oversight

                                                 U. S. Department of Housing and Urban Development
                                                                          New York/New Jersey Office
                                                                       Jacob K. Javits Federal Building
                                                                         26 Federal Plaza – Room 3430
                                                                     New York, New York 10278-0068



                                                MEMORANDUM NO: 2004-NY-1802

July 23, 2004

MEMORANDUM FOR: Rosalinda Lamberty, Director, Multifamily Housing, Buffalo HUB,
                                       2CHM


FROM:           Alexander C. Malloy, Regional Inspector General for Audit, 2AGA

SUBJECT:        Groton Community Health Care Center, Inc.
                FHA Project Number 013-43055 and 014-10010
                Groton, New York


                                      INTRODUCTION

We have completed a limited review of the Groton Community Health Care Center, Inc. (GCHCC)
located in Groton, New York. We initiated this review as part of an Office of Inspector General
inquiry into the default of Section 232 insured projects. Our specific objective was to determine
whether GCHCC operated in accordance with its regulatory agreement. In violation of the
regulatory agreement we found that GCHCC executed a note payable without prior approval from
the U.S. Department of Housing and Urban Development (HUD).

                               METHODOLOGY AND SCOPE

We reviewed GCHCC’s financial statements, bank records and disbursements, and selected a
nonrepresentable sample of disbursements to test for reasonableness and proper support. We
inquired about the nature of all short-term and long-term notes payable, and contracts with
related parties. We also reviewed HUD regulations pertaining to Section 232 insured projects,
the applicable Code of Federal regulations, and the regulatory agreements with GCHCC. We
interviewed HUD’s multifamily field office staff, as well as the contracted administrator and an
employee of GCHCC. Generally, our audit period was January 2001 through December 31,
2002. However, when appropriate, we extended the audit period to include other periods.

                                       BACKGROUND

GCHCC is a not-for-profit organization that operates an eighty bed skilled nursing facility and
leases space to an independent family health care center in Groton, New York. Under a HUD
regulatory agreement dated August 18, 1981, GCHCC had a Section 232 insured mortgage of
$2,642,700 with an interest rate of nine percent on the skilled nursing facility. Additionally,
under a separate regulatory agreement dated December 7, 1994, GCHCC had a Section 241
insured mortgage of $3,112,100, which also had an interest rate of nine percent. GCHCC
defaulted on the two HUD insured mortgages in November 2001, which were assigned to HUD
on January 14, 2002, and sold by HUD on December 7, 2002. HUD incurred a $3,450,085 loss
on the sale of the two notes.

                                   RESULTS OF REVIEW

Based on our testing, we determined that GCHCC disbursements generally were necessary,
reasonable, adequately supported, and in accordance with the regulatory agreement. We also
found that GCHCC operated at a loss for a number of years, and in an effort to reduce operating
costs, renegotiated numerous contracts for services. While some renegotiated contracts were with
a related party, the cost was less than that previously paid. However, we found that GCHCC
executed a note without prior HUD approval in violation of the regulatory agreement.

We obtained informal written comments from GCHCC on June 23, 2004. GCHCC commented
that the promissory note does not represent an encumbrance of the project since it was an
unsecured repayment arrangement. We requested formal written comments to the final draft
report, but we had not received any by the issuance date of this report.

The execution of a note payable violated the regulatory agreement

GCHCC executed a note payable in violation of the regulatory agreement. Section (4)(a) of the
1981 and 1994 regulatory agreements provide that “Mortgagor shall not without the prior written
approval of the Secretary:… (a) Transfer, dispose of or encumber any of the mortgaged
property…”

On June 12, 1998, GCHCC executed a 10% promissory note in the amount of $326,830.70 with
Cortland Memorial Hospital. GCHCC officials advised that the note represented the
consolidation of delinquent accounts payable due Cortland Memorial Hospital. The note was to
be paid in full by May 31, 2002. Payment on the note was suspended in April 2001, and was in
default as of December 31, 2001. GCHCC made payments totaling $271,007 on this note
through 2001, as follows:

                      Year             Principal    Interest    Total Payments

                      1998         $  33,626        $ 15,648     $  49,274
                      1999            72,490          26,058        98,548
                      2000            80,081          18,467        98,548
                      2001            21,298           3,339        24,637
                      Total        $ 207,495        $ 63,512     $ 271,007
                                     =======        ======         =======

While the costs associated with the original accounts payable were incurred for eligible services,
the regulatory agreement requires HUD’s approval for any action that would further encumber
the project. The conversion of the accounts payable to a promissory note resulted in an additional
encumbrance on the project. This resulted in the payment of $63,512 in additional interest
beyond that of the original liability. Additionally, we believe that if HUD’s approval had been
sought for the execution of the promissory note, HUD would have been made aware of the
deteriorating financial condition of the skilled nursing facility that led to its default on the HUD
insured loans.


                                  RECOMMENDATIONS

We recommend that you:

A. Recover the unallowed interest payments of $63,512 to mitigate the loss on the note sale1.

B. Take action to ensure that the mortgagor is aware of all regulatory agreement provisions
   prior to approving participation in any future mortgage insurance programs.

In accordance with HUD Handbook 2000.06 REV-3, within 60 days please give us, for each
recommendation in this report, a status report on: (1) the corrective action taken; (2) the
proposed corrective action and the date to be completed; or (3) why action is considered
unnecessary. Additional status reports are required at 90 days and 120 days after issuance for any
recommendation without a management decision. Also, please furnish us copies of any
correspondence or directives issued because of our review.

Should you or your staff have any questions, please have them contact John Harrison, Assistant
Regional Inspector General for Audit, at 212-264-8000, extension 3978.




1
 No recommendation is being made with respect to any interest that may be made paid upon the resumption of
payment because HUD’s financial interest terminated with the sale of the mortgage note.