For nearly three decades, the doctrine of equitable offset injected principles of fairness and practicality into the process for recovery of disallowed expenditures by federal education grantees. Since its genesis in the late 1980s, the doctrine has been an invaluable tool for U.S. Department of Education (ED or Department) grantees when faced with liabilities to the federal government. By invoking equitable offset as a defense, education grantees have been able to use hundreds of thousands of dollars in federal education funds for their intended purpose of serving schools and students, rather than returning those funds to the federal government. The premise of the defense is that when a grantee spends general, non-federal funds to benefit a federal program, those expenditures may be used to offset liabilities to the federal government. Applying the doctrine of equitable offset, a federal grantee may reduce its audit liability by demonstrating that non-federal funds were used to benefit the program in an allowable manner.
Grounded in basic contract principles, equitable offset treats federal grantees similarly to public contractors. When a federal grant is awarded, the grantee and the federal government enter into an agreement regarding the amount of funds to be spent on a particular program. Pursuant to that agreement, the federal government holds the grantee accountable for demonstrating compliance with agreed upon spending obligations. Under the doctrine of equitable offset, the grantee’s ability to demonstrate compliance with spending requirements is tantamount to complete fulfillment of its obligations. Therefore, a grantee may evade liability for misspent funds by demonstrating that it has spent the agreed-upon amount of funds to benefit the program at issue.
At its peak, the Department strongly embraced equitable offset. In fact, in 1995, the Department went so far as to publish proposed equitable offset regulations. Although they never made it to the final regulation stage,the proposed rules demonstrate the Department’s support for the doctrine and acknowledgment of its value to grantees. Despite the doctrine’s steady rise and undeniable value to federal award grantees, the Department has recently signaled a likely beginning of the end of this defense to repayment of federal funds in denying the availability of offset based on equitable factors surrounding the underlying mis-expenditures. Specifically, the ED denied an equitable offset for one grantee, in which it determined the underlying violations were too egregious to warrant the remedy, and for another grantee, in which the underlying violation was the result of intentional misconduct of three employees.Federal courts upheld the Department’s denial in both circumstances,providing the ED with almost unfettered discretion in determining whether an offset is warranted and departing from government-wide practice that automatically extends this opportunity to grantees — not as a matter of equity, but as a fulfillment of the government’s agreement.
This article will begin by tracing the origins of the doctrine of equitable offset and explaining the test used to determine whether it applies. Next, this article will analyze key examples of its application in administrative and judicial proceedings, including a case, that began to narrow the scope of its application. This article will proceed to cover a recent case, which eschewed the doctrine altogether, and discuss the likely implications of the Department’s recent rejection of the doctrine for ED grant recipients, and what this could mean for all federal grantees.
The enforcement mechanisms available to the ED are generally set out in the General Education Provisions Act (GEPA) and part 81 of the Education Department General Administrative Regulations.Pursuant to GEPA, the ED has a variety of mechanisms available to enforce federal requirements whenever it has reason to believe that a recipient of federal funds is failing to comply substantially with any applicable federal law, including requiring the repayment of funds that were either mis-expended or unaccounted for. When the ED decides to seek recovery of funds from a grantee, it must first provide the grantee with written notice, usually through a program determination letter (PDL). In its PDL, the ED must prove “a prima facie case for the recovery of funds, including an analysis reflecting the value of the program services actually obtained in a determination of harm to the [f]ederal interest.”
ED grantees can challenge sanctions both administratively and judicially. If a grantee decides to appeal the PDL, it must appeal it to the Office of Administrative Law Judges (OALJ), which is one of four divisions within the ED’s Office of Hearings and Appeals (OHA).When the OALJ receives a request for review, it will assign an administrative law judge (ALJ) to the case.After reviewing all of the evidence in the record, the ALJ will make an initial decision. Either party may appeal the ALJ’s determination to the Office of the Secretary of Education.The Secretary of Education (Secretary) will affirm, modify, set aside, or remand the ALJ’s decision.The Secretary’s decision can then be appealed directly to the respective U.S. Court of Appeals.
Although the term “equitable offset” is nowhere to be found in the decision, the Court of Appeals for the Fifth Circuit established the foundations for the doctrine in Tangipahoa Parish School Board (Tangipahoa). In this case, school boards in four South Louisiana parishes were ordered to repay the entirety of their grants received under Title VII of the Elementary and Secondary Education Act (the Bilingual Education Act, hereinafter, Title VII or BEA).These four school boards had successfully competed for BEA grants to fund programs designed to assist students with limited English proficiency, and their programs passed muster during on-site reviews and annual evaluations by the Department.In response to letters from citizens complaining of the misuse of these funds, the Department conducted truncated investigations into these school boards’ use of funds during brief, unannounced visits.The ED concluded, “ineligible students were participating in the programs and that the programs contained ineligible components ” The school boards appealed the action on substantive and procedural grounds, arguing, among other things, “only the amounts allegedly misspent should be refunded, not the entirety of the grants.” The Education Appeal Board (EAB) ruled against the school boards in an initial hearing, and then again on remand.
The four cases were consolidated and heard by the Court of Appeals for the Fifth Circuit, where the court planted the seeds for equitable offset by questioning the fairness and practicality of the Department’s demand for repayment of all funds, stating:
We cannot but note a serious deleterious effect of the Department’s position demanding the repayment of hundreds of thousands of dollars. The sums awarded to the four parishes during 1978–1981 were spent for the education of children then attending school. To require the repayment of those sums today penalizes innocent people, today’s students who are sorely in need of a quality education. . . . We do not see the Department’s action in these cases as furthering the obvious federal goals of educating children in bilingual programs.
