U.S. Department of Housing and Urban Development District Office of the Inspector General Richard B. Russell Federal Building 75 Spring Street, SW, Room 700 Atlanta, GA 30303-3388 (404) 331-3369 March 28, 1996 Audit-Related Memorandum 96-AT-212-1810 TO: Robert A. Rifenberick, Director, Multifamily Housing Division, 4EHM FROM: Kathryn Kuhl-Inclan District Inspector General for Audit-Southeast/Caribbean, 4AGA SUBJECT: Limited Review of Bentley Court (BC) Columbia, South Carolina INTRODUCTION In our initial survey, we found indications of irregular transactions using project funds. Also, th e partnership was in default during August 1994 to April 1995 on its BC mortgage, and the project had not earned a profit nor generated surplus cash since it began operations in August 1991. This limited review's purpose was to establish whether there were any improper distributions o f project assets; and if so, relationship to the mortgage default. Our review was conducted Ma y through September 1995 with updating during March 1996 for status information. BACKGROUND Bentley Court Apartments are owned by Bentley Court II Limited Partnership. The two genera l partners (GP) are Edwin Lewis, II and Canal Court II Limited Partnership. The Limited Partners are Boston Financial Qualified H ousing Tax Credits LP IV and SLP 89, Inc. The apartment complex is managed by Brookstone Ltd. of Columbia, an affiliate of GP Lewis. The mortgagee is America n Capital Resource, Inc. (ACR). BC is HUD insured and consists of 272 1 to 3 bedroom units. All units are available to low an d moderate income persons because they qualify for the Low Income Housing Tax Credit Program. SCOPE During this limited review for distributions of projec t assets, we reviewed 1991 through 1994 project financial statements*, and relate d documentation. Discussions were held with the managing GP and the affiliated management agent, and with HUD staff at the Columbia field office. We also reviewed the status of the mortgage and the re serve for replacement fund. Our limited review did not provide full audit coverage for any of the project's activities. * * * * We found that: - The GP made unauthorized distributions of $305,551, and - The reserve for replacement escrow was underfunded. More details on our findings and recommendations for corrective actions are in Attachment 1. We provided a draft to you and GP Lewis on September 7, 1995. We received comments from Mr . Lewis which are summarized following each finding and included in full as Attachment 3. Within 60 days, please furnish this office, for the recommendations in Attachment 1, a status report on: (1) corrective action taken; (2) prop osed corrective actions and the date to be completed; or (3) why actions are considered unnecessary. Also, fu rnish us copies of any correspondence or directives issued because of our review. Please keep in mind the recent emphasis for timely managemen t decisions on audit findings within set periods. We are providing GP Lewis a copy of this report. Should you or your staff have questions, please call Ted E. Drucker, Assistant District Inspecto r General for Audit (404 -331-3369), or Senior Auditor Richard Pirsig in Columbia (765-5784). Attachments: 1 - Findings and Recommendations 2 - Summary of Unauthorized Distributions 3 - Auditee Comments 4 - S c h e d u l e o f I n e l i g i b l e C o s t s 5 - Report Distribution * OIG Note At March 19, 1996, HUD had not received BC's audited Financial Statements for 1995, which were overdue. 2 3 ATTACHMENT I FINDINGS AND RECOMMENDATIONS Finding 1. Partners Made Unauthorized Distributions Of Project Funds . From 1992 through 1994 , BC paid $305,551 in unauthorized distributions while having no surplus cash. The distributions were payments for construction costs ($33,203), for non-project legal fees ($107,477), for or to affiliated entities or persons ($164,871) . These amounts are discussed below and listed in Attachment 2. Distributions in excess of surplus cash violate the project's contract with the mortgagee for HUD's benefit, and other applicable HUD requirements. Improper distributions subject the partners t o criminal and/or civil penalties; they contributed to defaults in mortgage