By:  J. Kent Holland

There are significant financial requirements that may prove to be insurmountable hurdles tripping unwary faith-based grantees and causing severe financial pain and loss. An organization that takes federal grant funds must formally apply for a grant and then sign a formal grant agreement.  This is a contract with the government agreeing to abide by all the applicable federal laws, regulations, and terms and conditions of the agreement.  With the acceptance of federal grant funding comes intrusion of the government, including reviews and audits to determine whether the government’s rules for running grant programs have been satisfied.  This includes a requirement that funds be used only for the social services intended and not for any religious activities or purposes.

When audited, a grantee must present evidence, including documentation, to prove how it spent the federal funds.  It must be able to prove that all government funds were spent on costs deemed allocable, allowable and reasonable under the federal grant cost principles.  If a grantee cannot meet this burden of proof, the federal grantor agency may terminate the grant, demand repayment of grant funds and take other legal action as it deems appropriate.

This article will briefly explain some of the basic requirements of all federal grants, including administration of the grants and application of federal cost principles, and will in particular focus on grants under the umbrella of the U.S. Department of Health and Human Services (HHS).

Grantee Required to Return Federal Funds

To understand how the federal grant process works it may be easiest to explain the requirements by way of example.   In one reported grant appeal, a faith-based organization was required to repay funds it had accepted under its federal grant because it failed to perform the grant purposes within the requirement time limitations of the grant.

Oakwood Child Development Center, Inc. (Oakwood) appealed a decision by
the Family Support Administration (FSA/Agency) denying a request by
Oakwood for a no-cost, one year extension of a grant under the Community
Services Block Grant Act.  ((DAB No. 1092).  Six reasons were given by the FSA for denial of the requested no-cost extension of Oakwood’s grant.  The three most significant reasons were, in

(1) Even though Oakwood received emergency funding it failed to
implement its proposed renovation project in the one year
project period;

(2) At the time the grant expired Oakwood had not achieved any of
its proposed goals or provided any other benefits to the
proposed low-income beneficiaries of this project; and

(3) Oakwood drew down the $300,000 for renovations of the building
soon after receiving grant approval but had not begun any renovations over one year later.

The terms of the grant prohibited Oakwood from using any part of the building
for any sectarian purposes.   Oakwood is a non-profit affiliate of The Yeshiva Rav Isacsohn (the Yeshiva) an educational institution serving more than 700 children from pre-school through high school in Los Angeles , California . The focus of this case is on Oakwood’s acquisition and proposed renovation of a building for use as a Child Development Center .  Oakwood applied for a $2.3 million grant under section 681 of the Community Services Block Grant Act. Oakwood sought
$1.5 million for purchase of the Azteca Building and $800,000 for renovations.  Oakwood received $1.8 million: $1.5 million for acquisition of the building and $300,000 for renovation.

In part, the Assurance required that Oakwood agree  that “that no portion of any property or facility acquired or renovated in whole or in part with funds awarded or otherwise acquired pursuant to this Application will be used for religious worship, sectarian instruction or any other religious purpose.”

In response to the FSA’s refusal to extend the time period of the grant, Oakwood filed an appeal to the Grant Appeals Board of the Department of Health and Human Services.  In the briefs submitted to the appeals board, the  FSA devoted much of its argument to the religious factor. It claimed that Oakwood had “improperly devoted itself to the religious objectives of the Yeshiva,” rather than implementation of the purposes of the grant. FSA further alleged that Oakwood’s “overriding goal” was to circumvent the Assurance of Non-Sectarian Activity so that the Azteca Building could be made available “for the religious activities of the Yeshiva.”

Rather than addressing the question of these religious factors, the Board instead focused on whether FSA acted within its legal discretion in denying the requested grant extension.  As explained by the Board, the standard of appellate review is very strict.  The decision of the grantor agency (FSA) must be upheld “unless it was arbitrary”  since it is a “general of administrative law, that a certain presumption of regularity attaches to
the actions of government officials.”  The Board stated: “In our view . . . the grantee must show that this decision was arbitrary and discriminatory.”

In federal grant dispute cases the burden of proof is always on the grantee – the recipient of the grant funds.  The federal agency action is presumed reasonable unless proved otherwise by the grantee.  This is a heavy burden.  For this reason, a brief perusal of federal grant dispute decisions will demonstrate that the vast majority of cases are decided against the grant recipients and in favor of the federal grantor agency that has terminated a grant, disallowed expenditures under grant, or taken other action adverse to the grantee.

It is important to understand how difficult it is for a grantee to prove the federal agency wrong.  As The Board in Oakwood explained, the only question for the Board is whether the grantor agency made “a reasonable decision, not was it the only decision, or even the best decision, or even the decision that others might have made . . . [was it simply] a reasonable, rational decision.”

In this case, the Board concluded that the decision whether to grant a no-cost extension was a discretionary determination and that the FSA had amble reason not to extend the grant.  Having lost its grant, Oakwood was directed by the Board to comply with the decisions of the FSA to return the grant funds.  To do so, Oakwood could have to sell the affected property to generate the necessary funds for repayment.