The court found support for its position in the ED regulations, providing, “[w]hen a grantee has materially failed to comply with the terms of a grant, [the Department] may suspend the grant, . . . terminate the grant for cause, . . . or take such other remedies as may be legally available and appropriate in the circumstances.” Based on these regulations, the court stated that the ED should only recover “funds expended in a manner clearly inconsistent” with the BEA.The court remanded “for reconsideration of the amount to be refunded [to the Department], with instructions that there be an appropriate articulation of all factors weighed in the analysis and disposition of that determination.”The court directed the Department to consider more than strict adherence to program requirements in determining the refund amount.One of the most important takeaways from this decision is the court’s language explicitly authorizing the Department to consider equitable factors in the recovery of funds, stating, “the equitable factors involved are proper considerations in the determination of appropriate refunding.” Once again, although this case did not officially coin the term “equitable offset,” it contains key considerations and language that were essential to the development of the doctrine.
After the groundwork was laid in Tangipahoa, it did not take long for the doctrine to be formally named and applied in the Appeal of the State of New York (New York).In New York, auditors disallowed unsupported salary expenditures charged to grants under the Vocational Education Act (VEA). The auditors recommended that certain salary expenditures funded by the state that could have been charged to the grant be used as a credit against any disallowed amount. The ED Assistant Secretary rejected the auditors’ recommendation and sought the entire disallowed amount.The case went before the EAB to determine whether salaries of non-budgeted employees, who devoted effort to VEA programs but whose salaries were not charged to VEA funds, could be offset against other expenditures that were ruled unallowable. The EAB examined New York’s Personnel Activity Report (PAR) system to determine whether it properly verified the amount of time that each unbudgeted, non-line item employee actually devoted to VEA programs. The EAB concluded that New York’s PAR accounting system provided an appropriate method of cost allocation and time distribution for employees involved in VEA activities. Because of this determination and precedent set in Tangipahoa, the EAB upheld the offset, explaining:
This EAB Panel is persuaded that it is the intention of federal appellate courts reviewing the Secretary’s decisions to inject the doctrine of fairness, including application of equitable offset or credit, where state educational services which support the legislative intent are actually performed, even though they were not originally charged to the appropriate federal grant.
Noting that in Tangipahoa “the doctrine of fairness and reasonableness prevailed,” the EAB sought to apply the same principles to the case in New York, beginning a line of decisions grounded in the same.
The decision in New York was reaffirmed soon after in Consolidated Appeals of the Florida Department of Education (Florida).In this case, Florida challenged two ED final letters of determination (FLDs) disallowing expenditures under the VEA in the amounts of $249,000 for fiscal year (FY) 1985 and $234,044 for FY 1986. The FLDs alleged that “the disallowed VEA expenditures were unsupported by adequate time distribution or other records to show the time actually spent on VEA activities by each employee.” Although the audits themselves did not request a refund of the allegedly unsubstantiated expenditures, the Assistant Secretary demanded repayment of those expenditures, pursuant to her authority under 20 U.S.C. § 1234a(a). Florida appealed both FLDs, and the appeals were consolidated for review before the EAB.In the brief supporting its appeal, Florida argued:
[F]irst, that it ha[d] submitted sufficient documentation for the charges at issue, and second, that “[it] in fact spent so much of its own state funds on activities properly chargeable to the federal grants that, even assuming arguendo that the Department’s allegations were true, the State’s excess expenditures for federally chargeable activities more than offsets (sic) the entire disallowed amounts. This doctrine of applying a credit or equitable offset against a disallowance has been squarely adopted by the EAB, the Secretary, and the federal courts.”
Florida claimed that for both fiscal years it “substantially overmatched the federal share through its contribution of [s]tate general revenue dollars” and that, due to this overmatch, application of an offset would completely extingish any liability to the federal government.
To assess Florida’s claim, the tribunal closely scrutinized evidence submit- ted by Florida regarding overmatching the offset for employees paid fully and partially with state funds, and ultimately concluded that those employees worked exclusively on vocational education during the times at issue.Drawing a direct comparison to New York, the tribunal explained that “[w]hile the evidence in the case herein is not so precise or systematic as the evidence in New York, the key inquiry in both cases is whether the evidence shows that the VEA services were actually performed.” The panel found that Florida met its burden of proving the actual performance of VEA services by the employees at issue.
The tribunal proceeded to discuss the question of whether applicable precedent permitted equitable offset. Early on in the discussion, the tribunal noted that it interpreted New York to “authorize the sort of offset claimed herein,” quoting the language from the decision regarding injection of the doctrine of fairness into repayment determinations. In addition to citing to the recent precedent in New York, the tribunal noted that one Supreme Court case and one federal court case, which both provided credits against disallowed costs, also suggested the availability of equitable offset as part of the recovery process. Specifically, the tribunal affirmed Florida’s position that the Supreme Court and the Ninth Circuit had also implicitly authorized equitable offset by applying equitable considerations in determining the amount to be repaid by the state.
After concluding that equitable offset could be properly applied to this case, the tribunal found that Florida was entitled to equitable offset in the amounts of $292,428 and $305,359 for the years 1985 and 1986, respectively.Because these amounts exceeded the disallowances, Florida was not required to repay any disallowance. This case was not only a major win for Florida, but it also solidified the doctrine by acknowledging and affirming the ample support for its application from the EAB based on Supreme Court precedent.
