HB 44 and Proposed Changes to the Preaudit Process

Published for Coates' Canons on June 25, 2015.

In recent years local governments and public authorities (collectively, local units) have struggled to comply with the statutory preaudit (G.S. 159-28(a)) and disbursement (G.S. 159-28(b) & (d)) processes, in particular when making web-based purchases, or when using credit cards, purchase cards, and fuel cards. In 2013 the North Carolina Court of Appeals made compliance even more difficult when it interpreted the provisions of G.S. 159-28(a) to require that all obligations subject to preaudit be in writing. See Howard v. County of Durham, 748 S.E.2d 1 (NC Ct. App. 2013), disc. rev. den’d, 367 N.C. 238 (N.C. 2013); Executive Medical Transportation, Inc. v Jones County Department of Social Services, 735 S.E.2d 352 (NC Ct. App. 2012), disc. rev. den’d, 737 S.E.2d 378 (N.C. 2013). This raised additional difficulties for units when dealing with electronic transactions and also when hiring, or changing the compensation of, at-will employees. A bill (HB 44) was introduced this session that, if enacted, would address these issues, modernize the preaudit and disbursements processes, and (hopefully) make it easier for local governments to comply. The amendments would go into effect on July 1, 2015 (again, if enacted), and would apply to any obligations incurred on or after that date. This post summarizes the proposed changes to the preaudit process. A future post will look at the proposed changes to the disbursement process.

Current Preaudit Requirements Before analyzing the proposed changes, it is useful to first review the current requirements of G.S. 159-28(a), as interpreted by the North Carolina courts. It requires that before a local government or public authority incurs an obligation that is accounted for in a budget ordinance or a project ordinance, the finance officer for the unit (or a deputy finance officer approved by the unit’s governing board for this purpose) must (1) ensure that there is an appropriation authorizing the obligation; and (2) ensure that sufficient funds will remain in the appropriation to pay the amounts that are expected to come due in the fiscal year in which the obligation is incurred (or during the life of the project if accounted for in a project ordinance). Furthermore, the obligation (3) must be evidenced by a “writing” and the writing (4) must include a preaudit certificate signed by the finance officer (or deputy finance officer). The preaudit certificate states that: “This instrument has been preaudited in the manner required by the Local Government Budget and Fiscal Control Act.” (A preaudit certificate is not required on agreements approved by the State’s Local Government Commission.) An obligation is incurred by a local unit, thus triggering the preaudit statute, when the unit legally commits to pay money to another entity or individual and, if the expenditure is accounted for in the budget ordinance, at least a portion of the money is expected to be paid in the fiscal year in which the agreement is executed. The form of the obligation is irrelevant. For example, a unit may incur an obligation by executing a construction contract, issuing a purchase order, paying for goods or services at the point of sale with a credit card, or committing to pay a salary to a newly hired at-will employee. What happens if the preaudit process (or a part of the preaudit process) is not performed before the unit incurs an obligation? The obligation (contract, purchase order, credit card transaction, or agreement) is void. That means that it cannot be legally enforced. It also means that the unit cannot disburse any monies that may come due under the contract or agreement. In fact, G.S. 159-28(e) provides that if “an officer or employee [of a local unit] incurs an obligation or pays out or causes to be paid out any funds in violation of [the preaudit statute], he and the sureties on his official bond are liable for any sums so committed or disbursed.” Proposed Changes to Preaudit Statute Section 6(a) of HB 44 proposes several changes to the preaudit statute. 1.  It adds a sentence to G.S. 159-28(a) stating that “[n]othing in this section shall require a contract to be reduced to writing.” This provision would render null the recent court of appeals’ holdings (cited above) that the preaudit statute requires that all contracts subject to its provisions must include a preaudit certificate and, therefore, must be in writing (steps (3) and (4) of the preaudit process). 2.  Closely related to the first change, the proposed amendments specify that a signed preaudit certificate is only required on purchase orders, contracts, or other agreements that are in fact in writing (step (4)). The first two steps in the preaudit process would still apply to all obligations subject to the preaudit. But the preaudit certificate would only apply if a purchase order, contract, or agreement subject to preaudit is memorialized in writing. Effectively it would exempt telephone orders or other oral contracts or agreements from the preaudit certificate requirement. The other steps in the process (steps (1) and (2)) would continue to apply. Thus, for example, under current preaudit provisions before hiring a new at-will employee, the finance officer must ensure that there is a budget appropriation authorizing the hire and that sufficient funds remain within the budget appropriation to pay the salary for the fiscal year (if accounted for in a budget ordinance) or for the project term (if accounted for in a project ordinance). The employment agreement must be memorialized in writing and include a signed preaudit certificate. Under the proposed amendments to the preaudit process, before hiring a new at-will employee, the finance officer must ensure that there is a budget appropriation authorizing the hire and that sufficient funds remain within the budget appropriation to pay the salary for the fiscal year (if accounted for in a budget ordinance) or for the project term (if accounted for in a project ordinance). The employment agreement does not need to be memorialized in writing. And, if it is not memorialized in writing it does not require a signed preaudit certificate. However, if a local unit does generate a written employment contract, as is common for managers and other senior level employees, the employment contract would still need to include a signed preaudit certificate. Note also that other provisions of law may require that a particular contract or agreement be in writing. For example, all contracts entered into by municipalities must be in writing, although the governing board may ratify a contract that violates this provision. See G.S. 160A-16. And all contracts involving the sale of “goods” for the price of $500 or more must be in writing. See G.S. 25-2-201. But the preaudit statute, itself, would not require a contract or agreement to be in writing. And it would not require a local unit to affix a signed preaudit certificate unless the purchase order, contract, or agreement is in writing. 3.  The proposed amendments would exempt certain transactions from the signed preaudit certificate requirement even if the contracts or agreements are memorialized in writing. The exemptions apply to:

