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.
July is right around the corner and we wanted to remind everyone of the HUD deadlines for closing RAD conversions by year end:
|Required Action||Deadline to close by
November 30, 2018
|Deadline to close by
December 31, 2018
|Upload all required Financing Plan
|June 15||July 13|
|Receive a HUD-executed RCC**||August 17||September 14|
|Submit complete closing package**||September 1||October 1|
|All RAD documents approved and ready for HUD signatures**||November 15||December 13|
* Note: FHA applications should be submitted at roughly the same time as the Financing Plan documents. PHAs should coordinate with their FHA lender to stay on track.
** Note: An RCC that has already been extended up to or beyond 6 months past the date of issuance will have a lower priority for closing during CY2018.
These deadlines don’t always align with standard low income housing tax credit closings and can sneak up quickly. Keep the following tips in mind to manage a successful year end conversion:
- Know the RAD checklists (PBV and PBRA) and what transaction documents must be submitted to HUD.
- Work out any title and survey issues before HUD submission.
- Establish a detailed RAD timeline and engage with financing partners as soon as possible on the timeline.
- Share the HUD-required ownership and control provisions that must be included in transaction documents with financing partners prior to the circulation of draft documents.
- Share the HUD sample RAD Subordination Agreement with lenders as soon as possible.
- If necessary, consider prioritizing circulation and review of transaction documents that must be submitted to HUD.
- Account for the time between receiving final HUD approval and HUD signing and mailing documents – this can take over a week.
- Aim to make an initial submission to HUD within 2 weeks of RCC issuance (if not sooner). A submission beyond 2 months of RCC issuance will have the transaction placed in “Delayed Submission” status.
- Make HUD aware of any targeted and hard closing deadlines.
Cheers to a smooth year end!
On March 23, the President signed the Consolidated Appropriations Act, 2018 (H.R. 1625), a $1.3 trillion dollar spending bill that funds the federal government through September 30, 2018. In addition to preventing a government shutdown, this omnibus spending bill incorporated the following key provisions that help to strengthen and expand the Low Income Housing Tax Credit (LIHTC):
- A 12.5% increase in the annual per capita LIHTC allocation ceiling (after any increases due to the applicable cost of living adjustment) for calendar years 2018 to 2021.
- An expansion of the definition of the minimum set-aside test by incorporating a third optional test, the income-averaging test. Pursuant to the Code, a project meets the 40-60 minimum set aside test when 40% of the units in the project are both rent restricted and income restricted at 60% of the area median income. Under the new law, the income test is also met if the average of all the apartments within the property, rather than every individual tax credit unit, equals 60% of the area median income. Notwithstanding, the maximum income to qualify for any tax credit unit is limited to 80% of area median income.
This legislation is a great win for affordable housing advocates who have been pushing for LIHTC improvements through the Affordable Housing Credit Improvement Act, introduced in both the Senate (S. 548 sponsored by Senators Cantwell and Hatch) and the House (H.R. 1661 now sponsored by Congressmen Curbelo and Neal) in 2017, as discussed previously in a prior blog post.
We will continue to provide updates on legislation related to Tax Reform. Just in case you missed it, last month Ballard Spahr hosted a webinar on the impact of Tax Reform on the Low Income Housing Tax Credit with our colleagues from RubinBrown LLP, Enterprise Community Partners, Inc. and Red Stone Equity Partners. Presentation slides and a recording of the webinar are available on our event page.
The Maryland Affordable Housing Coalition (MAHC) held its annual Housing Day in Annapolis today. The event brings together over 200 affordable rental housing advocates to inform legislators of the value of affordable housing and funding needs to continue to develop and rehabilitate affordable housing in Maryland. Housing Day also provides the opportunity to hear from State representatives regarding current issues and legislation related to the affordable housing industry. During today’s program, many State elected and appointed officials emphasized the need to continue to think creatively to meet the increasing demand for affordable housing in Maryland – including the opportunity to focus on work force housing.
