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Windsor Learning Center, Inc. v. New Jersey State Dep't of Education

SUPERIOR COURT OF NEW JERSEY APPELLATE DIVISION


January 3, 2008

WINDSOR LEARNING CENTER, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.
SHEPARD ACADEMY, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.
SHEPARD HIGH SCHOOL, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.
WINDSOR PREP, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.
WINDSOR ACADEMY, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.
WINDSOR SCHOOL, INC., PETITIONER-APPELLANT,
v.
NEW JERSEY STATE DEPARTMENT OF EDUCATION, OFFICE OF COMPLIANCE, RESPONDENT-RESPONDENT.

On appeal from the Office of Compliance, Department of Education, EDU Docket Nos. 5979-04, 5980-04, 5981-04, 5982-04, 5983-04, 5984-04.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

Argued December 17, 2007

Before Judges S.L. Reisner and Baxter.

Six private schools (appellants) appeal from a November 1, 2006 final decision by the State Board of Education (the Board) to disallow certain legal fees in the schools' calculation of the tuition rates they charged to sending school districts. We affirm.

Appellants are six private schools for disabled students, of whom four are non-profit corporations: Windsor School, Inc. in Pompton Lakes; Windsor Prep, Inc. in Paterson; Windsor Academy, Inc., also located in Paterson; and Shepard High School, Inc., in Morristown. Two are for-profit corporations: Shepard Academy, Inc., in Morristown and Windsor Learning Center in Pompton Lakes.

Prior to July 1, 2001, Dr. Daniel Greco and Philip Scardilli were officers and trustees of those six schools. On January 25, 2003, Greco and Scardilli were indicted by a Morris County grand jury on fifteen counts of criminal activity arising out of their management of the six schools. On March 17, 2003, Greco and Scardilli each pled guilty to one count of second-degree theft by deception, and the State dismissed the remaining counts. On August 18, 2003, Greco and Scardilli were each sentenced to a six-year term of imprisonment. At sentencing, both were required to (1) divest themselves of their interest in, and positions at, all six schools, (2) forfeit their professional licenses and certificates in the education field, and (3) pay restitution in excess of $3.6 million. The six schools are presently under new ownership and management.

Similar criminal indictments were also filed against the six corporate entities. Each corporation pled guilty to a single count of theft by deception on March 17, 2003. As part of the sentence, the corporations consented to entry of an order holding them jointly and severally liable for restitution in the amount of $3.6 million.

Greco, Scardilli, and the corporations incurred legal fees of more than $448,000 for the defense against the criminal charges. All six schools subsequently included those legal fees in the computation of tuition that they charged to the sending districts. Between May 28, 2003, and June 19, 2003, the New Jersey Department of Education, Office of Compliance (the Department) reviewed the tuition rates charged to the sending districts by appellants. The Department determined in its audit report that the legal fees incurred because of Greco and Scardilli's criminal conduct were non-allowable costs. On June 19, 2003, the Department concluded that the legal fees did not conform to the requirements of N.J.A.C. 6A:23-4.2(a)(1), and were unreasonable in accordance with N.J.A.C. 6A:23-4.5(a)(63).

By letters dated July 28, 2003, the Department amended the audit report to disallow the legal fees incurred by the six schools, based on the same reasoning applied to Greco and Scardilli: the legal fees incurred in defense of the corporations' criminal conduct did not conform to the requirements of N.J.A.C. 6A:23-4.2(a)(1) and were unreasonable in accordance with N.J.A.C. 6A:23-4.5(a)(63).

Appellants sought timely review of the Department's audit reports, and on November 18, 2003, Department of Education Chief of Staff Gloria Hancock denied appellants' appeals. After appellants filed separate petitions of appeal with the Commissioner of Education (the Commissioner), the Commissioner transmitted all six appeals to the Office of Administrative Law (OAL) for hearing.

