oversight

Carbondale Nursing Home, Carbondale, Pennsylvania

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-03-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                                            Issue Date
                                                                    March 25, 2004
                                                            Audit Case Number
                                                                    2004-PH-1004




TO: Encarnacion Loukatos, Director, Pennsylvania Multifamily HUB, 3AHMLA



FROM: Daniel G. Temme, Regional Inspector General for Audit, Mid-Atlantic, 3AGA

SUBJECT: Carbondale Nursing Home
         (Project #034-43089)
         Carbondale, Pennsylvania


                                   INTRODUCTION

In response to an audit request by the Philadelphia Multifamily HUB Office, we
completed an audit of Carbondale Nursing Home (Project), a Section 232 Multifamily
Insured Project owned by CNH, Incorporated (Owner). The purpose of our audit was to
assess the Owner’s compliance with the terms and conditions of the Regulatory
Agreement, and all other applicable HUD requirements.

To accomplish our objective, we: interviewed responsible staff from the Owner, current
Management Agent, Mortgagee, and HUD; examined files maintained by HUD, the
Mortgagee, and the Owner; obtained the Independent Public Accountant (IPA) reports for
1998 and 1999 and reviewed the related work papers; and, reviewed all surveys and
inspections conducted by Pennsylvania’s Department of Health and Medicare.

Our audit work was conducted from April 2003 to October 2003 and covered the
Owner’s operations from April 1998 through December 2002. We performed the audit in
accordance with generally accepted government auditing standards.

This report contains one finding and three recommendations. In accordance with HUD
Handbook 2000.06 REV-3, within 60 days please provide us, for each recommendation
without a management decision, 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 report
issuance for any recommendation without a management decision. Also, please furnish us
copies of any correspondence or directives issued because of the audit.

Should you or your staff have any questions, please contact J. Phillip Griffin, Assistant
Regional Inspector General for Audit, at (215) 656-3401, extension 3490.

                                      SUMMARY

We found the Owner did not comply with the Regulatory Agreement and other HUD
requirements in operating the Project. In total, the Owner made $1,261,301 of ineligible
and unsupported payments from Project funds. Specifically, the Owner: received
ineligible salary payments of $374,790; collected ineligible distributions/repayment of
advances of $170,155; paid ineligible expenses for another company of $485,997;
disbursed ineligible extension fees of $132,728; and paid unsupported loan payments of
$97,631. Several staff persons at the Project, including the Controller and Administrator,
stated the Owner was not aware of the HUD requirements prohibiting these expenditures.
If the Owner had complied with HUD requirements and used Project funds for only
necessary operating expenses of the Project, the Owner could have used these funds to
pay the mortgage costs (principal and interest) for over two years and possibly avoided
bankruptcy and default on the HUD-insured loan.

                                    BACKGROUND

In 1996, Ms. Joyce M. Kaufman, President and sole shareholder of CNH, Incorporated
(Owner), applied for a HUD-insured mortgage to construct a new nursing home in
Carbondale, Pennsylvania, to replace an already existing Carbondale Nursing Home.
HUD approved a mortgage for $5.4 million on March 11, 1997 between Beacon Hill
Mortgage (Mortgagee) and the Owner.

In March 1998, the construction of the Project was considered substantially complete and
HUD permitted the Project to be occupied. During March and April of 1998, residents of
the older existing Carbondale Nursing Home (owned by Carbondale Nursing Home,
Incorporated – President, Ms. Joyce M. Kaufman) were transferred to the Project.

Soon after the Project was occupied, a problem with the floor was identified. The floor
problem resulted from the removal of a vapor barrier from the original construction
specifications. As a result, HUD refused to allow the disbursement of the final loan draw
and the Owner was not allowed to go to final closing until the problem was corrected. As
a result, the Owner never went to final closing and the total final loan was $5,108,826.

The Project has been mainly self-managed from 1998 through 2001, except for a six-
month period at the end of 1998/beginning of 1999. Toward the end of 2001, the Owner
could not meet the financial demands of the nursing home and in February 2002, the
Project filed bankruptcy.

