implementation Guide ¶ 39 (explaining amortization of the UAL).)

C. Bond Financing for UALs as a Reimbursable Cost under Circular A-87

Circular A-87 contains a specific prohibition on "[c]osts incurred for interest on borrowed capital," unless those costs fall within certain limited exceptions not applicable here. 2 C.F.R. § 200.449(a).4 In the 1990s, favorable interest rates incentivized state and local governments to reduce

384 F.Supp.3d 1169

their costs on UALs by selling bonds whose interest rates were lower rate than the actuarial-assumed interest rate for UAL amortization. (AR 27.) By financing the UAL through bonds, the cost of amortizing the UAL was lowered and the yearly UAL payments were reduced. The question with respect to these bonds, however, was whether the bond interest paid by the non-federal entity each year would be considered interest on borrowed capital and thus no longer an allowable cost under Circular A-87. State and local governments argued to HHS and OMB that these bond payments should be allowable because they would save the Federal Government money by reducing the costs associated with pension plans for which reimbursement could be sought. (AR 27 ("State and local governments argue that, since interest on [UALs] has been allowed by Federal agencies ... interest on debt issued to fund the [UAL] should be allowable if this financing mechanism reduces costs to the Federal Government.").)

In response to HHS' request whether payment on pension bonds could be exempted from Circular A-87's prohibition on interest costs and considered an allowable pension cost, OMB issued a letter from its Chief of Financial Standards and Reporting Branch to provide guidance on this issue: the 1994 OMB guidance letter. (AR 27-28.) The 1994 OMB guidance letter states that interest on bonds issued to finance UALs acts as "a surrogate for interest on the underfunded pension liability included in the annual actuarially-determined pension contribution and, therefore, is allowable under ... Circular A-87," if the following criteria are met:

1. Debt financing of the [UAL] is not more costly to the Federal Government than regular pension financing over the remaining amortized life of the UAL, considering bond principle, interest, issuance costs, and any other relevant factors, as determined at the time of financing. If this criterion is not met, interest on debt issued to finance the UAL will be allowed only to the extent of the regular pension financing.

2. All net bond proceeds are made part of pension fund assets.

3. The funding for bond principal and interest is (a) included in each period's pension requirement (e.g., annual, biennial, or other), (b) computed in the same manner as the actuary's amortization of the UAL at the time of the conversion to debt financing, and (c) calculated using the weighted average interest rate on the bonds for the period in place of the actuarially-assumed interest rate. The period's pension requirement
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