**CHAPTER 7**

**FOLLOW-UP PROCEDURES**

**CONTENTS**

> INTRODUCTION 7-2
>
> BASIC FOLLOW-UP PRINCIPLES 7-3
>
> FOLLOW-UP IN A CHANGING REGULATORY ENVIRONMENT 7-4
>
> THE INFLUENCE OF POLITICS 7-5
>
> REWARDING SUPERIOR OR IMPROVED PERFORMANCE 7-6
>
> LEARNING FROM MISTAKES 7-7
>
> THE PRINCIPLE OF PROGRESSIVE SANCTIONS 7-8
>
> Stage I: Early Warning/Early Response 7-9
>
> Stage II: Intervention for More Serious or Persistent Problems 7-10
>
> Stage III: Red Alert 7-11
>
> SUMMARY 7-11

**APPENDIX**

-   Common Subrecipient Monitoring Problems:

> Program Income 7-16
>
> Economic Development 7-19

**CHAPTER 7**

> **FOLLOW‑UP PROCEDURES**

***Case #1**: The Community Development Director of Gotham City and her
staff took their subrecipient monitoring responsibilities seriously.
Unfortunately, the care they put into crafting thorough and
individualized monitoring letters meant that the letters often did not
reach subrecipients until three to four months after the site visits had
taken place. In addition, an intensive monitoring schedule left very
limited time for contacting subrecipients between monitoring visits.
Given the emphasis they put on monitoring, the CD staff were discouraged
by the large number of "repeat findings" they uncovered during
subsequent reviews of subrecipients' activities.*

***Case #2**: In the City of Port Culis, staff of the CD office rarely
performed "formal" monitoring of their experienced subrecipients,
particularly formal comprehensive monitoring. The CD Director assumed
that these subrecipients knew the regulations and their responsibilities
and would resent the "nitpicking" of formal monitoring. However, when a
HUD Field Office review compelled the CD Office to monitor their
subrecipients formally, site visits revealed serious deficiencies in the
record-keeping, administrative systems, and program compliance of many
experienced subrecipients, even among organizations the CD Director had
regarded as exemplary.*

***Case #3**: The CD Director of Parva preferred to emphasize frequent
technical assistance visits to subrecipients rather than formal
monitoring. He felt that formal monitoring would only make subrecipients
feel defensive and would put a strain on the pleasant working
relationship the CD office had struggled to establish with them. About
nine months into the program year, however, he became frustrated with
the subrecipients\' failure to implement the recommendations he offered
in the technical assistance visits. As a result, he concluded that
stronger action was necessary. He instructed the CD monitoring staff to
conduct formal subrecipient monitoring reviews "by the book" for the
rest of the program year. Not surprisingly, the initial reviews resulted
in scores of* *findings, questioned costs, and disallowances. Within a
few days of the monitoring visits, the Parva CD Director realized that
he had opened a political Pandora\'s box. Groups of subrecipients were
contacting city councilors and the mayor\'s office to complain bitterly
that the CD Office had "changed the rules" and had "set them up." The CD
Director was ordered to appear before the city council to explain his
action.*

**INTRODUCTION**

The hypothetical scenarios above describe three different approaches to
subrecipient monitoring, all of which failed to promote better
performance. *Although well‑intentioned, all three approaches fall short
because of inconsistent or inadequate follow‑up.* This chapter discusses
techniques you can use to follow up on subrecipient monitoring to make
sure that subrecipients correct the problems you brought to their
attention as a result of the monitoring. While found, you must still
ensure that subrecipients realize they will be sanctioned for problems
they fail to remedy and rewarded for good performance. Some common
problem areas of subrecipient monitoring are discussed in the Appendix
to this chapter.

**BASIC FOLLOW-UP PRINCIPLES**

-   **Accountability**

  -----------------------------------------------------------------------
  ***Accountability means follow-up and follow-through.***

  -----------------------------------------------------------------------

The approaches used in the cases just described fail to adhere to one or
more of the four principles of effective follow-up:

1.  ***Make sure your subrecipients know that they are [accountable for
    their performance]{.underline} (as defined by the Agreement) and for
    observing all program rules.*** Accountability means that there are
    understood consequences for observing and not observing program
    rules and regulations, and that satisfactory performance is a
    requirement for the reimbursement of costs and continued
    participation in the CDBG program. Accountability means that:

-   you will *follow up to verify that the subrecipient implements the
    corrective actions called for in your monitoring letter*, and

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-   you will *follow through to impose sanctions* if effective action
    has not been taken.

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-   **Clarity and Consistency**

2\. ***Make sure the standards for satisfactory performance, and the
sanctions and rewards for performance are [clear and
consistent]{.underline}***. Communicate ahead of time your definition of
satisfactory performance, including keeping adequate records and
assuring that services specified in the written Agreement are delivered
on time and within the budget. Don\'t change your standards of
acceptable performance after the fact.

-   **Regular Feedback**

3\. ***Based on your monitoring, let your subrecipients know [how they
are doing]{.underline} on a regular and complete basis*.** Don\'t
provide feedback just once a year in a monitoring letter, but rather
every time you have a chance to observe subrecipient activities. Don\'t
catch your subrecipients by surprise with your criticisms.

-   **Timeliness**

4\. ***Make all your communications with subrecipients, especially those
regarding the results of your monitoring visits,
[timely]{.underline}***. Let your subrecipients know right away when
there are problems. The longer you wait, the worse the problems will get
and the more difficult it will be to solve them.