A priority of the 2018 Housing Day was to advocate for increased funding for Rental Housing Works (RHW), subordinate gap financing used solely for projects utilizing 4% low-income housing tax credits and Maryland Department of Housing and Community Development’s Multifamily Bond Program. The Governor’s current budget proposes funding RHW at $20 million, but MAHC is advocating for a $5 million increase in this amount to $25 million in order to keep up with the demand for this popular financing. MAHC notes that for every $1 invested in RHW generates nearly $11 in new public and private investments and each RHW project creates 174 jobs. We heard from a number of elected officials regarding the value of speaking about RHW projects that have closed in their districts and the linked map provides a snapshot of the impact of RHW within each Maryland County.
Turning to the national stage, Molly Bryson, a Partner at Ballard Spahr, provided attendees of the 2018 Housing Day with an update on the need to continue to advocate for the expansion and enhancement of the federal low-income housing tax credit through the passage of the Cantwell-Hatch Affordable Housing Credit Improvement Act (S.548) in the U.S. Senate and the U.S. House of Representatives companion bill (H.R.1661 – Affordable Housing Credit Improvement Act of 2017). The Cantwell-Hatch Act was recently included in the Senate’s initial version of the budget bill, but it unfortunately did not make it into the House’s approved budget bill. Continued outreach is needed to keep up the momentum of this important legislation.
Ballard Spahr will continue to monitor both Maryland and federal legislation related to affordable housing and provide updates in future blog posts.
As we know, the President has signed what was originally titled Tax Cuts and Jobs Act, the most significant overhaul to the U.S. Tax Code since 1986. The President signed the Act into law after the first of the year in order to avoid some automatic spending cuts.
In its final form, this Tax Code overhaul retains private activity bonds and the the low-income housing tax credit. However, according to A Call To Invest in Our Neighborhoods (ACTION) Campaign, the amendment of other critical provisions of the Tax Code, especially, the lowering of the corporate tax rate from 35 percent to 21 percent and the creation of a base erosion and anti-abuse tax, present concern for affordable housing, as these provisions can impact an investor’s tax credit appetite. In an analysis performed by Novogradac and Company, the final version of the bill “would reduce the future supply of affordable rental housing by nearly 235,000 homes over 10 years.” Further, it is anticipated that other changes to the Tax Code, such as those relating to bonus depreciation, depreciation, and interest expense limitations, will impact equity pricing.
The legislation also retains the new market tax credit, with no change to its expiration which is after the 2019 allocation. The 20% historic tax credit was also retained, but with significant modification, including claiming the credit ratably over 5 years.
Ballard Spahr’s Tax Group is also following the legislative developments of other provisions of the bill. Late yesterday, the Tax Group issued a thoughtful analysis of the final bill.
Please use our Tax Reform Alert Center as a resource to find more information on the bill and/or reach out to us directly.
As we head into the fourth quarter, HUD sent out an e-mail reminder Friday afternoon about flexibility when establishing Housing Assistance Payments (HAP) contract effective dates in Rental Assistance Demonstration (RAD) transactions. The January 2017 revision to the RAD Notice at Section 1.13(B)(5) gives Project Owners the ability to establish a HAP contract effective date of either 1) the first day of the month after closing, or 2) the first day of the second month following closing. For example, this flexibility allows RAD transactions that close in October to have a HAP effective date of either November 1 or December 1.
The fourth quarter has historically been the busiest time for closing RAD transactions, and HUD made this policy change to try to relive come pressure from the November closing schedule. In the reminder, HUD suggested that those with hard November closing deadlines should consider closing in October but maintaining a December HAP effective date. HUD strongly encouraged working toward an October closing if a December 1 HAP effective date is critical to the transaction.