What are the Rules?

Rules Specific to Faith-Based Organizations

The federal regulations state that grantees may not engage in inherently religious instruction or proselytization as part of the programs or services funded with grant money.  To the extent such activities are conducted by an organization they must be offered separately in time or location from the federally funded programs or servides, and participation must be voluntary.  No discrimination against a program beneficiary on the basis of religion or religious belief is permitted.  And all eligible activities under a grant must be carried out “ in accordance with all program requirements and other applicable requirements governing the conduct of Department-funded activities.”  45 CFR 87.1

(c)  (e) and  (f).

Financial Management Requirements

All grant recipients are required to maintain financial management systems that provide “accurate, current and complete disclosure of the financial results of each HHS-sponsored project or program in accordance with the reporting requirements” of the HHS regulations.  45 CFR 74.21 (b).   This includes maintaining “Written procedures for determining the reasonableness, allocability and allowability of costs in accordance with the provisions of the applicable Federal cost principles and the terms and conditions of the grant” and “ Accounting records, including cost accounting records, that are supported by source documentation.”

To be accepted , costs must meet all of the following criteria:

(1)  Are verifiable from the recipient’s records;

(2)  Are not included as contributions for any other federally-assisted project or program;

(3)  Are necessary and reasonable for proper and efficient accomplishment of project or program objectives;

(4)  Are allowable under the applicable cost principles….

Moreover, the allowability of costs incurred by nonprofit organizations … is determined in accordance with the provisions of OMB Circular A-122, ‘Cost Principles for Nonprofit Organizations and the grantor agency regulations. 45 CFR  74.27 (a) …

Federal Cost Principles of the OMB

When grantee are audited by their grantor agency, any costs failing to meet the allowability requirements of OMB Circular A-122 will be disallowed.  So what does the Circular require the grantee to prove in order that costs be deemed allowable?  The grantee must be able to show that the costs meet each of the following general criteria:

“a) Be reasonable for the performance of the award and be allocable thereto under these principles.

b) Conform to any limitations or exclusions set forth in these principles or in the award as to types or amount of cost items.

c) Be consistent with policies and procedures that apply uniformly to both federally financed and other activities of the organization.

d) Be accorded consistent treatment.

e) Be determined in accordance with generally accepted accounting principles (GAAP).

f) Not be included as a cost or used to meet cost sharing or matching requirements of any other federally financed program in either the current or a prior period.

g) Be adequately documented.”

To be deemed “allowable,”  a cost must also be found to be “reasonable.”   The OMB Circular explains that: “A cost is reasonable if, in its nature or amount, it does not exceed that which would be incurred by a prudent person under the circumstances prevailing at the time the decision was made to incur the costs.”   The Circular further provides that in determining reasonableness, “consideration shall be given to whether the cost is of a type generally recognized as ordinary and necessary for the operation of the organization or the performance of the award.”   The cost must also be considered in light of restraints that would be imposed by sound business practices and arms length bargaining.  There also must not be “significant deviations from the established practices of the organization which may unjustifiably increase the award costs.”

Even if the cost is  “reasonable” and “allowable ” it will not be accepted under the grant unless it is also an “allocable cost.”    As explained by the Circular, “A cost is allocable to a Federal award if it is treated consistently with other costs incurred for the same purpose in like circumstances and if it: (1) Is incurred specifically for the award; (2) Benefits both the award and other work and can be distributed in reasonable proportion to the benefits received, or (3) Is necessary to the overall operation of the organization, although a direct relationship to any particular cost objective cannot be shown.”

What Happens if the Government Agency Disallows Costs?

Federal grantor agencies have the authority to take legal action they deem necessary to recoup disallowed costs.  As explained above, the disallowance could be due to any number of reasons such as the grantee’s failure to expend the funds on allocable costs for the specific grant purpose.  An example of misspending funds would be the expenditure of federal money for the religious purposes and programs of the grantee instead of on specified social services.   Assuming the grantee can prove that it kept its religious and social services separate from each other in either time or location, the government may still disallow costs if they were unreasonable, for example, excessive in comparison what other prudent persons would have paid.  That are certain costs that are unallowable for federal grant funding no matter how reasonable they may appear.  For example, grant funds cannot be used for lobbying efforts.

Even if the grantee did everything correctly under the grant, it may lose its grant funding if it cannot show with written documentation how it expended the funds and that the costs were reasonable.  The burden of proof falls to the grantee.  If it cannot present adequate documentation, the federal agency is within its rights to presume that the funds were misspent.  The federal agency is not required to prove any wrong doing.  Instead, the grantee must prove that it did everything by the book.

For HHS grants, once the grant award official has determined that a costs is unallowable, the agency must take action to collect the money from the grantee.  As explained by the HHS Grants Administration Manual (Chapter 1-105-60), “if a determination is made that a cost is unallowable, the Action and Approving Officials do not have the authority to “waive” (forgive) collection of the disallowance. These disallowances constitute claims by the Government, and may be waived or reduced only under the limited conditions prescribed in the Federal Claims Collection Act.”