+-----------------------------------------------------------------------+
| ***"If the monitoring results were so darned important, why did it    |
| take four months to tell me about them?"***                           |
|                                                                       |
| ***-Disgruntled subrecipient***                                       |
+-----------------------------------------------------------------------+

> In the first example above (Gotham City), instead of letting the
> subrecipients know quickly what issues they needed to address and how,
> the CD staff spent too much time worrying about the details of the
> problems their monitoring revealed and too little time telling their
> subrecipients the monitoring results. When the link between monitoring
> and follow-up is not direct and immediate, you will be issuing
> findings long after the visit. As a result, your subrecipients may
> ignore them, because they feel the findings don\'t apply to their
> current activities.

+-----------------------------------------------------------------------+
| ***"You have to be willing to use a big stick. If there are no        |
| consequences, they won't pay attention."***                           |
|                                                                       |
| ***-CD Program Specialist***                                          |
+-----------------------------------------------------------------------+

> In the second case (Port Culis), the real hang-ups are lack of
> accountability and feedback. Without monitoring and follow-up, there
> can be no accountability. Even the best performers may not keep doing
> good work or continue to comply with program rules without your
> regular attention and support. Without regular monitoring and
> follow-up, subrecipients may get the feeling that no matter what they
> do, good or bad, they are entitled to the same (or higher) level of
> support year after year.
>
> In the third case (Parva), the central weaknesses of the CD
> Director\'s monitoring are lack of clarity and consistency.
> ***Subrecipients have a legitimate expectation that the "rules of the
> game" are not going to change without warning \[or as a result of
> arbitrary decisions by a CD Director\]***. Your definitions of
> acceptable and unacceptable performance, described in detail and in
> writing before the award, need to be invariable and unambiguous.
> Simply "getting tough" after you discover unacceptable performance is
> likely to make subrecipients stubborn about fixing problems,
> especially if they feel you have changed your definition of
> "acceptable" performance or you have cracked down on a problem you
> never told the subrecipients they were responsible for handling.

**FOLLOW-UP IN A CHANGING REGULATORY ENVIRONMENT**

Despite the need for consistency in your performance requirements,
everyone knows that certain CDBG regulations, or their interpretation,
do change. For example, with regard to economic development activities,
the changes in the legislative language from "necessary or appropriate"
to "appropriate" alone, followed by the imposition of specific public
benefit requirements, as well as HUD's interpretation of the language,
resulted in some confusion. In some circumstances, you may want to take
a ***conservative approach*** with your subrecipients and rely on a
"narrow" interpretation of the rules.

**THE INFLUENCE OF POLITICS**

  -----------------------------------------------------------------------
  ***It also helps to get politicians to "buy into" a performance
  standards approach [before]{.underline} subrecipients are involved.***

  -----------------------------------------------------------------------

Say, for instance, that in the absence of any other funding source, one
of your local development corporations would like to provide a
struggling business with a \$30,000-economic development "survival" loan
that will keep jobs. However, the business can produce no financial
records or pro formas that allow you to gauge the "feasibility" of the
project or assess the likelihood of its success.

If you provide the loan, you and your subrecipient may be asking for
trouble. The business might not survive and that would raise questions
about how a CDBG National Objective was met. It is probably better to
wait until the documentation needed for assessing risk and underwriting
the loan is available. On the one hand, such delays may preclude
providing support to some worthwhile projects; on the other hand,
caution may save you from costly confrontations with HUD later.

Most grantees acknowledge that their selection of subrecipients can
sometimes be influenced by political considerations. These political
considerations can take the teeth out of your monitoring and follow-up
systems, because a subrecipient may think it is "immune" to findings,
disallowances, or other sanctions because of its political connections.

You can take four steps that will help you conduct effective follow-up
with these "well connected" subrecipients:

-   ***Try to establish standard selection criteria that will help
    ensure that an entity applying to be a subrecipient must demonstrate
    that it has appropriate qualifications for undertaking CDBG
    activities.*** Even if the final choice of subrecipients is not
    yours, the careful assessment of qualifications will help you to
    anticipate the types of problems you are likely to face with such
    organizations as subrecipients, and to prepare you to deal with
    them.

-   ***Insist on clearly defined and measurable performance expectations
    in a written Agreement.*** This will enable you to document poor
    performance or noncompliance, and to use the evidence to counter a
    subrecipient\'s claims that it was unaware of the grantee\'s
    expectations, or the subrecipient\'s refusal to respond to findings
    and concerns.

-   ***Share your dilemma with key elected officials (mayor, city
    council***). If your informal, pre-monitoring visits suggest that
    you will find serious deficiencies during the monitoring visit,
    sharing the circumstances and the documentation with appropriate
    elected officials can help motivate the subrecipient to take action
    before its problems become part of the public record.

  -----------------------------------------------------------------------
  ***If a subrecipient looks bad, the grantee looks bad too.***

  -----------------------------------------------------------------------

**REWARDING SUPERIOR OR IMPROVED PERFORMANCE**

  -----------------------------------------------------------------------
  ***Grantees should use "rewards or recognition for outstanding
  performance" as a technique to encourage improvement among their
  subrecipients.***

  -----------------------------------------------------------------------

-   **Praise for Performance**

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-   ***Point out the risks***. It is fair to point out to both elected
    officials and to subrecipients that HUD can impose sanctions on your
    entire program for substantial or continued subrecipient
    noncompliance with HUD rules. Most administrative and elected
    officials are unwilling to assume the risk of compromising the
    entire CDBG program and will therefore agree to pressure the
    subrecipient to rectify the operational deficiencies you have
    identified.