payments. Criteria Paragraph B.3.b. of the owners' contract (regulatory agreement) with ACR, for th e mortgage co-insured by H UD, states in part that the owners may use project funds only to pay reasonable expenses necessary to the proper operation and maintenance of th e project, distributions of surplus cash if permitted by paragraph B.4.a. of the regulatory agreement, and owner advances if such repayments are authorized by the Secretary' s administrative procedures and approved by the mortgagee. According to paragraph B.4.a. of the regulatory agreement, distributions may be pai d only from surplus cash which existed as of the end of a semi-annual or annual fisca l period. Distributions may be paid only after the end of the fiscal period in which th e surplus cash is generated. An improper distribution is any w ithdrawal or taking of cash or any assets of the project other than for the payment of reasonable expenses necessary to the operation an d maintenance of the project. If the owner takes distributions when the project is not in a surplus cash position, the owner is subject to criminal and/ or civil penalties. Surplus cash generated at the end of the p roject fiscal year is not to be distributed until the next fiscal period. (HUD Handbook 4370.2 REV-1, Financial Operations and Accountin g Procedures for Insured Multifamily Project, Chapter 2, paragraph 2-10) Owner advances for reasonable and necessary operating expenses may be repaid fro m surplus cash at the end of the annual or semi-annual period. (HUD Handbook 4370.2 REV-1, Chapter 2, paragraph 2-11). Repayment without specific advance approval of advances when the project is not in a surplus cash position is prohibited and may subject the owners to criminal and civil penalties. 4 ATTACHMENT 1 Summary of Unauthorized Distributions Surplus Cash at the Unauthorized Year end of Prior Year Distributions 1992 $ (196,374) $ 33,203 (1) 1993 (119,135) 123,870 (2)(3) 1994 (156,969) 148,478 (2)(3) Total Unauthorized Distributions $ 305,551 (1) Year 1992 These unauthorized distributions are, as detailed in Attachment 2, amounts paid for construction costs with project funds. These amounts were charged a s building improvements. The managing GP told us these payments were related to project construction cost paid after final endorsement (June 12, 1991) with no amounts escrowed for their payment. Section B.3.b. of the regulatory agreement provides that project funds may not be used to liquidate liabilities related to the cons truction of the project unless the mortgagee authorizes such use. We found no mor tgagee authorization for these construction costs to be paid with project operating funds. No surplus cash was availa ble as of the end of the prior year to pay these costs. In fact, there was negative surplus cash of ($196,374). (2) Legal Fees for 1993 and 1994 The owners made distributions while having no surplus cash as of the end o f either prior year. Unauthorized distributions during 1993 and 1994 include d $45,559 and $61,918, respectively, (detailed in Attachment 2) for non-project legal fees. Based on our review of the invoices and information, as provided by the managing GP, thes e amounts were primarily for partnership related and not project matters. The audited financial statements reported some as partnership legal expenses, and other charges were not supported as being project related. (3) Other Unauthorized Distributions in 1993 and 1994 In addition, unauthorized distributions of project funds during 1993 and 1994 included $78,311 and $86,560 paid to or for affiliated entities. These amounts are listed in Attachment 2. 5 ATTACHMENT 1 Mortgagor's Positions -The managing GP (Mr. Lewis) asserted that the owners mad e advances to the partnership in excess of distributions.