Sixth Circuit Addresses Right of First Refusal in Low-Income Housing Credit Dispute

(Parker Tax Publishing June 2022)

The Sixth Circuit reversed a district court's grant of summary judgment after finding that, in a contractual dispute among the partners of a limited partnership formed to operate a low-income housing complex pursuant to the low-income housing tax credit (LIHTC) program under Code Sec. 42, a genuine dispute of material fact existed as to whether a purchase offer solicited for the purpose of triggering a nonprofit organization's right of first refusal (ROFR) was a bona fide offer under the partnership agreement. The Sixth Circuit also held that the district court erred when it determined that the general partners lacked the requisite intent to sell the property to a third party in order to trigger the ROFR. SunAmerica Housing Fund 1050 v. Pathway of Pontiac, Inc., 2022 PTC 132 (6th Cir. 2022).

Low-Income Housing Tax Credit Program

The low-income housing tax credit (LIHTC) program under Code Sec. 42 is premised on a model of leveraging private-sector equity to facilitate cash flow into the development and rehabilitation of low-income housing. Through the program, the IRS allocates federal tax credits to state housing credit agencies, which then distribute the credits to eligible low-income housing developers.

In a typical LIHTC arrangement, a low-income housing developer first applies to a state housing credit agency for an award of federal tax credits. If the state agency grants the application, the developer then enters into a limited partnership as a general partner with a private investor as a limited partner. Often, the investor is a bank or another financial entity that has ample annual tax liability of its own that makes acquiring the nonrefundable tax credits a worthwhile investment. The limited partner investor then provides the capital needed to build and develop the low-income housing development. In return, the partnership allocates the vast majority (usually 99.99 percent) of tax credits and other tax benefits to the investor. These benefits alone provide the investor with a significant return on investment that makes the arrangement attractive and worthwhile to the investor.

Under Code Sec. 42(b)(1)(B), the LIHTC allows investors to claim the tax credits through the arrangement annually over a ten-year period. Housing developments that receive LIHTC tax credits must comply with income-eligibility requirements and rent limits for an initial 15-year compliance period, and, for projects that began in 1990 or later, an additional 15-year extended use period. Code Sec. 42(j) provides that, during the initial 15-year compliance period, the tax credits can be recaptured by the IRS if the developer violates the LIHTC requirements for the housing developments, such as certain rent or income restrictions, or if the development faces serious physical damage or financial problems. Beyond this initial period, however, the IRS cannot recapture any tax credit and the program is then enforced primarily by the state housing agencies.

Code Sec. 42(h)(5) requires that state agencies administering the LIHTC program award at least 10 percent of their tax credits to projects that involve nonprofit developers. In addition, a "carve-out" provision in Code Sec. 42(i)(7) facilitates the continued participation of nonprofit developers by authorizing them to negotiate provisions in the partnership agreements to "buy out" the limited partner investor after the initial 15-year compliance period through a right of first refusal (ROFR). Code Sec. 42(i)(7) is structured as a safe harbor ensuring that none of the tax credits allocated to the investor will be disallowed (and thus subject to recapture) because a qualified, tax-exempt nonprofit holds a below-market ROFR to purchase the property. This safe harbor provision operates to protect the incentives of for-profit entities to initially invest in affordable housing projects, while creating a means for nonprofits to regain ownership and continue the mission of affordable housing once those incentives expire.

Factual Background

In 2001, Presbyterian Village North (Presbyterian), a nonprofit provider of subsidized housing, organized a partnership (the Partnership) under Michigan law to rehabilitate and operate an affordable housing community, consisting of 150-unit apartments (the Property) for the elderly, pursuant to the LIHTC program.

The Partnership followed the same general structure discussed earlier. It originally consisted of Presbyterian and Pathway Senior Living of Michigan (PSL) as General Partners that managed the Property. They applied to the Michigan State Housing Development Authority for housing credits, which were granted in 2002. At that point, SunAmerica, a large institutional investor, joined the Partnership as a Limited Partner, owning 99.99 percent of the Partnership. To facilitate SunAmerica's receipt of its expected tax benefits, Presbyterian and PSL withdrew from the Partnership, and Pathway of Pontiac, Inc., and PV North - an affiliate of Presbyterian - entered as General Partners. The General Partners were responsible for managing and overseeing the Property. Consistent with the Limited Partnership Agreement (LPA), SunAmerica made $8,747,378 in capital contributions in exchange for 99.99 percent of the $11,606,890 in housing credits that had been secured as part of the LIHTC program.