As a result of the bankruptcy filing in 2002, the Mortgagee insisted that an outside
Management Agent be brought in to manage the Project. The Bankruptcy Court


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approved Amcare Management Services as the Management Agent. Amcare
Management Services assigned its contract to Merion Healthcare Incorporated on
April 30, 2002 and Merion Healthcare Incorporated has since been the Management
Agent.

In order to minimize its losses, HUD sold the Mortgage Note, along with others, in
September 2003.

                                             FINDING 1

     INELIGIBLE AND UNSUPPORTED COSTS WERE PAID FROM PROJECT
                              FUNDS

The Owner did not comply with the Regulatory Agreement and other HUD requirements
resulting in questionable payments from Project funds totaling $1,261,301. Specifically,
the Owner: received ineligible salary payments of $374,790; collected ineligible
distributions/repayment of advances of $170,155; paid ineligible expenses for another
company of $485,997; disbursed ineligible extension fees of $132,728; and paid
unsupported loan payments of $97,631. Several staff persons at the Project, including the
Controller and Administrator, stated that the Owner was not aware of the HUD
regulations that prohibited these actions. As a result, over $1.2 million in ineligible and
unsupported payments were made from Project funds.

The Regulatory Agreement1 between the owner and HUD requires the owner to
properly maintain the books and records of the Project, physically keep the Project in
good order, and submit annual financial statements within 60 days of fiscal year end.
Further, the Regulatory Agreement states:

      •    Owners shall not pay out any funds, except from surplus cash, except for
           reasonable operating expenses and necessary repairs [Paragraph 6. (b)].

      •    Owners shall not make any distribution of income except from surplus cash
           [Paragraph 6. (e)].

Surplus cash is defined by the Regulatory Agreement as the cash remaining after all
necessary and reasonable expenses of the Project have been paid or funds have been set
aside for such payment and all reserve requirements have been met [Paragraph 13. (f)].

Details of the ineligible and unsupported payments from Project funds follow.

Salary Payments to the Owner

From the period of April 1998 through December 2002, the Owner was paid a salary,
contrary to HUD requirements. Project records showed that the Owner worked 20-hour

1
    Signed by the owner on March 11, 1997.


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weeks for an average of $80,000 per year. As a result, the Owner received a total of
$374,790 in salary and bonus payments.

Project staff, who are also related to the Owner, stated that they did not think these payments
were excessive because the Owner put in significant hours that were not documented in the
books. However, regardless of whether the Owner worked 20 hours a week or more, the
Owner cannot receive a salary because these payments are considered distributions. HUD
Handbook 4370.1, Reviewing Annual and Monthly Financial Reports, Paragraph 2-25
contains the following regarding distributions to Owners:

       “A distribution is any withdrawal or taking of cash or any assets of the project
       other than for the payment of reasonable expenses necessary to the operation and
       maintenance of the project. The term distribution includes, for example,
       supervisory fees paid to general partners and any salaries or other fees paid to the
       sponsor or owner, unless those salaries or fees have been approved by HUD as
       essential to the operation of a project….”

On August 29, 2002, HUD sent a letter to the Owner explaining that the Owner’s salary is a
violation of the Regulatory Agreement and the salary paid appears to be an unauthorized
distribution of funds. Also, HUD asked for the repayment of these funds. However, the
Owner continued to receive a salary until December 2002 and did not reimburse the Project
for the salary payments.

Distribution/Repayment of Advances to Owner

Our review also identified $170,155 of direct payments to the Owner during our audit
period. Representatives of the Project told us that these payments were for the repayment of
advances from the Owner. In addition, they told us the Owner was not aware that HUD
prohibited these payments.

These payments are prohibited by paragraph 6 (e.) of the Regulatory Agreement, which was
signed by the Owner. In addition, paragraphs 2-10 and 2-11 of HUD Handbook 4370.2,
Financial Operations and Accounting Procedures for Insured Multifamily Projects, provide
further guidance on these prohibited payments.