* These advances wer e commingled with project funds in the same bank account. The GP also pointed out that as of November 14, 1994 a separate bank account wa s established to account for partnership transactions separate from project transactions. Delinquent Mortgage Payments - While the improper distributions were being made, BC mortgage and escrow payments were delinquent (i.e., ..received after the 16th day of the month in which they a re due). During most of 1993 and 1994 payments were generally received by the mortgagee during the last few da ys of the month in which they were due or the first few days of the following month. During the months of August 1994 to April 1995, BC was in default (i.e.. paymen t received more than 30 days after its due date) by one or more of its mortgage and escrow payments. The default was cured April 13, 1995; however at March 8, 1996, BC was again delinquent (for three monthly payments). Owners Subject to Civil Action for Double Damages - Among purposes of requiring a contract (regulatory agreement) with owners of multifamily insured housing are to help protect the security for the mortgage lien, and the financial viability of the insure d project. Violations of the regulatory agreement by misus e of project funds are a basis for civil legal action against owners to recoup double damages for the unauthorized use of project assets and income (12 U.S.C. 1715z-4a) . Auditee/GP Comments (Summary) Some assumptions made by the auditors were incorrect. The checking account fro m which the reportedl y unauthorized distributions were made was not and never had been a project operating account. Project funds were deposited into this real estate escrow account of the management company, Brookstone Ltd. The account was, and up until November 1994 had been, a partnership account. Also, during the period of 199 0 through November 1994 (when BC opened its own checking account), deposits of GP funds into this account were made of over $559,000; far in excess * OIG Note We did not audit the amount or timing of such advances to the partnership because such advances to the partnership usually would have been made for the purpose of funding critical cash flow needs; as indicated also by the mortgage default durin g most of 1993 and 1994, and again during 1996. 6 ATTACHMENT 1 of the reported $305,551 in unauthorized distributions. At no time were these funds ever considered to be part of the project. Therefore, any distributions of these funds could not be considered as unauthorized distributions of project assets. The Limite d Partnership also funded $193,818 to this account in August 1992. The GP did allow the management company to use funds in the account to subsidiz e short falls in the cash flow of the project, and to pay project expenses directly from this real estate escrow account. Both practices were discontinued in November 1994. According to the auditee, the two primary factors contributing to the mortgago r delinquency problem were: (1) the impact of the 1986 changes in the tax law; and, (2) the projected increase in the median income of Richland County which neve r materialized. The a uditee challenged the $33,202 in unauthorized distributions made in 1992 for construction related costs because dur ing 1992 the construction lender released $195,880 in completion assurance funds to the project, which should be considered. GP Closing Comments - As of June 30, 1995, the project has achieved a point that would indicate a surplus cash position of $1. These matters could be cured "from the records" by: - The recognition that t he accounting method was improper, but the funds were never co-mingled in any of the project owned accounts and therefore wer e never part of project funds. - The replacement of the funds that ACR removed from escrow accounts, and the replacement of funds improperly taken, and finally the refunding of late fees charged by ACR if the money authorized by the general partner had gone t o mortgage payments instead of to ACR's account. - And finally, doing a cash surplus report as of June 30, 1995, borrowing th e funds, making a deposit and then withdrawing the funds to pay the loan off. OIG Evaluation and Conclusion Actual circumstances differ from the auditee's views. Although the auditee contends that the real estate escrow account was never part of the project, its audited financia l statements up until November, 1994, presented this accou nt as a project asset, which was used in the computation of surplus cash. In actual practice this account was a projec t operating account, a nd was so used and reported. Also, the GP's Response to our draft findings