It is important to consider administrative and judicial decisions in the con- text of the greater legislative and regulatory landscape, particularly the 1988 amendments to GEPA. In reviewing the legislative history of the amendments, there are signs that Congress intended to create a more equitable process for the review of audit findings by the Department:
While the Committee recognizes the importance of audits in ensuring that [f]ederal programs serve their intended purposes, the Department’s audit and appeal process has sometimes adversely affected intended program beneficiaries. The Committee intends to create an effective, economical, and equitable process for the review of audit findings by the Department and for appeals of those findings by auditees. It is the Committee’s view that the amendments strike the necessary balance between giving auditees the means to defend themselves against adverse audit findings and retaining the Department’s ability to recover misspent funds and ensure overall program accountability.
As part of this effort to create a more equitable process, Congress replaced the EAB with the OALJ through the 1988 GEPA amendments.Prior to this legislative change, state and local officials complained that EAB members, who served part time and could be appointed and dismissed at will by the Secretary, were biased against grantees and lacked the requisite subject matter knowledge.The 1988 GEPA amendments replaced these EAB members with full-time ALJs with expertise in education law.
Additionally, the 1988 GEPA Amendments established a proportionate repayment provision for the recovery of federal funds. The statute states:
A recipient determined to have made an unallowable expenditure, or to have otherwise failed to discharge its responsibility to account properly for funds, shall be required to return funds in an amount that is proportionate to the extent of the harm its violation caused to an identifiable [f]ederal interest associated with the program under which the recipient received the award.
This concept of proportionality is reinforced in governing regulations, stating “[a] recipient that made an unallowable expenditure or otherwise failed to account properly for funds shall return an amount that is proportional to the extent of the harm its violation caused to an identifiable [f]ederal interest associated with the program under which it received the grant or cooperative agreement.”
The application of equitable offset is highly compatible with GEPA’s proportionate repayment provision. The Department may initially determine that the amount of harm done to a program is equal to the full amount of unallowable costs and seek recovery of an equivalent amount of funds on this basis.However, applying equitable offset, a grantee may demonstrate that it caused less overall harm to the program by showing that it spent non-federal funds in an allowable manner.This reduction to the level of harm would be accompanied by a proportionate reduction to the repayment amount. Therefore, application of equitable offset helps to ensure that repayments of federal funds are truly proportionate to harm caused to the federal government in a manner consistent with GEPA.
The OHA addressed the impact of the GEPA amendments on the applicability of equitable offset in a second case from New York, the Application of the New York State Department of Education.Here, the New York State Education Department (NYSED) received a preliminary departmental decision (PDD) from the Assistant Secretary for Special Education and Rehabilitative Services (Assistant Secretary) demanding repayment of funds awarded to the agency pursuant to the VEA, part B of the Education of the Handicapped Act (EHA- B), and the Carl D. Perkins Vocational Education Act (Perkins) based on the claim that the NYSED charged unallowable salaries, benefits, and indirect costs of state employees to these grants.The NYSED argued that collateral estoppel should bar reconsideration of these claims since the same issue was addressed in the New York and Florida cases discussed previously.The tribunal acknowledged the similarities between these cases and explained its intent to follow those decisions to the extent applicable.
In response, the ED Assistant Secretary for Vocational and Adult Education and the Assistant Secretary for Special Education and Rehabilitative Services (Assistant Secretaries) argued that because the New York and Florida decisions were decided under GEPA as it existed before the 1988 amendments, the tribunal could not apply an identical analysis.Specifically, the Assistant Secretaries contended that the proportional-recovery rule added to GEPA precluded the application of equitable offset. The tribunal rejected this argument, explaining that “the 1988 amendments to GEPA d[id] not limit the availability of equitable offset in any way” and that, in fact, “the concept of proporti[o]nality is quite harmonious with the principle of equitable offset.”The NYSED was ultimately able to apply an equitable offset to its liabilities under the PDD, resulting in the halving of its liability for VEA disallowances and the complete extinguishing of its EHA-B disallowances.
The same issue arose in a series of similar cases following the 1988 GEPA amendments. In each of these cases, ALJs reinforced the notion that the 1988 amendments and their legislative history reflected no congressional intent to preclude the doctrine of equitable offset.In Application of Colorado State Board for Community Colleges and Occupational Education, for example, the tribunal supported its position by explaining:
[T]his tribunal does not adopt the Assistant Secretary’s conclusion that allowance of offsets would harm the federal interest by turning the audit process into a hunt for allowable offset costs. To the contrary, this tribunal believes the application of equitable offset will uphold the Secretary’s intention to implement reasonableness and equity in the review of audit determinations of federal educational grants.
The consistent rejection of arguments that the 1988 GEPA amendments limited or eliminated equitable offset left no room for doubt that equitable offset would survive beyond the 1988 legislation.
At its core, the equitable offset test involved two key considerations: (1) whether the entity actually used non-federal funds to pay for costs in the program in question, and (2) whether the entity could have paid for the activities with federal funds. For more than twenty-five years, if these considerations were answered in the affirmative, then equitable offset would be applied, and the entity could credit or offset the costs at issue against any disallowances of federal funds. Notably, the test focused exclusively on the proposed offsetting costs, not the underlying violation. The equity of the remedy was rooted in the contractual nature of grants: grantees receive federal funding in exchange for carrying out federal programs. When a grantee mis-expended its federal funds, but still carried out the program using other, non-federal funds to do so, then the grantee does not harm the federal interest and the grantee could use its non-federal investment in the program as a credit against the identified federal mis-expenditures.
