United States Court of Appeals, District of Columbia Circuit
May 5, 2017
from the United States District Court for the District of
Columbia (No. 1:14-cv-01545)
Alexandra R. Rosenblatt argued the cause for appellant. With
her on the briefs were Edward T. Waters and Christopher J.
M. Kolsky, Assistant U.S. Attorney, argued the cause for
appellees. With him on the brief was R. Craig Lawrence.
Before: Tatel, Pillard and Wilkins, Circuit Judges.
Pillard, Circuit Judge
performance bonuses can be a useful tool for motivating
employees, so long as the employees know in advance that the
quality of their work will be reflected in their paychecks.
The federal government accordingly allows federal grantees to
award performance bonuses that are reasonable, announced in
advance, and adequately documented. Between 2010 and 2012,
plaintiff Texas Neighborhood Services received Head Start
grant money to provide childcare services to low-income
families in Texas. During that time, Neighborhood Services
used $1.3 million in federal funds to award performance
bonuses to its staff. In 2013, the Department of Health and
Human Services (HHS), which administers Head Start grants,
required Neighborhood Services to repay the bonus money to
the government, explaining that the bonuses were unreasonable
and inadequately documented. After the repayment decision was
sustained by HHS's Departmental Appeals Board (Appeals
Board or Board), Neighborhood Services filed suit, arguing
that the Appeals Board's ruling was arbitrary and
capricious in violation of the Administrative Procedure Act
(APA). Finding no prejudicial error in the Board's
decision, the district court rejected the APA challenge. We
Administration for Children and Families (the Administration)
provides grants to Head Start organizations across the
country to support their provision of "health,
education, parental involvement, nutritional, social, and
other services" to low-income, preschool-aged children.
42 U.S.C. § 9833; see 45 C.F.R. §§
1301.1 et seq. The Office of Management and
Budget's Circular A-122 (OMB Circular or Circular)
explains when and how the government will reimburse federal
grantees, including organizations receiving Head Start money,
for different types of expenses. See 2 C.F.R. Pt.
230 (2007). For our purposes, the key
provisions in the Circular are those governing employee
salaries and performance bonuses.
Circular's salary and bonus provisions authorize federal
grantees to use performance bonuses to motivate their staffs,
so long as: (1) the "overall compensation" paid to
employees-including performance bonuses-is "reasonable,
" 2 C.F.R. Pt. 230, App. B ¶ 8.j; (2) the bonuses
are paid "pursuant to an agreement entered into in good
faith between the organization and the employees before the
services were rendered, or pursuant to an established plan
followed by the organization so consistently as to imply, in
effect, an agreement to make such payment, "
id.; and (3) the incentive payments are
"adequately documented, " id., App. A
¶ A.2.g. If a grantee does not follow those rules in
awarding performance bonuses, HHS may disallow-i.e.,
refuse to cover the cost of-the bonuses. See id.,
App. A ¶ A.2, App. B ¶ 8.j.
2007, Neighborhood Services decided to develop a way to use
performance bonuses to motivate its employees. The
Neighborhood Services Board of Directors adopted an Incentive
Compensation Policy (the 2007 Policy), which contemplated
that senior Neighborhood Services staff would develop a
"plan" for rewarding "consistent or exemplary
job performance." J.A. 100. Two years later, senior
staff announced the 2009 Plan: Neighborhood Services staff
would implement a series of "cost reductions, "
with a goal of operating at 95% of its annual budget and, if
those cost reduction strategies were effective, Neighborhood
Services would use the savings to implement an
"incentive" system. J.A. 103. Under that system,
Neighborhood Services would use a "matrix" to
assess employee performance, rewarding
"superior"-rated employees with more generous
bonuses than employees with "average or below
average" performance records. J.A. 103.
February 2013, the Administration conducted a
"monitoring review" of Neighborhood Services's
use of federal funds in Fiscal Years 2010 through 2012 (FY
2010-2012). J.A. 86, 90-91. That review resulted in a
Monitoring Report. Among the Report's negative findings
was an allegation that Neighborhood Services had issued
performance bonuses without taking adequate steps to ensure
that "overall compensation" for its employees was
reasonable and without "document[ing] the basis for
amounts awarded as incentive compensation, " as required
by the OMB Circular. J.A. 90
September 19, 2013, the Administration sent Neighborhood
Services a letter stating that, in light of the Monitoring
Report's conclusion that Neighborhood Services had paid
performance bonuses in violation of the OMB Circular, the
Administration would disallow the $1, 332, 698.09 in federal
funds that Neighborhood Services had used to issue the bonus
checks (the Disallowance Letter). See J.A. 82-83.
The Disallowance Letter instructed Neighborhood Services to
repay that amount to the government.
Services appealed the Disallowance Letter to the Appeals
Board, which rejected the challenge. The Board explained that
Neighborhood Services failed to carry its burden of
demonstrating that the performance bonuses were reasonable.
The Board emphasized that Neighborhood Services had not
established that it was reasonable to pay a relatively large
percentage of employees' overall compensation as
performance bonuses. Further, based on Neighborhood
Services's own documentation, the Board found that it had
not consistently given higher bonuses to employees who
performed better than their peers. The lack of correlation
between employees' performance and the size of their
bonuses suggested that the monetary awards were "based
on factors such as favoritism, rather than performance."
Id. at 311. Regardless of whether such favoritism
was barred by Neighborhood Services's own policies, the
Board concluded, the ...