included as its last page (page 18 herein) a sample statement for this ban k account entitled: Brookstone Ltd of Columbia; DBA Bentley Court II. 7 ATTACHMENT 1 Concerning the $33,202 in unauthorized distributions for construction costs made i n 1992, and the contention that these payments were made from the release of th e completion assurance fund by the construction lender, the GP admitted that these funds should have been deposited into the partnership account and not the project account . When funds are deposited into the project account, they become subject to the surplus cash rules for subsequent distributions. The surplus cash position of the project at th e end of 1992 was a negative ($119,135) which in our opinion confirms that all deposits were for project-cash needs. The GP also contended that they advanced other funds to the project to cover cash flow shortfalls. Such advances, without the prior approval of HUD, can only be repaid from surplus cash. Pertaining to the auditee's rebuttal that as of June 30, 1995, the project has achieved a $1 cash surplus position, this assertion has not been verified to our knowledge by a n independent public accountant. Even if correct, only any amount confirmed (the $1) as surplus cash can be distributed. The available evidence however indicates that surplu s project cash does not exist. At the start of 1994, surplus cash was a negative ($156,969). We emphasize also the mortgagor's retention of resid ual project cash while three monthly payments, as of March 8, 1996, were delinquent. The di sputes between the GP and ACR are beyond the scope of our limited review. The surplus cash rules limit the repayment of owner advances until the project generates surplus cash, so as to protect bot h the project's cash flow needs and the likelihood of the insured mortgage's repayment. Thus, any advances placed in the project account by the owners became project funds restricted by the surplus cash rules. Recommendations We recommend that you: 1A. Notify the owners wi thin 10-working days that they must repay $305,551 to the project account to restore the identified unauthorized distributions made during 1992 through 1994, and any additional d istributions of these types for 1995 to date* (as determined in part by analysis of the overdue 1995 audited financial statements). * OIG Note The process of identifying any diverted project funds during 1995 and 1996 to dat e should not delay either management actions on the known $305,551 of imprope r distributions or sanctions' consideration. 8 ATTACHMENT 1 1B. If the owners fail to repay within 30 days of the above notice, pursue administrativ e sanctions and/or referral to Counsel (program enforcement) for consideration o f litigation. 1C. Take actions with the mortgagee to protect HUD's interests in the delinquent insure d mortgage (such as: By either having the GP bring the mortgage fully current by May 17, 1996; or replace the management agent affiliate of the GP, and initiate through HU D Counsel litigation to obtain all BC assets including the residual project cash generate d recently by the mortgagor while monthly mortgage payments were not made). 9 ATTACHMENT 1 Finding 2. Reserve for Replacement (RR) Escrow Was Underfunded The regulatory agreement requires monthly deposits of $3,237 (rounded) to the R R escrow account commencing on the date amortization of the mortgage began. Al l requests for withdrawals fro m the RR account must be in writing. As of 7/31/95, there was a shortfall of $74,455 in the RR escrow account, and no request for withdrawal: Required RR deposits: 5/1/91 to 7/31/95 51 mo. X $3,236.92 $ 165,083 Less actual RR balance at 7/31/95 -90,628 Amount Underfunded $ 74,455 As a result of BC's failure to make its August 1994 mortgage and escrow paymen t within 30 days of its due date, the mortgagee ACR transferred from the RR escro w $75,538 during Sept ember for the August payment of principal, interest, and insurance escrow. ACR did not notify HUD of this withdrawal from RR for up to one month' s debt service and mortgage escrows (as required under Handbook 4566.2.) The managing GP beli eves that BC can justify the reduced RR escrow balance because the project has