If a media story or outside review focuses attention on poor
subrecipient performance that you have tolerated, your agency\'s
reputation will probably be tarnished just as much as the
subrecipient\'s, no matter what political support you or the
subrecipient may have enjoyed previously. If a subrecipient looks bad,
you look bad.

If the subrecipient looks [good]{.underline}, you and the elected
officials can share in the credit. Try to convince local officials that
good subrecipient performance is good for politics. For example,
competent subcontractor performance helps protect them from charges of
political favoritism.

#### Securing official support for following up on monitoring results can be a lot easier if you can get subrecipients *to meet performance expectations through positive motivation*, rather than through imposing sanctions. Relying on penalties alone can result in a contentious relationship with your subrecipients. As a result, you may overlook (and therefore not reward) examples of superior performance. It helps to appreciate what has been accomplished already. It also helps to acknowledge a subrecipient\'s efforts at improvement, even when there\'s still a long way to go.

There are a variety of ways to reward good performance and regulatory
compliance among your subrecipients.

In your monitoring letters and other communication with subrecipients,
***pay as much attention to areas of success as to areas that need
work***. For example, if a community development corporation has
recently completed a 20-unit rehabilitation project, but has neglected
to complete inspections of the last three units, recognition of the
primary achievement should precede your concern for the missing
inspections.

There are few things more discouraging than to have your achievements
taken for granted while your flaws are publicly scrutinized and
censured. Consider issuing special letters of commendation or even
organizing annual awards ceremonies for the best performers in various
categories of activities. Send copies of the letter to pertinent public
officials and invite these officials to your

award ceremonies. (Be aware when holding awards events that CDBG funds
cannot be used for entertainment.)

-   **Competition**

***Try to create a little healthy competition among your
subrecipients***. For example, a simple newsletter might highlight the
achievements of particular subrecipients or present information about
the (relative) performance of each subrecipient. By also reporting on
recent regulatory issues, training opportunities, and application
deadlines, the newsletter can take the place of memoranda that a grantee
would otherwise have to write and disseminate anyway.

-   **Public Relations**

If you have a good relationship with a local newspaper, radio station,
or cable or TV station, ***ask it to do a feature story on subrecipient
activities that deserve public recognition***. You might also arrange
for local officials or visiting dignitaries to make site visits to
exemplary subrecipients.

-   **Contingency Awards**

***Plan on making extra funding available for subrecipients that surpass
their goals and achieve outstanding performance***. You can set aside
funds in activity categories beyond what is initially obligated to
specific subrecipients. Your written Agreement with subrecipients can
include incentive clauses stating that documented levels of performance
within a specified timeframe will automatically result in supplemental
funding for the activity area in which the subrecipient has excelled.

Alternatively, you might invite a select group of top-performing
subrecipients to compete for extra funding under a contingency-funded
bonus round. Subrecipients also might be requested to propose new
activities that would make use of the money or be permitted to use funds
not normally available to them (e.g., program income).

*In all such cases, however, the grantee would need to satisfy the
citizen participation requirements of the CDBG program with respect to
the new or increased activities.*

**LEARNING FROM MISTAKES: YOUR COMMITMENT TO CONSTANT IMPROVEMENT**

In addition to providing rewards for improved or superior performance,
you also need to pay attention to the way you respond to subrecipients\'
mistakes. All subrecipients make mistakes; what is important is that
they learn from the experience so they can improve their performance.

If you create an environment where subrecipients are afraid to
acknowledge mistakes and learn from them, very little improvement is
going to take place. Instead, subrecipients will devote much of their
energy to denying there is a problem or arguing the problem wasn\'t
their fault. You then have to take extra time getting the subrecipient
to admit that a problem exists. If subrecipients end up

thinking you were the cause of their problem, they may remain angry with
you long after they have forgotten what the issue was all about.

The key to preventing this kind of deadlock is to take a balanced
approach. Don\'t treat the problem too casually, or the subrecipient may
conclude that its performance doesn\'t matter that much. However, don\'t
be too harsh in your response; otherwise the subrecipient may become
reluctant to raise issues or ask questions that should be dealt with
right away.

***Treat subrecipient mistakes as opportunities to correct weaknesses,
and support the subrecipient in improving its operations***. If a
subrecipient refuses to learn from the experience and persists in
repeating the mistake, then you may have to consider using sanctions.
But you have to be very clear with your subrecipients about the
conditions under which sanctions will be imposed.

The grantee must also keep in mind, however, that ultimately it is
responsible for anything the subrecipient does with CDBG funds. If HUD
decides to disallow costs incurred by a subrecipient, the grantee must
"settle up," and then decide if it wants to pass the disallowance on to
the subrecipient.