This principle — that grantees are entitled to substitute allowable costs for costs which the grantor has disallowed — is consistent with decisions by federal courts, the Comptroller General, other agencies, and the governing principles of federal appropriations law. In Institute for Technology Development v. Brown, the Fifth Circuit held that the Assistant Secretary of the U.S. Economic Development Administration must permit a grantee to substitute unclaimed, but otherwise allowable costs for disallowed costs.Disallowed costs are “regarded as never expended or claimed,” and therefore the grantee may “substitute other allowable costs for those disallowed and, to the extent allowable costs are available, does not need to repay the government.”
The long-standing and consistent application of this test is further supported by the Notice of Proposed Rulemaking (NPRM) issued by the Department in 1995,which enumerated specific conditions under which equitable offset may apply:
Of the five proposed conditions for the remedy, only one involved a review of the underlying violation, which was limited to ensuring that the violation was not intentional or willful.Although never adopted, these conditions reiterate the right of grantees to reduce their audit liability by demonstrating that other allowable costs are available to be substituted for the disallowed costs. As discussed infra, recent Secretary and circuit court decisions remove this right and place the availability of equitable offset within the Secretary’s unfettered discretion.
As noted earlier, the two-pronged analysis for applying equitable offset depended exclusively on the availability of allowable offsetting costs, regardless of the grantee’s underlying violation. Two decisions that most clearly emphasize this point are the Application of Arizona Department of Education (Arizona) and the Application of Pittsburg Pre-School and Community Council, Inc. (Pittsburg). In Arizona, the ED demanded that the Arizona Department of Education (ADE) pay back over $200,000 after employees, over the course of four years, embezzled funds received through part B of the Individuals with Disabilities Education Act (IDEA-B). Several employees falsified travel receipts and paid vendors who were not qualified and did not perform any services in order to divert federal funds to their own pockets.Upon discovery of the fraud, there was an audit, and then the ED issued a PDD demanding the repayment of federal funds.The ADE reimbursed the full amount to the ED. After reimbursing the full amount, the ADE filed an appeal, which did not dispute that the funds were improperly expended but instead sought a refund based on the doctrine of equitable offset.
In Arizona, the parties agreed that the doctrine of equitable offset may apply to the case.The arguments focused on the proper amount of funds to be applied through equitable offset as it relates to the state’s maintenance of effort requirements under IDEA-B. Because of this requirement, any non-federal expenditures that went to meet the maintenance of effort requirements could not also be used for equitable offset.The tribunal accepted the amount of equitable offset that the parties determined to be available for two fiscal years, and, without any review of the intentional fraud, held that the ADE was entitled to recover more than $160,000 of the over $200,000 of the misspent funds.
Another case demonstrating the application of the equitable offset defense was Pittsburg.Specifically, the Chief Administrative Judge Allen Lewis considered a claim for equitable offset based on the payment of salaries of three employees from non-federal funds.The Pittsburg Pre-School and Community Council, Inc. (PPCC) was a nonprofit organization located in California that provided services, including preschool programs, to low-income and no-income families. Following an audit of three grants, the ED issued a PDL seeking recovery of over $520,000 for disallowed expenditures. In addition, due to the audit, the ED designated the PPCC as “high risk,” and its grant ultimately was terminated after only one year. While the decision did not elaborate on the widespread violations, the ED Office of Inspector General (OIG) audit report reflects what occurred.In summary, the PPCC (1) improperly charged costs to the grants that were not necessary, approved, or related to grant activities; (2) “did not have required documentation for personnel costs”; (3) “did not provide adequate documentation for non-personnel costs”; (4) failed to meet the grant matching cost requirements; (5) drew down funds in excess of its immediate needs; and (6) lacked procedures and practices that met the federal standards for financial management systems.
The PPCC argued that the recovery of funds should be reduced by over $68,000 in salary for three employees under the doctrine of equitable offset.Judge Lewis stated, “Just as the doctrine of proportionality must be applied to the disallowed expenditures in this case, so too must be the doctrine of equitable offset.” Furthermore, he stated that “the doctrine of equitable offset permits a grantee to reduce any recovery due [the] ED by the amount of any expenditures made by the grantee for grant purposes that were incurred/ paid by the grantee.” Judge Lewis’s analysis of whether equitable offset could apply to those salary expenditures was two-pronged: (1) whether the salaries were paid with non-federal funds; and (2) whether the salaries could have been paid with federal funds. In applying this two-pronged analysis, the tribunal determined that, while the PPCC had used non-federal funds for some program-related expenditures, not all funds were spent on costs allowable under federal rules. Accordingly, the tribunal only applied the equitable offset doctrine to the costs that would have been allowable under the federal grants.
Both Arizona and Pittsburg represented a mechanical application of equitable offset. The analysis centered on whether there were non-federal expenditures available to credit against the recovery that supported the grant program. If so, equitable offset was applied. The tribunal did not discuss in either case whether equitable offset should be reduced or not be available because of intentional fraud (Arizona) or egregious mismanagement of funds (Pittsburg).
In 2014, the Application of the Pennsylvania Department of Education (Pennsylvania) signaled the beginning of the end of equitable offset. In Pennsylvania, the Court of Appeals for the Third Circuit affirmed that the Secretary has discretion to deny a grantee’s claims for equitable offset based on the grantee’s underlying violation. This ruling effectively reversed the ED’s existing, well-established standard for equitable offset and will have recurring and significant implications for all grantees on the resolution of audit findings with the ED. For that reason, it is important to detail the decisions of the Chief Administrative Law Judge, the Secretary, and the Third Circuit for the case.
The facts around this controversy involve the OIG’s audit of one of the Pennsylvania Department of Education’s (PDE’s) sub-grantees, the School District of Philadelphia (Philadelphia).As a result of this audit, close to ten million dollars were disallowed related to Philadelphia’s administration of grants under Titles I and II of the Elementary and Secondary Education Act of 1965 (ESEA), as amended by the No Child Left Behind Act and the Safe and Drug-Free Schools Communities Act Program. After settlement negotiations, around seven million dollars remained in dispute.