A grantee may feel that because it accomplished its program objectives the government should be kind, patient, and understanding when it comes to auditing the grant.  But this is not the case.  In fact, the HHS Manual specifically admonishes the HHS grant officials as follows:  “In determining whether a cost is allowable or unallowable, factors such as the good faith of the organization, its successful accomplishment of program objectives or its ignorance of the provisions of the awards, although important for other purposes, shall not be used as a basis for allowing costs which are unallowable under the provisions of the awards. The organization’s ability to make restitution also has no bearing on the allowability of a cost, but should be considered, where necessary, in establishing recovery periods and in determining whether there is justification for reducing or waiving collection of a claim under the Federal Claims Collection Act and implementing procedures.”

What I Learned as a Qausi-Judge at EPA

For several years in the 1980s, I served as a Standing Member (quasi-judge) of the grant appeals board of the U.S. Environmental Protection Agency.  Following audit reviews of grants to municipalities under the Clean Water Act, many cities were directed to return millions of dollars to the EPA.  When grantees appealed the adverse decisions, it was my job to determine whether the grantee had met its burden of proving that the questioned costs were “allowable” and properly expended for the allocable grant purposes.   This had to be accomplished with written documentation showing that the grantee satisfied the EPA program regulations, and the relevant cost principles.  In most cases that came before me for review and decision, I found in favor of the EPA against the grantee.  This was so even though virtually every grantee had accomplished the basic grant purpose of building a project to help clean up water or improve water quality.

There were cases that I decided against a grantee for the sole reason that the grantee didn’t maintain proper paper documentation to prove how the funds were expended and that they were used for allocable and allowable costs.  It didn’t matter that I believed the project worked great and accomplished its intended purpose.  It didn’t matter that I personally believed the Mayor and city personnel acted with integrity and honesty in managing their grant.  It didn’t matter that I thought the EPA and its auditors were being unduly demanding and perhaps interpreting and applying the regulations in a overly strict manner.

As explained by the HHS Grant Appeal Board decision at the beginning of this article, the burden of proof is on the grantee to prove that the federal agency acted arbitrarily and capriciously in disallowing the questioned costs.  On review to an appeals board, the only question is whether the grantor agency decision was reasonable, not whether it was the “only decision, or even the best decision.”  This same standard applies if a grantee files suit in court against the federal grantor agency.  The court will review the administrative record to determine whether the agency acted within its legal discretion.   There will not be a trail with witnesses and a jury.

I have seen judges frustrated that they had to abide by this strict standard.  One judge in one of my EPA cases even chastised the agency for issuing a decision based on a regulatory interpretation that the judge said he disagreed with and would have interpreted the way the grantee wanted it interpreted.   Nevertheless, the judge went on to explain that he couldn’t reverse the agency merely because he didn’t like the agency’s position as well as that of the grantee since there was nothing about the agency position that was arbitrary and capricious.   It was not long afterwards that I decided to leave the agency and go into private practice representing EPA grantees to help them survive the audit and preserve their funds for their programs.


Before accepting a federal grant, a faith-based organization needs to learn the requirements of the federal regulations, cost principles, and the specific terms and conditions of its grant agreement.   The consequences of failing to document that every dollar is spent consistent with the requirements could be devastating.   If it is determined that grant funds were expended for costs that are unreasonable, unallowable or for items unallocable to the grant purposes (such as proselytizing or conducting religious services), the federal agency must recoup recover the unallowable costs from the grantee.  As explained by the HHS grants manual, the grant award official has not discretion to show mercy when it comes to recovering unallowable costs.

When an organization accepts federal grant funds, it better be prepared to document, using written records, showing that religious services were kept strictly apart from the social services funded under the grant. They also will need to be able to prove where, how and why the funds were spent, and that they were spent on allocable and allowable costs.  This may not be an easy task, but it is too important not to do it right.  Indeed, some grantees that have been unable to repay their grant debt to the federal agency have been sued in federal court by the agency to collect the debt.  In the event that liquid funds are not available, it is conceivable that the government could attach and sell off physical property (perhaps church buildings) belonging to the grantee organization in order to recover the debt.

Carefully weigh the requirements and the risks before accepting federal grant funds!

About the author: Kent Holland is a construction lawyer  in Tysons Corner , Virginia .  He is also publisher of Report.  For several years in the early mid 1980s, as an attorney with the U.S. Environmental Protection Agency (U.S. EPA) Office of General Counsel, Grants and Contracts Branch.  he served several years on the EPA Board of Assistance Appeals, deciding grant appeals filed by recipients of wastewater treatment construction grants and Superfund cooperative agreement funds.  Since leaving the Agency, he has successfully represented numerous municipalities in disputes with EPA over the eligibility and allowability of costs claimed under grant programs. He may be reached at