**THE PRINCIPLE OF PROGRESSIVE SANCTIONS**

+-----------------------------------------------------------------------+
| ***The principle of progressive sanctions requires that you always    |
| specify a timetable for improvements, setting forth:***               |
|                                                                       |
| -   ***the corrective actions required; and***                        |
|                                                                       |
| -   ***the deadlines when they must be implemented.***                |
|                                                                       |
| ***Without a timetable, the targets for improvement will remain       |
| unclear.***                                                           |
+-----------------------------------------------------------------------+

In applying sanctions, you want to use the least amount of punishment
needed to get the subrecipient to take corrective action. This
***principle of progressive sanctions*** involves a gradual escalation
of penalties for continued poor performance, while affording the
subrecipient a reasonable opportunity at each stage to settle the
problem ***before*** more serious sanctions are considered.

The success of progressive sanctions depends on your taking two steps:

-   First, you must identify and discuss problem areas in the
    subrecipient\'s operations as early as possible.

-   Second, you have to communicate clearly and effectively to the
    subrecipient the standards for correcting those problems and the
    consequences for failing to meet these standards within a prescribed
    period of time.

The progressive sanctions approach has several benefits:

-   Most problems can be resolved when they are still minor, thereby
    putting the least amount of stress on both you and the subrecipient;

-   If the subrecipient continues to refuse to take corrective action,
    you can prove to other interested parties (such as local elected
    officials or other subrecipients) that you have given the

> subrecipient every possible consideration before imposing serious
> penalties; and

-   With a gradual approach to sanctions, you can demonstrate to HUD
    that you are pursing a reasonable, yet serious, course to get the
    subrecipient to address its deficiencies in a timely manner.

The strategy of progressive sanctions offers a dramatic contrast to the
approach taken by the grantee in Case #3 (Parva) described at the
beginning of this chapter. There, subrecipients received no prior
notification that the grantee was considering serious sanctions, or even
that the grantee no longer considered their past practice to be
acceptable. Consequently, they had neither opportunity nor incentive to
improve their operations before the sanctions were imposed.

You can apply progressive sanctions in a series of stages, from simply
making a subrecipient aware of its operational weaknesses all the way to
disallowing its expenses or terminating its activities. The following
provides a description of three stages of progressive sanctions.

**Stage I: Early Warning/Early**

**Response**

Stage I begins when the subrecipient\'s difficulties have just come to
your attention. Your tracking and monitoring systems should be able to
bring the problem to light before it presents serious financial
implications for the subrecipient.

At this initial stage, after you verify the nature and extent of the
problem, your first task is to communicate to the subrecipient the
nature of the problem, what needs to be done to correct it, and what
assistance you can provide to help carry out the necessary corrective
action. You should develop and notify the subrecipient about a timetable
for corrective action.

You have three main options for implementing an intervention strategy:

(1) ***Plan an intervention strategy with the subrecipient that involves
    additional training or technical assistance.*** In this response,
    you assume some of the responsibility for helping the subrecipient
    to correct the problem. Although this response may require staff
    time not readily available, the time spent can be both effective in
    solving the problem and beneficial in enhancing your relationship
    with the subrecipient.

(2) ***Require more frequent or more thorough reporting by the
    subrecipient***. This imposes a mild sanction on the subrecipient,
    while improving your ability to track the subrecipient\'s progress
    or regulatory compliance. The strategy sends a clear message to the
    subrecipient that you are going to monitor its activities closely.

+-----------------------------------------------------------------------+
| ***Follow up a monitoring visit:***                                   |
|                                                                       |
| -   ***With additional communications, technical assistance or        |
|     training;***                                                      |
|                                                                       |
| -   ***additional monitoring if a problem is detected and/or is       |
|     found; and***                                                     |
|                                                                       |
| -   ***extra reporting by the subrecipient if a problem is found.***  |
+-----------------------------------------------------------------------+

\(3\) ***Conduct more frequent on-site monitoring or follow-up
monitoring of the subrecipient.*** This is an effective action for
somewhat more serious or widespread deficiencies in a subrecipient\'s
operations. While it requires additional effort on your part, it
communicates that you view the matter very seriously. Give the
subrecipient a specific period of time in which to correct the problem,
and then review progress on-site to ensure that the subrecipient
properly implemented the required corrective action.

If the support and milder sanctions you impose in Stage I don\'t work,
you may have to take more decisive action. You may also want to skip
Stage I and move directly to Stage II for subrecipients that you
discover have serious or widespread problems that demand an emphatic
response. For example, a new subrecipient may have initiated activities
before receiving environmental clearance, may have failed to initiate
adequate income documentation for beneficiaries, or may not have
adequately inspected "completed" work in its housing rehabilitation
activities before allowing the units to be occupied and/or authorizing
final payment to contractors.

**Stage II: Intervention for More Serious or Persistent Problems**

  -----------------------------------------------------------------------
  ***Grantees may find it necessary to disallow the expenses of a
  subrecipient, or place a subrecipient on probationary status for
  non-performance.***

  -----------------------------------------------------------------------

Some of the possible actions you might consider at this stage are:

-   ***Restrict the subrecipient\'s payment requests***. You can
    restrict the frequency of requests or the budget line items for
    which the subrecipient can request payment. You can also increase
    the documentation the subrecipient must provide with its payment
    requests before you will approve them. Through this mechanism you
    can "micro-manage" the subrecipient\'s implementation of corrective
    action.

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-   ***Disallow subrecipient expenses (or require repayment).*** This is
    a severe sanction, since many subrecipients have very limited
    unrestricted funds for making repayments. In some cases (as when a
    subrecipient incurs program expenses prior to environmental review
    clearance), you may have no option other than to disallow the
    expenses. In other instances, you might allow a subrecipient to
    provide additional documentation to validate an expense or find some
    other way to avoid the disallowance, but usually on the condition
    that the subrecipient make a dramatic reform in its operations.