Because all six appeals involved common issues of fact, the parties agreed to consolidate the cases before the OAL and stipulate to all relevant facts. On March 8, 2006, Administrative Law Judge (ALJ) Ken R. Springer issued his initial decision, finding that the Department properly disallowed legal fees from appellants' approved tuition rates for the 2001-2002 and 2002-2003 school years.

The ALJ found that the legal expenses incurred in the "unsuccessful defense of individuals and corporate entities engaged in the misuse of public funds do not qualify as an expense 'incurred by an ordinary prudent person in the administration of public funds.'" Administrative Law Judge Springer further denied appellants' request for an extension of the thirty-day requirement for repayment of the funds to the school districts, reasoning that the Commissioner had not reserved the right to waive application of the deadline. The ALJ reasoned that even if the Commissioner did have such authority, it should be exercised sparingly. Given that the legal expenses here were incurred from criminal conduct, the ALJ determined that the equities did not favor an extension of the 30-day period.

On April 6, 2006, the Commissioner adopted the ALJ's initial decision. The Commissioner's decision stated:

[T]he Commissioner is in accord with the ALJ's grant of summary decision to the Department, as she concurs with his determination that the Department appropriately disallowed legal fees incurred in connection with the defense against criminal charges-leading to the convictions for theft by deception of two former directors and the corporate entities-from petitioners' approved tuition rates for the 2001-02 and 2002-03 fiscal years. The Commissioner further agrees that even assuming, arguendo, she had the authority to extend the 30-day timeline prescribed by regulation for the repayment of these monies, public policy and the equities in this matter militate against such an action.

The Board upheld the Commissioner's decision in an opinion dated November 1, 2006, after which appellants filed a notice of appeal with this court.

Appellants present three issues for our consideration: (1) the Board's decision to disallow the legal expenses was arbitrary, capricious and unreasonable because it has no legal basis and the Board did not explain its decision; (2) the Board's decision constituted "impermissible ad hoc rule-making;" and (3) the Board's decision that required appellants to repay the legal fee expenses within thirty days was arbitrary, capricious, and unreasonable.

I.

"Administrative regulations enjoy a presumption of legality." Ocean Med. Imaging Assocs. v. New Jersey Dep't of Health & Senior Servs., ____ N.J. Super. ____ (App. Div. 2007)(slip op. at 6). This court does not ordinarily overturn an agency decision "in the absence of a showing that it was arbitrary, capricious or unreasonable, or that it lacked fair support in the evidence." In re Carter, 191 N.J. 474, 482 (2007). This court's role is generally limited to determining the following:

(1) whether the agency's action violates express or implied legislative policies, that is, did the agency follow the law; (2) whether the record contains substantial evidence to support the findings on which the agency based its action; and (3) whether in applying the legislative policies to the facts, the agency clearly erred in reaching a conclusion that could not reasonably have been made on a showing of the relevant factors. [Ibid.]

"A court may not substitute its own judgment for the agency's even though the court might have reached a different result." Id. at 483. "Arbitrary and capricious action of administrative bodies means willful and unreasoning action, without consideration and in disregard of circumstances. Where there is room for two opinions, action is [valid] when exercised honestly and upon due consideration, even though it may be believed that an erroneous conclusion has been reached." Beattystown Cmty. Council v. Dep't of Envtl. Prot., 313 N.J. Super. 236, 248 (App. Div. 1998)(quoting Worthington v. Fauver, 88 N.J. 183, 204-05 (1982)).

Appellants argue that the Board's decision was arbitrary, capricious, and unreasonable because (1) there is no case law, statute, or regulation that identifies bona fide legal fee expenses as non-allowable; (2) the fees incurred were justified and necessary given that virtually all of the charges against the schools and their officers were dismissed; and (3) there is no legal justification or support for the Board's determination that the legal fees were "patently unreasonable," pursuant to N.J.A.C. 6A:23-4.5(a).