  • Any obligation or document that has been approved by the Local Government Commission (LGC). This exemption already exists. It applies to loan agreements, debt issuances, and other lease and financing transactions that are subject to LGC approval and have, in fact, been so approved.
  • Payroll expenditures, including all benefits for employees of the local government. This exception ensures that yearly salary and benefit changes for current employees need not include a preaudit certificate, even if they are recorded in writing.
  • Electronic payments, defined as payments made by charge card, credit card, debit card, gas card, procurement card, or electronic funds transfer. (An electronic funds transfer is “initiated by using an electronic terminal, a telephone, a computer, or magnetic tape to instruct or authorize a financial institution or its agent to credit or debit an account.”) These types of transactions have been the most difficult to preaudit, and this exemption would facilitate electronic payments by local units. The exemption would only apply if a local unit complies with rules and procedures promulgated by the LGC for handling these types of electronic transactions. In other words, unless and until the LGC adopts rules related to electronic payments, those transactions would not be exempt from the signed preaudit certificate requirement.

It is worth emphasizing that all of these exemptions only apply to the preaudit certificate requirement (step 4). A unit still must perform the other steps (steps (1) and (2)) before incurring an obligation. 4.  The proposed amendments would empower the Local Government Commission to adopt rules of procedure for local units to follow when performing the preaudit process. A finance officer or deputy finance officer must incorporate any rules adopted by the LGC into his or her own internal procedures related to the preaudit process. Although the proposed amendments do not appear to require the LGC to adopt any rules related to these processes, as previously noted, the exemptions from the preaudit certificate requirement for electronic payments will only apply if the LGC does in fact adopt procedural rules that are followed by the local unit. 5.  The proposed amendments clarify that it is a local unit’s governing board, and only the governing board, that determines whether or not to impose penalties under G.S. 159-28(e) on a finance officer or deputy finance officer for failing to follow the required preaudit process. The penalty provisions in subsection (e) apply to any employee or official who violates the preaudit provisions, or causes them to be violated. In fact, the most common violation occurs when a department head or other staff member orders goods or enters into a contract before it is properly preaudited. The proposed amendments do not address whether or not taxpayers, vendors, contractors, or others could force a local unit to hold these individuals accountable for preaudit violations under G.S. 159-28(e). Will HB 44 Get Enacted?  As recently as a week ago the bill appeared to be moving toward enactment. The House approved it on April 21, 2015. The Senate, however, made a few amendments to the bill and on June 17, 2015; the House failed to concur in the amendments. None of the amendments relate to the proposed preaudit statute. (The bill is an omnibus bill dealing with several different regulatory reforms.) It is unclear, though, whether or not the Senate’s amendments ultimately will derail the bill’s enactment. A conference committee has been appointed. Of course, even if this bill does not become law, the preaudit provisions might be included in another bill or in the state budget act. Currently there is placeholder language in Section 6(a) of SB 617. Local units will need to stay tuned in the coming weeks.