At issue were three of the five findings in the audit: finding two — supplanting of federal funding; finding four — inadequate enforcement of policies and procedures; and finding five — failure to have written policies and procedures.Under finding two, the OIG found that Philadelphia initially made payments using state and local funds and subsequently switched the charges to federal accounts, violating the prohibition on supplanting.The Department relied specifically on the testimony of Philadelphia’s chief financial officer, who stated that the District transferred charges to federal grant funds in order to alleviate its $66.1 million budget deficit. In finding four, the OIG determined that Philadelphia failed to enforce its policies and procedures for processing financial transactions, including having duplicate charges for preparation time and inaccurate payments for employee’s salaries and benefits. Regarding finding five, the OIG concluded that Philadelphia did not have written procedures for certain fiscal processes.
For the first time since the beginning of the doctrine, the ED refused to consider proposed offsetting costs, arguing that the remedy is unavailable because the underlying violations were so egregious.Nonetheless, the PDE sought an equitable offset through administrative proceedings. In determining whether the PDE was entitled to equitable offset, the Chief Administrative Law Judge, Judge Lewis, created a new standard for evaluating equitable offset under two factors: “equitable” and “offset.” The “equitable” inquiry included a fact-based analysis, focusing on “the seriousness and scope of the violation(s) and any mitigating circumstances.”Specifically, the party seeking equitable offset must prove it acted in good faith, and the party bears the “burden to show that the disallowed expenditures were not the result of gross negligence or intentional violations.”If the party is able to demonstrate that the circumstances merit equitable consideration, then the “offset” factor can be considered. The “offset” analysis focused on whether the proposed expenditures to be used as an offset supported the “objectives, goals and technical requirements of the grant itself.”
Applying these standards to Pennsylvania, the tribunal held that the PDE failed both prongs of the “equitable” inquiry.Under the supplanting finding (finding two), the tribunal found that, contrary to the PDE’s argument that Philadelphia’s practice of transferring costs to federal accounts after initially paying for them from a general account was normal-course accounting, Philadelphia’s actions were “with deliberate disregard for the regulations” and “may constitute gross negligence.” Regarding finding four, the tribunal held that Philadelphia “failed in its fiduciary duty” by making duplicate charges in salaries and benefits. For finding five, Judge Lewis found that the misspent or improperly documented federal funds were the result of Philadelphia’s “systemic failures,” and therefore did not merit equitable consideration. Because the PDE failed to demonstrate that Philadelphia acted in good faith “and that it did not act in a grossly negligent or intentionally improper manner, nor with deliberate disregard for the regulations and statutes,” the tribunal declined to even evaluate the second factor of the new standard. As such, Judge Lewis denied applying equitable offset to this case.
On appeal, the Secretary declined to apply the doctrine of equitable offset, but also declined to uphold the standard set forth by Judge Lewis.In considering whether to apply the doctrine of equitable offset, the Secretary evaluated prior rulings, including Pittsburg and Arizona. The PDE argued that the prior two cases established the availability of equitable offset, even in cases when there were serious violations.However, the Secretary disagreed, stating that the cases demonstrate “a variety of factors” influence the application of equitable offset and that applying the doctrine “is a fact-intensive determination to be made in light of the circumstances of each case.” He further provided that “the [a]ppellant has the burden of proof to demonstrate that funds should be offset,” not just “that the offset is in furtherance of the purpose of the grant.”The Secretary held that “equitable offset is at the discretion of the trier of fact” with each request analyzed individually, considering “the scope and persuasiveness of the underlying actions, whether the grantee acted in ‘good faith’ in response to the issue, and the arguments, if any, that the Department offers in opposition to the request for offset.”
The Secretary determined that Judge Lewis “correctly noted” that equitable offset is a fact-based determination, considering “the seriousness and scope of the violation(s) and any mitigating circumstances.”However, in a footnote, the Secretary declined to adopt “the more formal two-part standard” established by Judge Lewis, stating, “[T]he Department is better served by [administrative law judges] exercising their discretion to apply the equitable offset doctrine using a case-by-case, fact-specific analysis.”
According to the Secretary, the facts in Pennsylvania demonstrate that the PDE was not entitled to an equitable offset.In particular, the Secretary noted that this case contrasted with Pittsburg and Arizona, finding that there was a “complete breakdown” in basic practices required by federal regulations and the “[f]ailures of the magnitude here” did not merit an offset. Furthermore, because Philadelphia did not start to make corrective actions prior to the OIG audit report, the Secretary questioned whether these practices would have been addressed at all.The Secretary concurred with the Department’s argument that applying the doctrine here would undermine the Department’s ability to enforce grant monitoring findings effectively.
In addition, at the request of the Department, the Secretary clarified that any corrective action efforts “do not automatically merit the granting of equitable offset.”The Secretary stated that although Philadelphia made notable improvements since the audit report was issued, these corrective actions do not require the application of equitable offset given the seriousness of the violations.
The PDE appealed the Secretary’s decision to the Third Circuit, and, in a non-precedential opinion, the Third Circuit held that equitable offset was not warranted. The Third Circuit declined to decide whether the Secretary’s determination “was an arbitrary departure from established precedent,” stating that deference must be given “to an agency’s interpretation of its own decisions unless the proffered interpretation is capricious.” The Third Circuit detailed that the Secretary’s discussion of previous equitable offset cases demonstrates that “a variety of factors may impact” the decision of whether to apply the remedy.The Third Circuit determined that the Secretary conducted a “thorough evaluation” of the circumstances and of why the application of equitable offset was not merited in this situation due to the underlying violations.