New Jersey law authorizes public school districts to send their students to approved private schools that have special programs and facilities for children with educational disabilities. N.J.S.A. 18A:46-14(g). These private schools are authorized to charge the sending districts for the cost of tuition for each child sent to their schools; however, the calculation of the tuition rates is strictly regulated. The Department has promulgated regulations to govern the accounting and bookkeeping procedures to be employed by the private schools. See N.J.A.C. 6A:23-4.1 to -4.16. This court has upheld these regulations, finding that they are not "ultra vires or facially confiscatory." Council of Private Sch. for Children with Special Needs, Inc., v. Cooperman, 205 N.J. Super. 544 (App. Div.), certif. denied, 103 N.J. 490 (1985).*fn1

Tuition rates charged by the private schools can not "exceed the actual cost per pupil as determined under the rules prescribed by the [C]commissioner and approved by the State Board of Education." N.J.S.A. 18A:46-21. The final tuition rate must be "an amount less than or equal to the certified actual cost per student." N.J.A.C. 6A:23-4.2(a). When determining the certified actual cost per student, the "actual allowable cost for the school year" must be factored into the calculation. N.J.A.C. 6A:23-4.2(a). Calculation of the actual allowable cost must, in turn, comply with the requirements of N.J.A.C. 6A:23-4.2(a)(1). In its regulations, the Department has issued a list of costs that it has determined are "non-allowable" in the calculation of the certified actual cost per student. See N.J.A.C. 6A:23-4.5. In this case, the Board based its decision on two regulations: N.J.A.C. 6A:23-4.2(a)(1) and N.J.A.C. 6A:23-4.5(a)(63). Consequently, both regulations must be analyzed to determine whether the Board's determination was arbitrary, capricious or unreasonable.

First, the actual allowable cost for the year must comply with the requirements of N.J.A.C. 6A:23-4.2. To qualify as actual allowable costs for the program, the costs must be: based on all costs of student instruction from July 1 through June 30. Such costs shall be consistent with the individualized education program (IEP) of a disabled student, and shall include all costs required to implement all students' IEPs including all related services. Such costs shall [be] reasonable, that is, ordinary and necessary and not in excess of the cost which would be incurred by an ordinary prudent person in the administration of public funds. [N.J.A.C. 6A:23-4.2(a)(1).]

In this case, appellants incurred the legal costs because of their criminal conduct. An "ordinarily prudent person" would not steal money "in [his or her] administration of public funds." N.J.A.C. 6A:23-4.2(a)(1). Moreover, defense of unlawful conduct is not "consistent with the students' individualized education programs." Ibid. Based on this regulation, we reject appellants' argument that the Board had "no legal basis" for its decision to disallow appellants' legal expenses. Consequently, we also reject their contention that the Board's November 1, 2006 decision was arbitrary, unreasonable or capricious.

Second, we turn to an analysis of appellants' contention that the Board erred when it based its decision on N.J.A.C. 6:23-4.5(a)(63) because that regulation does not expressly disallow the inclusion of legal fees such as these in the calculation of tuition. The Department's regulations contain a list of costs that the Department deems "non-allowable" in the calculation of the certified actual cost per student. See N.J.A.C. 6A:23-4.5. Two of these non-allowable costs in N.J.A.C. 6A:23-4.5(a) are relevant to this appeal:

19. The cost of a fine or penalty which results from a violation of or failure by the school to comply with a Federal, State and/or local law or rule;

63. Cost found to be patently unreasonable by the Commissioner or his or her representative(s) or the independent auditor/accountant.*fn2

Subsection (63) of N.J.A.C. 6A:23-4.5 is a "catch-all" provision that gives the Commissioner discretion to disallow costs that are not expressly included in the rest of N.J.A.C. 6A:23-4.5 and that the Commissioner finds "patently unreasonable." Thus, the Commissioner in this case had authority and discretion under subsection (63) to disallow the legal fees incurred from appellants' criminal conduct. The Commissioner's interpretation of (63), and ultimate conclusion that the legal expenses were "patently unreasonable," are entitled to deference because an agency has the authority to "give specific content to general regulations." In re Appeal of Certain Sections of Unif. Admin. Procedure Rules, 90 N.J. 85, 93 (1982). Furthermore, an agency's interpretation of its own regulation "is entitled to great weight . . . since [it] is in the best position to understand what was meant by the regulation when it was promulgated." In re Hosps.' Petitions, 383 N.J. Super. 219, 239 (App. Div.), certif. denied, 187 N.J. 81 (2006).