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-   ***Impose probationary status***. You can take this step when a
    subrecipient has significant or widespread shortcomings in its
    operations and has ignored your efforts to bring about corrective
    action. With this step, you are giving notice that you will
    terminate the subrecipient if it doesn\'t correct its problems.

**Stage III: Red Alert**

  -----------------------------------------------------------------------
  ***Performance problems are a common reason for not renewing a
  subrecipient in a subsequent program year for performance reasons. Many
  grantees have had cause to either suspend or terminate a subrecipient
  prior to the end of a program year.***

  -----------------------------------------------------------------------

Stage III includes "last ditch" measures to turn around the situation
with a poorly performing subrecipient. Possible actions include:

-   ***Temporarily suspend the subrecipient (or the activity being
    carried out by the subrecipient***). This action should help
    convince the subrecipient that you "mean business." However, an
    action of this severity also suggests that the subrecipient\'s
    operations are in such bad shape that you will need to provide
    intensive technical assistance to get the subrecipient\'s systems
    working properly.

-   ***Do not renew the subrecipient the next program year***. This is
    often the easiest approach to "terminating" a badly performing
    subrecipient, but you have to be careful not to wait until next year
    if there is a significant danger of continued mismanagement or
    misuse of funds in the current program year.

-   ***Terminate the subrecipient in the current program year***. If you
    plan to take this action, first review the language of the written
    Subrecipient Agreement regarding termination (allowable reasons for
    termination, rights of appeal, access to and maintenance of records,
    computation of compensation due in the event of termination,
    disposition of property bought with CDBG funds, and the general
    liability of the subrecipient).

-   ***Initiate legal action***. You may need to follow termination with
    legal action in order to gain control of program funds, records, and
    property, or to get back improperly spent funds.

**SUMMARY**

This chapter has presented techniques for following up the results of
your subrecipient monitoring. The goals of follow-up are to make sure
that subrecipients implement the corrective actions you specify in your
monitoring letters and to reward subrecipients who improve their
performance and comply with CDBG regulations. You will not be alone if
you find you must suspend, terminate, or not renew a subrecipient. The
majority of CDBG grantees have had to take similar positions for
performance reasons.

  -----------------------------------------------------------------------
  ***Without effective follow-up, monitoring will have little impact on
  improving performance and achieving regulatory compliance.***

  -----------------------------------------------------------------------

Effective follow-up is based on five principles:

-   The accountability of subrecipients;

-   The clarity and consistency of performance standards;

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-   The clarity and consistency of corrective actions;

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-   The continuous provision of feedback; and

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-   Timely communications with subrecipients.

In cases where the interpretation of regulations is changing, you can
avoid follow-up problems by taking a conservative approach in the
selection of subrecipients and the awarding of grants or loans.
Follow-up is easier if you verify the subrecipient\'s qualifications
according to standard selection criteria *(before award*); specify
measurable performance expectations in a written Agreement; share your
findings and concerns with key elected officials; and point out to these
officials the risks of HUD sanctions on your entire program if the
subrecipient does not take appropriate corrective actions.

You should follow up your subrecipient monitoring with rewards for
superior or improved performance, and sanctions for poor performance or
noncompliance. Rewards can include acknowledgement and praise among
peers, public recognition, and additional funding. Sanctions should be
progressive and reflect three stages. Stage I involves the early
identification of problems and moderate intervention to provide more
training or technical assistance, more frequent reporting, and more
frequent monitoring and follow-up. Stage II sanctions (for continuing or
more serious problems) may involve restricting reimbursements,
disallowing program expenses, and imposing probationary status. In Stage
III, the most serious sanctions include temporary suspension of
activities, non-renewal of the subrecipient for the following program
year, or (as a last resort) immediate termination in the current program
year.

***Case 4:** As the new CD Director, Sheila Bollings had been warned
that the monitoring results for The House of Daniel would be disastrous.
The numerous repeat findings showed the warnings were right. There were
still no consistent records to verify how many people the church-based
meals program was serving, whether these services were being offered on
a non-denominational basis, and how costs of staff and indirect expenses
were being allocated to the activity. There was no IPA audit and only
sporadic bookkeeping. Reverend Watson, now 72 years old, had not set up
a separate bank account for CDBG funds. As a result, donations and
grants from other sources for various church-sponsored activities could
not be tracked separately from CDBG-funded activities. Several members
of the House of Daniel's Board of Directors were also local suppliers to
the program. The Reverend's strong political support in the
neighborhoods and in City Hall, and the small size of the program
(\$15,000) meant that the CD Office would have difficulty imposing any
serious sanctions to bring about corrective action.*

*In this situation, Sheila decided not to confront the Reverend with a
threat of disallowed costs, but rather to implement a six-month
intervention strategy involving three steps. First, her staff
immediately set up a three-week training and technical assistance
program with the Reverend and his staff to overhaul the House of
Daniel's books, to establish a monthly accounting and reporting cycle,
and to devise a cost allocation plan. Second, Sheila and the Reverend
together wrote a new Statement of Work for the coming year's Agreement
that identified specific performance targets for the program that could
be easily measured and reported on a monthly basis, as well as monitored
quarterly. This revised Statement became part of the formal Application
for Funding for the next program year. Third, with the Reverend's
permission, Sheila invited the city council member from the district,
and the House of Daniel Board of Directors, to attend an evening
planning and orientation session for House of Daniel staff before the
annual notification of CDBG Grant Awards. All staff members were
reminded of the goals for the coming year and the particular regulations
that should be observed. Everyone was optimistic that the goals would be
achieved.*