The Owner received $170,155 from May 1998 through January 2002, with $94,121, or
more than half, taken within 3 months of filing bankruptcy. The payments from Project
funds are as follows:




                                              4
CHECK NUMBER CHECK OR WIRE DATE                       AMOUNT OF CHECK/WIRE
    6909           05/20/98                                 $ 5,000.00
    7074           06/23/98                                 $    763.06
    7281           08/10/98                                 $ 14,552.00
    7811           12/21/98                                 $    500.00
    7829           12/24/98                                 $ 1,000.00
    1097           06/03/99                                 $ 5,000.00
    1179           07/07/99                                 $     33.92
    1663           12/17/99                                 $    367.14
    1116           02/10/00                                 $ 3,000.00
    2005           10/24/00                                 $ 10,000.00
    Wire           12/18/00                                 $ 25,000.00
    2525           03/26/01                                 $ 5,000.00
    2560           04/05/01                                 $ 5,000.00
    2653           05/01/01                                 $    617.74
    2662           05/03/01                                 $    200.00
    1133           11/29/01                                 $ 54,032.30
    1134           11/29/01                                 $ 20,089.00
    1364           01/22/02                                 $ 20,000.00
   TOTAL                                                    $170,155.16

Since the accounting records were so poorly maintained, we could not confirm these
payments as offsets of the Owner’s advances. An outside Certified Public Accountant
working for the Owner could only provide us with a schedule of payments that were
supposed to be evidence that money was advanced by the Owner.

Nonetheless, whether the payments were direct distributions and/or repayment of advances,
the payments are still prohibited because there was no surplus cash available since the
inception of the Project.

Payments on the Behalf of an Affiliate

The Owner allowed ineligible expenditures totaling $485,997 to be paid for loan and other
expenses of an Affiliate. In addition, the Owner could not provide support for another
$97,631 for other loan payments. Again, representatives of the Project told us the Owner
was not aware of the HUD requirements that prohibit these payments.




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Ineligible Payments

We identified numerous payments to two local banks that were not disclosed to HUD.
These payments were for 13 loans (12 loans from one bank and one loan from the other).
Payments for seven short-term loans were determined to benefit the HUD-insured Project.
Since we could track the loan funds being used for eligible Project purposes, we classified
these seven loans as eligible. However, any additional cost for these loans, including
interest expense and late fees were classified as ineligible because the Owner failed to
obtain, as required, HUD’s prior approval. The loan expense above the loan proceeds that
benefited the Project for these seven loans totaled $3,753.

Several other payments, though, were for four loans taken out for the old nursing home. We
determined $355,154 was paid for two loans that were issued in 1992. We also identified
$2,693 in payments that appeared to include personal loan debt for the Owner. Although we
did not receive the loan agreement for the fourth loan and thus could not determine the exact
issue date, we did determine that the loan existed before the construction of the new HUD-
insured Project because we found payments in early 1996. In addition, this loan’s invoices
listed the old nursing home’s Owner and the old nursing home’s location as the debtor. Due
to the early existence of payments and the debtor information listed on the invoices, we also
classified this loan for the old nursing home and disallowed these loan payments. The
payments for this fourth loan totaled $19,248.

Besides undisclosed loan payments, we also identified $105,149 in other expenses paid for
the old nursing home during our review of account payables. These expenses included,
among others, maintenance costs for elevator repairs, insurance expenses, utility payments,
corporate taxes, and delinquent taxes.

Unsupported Payments

The two remaining loans were classified as unsupported because we could not find evidence
that the loans were used for Project purposes. Although we received the loan agreement for
one loan and it appeared to be for the new HUD-insured Project, we could not locate a
deposit in any Project account. The other loan is considered unsupported because we were
never provided the loan agreement and thus, do not know its purpose. All payments for the
two loans totaled $97,631.

Overall, the Project made ineligible payments of $485,997 on the behalf of the old nursing
home or loans not approved by HUD and could not support another $97,631 in loan
payments.

Ineligible Extension Fee Payments

Although prohibited by mortgage documents certified by the Owner, the Owner paid
extension fees to the Mortgagee out of Project funds. The Owner, we were advised, did
not know that this was prohibited. Consequently, $132,728 was used for these payments
that could have been used for much needed operating expenses.



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In order to receive an approved mortgage from HUD and the Mortgagee, the Mortgagor
was required to sign a number of documents at the initial endorsement. These documents
included the Mortgagee’s Certificate, Third Party Obligee Certification, and the Cognovit
Promissory Note, which all prohibit the payment of extension fees from Project funds.