There is nothing arbitrary, capricious or unreasonable about the Commissioner's finding; the schools and their former directors engaged in prohibited conduct. Thus, there is no rational reason for the school districts to reimburse them for the defense of such conduct. Appellants argue that "the schools themselves, and their current officers and directors have to absorb the burden of these activities due to the fraudulent activities of [their predecessors Greco and Scardilli] . . . . Indeed, the schools themselves, and their current owners, should not be punished for the wrongdoings of Dr. Greco and Mr. Scardilli." We disagree. That argument fails to acknowledge that the schools, too, engaged in and were convicted of fraudulent activity; thus, they are being punished for their own wrongdoing, not the wrongdoing of Greco and Scardilli. Although each school now has new directors, we have been presented with no meritorious argument as to why the taxpaying public should absorb these costs, rather than the private schools themselves.

In addition to N.J.A.C. 6A:23-4.5(a)(63), subsection (19) disallows any fines incurred from a school's violation of federal, state or local law. N.J.A.C. 6A:23-4.5(a)(19). It stands to reason that if the Board finds that fines incurred because of wrongdoing are unreasonable, then expenses incurred from the defense of such wrongdoing are likewise unreasonable.

We note that since 2003, when the corporations incurred their legal fees and charged them to the sending districts, N.J.A.C. 6A:23-4.5 has been amended two times, in 2004 and 2006. The most recent amendment specifies that legal fees for the defense of criminal conduct are a non-allowable cost:

Legal costs for an approved private school for students with disabilities and/or for a school representative(s), which includes an owner, employee or agent that have plead[sic] guilty and/or are found to be guilty or liable in a case involving the misuse of funds or fraud (criminal or civil); [N.J.A.C. 6A:23-4.5(a)(66)(effective October 2, 2006).]

Because we conclude that the Board's decision was justified based on the catch-all provision, number (63) of the original regulations, it is unnecessary to determine whether the new subsection (66) should apply retroactively.

We also agree with the Board's reliance on N.J.S.A. 18A:16-6, which provides that an employee of a school board is entitled to indemnification for legal expenses only when such expenses are incurred in the successful defense against criminal charges, and the conduct at issue arises out of and in the course of performance of the employee's duties. The Board is correct that appellants' conduct did not arise out of the performance of their official duties and they were not successful in their defense.

We recognize that the issue in this appeal is whether legal fees incurred in connection with a criminal conviction are considered a tuition cost, pursuant to N.J.A.C. 6A:23-4.1 et seq, and not whether appellants are entitled to indemnification for the defense of a criminal charge under N.J.S.A. 18A:16-6. Nonetheless, we agree with the Board's argument that it would be incongruous to permit appellants to pass on to the sending districts costs that their directors could not have recovered from their employers had the directors been employed in a public school setting.

II.

Appellants next argue that "the Office of Compliance's amended reports provide no explanation or justification for the reversal of its position-the very essence of arbitrariness." The characterization of the July 28, 2003 audit report as a "reversal" of the June 19, 2003 audit report is baseless. Appellants' arguments to the contrary lack sufficient merit to warrant a discussion in a written opinion. R. 2:11-3(e)(1)(D) and (E).

III.

Appellants also argue that the Board's decision constitutes impermissible ad hoc rule-making because "the Office of Compliance implemented methodologies, upheld by the Board, that were never used before and were not based on any law" when it included bona fide legal expenses as a non-allowable cost. We disagree.

In In re Appeal, supra, 90 N.J. at 92-93, the Court emphasized the board powers an agency is entitled to exercise in the discharge of its statutory responsibilities:

Administrative agencies are empowered to effectuate their regulatory responsibilities through either rulemaking or adjudication. . . . .