The HUD reminder also reiterated the milestones established by HUD in March for yearend closings:
|Deadline to close by Nov. 30, 2017||Deadline to close by Dec. 31, 2017|
|Receive a RAD Conversion Commitment (RCC)||August 16||September 15|
|Submit complete closing package||September 1||October 1|
|All RAD documents approved and ready for HUD signatures||November 16||December 14|
HUD’s methodology for prioritizing yearend closings are based on several factors, including:
- Adherence to the deadlines set forth in the table above.
- Prioritization categories for CHAP processing listed in Section 1.11 of the RAD Notice.
- Critical deadlines beyond the control of the PHA and its development team (note that HUD will require documentation of these deadlines when considering this factor).
- Lower priority will be given to transactions when the original RCC expiration date has been extended past 90 days from issuance.
Ballard Spahr will continue to monitor any further guidance issued by HUD regarding yearend RAD closings and update our readers.
On September 11, 2017, HUD published a Notice designating the 2018 Qualified Census Tracts (QCTs) and Difficult Development Areas (DDAs) for the Low Income Housing Tax Credit (LIHTC) program. Qualified Census Tracts are those areas where either (1) 50% or more of the households have incomes below 60% of the area median gross income or (2) the poverty rate is at least 25%. Difficult Development Areas are those areas with high construction, land and utility costs relative to the area median gross income. Both QCTs and DDAs are eligible for an increase in basis and available tax credits of up to 30%. The Notice specifically details HUD’s methodology in determining the QCTs and DDAs through the use of fair market rents, FY2017 income limits, census counts, and other income and poverty data. An interactive map, full listing of the 2018 QCTs and DDAs, and other historical data can be accessed at https://www.huduser.gov/portal/datasets/qct.html.
These 2018 designation lists are effective for allocations of LIHTC credit after December 31, 2017, or in the case of bond transactions where tax-exempt bonds are issued and the building is placed in service after December 31, 2017. The HUD Notice also explains the effectiveness of the designations for areas not specifically on a 2018 QCT or DDA list, along with illustrative examples of the consequences of the effective date for areas that either gain or lose QCT or DDA status.
At the National Housing Conference 2017 Annual Policy Symposium on June 9, 2017, HUD Secretary Ben Carson delivered the keynote address and participated in a Q&A session with Chris Estes, President and CEO of NHC. While much of the keynote address focused on homeownership issues, remarks made during the Q&A included such topics as the Rental Assistance Demonstration (RAD) program, Housing First, veterans housing, rural housing, fair housing, and the Federal Housing Administration.
With respect to RAD, the Secretary called it the “perfect example” to leverage funds to provide more affordable units through public private partnerships. He called for the lifting of the RAD cap on units (currently 225,000 units), as he described the program as a “win win situation” in the context of spreading funds further in light of fiscal constraints. In emphasizing “enhancing public private partnerships,” the Secretary specifically mentioned the use of low-income housing tax credits.
A recording of the Secretary’s remarks can be found here. Remarks relating to RAD can be found beginning at time stamp 12:42 and also at 21:47.
Last week at the annual meeting of the American Bar Association Forum on Affordable Housing and Community Development (Forum), Michael Novey, Associate Tax Legislative Counsel, Office of Tax Policy, U.S. Department of the Treasury, encouraged the Tax Credit Equity and Financing Committee of the Forum to consider submitting a request to the IRS for priority guidance on issues relating to the low-income housing tax credit (LIHTC). Based on discussions at the annual meeting, the Committee submitted its top five issues today, which can be found here. Not only does the request provide background on the issues, it also describes why it is important for guidance to be provided now.
Each year the public is invited to submit recommendations to the IRS about what guidance would be helpful for the IRS to provide. This year’s notice from the IRS can be found here. In past guidance plans, various LIHTC topics have been included, such as the right of first refusal under tax code Section 42(i)(7) and the federally or state assisted exception to the 10-year acquisition credit rule under tax code Section 42(d)(6). Since the IRS has not yet provided formal guidance on these two important topics, they are among the issues included in the Committee’s request.
We will keep you posted if/when the IRS responds to these issues.