The Mortgagee’s Certificate explains that the Owner will be personally liable for the
payment of extension fees if the mortgage does not go to final closing. In addition this
document explains how these fees will be calculated.

As detailed in the Background section of this report, this mortgage never went to final
closing and the Owner was personally liable for these expenses. The Third Party Obligee
Certification signed by both the Mortgagee and the Mortgagor (Owner), restates that
extension fees will not be paid from Project funds (similar to the Rider or Addendum to
Mortgagee’s Certificate) as follows:

       "The undersigned does not now have and will not later assert, any claim against
       the mortgagor, mortgaged property, mortgage proceeds, any reserve or deposit
       made with the undersigned or another required by HUD in connection with the
       mortgage transaction, or against the rents or other income from the mortgaged
       property for payment of any part of such discount.”

Under the Cognovit Promissory Note, the Owner agrees to pay the extension fees to the
Mortgagee. The Note shows how the fees will be calculated and further contains
language which also prohibits the payments of extension fees as detailed below:

       "It is a condition of this note that the payee or any subsequent holder hereof may
       not assert any claim arising from this note against the following assets of the
       maker:

       The interest of the maker in property located at Hart Place and Dundaff Street,
       Carbondale, PA and covered by a mortgage insured by HUD under Project No.
       043-43089 [sic] or deposit made with the Mortgagee or another required by HUD
       in connection with the mortgage transaction or the rents or other income from the
       property."

In May 2000, the Director of the Philadelphia Multifamily HUB sent a letter to the Owner
explaining that the extension fees could not be paid from Project funds. This was almost
two years after $132,728 had already been paid from Project funds. The payment of the
extension fees stopped in June 2000.

In total, the Owner paid $1,163,670 in Project funds for ineligible purposes and another
$97,631 for items not properly supported. The Owner allowed these funds to be
disbursed for personal purposes, including salary, distributions/repayment of advances,
debts for an Affiliate company of the Owner and the personal liability of extension fees.
If the Owner had complied with HUD requirements and used Project funds for only



                                           7
necessary operating expenses of the Project, the Owner could have used these funds to
pay the mortgage costs (principal and interest) for over two years.

                                AUDITEE COMMENTS

We discussed the results of our audit with Project representatives during the audit. On
February 4, 2004, we provided the Owner a copy of our draft report and we discussed the
finding and recommendations with Project representatives in a meeting on March 3, 2004.
At that meeting, it was agreed the auditee would meet us on March 17, 2004, for an Exit
Conference and provide comments if deemed necessary. On March 16, 2004, we received
notice from a representative of the auditee the meeting the next day was not necessary at the
time. We feel the auditee was afforded ample opportunity to comment on the report and, as
of the issuance date of this report, the auditee had not provided any written comments to the
report.

                                RECOMMENDATIONS

We recommend you:

1A.    Require the Owner to immediately repay the ineligible cost totaling $1,163,670 to
       HUD.

1B.    Instruct the Owner to provide documentation to support the eligibility of the
       unsupported cost totaling $97,631 and require the Owner to reimburse HUD any
       amounts not supported or determined to be ineligible based on your review of the
       support provided.

1C.    Based on the information in this report, take appropriate administrative action
       against the Owner.




                                             8
                        FOLLOW-UP ON PRIOR AUDITS

This was the first audit the Office of Inspector General completed on the Carbondale
Nursing Home.




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                                                                                Appendix A



                        SCHEDULE OF QUESTIONED COSTS

                   Recommendation
                       Number            Ineligible1/     Unsupported2/

                           1A            $1,163,670          $97,631

                          Total          $1,163,670          $97,631



1/
     Ineligible costs are those that are questioned because of an alleged violation of a
     provision of a law, regulation, contract, grant, cooperative agreement or other agreement
     or document governing the use of funds, or are otherwise prohibited.
2/
     Unsupported costs are those whose eligibility or reasonableness cannot be clearly
     determined during the audit since they were not supported by adequate documentation
     or due to other circumstances. Under Federal cost principles, a cost must be adequately
     supported to be eligible.




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