In the context of public administration, adjudication is regulation. In effect, an agency engages in ad hoc rulemaking every time it decides a contested case. The agency can use the adjudicative process to set certain policies, to define the contours of its regulatory jurisdiction, to give specific content to general regulations, and to handle specialized problems that arise.

Thus, the agency's decisional authority over contested cases is directly and integrally related to its regulatory function.

In this case, the Board's decision was based on regulations, N.J.A.C. 6A:23-4.2 and -4.5, that were in existence when appellants were indicted and when the tuition was calculated by appellants. The Board did not create new rules; it merely interpreted regulations that had already been promulgated. The regulations prohibit allowance of costs that are not consistent with students' IEPs or are determined to be patently unreasonable. Legal expenses incurred as a result of engaging in criminal conduct are not (1) a reasonable cost that an ordinarily prudent person would incur, or (2) necessary for the provision of instruction and related-services to students. See N.J.A.C. 6A:23-4.2.

Furthermore, appellants were on notice that the Commissioner has discretion under N.J.A.C. 6A:23-4.5(63) to determine whether the costs are unreasonable and thus non-allowable. The Board's decision relied on and interpreted regulations that were already in place. The Board used the adjudicative process "to give specific content to general regulations." In re Appeal, supra, 90 N.J. at 93. Contrary to appellants' argument, the Board did not create new regulations to support its decision.

Appellants' reliance on Metromedia, Inc. v. Dir., Div. of Taxation, 97 N.J. 313 (1984) is misplaced. Although we agree with appellants' argument that agencies are prohibited from engaging in ad hoc rule-making, the facts in Metromedia do not support appellants' argument that the Board engaged in such conduct here. In Metromedia, the Director of the Division of Taxation employed a method for determining a corporation's tax base that was not codified in a rule. Id. at 337. In this case, the Board based its decision on regulations that had already been enacted.

IV.

Finally, appellants argue that the Board's order that required them to repay the legal expenses within thirty days is arbitrary, capricious and unreasonable because the outcome would be highly inequitable. Specifically, appellants argue that the schools can not afford to pay back the expenses within such a short period of time, and should be allowed to negotiate payment plan schedules with the individual public school districts. For example, Windsor School argues that it will be "forced to repay over $150,000 to various public school districts within thirty days if this appeal is unsuccessful--such a finding would threaten the financial viability of this highly regarded educational institution."

N.J.A.C. 6A:23-4.2(l) provides:

If the Commissioner determines that the tentative tuition rate for the school year established by written contractual agreement is greater than the final tuition rate charged for the school year, the [approved] private school for [students with disabilities] shall pay or credit the difference to subsequent tuition bills for each sending district board of education no later than June 30 of the school year in which the final tuition rate charged is received from the Commissioner, or not more than 30 days after an appeal on a certified amount is finally resolved.*fn3

That regulation does not expressly authorize the Commissioner to waive application of the deadline, or in other words, disregard the regulation for equitable reasons. Compare N.J.A.C. 6A:23-4.2(l) with N.J.A.C. 6A:3-1.16 (expressly providing that the Commissioner has the authority to relax the procedural rules in that chapter).

As ALJ Springer reasoned, even if the Commissioner did have such authority, public policy and the equities in this matter militate against overturning the Board's decision. A thirty-day extension would essentially be an interest-free loan for the expenses incurred as a result of appellants' criminal misconduct, and the loan would be at the expense of the public fisc. Even if this court were to disagree with the Board's decision on this issue, we would leave it undisturbed because it is neither arbitrary, unreasonable nor capricious. Carter, supra, 191 N.J. at 482.

N.J.A.C. 6A:23-4.2(1) requires the money to be repaid within thirty days. Appellants conceded at oral argument that they still had not repaid these disallowed costs, despite the November 1, 2006 decision that required repayment within thirty days. Thus, appellants have already had the benefit of an unauthorized one-year extension of their repayment obligation. We have been presented with no meritorious basis to depart from the provisions of N.J.A.C. 6A:23-4.2(1).

Affirmed.


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