QUESTIONS PRESENTED

1. Whether a third-party contractor employed by a funding recipient for check-writing and payroll services “handles” funds as that term is used in 45 C.F.R. Part 1629.
2. How the bonding requirement set forth in Part 1629 should be interpreted when compliance with the requirement is impossible because the recipient operates in a service area where the required coverage is not available.

BRIEF ANSWERS

1. Yes, a third-party contractor retained by a funding recipient (“recipient”) for check-writing and payroll services “handles” funds as that term is used in 45 C.F.R. Part 1629. LSC’s regulations at Part 1629 require recipients to bond or provide for insurance coverage to “indemnify recipients against losses resulting from fraudulent or dishonest acts” by recipient employees, officers, directors, agents, and third-party contractors “who handle LSC funds.” Id. § 1629.1. Section 1629.3(b) explicitly provides that a recipient must secure or ensure a third-party contractor has secured a fidelity bond or similar insurance coverage where the third party performs payroll or billing services for the recipient.
2. Where strict adherence to 45 C.F.R. § 1629.3(b) is impossible because insurance companies do not provide for fidelity bond or similar insurance coverage in a recipient’s service area, the regulation should not be interpreted to thwart the core purpose of the LSC Act. See Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571 (1982). The LSC Act defines LSC’s core purpose as “providing financial support for legal assistance in noncriminal proceedings or matters to persons financially unable to afford legal assistance.” 42 U.S.C. § 2996b(a). Where a recipient operates in a service area where no insurance company offers fidelity bond or similar insurance coverage, the recipient must make best efforts to identify and secure adequate coverage to satisfy the regulatory standard.

BACKGROUND

The questions presented arise out of American Samoa Legal Aid’s (“ASLA’s”) efforts to comply with 45 C.F.R. Part 1629, which requires a fidelity bond or similar insurance coverage to protect LSC funds. ASLA employs a local Certified Public Accountant firm to prepare unsigned checks for ASLA’s accounts payable and to input payroll information. The contractor does not have authority to access any ASLA funds, nor are its employees signatories for ASLA’s bank accounts. ASLA maintains fidelity-bond-type coverage for its own employees but has not successfully secured coverage that would indemnify ASLA for dishonest or fraudulent acts committed by the contractor’s employees.

In 2016, ASLA contacted LSC to explain it had not successfully secured coverage to protect against dishonest or fraudulent acts by the contractor’s employees. ASLA forwarded to LSC correspondence from one of the only two insurance companies writing business in American Samoa. This company offered fidelity bond coverage only for directors and employees of ASLA, not those of a third-party contractor. In its correspondence, the insurance broker informed ASLA that financial services and products providing for third-party coverage, such as fidelity bonds, professional negligence covers, real life or health insurance, and Circular 570 list surety coverage, are available in mainland states and territories, but not in American Samoa due to local law and regulation and a lack of demand or economical market for such products.

In 2016, ASLA also consulted two non-American-Samoan insurance companies which provided adequate coverage for LSC’s funding recipients in Micronesia and Hawaii. Neither company offered coverage in American Samoa as of September 2016. One of the companies, headquartered in the United States, offered to extend fidelity bond coverage to the contractor if an American Samoan insurance company would provide an endorsement. However, American Samoan insurance companies refused to issue an endorsement, reiterating that their coverage extended only to ASLA’s employees and directors, not those of a third-party contractor.

ASLA continued to seek adequate coverage and in 2018 and 2019 recontacted the American Samoan insurance company consulted in 2016. In 2019, ASLA also contacted the only other insurance company writing business in American Samoa. These companies reiterated the points provided to ASLA in 2016. Further, these companies explained that coverage for the contractor that would name ASLA as a beneficiary or otherwise cover for the loss of a third party’s property, whether through a fidelity bond, professional liability insurance, or vicarious liability insurance for misappropriated property belonging to third parties, was not available. ASLA also showed that its payroll contractor’s current insurance policy covers business liability, but specifically excludes losses attributable to fraudulent acts, embezzlement, or misappropriation by the contractor’s employees. Thus, neither ASLA nor the contractor has secured coverage to protect ASLA’s LSC funds when the contractor is handling the funds.

On July 26, 2019, ASLA contacted LSC’s Office of Compliance and Enforcement to explain ASLA’s efforts and inability to secure coverage. ASLA also requested that LSC’s Office of Legal Affairs provide an opinion on the issue of compliance with Part 1629 where neither ASLA nor its payroll contractor could secure the coverage required.

APPLICABLE AUTHORITY

45 C.F.R. Part 1629 requires LSC funding recipients to obtain insurance coverage to protect LSC funds from losses resulting from fraudulent or dishonest acts. Under § 1629.1, such coverage should “indemnify recipients against losses resulting from fraudulent or dishonest acts” by recipient employees and officers and third-party contractors “who handle LSC funds.” Coverage should “provide recovery for loss caused by such acts as fraud, dishonesty, larceny, theft . . . or any other fraudulent or dishonest act committed by an employee, officer, director, agent, or volunteer.” Id. § 1629.5. Under § 1629.3(b), if a funding recipient uses a third-party contractor for “payroll, billing or collection services,” the recipient must provide for coverage or ensure that the third party does so.