*Six months later, the well documented achievements of the program were
even greater than originally planned.*

**NOTES:**

**CHAPTER 7: APPENDIX**

-   Common Monitoring Problems Re:

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-   Program Income 7-16

-   Economic Development 7-19

#### COMMON SUBRECIPIENT MONITORING PROBLEMS

#### 

#### Common Problem Area #1: Program Income

"Program income" refers to any gross income received by a grantee or
subrecipient that was directly generated from the use of CDBG funds.
Some common sources of program income include:

-   **payments of principal and interest** on loans made with CDBG
    funds;

-   proceeds from the **sale of loans**, or of obligations secured by
    loans, which were made with CDBG funds;

-   funds collected through **special assessments** made against
    properties owned and occupied by households that are not low or
    moderate income in order to recover part or all of the CDBG portion
    of a public improvement;

-   **proceeds from the sale or long-term lease** of equipment
    purchased, or of real property purchased or improved with CDBG
    funds; and

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-   **gross income from the use or rental of real property** constructed
    or improved with CDBG funds, less the costs incidental to the
    generation of such income

> .

**General Regulatory Requirements**

The primary regulations regarding program income are found at 24 CFR
570.500(a), 570.503 and 570.504. A guiding principle is that **program
income funds are subject to all applicable regulations governing the use
of CDBG funds.** The written agreement with the subrecipient must
specify whether any program income received by the subrecipient is to be
returned to the grantee or retained by the subrecipient and, if the
latter, for what CDBG-eligible activities such program income will be
used. The financial records of the subrecipient (as well as the grantee)
must include complete information on the receipt and expenditure of
program income.

Program income must be used before drawing down additional grant funds,
unless the program income is in an approved revolving fund, in which
case it must be used for the specified purpose of the revolving fund
before further drawdowns for that specified activity. At the end of the
term of the Agreement, program income on hand or subsequently received
by a subrecipient must be returned to the grantee.

**Three Typical Problems**

**1) Improper collection/retention of program income**

-   Subrecipient treats interest earned on cash advances or on funds in
    a revolving account as program income, rather than remitting to the
    grantee for return of such interest income to the U.S. Treasury.

-   Subrecipient retains program income without grantee permission, or
    uses it in violation of terms of Agreement.

-   Program income in a revolving fund account is not used prior to
    drawing down additional funds for that activity.

-   Subrecipient improperly disposes of property a year after purchase
    and fails to ensure sale at fair market value (the amount of program
    income due the grantee is the current fair market value of the
    property).

-   When property that is only partially financed with CDBG funds is
    rented or sold, the CDBG program does not receive its fair share of
    proceeds generated.

-   Program income is not returned at expiration of subrecipient
    agreement.

-   Failure to repay CDBG funds for property acquired or improved with
    CDBG funds in excess of \$25,000 when use changes and when new use
    does not meet a National Objective for the required time period.

2\) **Improper utilization of program income**

-   Program income is treated by subrecipient as unrestricted funds.

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-   Program income is spent on an activity that is not eligible under
    CDBG rules.

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-   Program income is used for an activity that the grantee has not
    approved via the Agreement.

-   Program income is not used in compliance with all applicable
    regulations.

-   The subrecipient draws down program funds without using program
    income first.

3\) **Improper recording and reporting of program income**

-   Subrecipient\'s financial records do not describe receipt and use of
    program income in an accurate, complete, and timely fashion.

-   Subrecipient has an inadequate system to monitor repayment or sale
    of loans that it has made with CDBG funds.

-   Information on the status and use of program income reported to
    grantee by subrecipient is inaccurate or untimely.

**Useful Strategies for Avoiding Problems with Program Income**

(1) Have a detailed explanation of program income requirements in your
    written Agreement with each subrecipient.

(2) Provide technical assistance to subrecipients in setting up their
    record-keeping systems to capture data on program income.

(3) For those subrecipients operating loan programs, provide technical
    assistance to ensure adequate loan documentation and loan servicing
    systems.

(4) Require detailed program income information as part of regular
    progress reports and drawdown requests from subrecipients, with
    periodic on-site "spot-checking" of records by the grantee to
    confirm the reported data.

Technical assistance with early intervention to identify problems while
they are still quite small is particularly important with respect to
program income. In the event that the subrecipient has misspent program
income, a grantee may have no option other than to disallow the related
expenses. A disallowance is likely to represent a severe burden to a
subrecipient and can impose a serious strain on the grantee\'s
relationship with the subrecipient.

Ideally, any program income issues encountered with subrecipients will
be of a minor and correctable nature. However, if the subrecipient is
not responsive to directed corrective action, and/or persists in viewing
the program income as "its own money," the grantee needs to act
expeditiously to curtail the subrecipient\'s authority to retain and use
such funds.