The LPA stated that the General Partners could not, without SunAmerica's consent, sell the property except as provided in Article 17 of the LPA. Under Article 17, Presbyterian had a right of first refusal (ROFR) to purchase the Property at an amount less than fair market value upon the Partnership's receipt of a "bona fide offer." In late 2017 - about a year before the end of the LIHTC compliance period - Presbyterian expressed its desire to acquire the Property. In March 2019, a third-party entity called The Michaels Organization (Michaels) sent the General Partners a letter of intent (LOI), indicating its desire to purchase the Property and stating the terms of its intended offer. PV North reached out to another third-party entity called Lockwood Development Company LLC (Lockwood). PV North sent an email to Lockwood indicating that Michaels had offered to buy the Property. The email stated that PV North intended to submit Michaels' offer to SunAmerica, let them know that another offer was forthcoming (presumably from Lockwood), and that after presenting the offers to SunAmerica, the General Partners intended to "put the ROFR to" SunAmerica.

Lockwood submitted its offer to purchase the Property (Proposal). The General Partners told SunAmerica that they had received a bona fide offer, and thus Presbyterian could exercise its rights under the ROFR. Presbyterian then wrote to the General Partners, indicating that it planned to exercise its ROFR. In response, SunAmerica filed a lawsuit in a district court against the General Partners and Presbyterian.

SunAmerica sought declaratory relief as to its rights under Code Sec. 42, and brought breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty against the General Partners and Presbyterian. The district court granted summary judgment to SunAmerica. The district court found that in order to exercise the ROFR, two conditions had to be met: (1) the Partnership needed to receive a bona fide offer, and (2) the General Partners needed to manifest a true intention to sell the Property to a third party. In the district court's view, the Lockwood offer did not constitute a bona fide offer because it was solicited for the purpose of triggering the ROFR and because the offer was not legally enforceable. The district court also found that the General Partners lacked any intention to sell the property and merely wanted Presbyterian to be able to exercise the ROFR. The court held that neither condition was met, the General Partners breached the contract by exercising the ROFR, and, as a result, the General Partners also breached their fiduciary duties to SunAmerica.

The General Partners and Presbyterian appealed to the Sixth Circuit. They argued that the district court erred in applying the common law definition of the term "bona fide offer." They also contended that the district court erred in requiring that the General Partners' intent to sell be directed at a "third party." According to the General Partners and Presbyterian, Congress intended only a general willingness to sell in order for the ROFR to be triggered.

Analysis

The Sixth Circuit reversed the district court's grant of summary judgment and remanded the case to the district court.

The Sixth Circuit found that the term "bona fide offer" as used in the LPA had to be understood in the context of the LIHTC program. According to the Sixth Circuit, Congress enacted Code Sec. 42(i)(7) as a mechanism through which properties can be transferred to nonprofit organizations to ensure that the housing remains affordable over the long term. It chose to do so, the court found, by allowing nonprofits to retain a ROFR at a below-market price. The court reasoned that the ROFR in the LPA and under Code Sec. 42(i)(7) eliminates the possibility of a third party making an unreasonable offer the nonprofit ROFR holder cannot beat by establishing the price at which the nonprofit will purchase the project: the outstanding debt on the property plus any "exit" taxes that result from the sale. Thus, according to the court, Code Sec. 42(i)(7) clearly deviates from the common law definition of ROFR, and applying the common law definition of "bona fide offer" in this context would contravene Congress's intent in establishing the LIHTC program. Further, the court reasoned that doing so would also go against the Partners' bargained-for exchange under arrangement, the purpose of which was for SunAmerica to reap the benefits from the housing tax credits, not from the Property's long-term appreciation gains.

The Sixth Circuit also held that the district court erred in finding that the General Partners' intent to sell had to be directed toward a third-party offer. Based on the record and the plain language of the LPA, the court found that there had to be an offer on the table from a third-party in order to trigger Presbyterian's ROFR. However, the court found that the intent to sell to Presbyterian if the ROFR procedure was invoked - i.e., the willingness to comply with the ROFR provision - did not defeat the LPA-required intent to sell the property. In the Sixth Circuit's view, the district court erred in concluding that the evidence "overwhelmingly" showed that the General Partners did not intend to sell. The court reasoned that in some sense the two offers that they did receive, and the fact that they solicited at least one of those, seemed to suggest that the General Partners did intend to sell or entertain third-party offers. In any case, the court concluded that summary judgment was inappropriate where a genuine dispute of material fact existed as to whether the General Partners had the requisite intent to trigger the ROFR.

For a discussion of the low-income housing tax credit, see Parker Tax ¶105,100.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com