ANALYSIS

I. Whether a third-party contractor employed by an LSC funding recipient for check-writing and payroll services “handles” funds as meant by 45 C.F.R. Part 1629.

The purpose of Part 1629 is to require fidelity bond or similar insurance coverage to protect LSC funds against fraudulent or dishonest acts by LSC funding recipients’ and third-party contractors’ employees and agents. 45 C.F.R. § 1629.1. LSC requires, and historically has required, recipients to bond employees, officers, directors, agents, and third parties who “handle” LSC funds or property. Id.; 82 Fed. Reg. 37,177, 37,178 (Aug. 9, 2017). 45 C.F.R. § 1629.3(b) states that a recipient must secure or ensure a third-party contractor has secured fidelity bond or similar insurance coverage where the third party performs “payroll” or “billing” services for the recipient.

According to correspondence sent to LSC on July 26, 2019, ASLA’s contractor “does not have authority to access any ASLA funds,” nor are “any of its employees . . . signatories on any of ASLA’s bank accounts.” Thus, the question arises as to whether ASLA’s third-party contractor “handles” LSC funds or property, as that term is used in Part 1629.

While the term “handle” is not explicitly defined by the regulation, the regulation’s plain language answers the question posed here. The regulation states that if a recipient uses a third party for “payroll” or “billing” services, the recipient “must” ensure that either the recipient or the third-party employed by the recipient provides for adequate coverage. ASLA’s payroll provider, an independent Certified Public Accountant firm, is a third-party contractor engaged by ASLA. The contractor inputs payroll information and prepares unsigned checks from ASLA’s accounts payable. The former service constitutes a payroll service, and the latter constitutes a billing service. Consequently, the contractor’s services fall under those enumerated by Section 1629.3(b), and, thus, ASLA or the contractor must provide a fidelity bond or similar insurance coverage.

II. How the bonding requirement set forth in Part 1629 should be interpreted when compliance with the requirement is impossible because the recipient operates in a service area where the required coverage is not available.

Part 1629 provides,

If a recipient uses a third party for payroll, billing, or collection services, the recipient must either supply coverage covering the third party or ensure that the third party has a fidelity bond or similar insurance coverage.

45 C.F.R. § 1629.3(b).

Such coverage should indemnify for “loss caused by such acts as fraud, dishonesty, larceny, theft, embezzlement, . . . or any other fraudulent or dishonest act committed by an employee, officer, director, agent, or volunteer” of a recipient or a third-party contractor. Id. § 1629.5. Any bond may be used as long as the coverage “adequately protects LSC funds,” id. § 1629.4(a), and “similar forms of insurance that essentially fulfill the same purpose as a fidelity bond” may be used. Id. § 1629.4(b); EX-1999-26 (Oct. 26, 1999).

As described above, ASLA has made extensive efforts to meet this bonding requirement. ASLA has detailed its unsuccessful attempts to secure the required coverage. Neither of the only two insurance companies in American Samoa would offer fidelity bond or similar insurance coverage to protect against losses due to the acts of ASLA’s contractor or its employees. Nor would they offer financial, business, vicarious, professional negligence, or other liability insurance for the contractor designating ASLA as a third-party beneficiary. ASLA unsuccessfully attempted to secure coverage from these two companies in 2016, 2018, and 2019. Thus, ASLA does not meet the requirement of 45 C.F.R. § 1629.3(b) because neither it or its third-party contractor has the required coverage. ASLA has shown that the failure to secure adequate coverage is due to the lack of availability of the appropriate instruments in American Samoa.

The Supreme Court has held that where strict adherence to a statutory or regulatory provision is impossible, the provision should not be interpreted to thwart the core purpose of the statute or regulation. See Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571 (1982). Consistent with this principle, the Office of Legal Affairs recently advised that where a recipient fails to meet regulatory requirements because it is impossible to meet those requirements, LSC should interpret its regulation consistent with the core purpose of the LSC Act and appropriation. AO-2018-001. The LSC Act defines LSC’s core purpose: “providing financial support for legal assistance in noncriminal proceedings or matters to persons financially unable to afford legal assistance.”  42 U.S.C. § 2996b(a). Although LSC is not obligated to fund a recipient in a service area where no qualified recipient exists, that is not the case here. ASLA’s inability to comply with a regulatory requirement with which it is impossible to comply does not render ASLA unqualified. Where a recipient operates in a service area with a limited insurance market, the recipient must make best efforts to identify and secure adequate coverage to satisfy the regulatory standard. On the facts presented here, ASLA has, to date, met this standard and should annually make best efforts to secure the coverage required by Part 1629.

RONALD S. FLAGG

Vice President for Legal Affairs and

General Counsel

 

STEFANIE K. DAVIS

Assistant General Counsel

 

DANNY HANKES

Graduate Law Fellow