On June 15, 2018, the Massachusetts Supreme Judicial Court affirmed a grant of summary judgment by the Massachusetts Superior Court to a nonprofit developer allowing it to exercise its Section 42 right of first refusal (“ROFR”) to acquire an affordable housing project financed with Low Income Housing Tax Credits (“LIHTC”) despite the investor’s claims that the ROFR could not be exercised until a third party bona fide offer was received and accepted by the LIHTC partnership with the approval of the investor and that the exercise of the ROFR in this instance constituted a breach of fiduciary duties and could not be enforced.
In Homeowner’s Rehab Inc. v. Related Corporate V SLP, L.P. (SJC 12441) (Mass. 2018), the court resolved three discrete issues: (1) is a bona fide, third party offer required to trigger the right of first refusal; (2) must the owner of the property accept the third party offer in order to enable the nonprofit entity to exercise the ROFR; and (3) is the general partner of the property owner permitted to accept the third party offer without the consent of the investor. Each of these issues will have implications on the reading of partnership agreements and rights of first refusal in LIHTC housing transactions. It will be interesting to observe whether this Massachusetts case is the beginning of a trend and how the findings here will impact LIHTC partnership negotiations going forward.
First, the court held that an offer need not be “bona fide” in the common law sense to trigger a ROFR. In making this determination, the court provided that the ROFR could not be read in isolation and had to be construed in connection with the partnership agreement, the intent of the parties, the purpose behind the LIHTC program and Section 42(i)(7) of the Internal Revenue Code (“Section 42(i)(7)”). As stated in the preamble of the ROFR in question, the ROFR was granted “in accordance with Section 42(i)(7).” The partnership agreement and the ROFR in question were silent on the specific issue of whether the ROFR can only be triggered by a “bona-fide” offer.
In considering the purpose behind Section 42(i)(7), the court considered the legislative history of Section 42(i)(7) and interpreted it to confirm “that it was intended to facilitate the inexpensive transfer of properties to nonprofit organizations.” See Homeowner’s Rehab Inc. v. Related Corporate V SLP, L.P. (SJC 12441) (Mass. 2018), at 26. The court reasoned that because the ROFR here was granted under Section 42(i)(7) and Section 42(i)(7) allows the nonprofit organization to purchase the property at a price that is often below-market value and less than the price offered by the third-party, a determination that a “bona fide” offer was needed would be inconsistent with the statutory mechanism of Section 42(i)(7). However, the court noted that the third party offer must be “an enforceable offer from the third party.” See id. at 31.
The court also agreed with the lower court that there is nothing in the agreements that bar the general partner from soliciting an offer.
Second, the court concluded the ROFR could not be exercised by the nonprofit developer unless the owner of the property decides to accept an offer from the third party. In making this determination, the court again relied on the terms of the ROFR itself and the legislative intent of the drafters of Section 42(i)(7).
The terms of the ROFR here stated that before the ROFR could be exercised, the partnership must deliver notice of an offer to purchase from a third party to the nonprofit developer. This notice was required to include whether the partnership was willing to accept the offer. In the lower court, the judge interpreted this to mean the partnership did not have to decide to accept the offer in order to trigger the ROFR. Here, the court disagreed stating that the lower court’s interpretation went against the common law distinction between “right of first refusal” and “option to purchase” and the legislative intent of Section 42(i)(7). Congress intended there be a right of first refusal which cannot be exercised until the owner decides to sell. Under the partnership agreement, the court noted that the general partner had the power to decide to sell but the court distinguished that power to accept a third party offer, which triggered the ROFR, from the consummation of the sale which required the limited partner’s consent. The court noted that the decision by the owner to accept the third party offer need not be communicated to the third party and does not constitute an acceptance of the offer.
Third, the court held that the general partner is authorized to trigger the nonprofit developer’s ROFR by soliciting an offer from a third party and, upon receipt of the offer, issuing a disposition notice if the general partner has decided, on behalf of the partnership, to accept the offer. The court stated that “the partnership could not consummate a sale to a third party without the consent of the special limited partner, but that does not mean that the special limited partner must consent to the terms of an offer before the disposition notice can be issued.” See id. at 36.
The court stated that if the limited partner or special limited partner’s consent were needed before the nonprofit developer could exercise its ROFR, “one would expect that the limited partners would withhold their consent unless they were willing to sell the property interest at the § 42 price.” See id. at 33. If this were the case, then according to the court, the limited partner “would have no reason to wait for a third-party offer to trigger the right of first refusal; they could simply sell to the nonprofit developer at that price.” See id. at 34. The court’s determination was made in part to avoid denying the nonprofit developer the opportunity to acquire the property at the Section 42 price in situations where the limited partner is unwilling to trigger the ROFR.
The limited partner contended that this determination would be contrary to the language of the agreements, but the court disagreed. According to the court, there are only a few instances in which the partnership agreement identifies general partner actions that need to be consented to by the special limited partner. The court states that “section 5.5.B(iv) prohibits the general partner from ‘sell[ing] all or any portion of the property,’ except with the Consent of the Special Limited Partner.” See id. at 35. The court further states that “this prohibition is ‘subject to the provisions contained in Section 5.4,’ which grant the general partner the authority to sell ‘all or substantially all of the assets of the Partnership; provided, however, that except for a sale pursuant to the Option Agreement, the terms of any such sale . . . must receive the Consent of the Special Limited Partner before such transaction shall be binding on the Partnership.’” See id. at 35. The court notes that the “limited partners concede that, under section 5.4, the special limited partner need not consent to the terms of a sale if the sale is pursuant to the option agreement, for example where the nonprofit developer has exercised its right of first refusal,” but “the limited partners nevertheless contend that the special limited partner must consent to the terms of a sale if the sale is to a third party, which is what triggers the right of first refusal, before the general partner can issue a disposition notice.” See id. at 35.
In response to this argument, the court determined that Section 5.4 of the partnership agreement “states only that the special limited partner must consent to the terms of a sale ‘before such transaction shall be binding on the Partnership’” and “[a]s stated, the decision to accept a third-party offer does not itself constitute an acceptance of the offer.” See id. at 35-36. Therefore, the court determined that the issuance by the general partner of a disposition notice does not bind the partnership to sell or to accept the third party offer if the nonprofit developer failed to exercise its ROFR.
The court looked to other provisions of the partnership agreement and determined that there were no restrictions on the general partner’s authority to issue the disposition notice. The only potentially relevant provision was the one relating to the prohibition on any general partner action that would threaten the limited partner’s tax credits. The court determined that “[o]nce the compliance period has ended . . . there is nothing in the partnership agreement that restricts the general partner’s authority to issue a disposition notice, or that requires it to obtain the consent of the special limited partner before issuing such notice.” See id. at 37.
The court was careful to note that in reaching this decision, it was only interpreting the language of the agreements that were executed by the parties here and that it was not “declaring that every partnership participating in the LIHTC program must permit a right of first refusal that can be exercised under these circumstances.” See id. at 38. The case offers that parties in future LIHTC transactions are free to negotiate an agreement that contains different requirements than those set forth in this case.