Texas Neighborhood Services v. United States Department of Health and Human Services

          Argued May 5, 2017

         Appeal 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. Frisina.

          Joshua 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.

          OPINION

          Pillard, Circuit Judge

         Year-end 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 affirm.

         I.

         HHS's 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).^[1] For our purposes, the key provisions in the Circular are those governing employee salaries and performance bonuses.

         The OMB 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.

         In 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.

         In 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

         On 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.

         Neighborhood 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 ...