incurred and paid for qualified capital expenditures approximatin g $75,000. At August 2, 1995, he had not su bmitted to ACR the required documentation to claim these amounts. Based on our discussions with ACR, they believe that BC had incurred qualified capital expenditures, and they had not pursued full funding of the RR escrow account. ACR recognized that BC sho uld provide documentation supporting the capital expenditures. On June 21, 1995 ACR wrote BC requesting that documentation. Auditee Comments The auditee did not specifically address this finding in its comments. Recommendation 2A We recommend that you have the general partners fully fund the RR account, or submit the required documentation (supporting qualified expenditures) to clai m credit for a reduced escrow balance. 10 ATTACHMENT 2 Page 1 of 3 BENTLEY COURT Summary of Unauthorized Distributions For the Year Ended 12/31/92 Building Improvements Check BC G/L Date Payee No. (1) Acct.# Amount Reason 08/19/92 Dixie Heating & Cooling 380 1200 $ 11,203 Health Club Electrical Work less A/C Repairs Total Check Amount $12,897 Less $1,694 08/19/92 James C. Stancel 381 1200 10,000 Note Payment for James C. Stancel 08/27/92 Jim Griggs 392 1200 12,003 Note Payment for James C. Stancel Total for 1992 $ 33,203 For the Year Ended 12/31/93 Non-Project Legal Expenses Check BC G/L Date Payee No. (1) Acct.# Amount Reason 01/28/93 Ralph C. Robinson 471 6910 $ 5,000 Non-Project Legal Fees 03/01/93 Ralph C. Robinson 3006 6910 7,559 Non-Project Legal Fees Total Check Amount $8,000 less $441 for Project 04/05/93 Ralph C. Robinson 508 6910 3,500 Non-Project Legal Fees 05/03/93 Ralph C. Robinson 528 6910 3,500 Non-Project Legal Fees 06/03/93 Ralph C. Robinson 3136 6910 3,500 Non-Project Legal Fees 07/13/93 Ralph C. Robinson 3199 6910 3,500 Non-Project Legal Fees 08/10/93 Ralph C. Robinson 3273 6910 3,500 Non-Project Legal Fees 10/04/93 Ralph C. Robinson 3363 6910 3,500 Non-Project Legal Fees 10/06/93 Ralph C. Robinson 3365 6910 1,500 Non-Project Legal Fees 10/28/93 Ralph C. Robinson 3408 6910 3,500 Non-Project Legal Fees 12/01/93 Ralph C. Robinson 3458 6910 3,500 Non-Project Legal Fees 12/30/93 Ralph C. Robinson 3489 6910 3,500 Non-Project Legal Fees Sub-total $ 45,559 Payments to or for Affiliated Entities or Persons Check BC G/L Date Payee No. (1) Acct.# Amount Reason 04/01/93 Canal Court II, Ltd. 508 2434 $ 7,000 Cash transfer by GP to Canal Court II, LP 04/02/93 Canal Court II, Ltd. 510 2434 16,000 Cash transfer by GP to Canal Court II, LP 06/09/93 First Union National Bank 542 (2) 11,647 Pay IRS Trust Portion of Payroll Taxes for Bentley Construction Co. Inc. 06/11/93 First Union National Bank 544 2434 7,826 Purchase Cashier's Check to repay portion of - Continued - Personal Loan made to Charlotte S. Lewis (1) Three-digit numbered check s were drawn on the project account at First Union National Bank. Four digit checks were drawn on the Management Agent account at First Union National Bank and reimbursed by the project account. (2) General Ledger ( G/L) Account number could not be determined from accounting records provided; however the canceled check was payable to an affiliated company. 11 ATTACHMENT 2 Page 2 of 3 BENTLEY COURT Summary of Unauthorized Distributions For the Year Ended 12/31/93 Payments to or for Affiliated Entities or Persons - Continued - Check BC G/L Date Payee No. (1) Acct.# Amount Reason 07/20/93 Orangeburg National Bank 571 2434 $ 1,000 Repay Portion of Loan made to Charlotte Lewis 07/27/93 BDL Partnership 578 2434 5,323 Monthly Reimbursement of Construction Loan provided to BDL '89, Inc. 07/30/93 Richland County Treasurer 581 2434 28,515 Pay Real Property Taxes for Canal Court II, L 08/09/93 Orangeburg National Bank 590 2434 1,000 Repay Portion of Loan made to Charlotte Lewis Sub-total $ 78,311 Total for 1993 $ 123,870 For the Year Ended 12/31/94 Non-Project Legal Expenses Check BC G/L Date Payee No. (1) Acct.