These decisions marked a serious departure from previous equitable offset cases in a number of ways. As reflected in the aforementioned cases, there was a significant body of precedent establishing that qualified expenditures supporting a federal program may be substituted for expenditures disallowed by an audit, without analysis of the underlying violations. By focusing centrally on the underlying violations, Judge Lewis created an entirely new standard. On appeal for reconsideration by the Secretary, the break from established principles was compounded with the Secretary also denying equitable offset based upon the perceived egregiousness of the underlying violations.
Even accepting that equitable offset is a judge-made remedy, Judge Lewis should have been bound by legal precedent.Prior decisions of this tribunal have expressly recognized the ALJs’ obligation to follow established precedent (stare decisis).In particular, Judge Lewis departed from the precedent set forth in several equitable offset cases.
For example, Judge Lewis’ decision in Pennsylvania incorrectly concluded, “In most cases where an equitable offset was allowed, the disallowed expenditures were due to simple error, a lack of adequate documentation or were later deemed permissible costs.”To support this assertion, Judge Lewis cited to his prior decision in Pittsburg.However, in Pittsburg, the underlying audit findings were so significant that the grantee was placed on “high risk” status, the vast majority of the grant funds were determined unallowable or unsupported, and the four-year grant was subsequently terminated after only one year.And yet, in its discussion on equitable offset, instead of analyzing the original misconduct (which were far-reaching and ultimately resulted in termination of the award), the Pittsburg decision focused on the established two-part test: (1) whether the costs were allowable under the grant; and (2) whether the costs were paid with non-federal funds. The Secretary likewise reasoned that Pennsylvania differed from Pittsburg because the “[f]ailures of the magnitude [in Pennsylvania] . . . are too widespread in their scope and too deep in their reach to merit an offset.”The Secretary’s attempt to distinguish the scope and pervasiveness of the violations here from Pittsburg does not hold up. If the tribunal applied the Secretary’s new standard to Pittsburg, considering the lack of self-reporting, the Department’s opposition to an offset, and the widespread audit findings, it is likely that the tribunal would have denied the availability of equitable offset.
As such, the tribunal’s, and subsequently the Secretary’s, reliance on Pittsburg to support “the underlying ‘fairness’ consideration” is misplaced. Instead, the reality of Pittsburg is that the grantee failed its fiduciary duty so much that it was deemed “high risk” and had its award terminated after one year, yet the tribunal still held that the grantee was entitled to equitable offset.
Also baffling about this departure from precedent is that Judge Lewis’s decision in Pennsylvania was in stark contrast to every other equitable offset case he presided over. Judge Lewis presided over North Carolina Department of Public Instruction (North Carolina), where he held, that “as a matter of law, the doctrine of equitable offset is applicable in the review of audit determinations,” and ordered for an evidentiary hearing to determine what expenditures could count towards equitable offset. Judge Lewis also presided over Arizona, in which he did not dispute the parties’ agreement that equitable offset may be applied even when fraud was committed. In addition, Judge Lewis was the presiding judge in Pittsburg, in which he stated that the doctrine of equitable offset “must” be applied and focused the analysis only on the allow- ability of the salaries proposed to be used as offset.
Furthermore, in Pittsburg, he specified that “an equitable offset permits the substitution of any costs paid under the grant that are subsequently disallowed with otherwise allowable expenditures paid by the grantee, and thereby reduces or eliminates a liability due to [the] ED.”In contrast, in Pennsylvania, Judge Lewis emphasized that the availability of “equitable offset is a discretionary determination made by the tribunal where the evidence justifies such consideration and is not a right as [a] matter of law”and further that the appellant seeking equitable offset has the “burden of production and persuasion” with a focus on the “seriousness and scope of the violation(s) and any mitigating circumstances.”Unlike North Carolina, Pittsburg, and Arizona, where the grantees’ underlying violations had no impact on the availability of equitable offset, Judge Lewis in Pennsylvania scrutinized the underlying violations to determine that equitable offset was not available while creating an entirely new standard. It is unclear how the same judge could have authored opinions on the same subject that vary so differently on the application of law.
Similarly, the Secretary cites these same cases in affirming Judge Lewis’s decision to deny the availability of equitable offset based on the underlying violation.Again, in all of the cases, the Secretary’s decision focused the determination of whether an offset was warranted entirely on whether the grantee demonstrated allowable offsetting costs.As such, the Secretary’s reliance on these cases for the denial of equitable offset based on the underlying violation, rather than based on an allowability review of the proposed offsetting costs, seems rather arbitrary and, in fact, a departure from this precedent.
Through the appeal proceedings, the PDE unsuccessfully argued that the abrupt departure from precedent on equitable offset should have been subject to notice and other rule-making requirements mandated by statute and necessary for the establishment of new rules and changes in long-standing interpretations. Specifically, the Administrative Procedure Act (APA) requires that, when an agency revises an interpretation of its governing rules and policy, the agency has to provide notice of that reversal. Similarly, GEPA calls for the Department to officially promulgate guidelines and interpretations through statutorily prescribed channels. The purpose of this statutory language is to ensure agencies follow proper notice and rulemaking requirements and to avoid unfair application of changed rules and interpretations.