**FOR ADDITIONAL GUIDANCE ON USE OF PROGRAM INCOME, GRANTEES SHOULD
CONSULT THE RELEVANT FEDERAL REGULATIONS (24 CFR 570. 500(a), 570.503
AND 570.504).**

#### Common Problem Area #2:

#### Meeting a National Objective for Economic Development Activities

#### 

Many grantees and subrecipients run into difficulty in documenting
achievement of a CDBG National Objective when providing economic
development assistance to a for-profit business. Economic development
activities directed to for-profit businesses can only be undertaken if
they meet one of the three National Objectives.

**NATIONAL OBJECTIVE: BASIS FOR QUALIFYING (AND EXAMPLES)**

**[Low/Moderate Income Benefit]{.underline}**

**L/M Area Benefit**

Assistance is being made to a **commercial** business that serves a L/M
**residential** area. (Example: assistance to neighborhood businesses
such as grocery stores or laundromats.) See 24 CFR 570.203, 570.204,
570.208(a)(1), and 570.506(b)(1) and (b)(2).

**L/M Jobs**

Assistance is directly linked to **the creation or retention of
permanent jobs, at least 51 percent of which (on a full-time equivalent
basis) are to be held by, or made available to, low- and moderate-income
persons.** (Example: assistance to a manufacturer for plant expansion
that will create permanent jobs, at least 51 percent are for L/M income
persons.) See 24 CFR 570.203, 570.204, 570.208(a)(4), and 570.506(b)(1),
(5), (6) and (7).

**[Slums or Blight]{.underline}**

**Slum or Blighted Area**

The assistance is directed to a business in a designated slum or
blighted area and **addresses one or more of the conditions that
contributed to the deterioration of the area**. (Example: a low-interest
loan as inducement for a firm to locate in a redeveloping, blighted
area.) See 24 CFR 570.203, 570.204, 570.208(b)(1), and 570.506(b)(7) and
(9).

**Spot Blight**

Assistance that is provided to a commercial or industrial business
**outside** of a designated slum or blighted area, **but which**: (1) is
designed to eliminate specific conditions of blight or physical decay;
and, (2) where the use of CDBG funds is specifically limited to the cost
of **acquisition, clearance, relocation, historic preservation, or
building rehabilitation** (and the rehabilitation is limited to actions
necessary to eliminate the specific conditions detrimental to public
health and safety). (Example: demolition of dilapidated structure owned
by a business to make room for a new commercial building.) See 24 CFR
570.203, 570.204, 570.208(b)(2), and 570.506(b)(10).

**Urban Renewal Completion**

Assistance is to a commercial or industrial business **located in an
Urban Renewal project area** (or a Neighborhood Development Plan action
area designated under Title I of the Housing Act of 1949), and is
**necessary to complete the urban renewal plan**. (Example: loan to

a business to complete facilities consistent with urban renewal plan.)
See 24 CFR 570.203, 570.204, 570.208(b)(3), and 570.506(b)(11).

**[Urgent Needs]{.underline}**

Assistance to a business as part of an activity designed to alleviate
existing conditions that the grantee has certified pose a serious and
immediate threat to the health or welfare of the community, are of
recent origin (or recently became urgent), and the grantee cannot
finance the activity on its own and other sources of funds are not
available. (Example: a loan to reconstruct the only grocery store, a
small locally owned market, in a remote area of the urban county that
was severely damaged in an earthquake, where other resources \[local,
FEMA, Small Business Administration\] are insufficient or unavailable to
address this imminent threat to the community.) See 24 CFR 570.203,
570.204, 570.208(c), and 570.506(b)(12).

Among the three National Objectives, the documentation required for
activities undertaken to address conditions of **slums or blight** are
somewhat less complicated than that required for activities designed to
address other objectives (low/moderate income benefit, urgent needs).
For this reason some grantees and subrecipients seek to reduce their
record-keeping requirements by providing economic development assistance
to for-profit businesses under the slums/blight objective. However,
grantees are still required to ensure that, over the one-, two-, or
three-year period certified by the grantee, 70 percent of their CDBG
expenditures are for activities that principally benefit low- and
moderate-income persons. This requirement constrains a grantee\'s
ability to conduct economic development activities under the National
Objectives of "slums or blight" and "urgent needs." By definition, the
"urgent needs" category can be justified in only very limited
circumstances.

Job creation for low- and moderate-income persons is a critical element
of local revitalization strategies in many communities experiencing
economic problems. In using CDBG funds for job creation, grantees have
to be careful to map out specific ways to meet the record-keeping
requirements for demonstrating low/moderate income benefit **before**
funds are provided to a subrecipient.

**LOW- AND MODERATE-INCOME BENEFIT DOCUMENTATION REQUIREMENTS**

In assisting for-profit businesses, the requirements for documenting
benefits to low/moderate income persons depend upon the type of
activities undertaken:

**For job creation activities:**

> Where the subrecipient (or grantee) chooses to document that at least
> 51 percent of the jobs will be **available to** low- and
> moderate-income persons, documentation must include:

-   a **written agreement** containing: a commitment of the business to
    make at least 51 percent of the jobs, on a **full-time equivalent
    basis,** available to low- and moderate-income persons and to
    provide training for any such jobs requiring special skills or
    education; a listing by job title of the permanent jobs to be
    created, indicating which will be made available to L/M persons,
    which ones are part-time, which jobs require special skills and
    education; and a description of actions to be taken by subrecipient
    (or grantee) and business to ensure that L/M persons are given
    **first consideration for** those jobs; and

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-   a **listing by job title of those permanent jobs that were filled**
    and which of those were **made available to** L/M persons; a
    description of how **first consideration** to such persons was
    given, including an explanation of the **hiring process**, which L/M
    persons were interviewed for each job, and which were hired.