# Amount Reason 02/23/94 Ralph C. Robinson 3570 6910 $ 3,500 Non-Project Legal Fees 03/01/94 Ralph C. Robinson 3586 6910 3,500 Non-Project Legal Fees 03/28/94 Powell, Goldstein 699 6910 7,168 Non-Project Legal Fees 03/31/94 Ralph C. Robinson 3634 6910 3,500 Non-Project Legal Fees 05/02/94 Ralph C. Robinson 3697 6910 3,500 Non-Project Legal Fees 05/31/94 Ralph C. Robinson 3728 6910 3,500 Non-Project Legal Fees 06/27/94 Ralph C. Robinson 3784 6910 3,500 Non-Project Legal Fees 07/22/94 Ralph C. Robinson 3836 6910 3,500 Non-Project Legal Fees 07/28/94 Ralph C. Robinson 3847 6910 3,500 Non-Project Legal Fees 08/31/94 Ralph C. Robinson 3918 6910 3,500 Non-Project Legal Fees 09/08/94 Ralph C. Robinson 3926 6910 9,750 Non-Project Legal Fees 11/01/94 Ralph C. Robinson 4035 6910 3,500 Non-Project Legal Fees 12/06/94 Ralph C. Robinson 4072 6910 7,000 Non-Project Legal Fees 12/15/94 Ralph C. Robinson 4094 6910 3,000 Non-Project Legal Fees Sub-total $ 61,918 Payments to or for Affiliated Entities or Persons Check BC G/L Date Payee No. (1) Acct.# Amount Reason 03/16/94 Canal Court II Draft Transfer 2440to Canal Court $ 4,025 II (GP) 03/21/94 Canal Court II Draft Transfer 2440to Canal Court 7,500II (GP) 07/07/94 Brookstone, Ltd 748 2430 15,000 Transfer to Brookstone, Ltd. (MA) of Columbia 07/08/94 Primesouth, Inc. 749 2434 5,500 Repayment on Letter of Credit Fee 07/12/94 Primesouth, Inc. 751 2434 2,200 Repayment on Letter of Credit Fee - Continued - (1) Three-digit numbered check s were drawn on the project account at First Union National Bank. Four digit checks were drawn on the Management Agent account at First Union National Bank and reimbursed by the project account. Bank drafts were drawn on the project account. 12 ATTACHMENT 2 Page 3 of 3 BENTLEY COURT Payments to or for Affiliated Entities or Persons - Continued - Check BC G/L Date Payee No. (1) Acct.# Amount Reason 09/19/94 Primesouth 797 2434 $ 1,100 Repayment on Letter of Credit Fee 09/26/94 First Union National Bank 3967 2434 4,235 Repayment on Commercial Loan Invoice 09/28/94 Prime South Construction 3969 2428 25,000 Repayment on Letter of Credit Fee 10/03/94 Hungiville, J.R. 3979 2428 12,000 Repayment on Loan from General Partner 11/16/94 Prime South Construction 4051 2430 10,000 Repayment on Letter of Credit Fee Sub-total $ 86,560 Total for 1994 $ 148,478 Building Non-Project To or For Affiliated Summary Improvements Legal Fees Entities or Persons Total 1992 $ 33,203 $ 33,203 1993 $ 45,559 $ 78,311 123,870 1994 61,918 86,560 148,478 $ 33,203 $ 107,477 $ 164,871 $ 305,551 (1) Three-digit numbered checks were drawn on the project account at First Union National Bank. Four digit checks were drawn on the Management Agent account at First Union National Bank and reimbursed by the project account. 13 ATTACHMENT 3 14 ATTACHMENT 3 15 ATTACHMENT 3 16 ATTACHMENT 3 17 ATTACHMENT 3 18 ATTACHMENT 3 19 ATTACHMENT 4 SCHEDULE OF INELIGIBLE COSTS Recommendation Ineligible Costs 1 1A $ 305,551 1 Ineligible amounts obviously violate law, contract, HUD or local agency policies or regulations. 20 ATTACHMENT 5 DISTRIBUTION Secretary's Representative, 4AS Assistant General Counsel, 4AC/4ACE Special Agent in Charge, 4AGI Field Comptroller, 4AF Director, Accounting Division, 4AFF South Carolina State Coordinator, 4ES Director, Multifamily Housing Division, 4EHM (2) Associate Director, US GAO, 820 1st St. NE Union Plaza, Bldg 2, Suite 150, Washington, DC. Chief Financial Officer, F (Room 10166) (2) Office of Internal Control and Audit Resolution, FOI (Room 10176) Housing-FHA Comptroller, HF ATTN: Audit Liaison Officer (Room 5132) Associate General Counsel, Office of Assisted Housing and Community Development, CD (Room 8162) Assistant to the Deputy Secretary for Field Management, SDF (Room 7106) Bentley Court II (Mr. E. Lewis, GP) 21 We did not audit the amount or timing of such advances to the partnership because any suc h advances to the partnership usually would have been made for only one purpose: to fund critical cash flow needs. The surplus cash rules limit the repay ment of owner advances until the project generates surplus cash, so as to protect the project's cash flow needs and thereby the insured mortgage' s repayment. Thus, any advances placed in the project account by the owners became project funds restricted by the surplus cash rules. 22
Limited Review of Bentley Court, Columbia, SC
Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-03-28.
Below is a raw (and likely hideous) rendition of the original report. (PDF)