The ALJ and Secretary decisions both revise the standard for determining the availability of equitable offset and represent a change in the long-standing policy of the Department without notice. The ALJ and Secretary essentially created new interpretations requiring the PDE to prove that the underlying circumstances warrant the offset, despite years of agency practice and con- trolling precedent consistently applying an equitable offset based solely on an analysis of the auditee’s proven offsetting costs. This runs contrary to the notion of rule-making requirements. In fact, the ALJ’s decision mirrors the 1995 proposed rules by the Department that would have required that equitable offset is only available when the original violation is not intentional or willful. As such, the tribunal’s decision, in effect, adopts a proposed rule after-the-fact without going through agency rulemaking, arguably in violation of the APA and GEPA. However, because the Secretary limited the decision to the parties and facts to the case, the Third Circuit held that “no argument can be made that the decision created a new rule without going through notice and comment rulemaking.”
While the PDE’s appeal was still pending, another grantee, the Georgia Department of Education (GDE), faced a significant recovery action and was seeking equitable offset. In Application of the Georgia Department of Education (Georgia), the Assistant Secretary for the Department sought recovery of allegedly misspent 21st Century Community Learning Center (Twenty-First CCLC) grant program funds. This case was stayed until the Secretary’s decision in Pennsylvania came out, after which the Chief Administrative Law Judge Rod Dixon issued his opinion. There was no dispute between the GDE and the Department regarding the GDE’s failure to comply with all 21st CLCC program requirements.
Judge Dixon refused to apply equitable offset to the GDE’s liability, contending that “application of the doctrine would contravene the congressional mandate expressed in GEPA.” The tribunal claimed that it lacked the authority to apply equitable offset in any case, in part because GEPA lacks any explicit references to the term “equitable offset,” or any express authorization of its use in administrative proceedings. Judge Dixon interpreted GEPA’s measure of recovery provision (20 U.S.C. § 1234b(a)(1)) literally and narrowly, explaining that Congress had already injected a measure of fairness into GEPA by including a proportionality provision (see discussion supra). Judge Dixon then seems to conclude that additional fairness considerations in this context should be avoided because it would somehow subvert congressional intent. Although the GDE cited to a long line of cases supporting its argument for the application of equitable offset, Judge Dixon dismissed this authority, describing the cases as “unmoored from a consistent and ascertainable manner.” The tribunal concluded its decision, stating:
[I]t simply cannot be the case that an open-ended judicially created standard can be relied upon by Georgia in this case or any other to replace a statutory standard without running afoul of commonsense legal principles limiting judges from legislating from the bench or otherwise exceeding the limited scope of authority granted by statute.
This decision is significant, if not well-reasoned, for its abrupt dismissal of a well-established legal doctrine and its narrow interpretation of the authority of the tribunal in its judgment on proceedings on the recovery of federal funds. Because the timing of this decision took place after the Secretary issued his decision in Pennsylvania, it is notable that Judge Dixon determined equitable offset was not available, even though the Secretary had just reaffirmed the remedy (albeit, putting it at his discretion) only a few years prior.
While Judge Dixon’s decision might have completely eliminated the availability of equitable offset, on appeal, the Secretary reached a narrower conclusion. Contrary to Judge Dixon’s decision, which provided a short summary of the facts, the Secretary outlined the extent of the GDE’s violations in implementing the 21st CCLC program. Specifically, the Secretary noted that an audit of the 21st CCLC program exposed a fraud scheme where the grant program consultant excluded twenty-three grant proposals from consideration, and the GDE ignored the scores of the peer review panel for potential sub-grantees, essentially eliminating the competition aspect of the grant program. As a result, seventeen lower-scoring entities received funds when they should not have, totaling to approximately $5.7 million. However, the parties stipulated that only about $2.1 million in liability remained, as a portion of the liability is barred from recovery by the statute of limitations applicable under GEPA recovery of funds actions.
The Secretary evaluated and reversed Judge Dixon’s broad holding that the 1988 amendments to GEPA extinguished the doctrine of equitable offset. The Secretary noted that, since 1988, “the Department and federal courts have consistently upheld the legal propriety of using an equitable offset” and “those decisions show a consistent interpretation that the 1988 GEPA amendments do not conflict with, or extinguish, the equitable offset doctrine.” Furthermore, the Secretary indicated that the doctrine of equitable offset was consistent with the 1988 GEPA amendments because, like the amendments, it made the “audit and appeal process more equitable.” As such, the Secretary held that equitable offset is still an available remedy, albeit one that is available only at the discretion of the Secretary.
The Secretary then turned to whether it would be appropriate to allow equitable offset to the GDE. Citing the Secretary’s decision in Pennsylvania, the Secretary noted that equitable offset is not a matter of right, but rather the determination is “fact-intensive and should proceed case-by-case.” Furthermore, the Secretary stated, “the scope of the violation, whether the violation was intentional or an honest mistake, and the efforts by the appellant to mitigate the violation’s harm” might affect the application of equitable offset.
The Secretary found that “the nature and scope of [the] GDE’s violation [was] too serious to warrant an equitable offset.” Furthermore, the Secretary found that nothing “outweigh[ed] the scope and severity of the violation.” The Secretary distinguished this case from Arizona, as that case only involved a violation totaling approximately $212,000, compared to the $5.7 million in this case. Finally, the Secretary stated that any mitigating steps taken by the GDE (the GDE had self-identified the issue, reported it to the Department, dismissed the involved employees, and ran a new subgrant competition) were limited because by the time that happened, the entire grant award was already improperly expended. As such, the Secretary ordered the GDE to pay the entire liability remaining.
The Secretary’s decision here somewhat mirrors the Secretary’s decision in Pennsylvania. Both cases followed ALJ decisions that marked a serious departure from previous cases dealing with equitable offset. Similar to the Secretary’s decision in Pennsylvania, the Secretary had to walk back on the ALJ’s limitation and, in this case, complete elimination of the availability of equitable offset.