> Where the subrecipient (or grantee) chooses to document that at least
> 51 percent of the jobs **wills be held by** low- and moderate-income
> persons:

-   a copy of **a written agreement** containing: a commitment by the
    business that at least 51 percent of the jobs, on a **full-time
    equivalent basis**, will be held by L/M persons; and, a listing by
    job title of the permanent jobs to be created, identifying any that
    are part-time;

-   a listing by job title of **permanent jobs filled** and which were
    **initially taken by** L/M persons; and

-   for each L/M person hired, the family size and annual income of the
    person\'s family prior to being hired, or evidence that they may be
    presumed to be a L/M person under 24 CFR 570.208(a)(4)(iv).

**For job retention activities:**

-   **objective evidence** that in the absence of CDBG assistance the
    jobs would be lost;

-   a listing by job title for the business showing **which permanent
    jobs were retained**, which were part-time, which are known to be
    held by L/M persons, which other jobs are projected to become
    available to L/M persons over the next two years due to turnover,
    and **on what basis the turnover is being predicted;**

-   for each retained job held by a L/M person, information on the size
    and annual income of the person\'s family, or evidence that they may
    be presumed to be a L/M person under 24 CFR 570.208(a)(4)(iv);

-   for jobs claimed to be "available to" L/M persons through turnover,
    the information cited above as that required for "available to" job
    creation activities; and

-   for jobs claimed to be "available to" L/M persons through turnover,
    a listing of each job that has turned over to date, identifying
    which actually were **taken by** or **made available** to L/M
    persons, and for the latter, how **first consideration** was given
    to such persons.

**For area benefit activities** (providing assistance to commercial
businesses serving a low- and moderate-income residential area):

-   provide a **definition of service area** with respect to geographic
    limits, census tract block groups, and/or neighborhood names;

-   **identify the percent of the residents of the service area who are
    L/M persons** pursuant to 24 CFR 570.208(a)(1)(vi) or demonstrate
    that the area qualifies under 570.208(a)(1)(vii);

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-   where applicable, demonstrate that the percent of residents in the
    service area who are L/M persons qualifies under the exception
    criteria because it falls into the upper quartile of the city/county
    per 24 CFR 570.208(a)(1)(ii); and

-   provide evidence of the residential character of neighborhood.

**SUGGESTIONS FOR SATISFYING DOCUMENTATION REQUIREMENTS**

The documentation requirements can be extensive, particularly if the
subrecipient (or grantee) is dealing with a business with little or no
prior experience with the regulatory requirements of a Federal
assistance program. There are a number of steps that a subrecipient (or
grantee) can take to reduce the likelihood of inadequate National
Objective documentation relative to low- and moderate-income benefits:

1)  **Be clear** with the subrecipient and the business concerning the
    documentation requirements from the very first contact (at the
    outreach and application stage).

2)  Incorporate a **detailed description of the documentation
    requirements** **in the assistance** **agreement** with the
    business, including **provisions for** **recapture** of the
    assistance in the event that the business fails to honor its
    commitments and responsibilities under the agreement.

3)  Before the assistance agreement is executed, develop with the
    business the **specific procedures and forms** that will be employed
    to capture the desired information.

4)  In terms of job creation goals, make every effort to **ensure that
    the business is not promising more than it can deliver**. As long as
    the level of assistance per job created is reasonable,\* it is
    better for the business to propose to develop 11 L/M jobs out of 20
    created (for 55 percent L/M benefit) and to meet this goal, than it
    is to promise 20 L/M jobs out of 30 created and to only achieve 14
    L/M jobs (47 percent L/M benefit). Nevertheless, the HUD standard
    **is 51 percent of whatever number of jobs are created.**

5)  Even if the business proposes to achieve the L/M benefit for job
    creation through hiring L/M persons, the assistance agreement should
    stipulate that **documentation must also be collected for jobs "made
    available to" L/M persons**; this information may be used as
    alternate documentation in the event that the business fails to fill
    some of the jobs with L/M persons that it expected to.

6)  Many businesses are not accustomed to capturing information on
    family size and income from job applicants. It may also be that
    their typical applicant pools have a lower L/M percentage than
    desired. Such businesses should give serious consideration to
    securing **referrals through a local agency** that has a L/M income
    clientele and is experienced at collecting such data (for example,
    the local Jobs Training Partnership Act (JTPA) agency or office of
    the State\'s department of employment security or department of
    labor).

7)  Make it a practice of **obtaining the job applicants' addresses**
    and determining whether they live in an area that would enable a
    presumption of L/M status before checking their actual income status
    (thus eliminating the need to determine their family size and income
    when the person lives in an area that qualifies for the
    presumption).

\* The amount of CDBG assistance per full-time equivalent job must meet
the Public Benefit standards under 24 CFR 570.209.

**FOR ADDITIONAL GUIDANCE ON MEETING NATIONAL OBJECTIVES IN ECONOMIC
DEVELOPMENT, GRANTEES SHOULD CONSULT THE RELEVANT FEDERAL REGULATIONS
(24 CFR 570.203, 570.204, 570.208, AND 570.506(b)).**