In addition, both Secretary decisions essentially find that equitable offset is unavailable if the underlying violation was intentional, while at the same time failing to acknowledge that such a holding contradicts Arizona — where an offset was applied to fraudulent mis-expenditures. The decisions attempt to reconcile this contradiction because, in Arizona, the Department did not oppose the application of equitable offset. However, this argument falls flat. If equitable offset were not allowable for intentional violations, like in Arizona, then the Department would not have agreed to apply the offset and the ALJ would not have gone forward. The fact that the Department did not oppose the application of equitable offset in Arizona, where there was intentional fraud, demonstrates that equitable offset is an available remedy even when there are intentional violations; certainly, we are entitled to presume that senior officials of the Department would not have agreed to something that cannot be done.
On appeal to the Eleventh Circuit, the GDE was challenged with overcoming the deference afforded to agency decisions to demonstrate that the Secretary’s decision was arbitrary and capricious. The Eleventh Circuit noted that, consistent with GEPA, equitable offset “is a recognized equitable remedy that has been applied in [Department of Education] refund cases since the late 1980’s on a case-by-case basis at the discretion of the finder of fact.” However, the court noted that, if the Secretary were not permitted to consider the underlying violations in determining the availability of the remedy, it “would effectively remove the Secretary’s discretion and convert an equitable offset into a matter of right.” The court stated that no case “necessitates such a result,” and, therefore, the GDE cannot overcome the exceedingly deferential review of an administrative agency’s decision. Accordingly, the Eleventh Circuit held that, in denying the application of equitable offset, the Secretary properly considered the underlying fraud in the case. Furthermore, the court held that this was not arbitrary, capricious, or an abuse of discretion, again reiterating that “[s]ubstantial deference must be shown to the Secretary’s decision ordering the state department of education to refund disallowed grant funds.”
Similar to the Third Circuit decision in Pennsylvania, the court here makes clear it will not substitute its view of a more equitable remedy for the action of the Secretary; rather, the court must be exceedingly deferential to the Secretary in determining whether equitable offset is warranted.
The Pennsylvania and Georgia decisions discussed here signaled a significant shift in the Department’s approach to recovery of grant funds. Under New York and its progeny, the Department treated its relationship with grant recipients as contractual in nature. A grantee and the Department entered into an agreement regarding the amount of funds to be spent on a particular program, and a grantee capable of demonstrating compliance with spending requirements could evade liability for repayment of funds. This mechanical application of equitable offset is consistent with government-wide principles stating that “[a] grant official is without discretion to refuse to authorize payment of allowable costs from funds that become available because of the disallowance.” The equity of the remedy is that the grantee invested its own funding in the grant program and, therefore, could seek reimbursement for such investment should other costs charged to the federal grant be deemed unallowable. As a result, grantees were able to direct more resources towards schools and students to pursue program objectives. The Pennsylvania and Georgia decisions, however, dramatically altered this scheme. These cases endowed the Secretary with the authority to exercise increased discretion in determinations regarding fund repayment. Instead of a mechanical application of crediting grantees for their proven non-federal investment in grant programs, now the Secretary may refuse an offset based on the perceived egregiousness of the underlying violation, leaving grant recipients less equipped to anticipate outcomes of administrative proceedings and plan their program spending accordingly.
What does this mean for Department of Education grantees today? The answer may depend on the particular grant program at issue. Given recent case law, education grantees should exercise caution in the pursuit of equitable remedies. Meeting the evidentiary burden required for an equitable offset claim is incredibly resource and labor intensive. Therefore, education grantees should only pursue equitable offset claims with a prior agreement from the Secretary regarding availability of the remedy, lest the grantee waste valuable resources on a futile claim. This would largely depend on the underlying violations at issue. Despite the bleak outlook for equitable offset following the Pennsylvania and Georgia decisions, not all hope for the doctrine should be lost. The Pennsylvania and Georgia decisions were issued under the Obama administration, a notably proactive and aggressive federal education department. Shortly thereafter, the Trump administration assumed control of the Department and has taken steps to shift responsibility and power from the federal government to state and local agencies, while adopting a more hands- off approach to enforcement actions.
There are early signs of change in the Department’s evolving stance on enforcement actions in the Department’s treatment of a recent major audit finding of Western Governors University (WGU). In January 2019, the Department rejected a $712 million fine against the University, noting, “Because of the ambiguity of the law and regulations and the lack of clear guidance available at the time of the audit period . . . it would not be appropriate to require WGU to return Title IV funds.” The Department further explained that such a significant financial penalty would be inappropriate because WGU demonstrated a “reasonable and good faith effort” to comply with applicable regulations. The Department’s actions are noteworthy here, as they may provide precedent for the development of a new legal standard for liability determinations, with greater consideration for factors such as the availability of sufficient guidance and the grantee’s good faith efforts at compliance.
It is still unclear whether this shift in departmental control and new standard for audit liability is going to open the door for a resurrection of equitable offset for education grantees. The outlook is also uncertain for recipients of federal grants from other agencies. As noted above, there is government-wide authority to support the application of equitable remedies to the administration of federal programs. Pursuant to this government-wide authority, other agencies have repeatedly applied principles similar to equitable offset in their administrative proceedings. However, it is possible that other agencies will be emboldened by the Pennsylvania and Georgia decisions to grant their Secretaries similarly broad discretion to eschew equitable remedies. While there have not been signs that such a departure from standard practice is forthcoming in other parts of the government, Pennsylvania and Georgia teach us that this type of change can occur in unexpected and unpredictable ways. As such, it is important for grantees across the government to be prepared for change.
