Readers Respond to Novogradac Blog Posts about Right-Of-First-Refusal and Qualified Contracts

Novogradac welcomes feedback on Notes from Novogradac blog posts. Responses can be submitted via email to [email protected]

Selected responses are posted here with permission.

Multiple Affordable Housing Organizations Respond to Right-Of-First-Refusal Blog

We are writing in response to your July 24, 2019 blog “Congress Considering Retroactive Changes Affecting Low-Income Housing Tax Credit Property Ownersregarding the proposed changes to the right-of-first refusal (ROFR) in section 303 of the Cantwell and DelBene Low-Income Housing Tax Credit bills. We want to share with you our perspective on this issue based on many of our organizations’ participation in the original construction of the ROFR in 1989 and the modifications proposed in the introduced bills.

When section 42(i)(7)) was first drafted in 1989, it was for the purpose of enabling nonprofit general partners (in addition to government agencies and tenant organizations) to obtain full ownership of the affordable housing development after 15 years.  Virtually all partnerships involving nonprofit owners include a ROFR and in almost all cases the ROFR has worked as intended to transfer ownership under the terms of the statute.   More recently, in a limited number of cases, disputes have arisen as a few limited partners – typically entities who acquired control of the limited partnership interests years after the original investment – have rejected the ability of nonprofits to exercise their rights under the ROFR.  This has engendered legal disputes that have in a few instances resulted in litigation.

In such disputes, limited partners have typically taken the position that the section 42(i)(7) ROFR is a common law right-of-first-refusal and they don’t have to recognize the rights established in the partnership agreement without a bona fide offer from an unrelated third party that the investor has singular authority to accept.  In essence, they have rejected a bargained-for-right in the partnership agreement held by the nonprofit -- taking the position that the contractual language is basically meaningless.  Most nonprofits do not have the resources to litigate these issues in court so a stalemate ensues that the investors uses to leverage a cash payment in return for the investor leaving the partnership.  The payment of such scarce funds undermines the continued viability of the property as affordable housing in contravention of public policy. 

While the language is section 42(i)(7) refers to a “right-of-first-refusal”, it clearly was not intended to be a common law right-of-first-refusal because the purchase price is set in the statute and therefore is not based on the holder of the right meeting an offer price from a third party.  This view is supported by the Supreme Court of Massachusetts in Homeowner’s Rehab, Inc. v. Related Corporate V SLP. LP (479 Mass. 741 (2018)), where the Court found that a nonprofit general partner appropriately exercised its ROFR even though not all common law ROFR requirements were satisfied.  In reaching this holding, the court gave significant weight to public policy considerations and congressional intent. For instance, the court noted, “To condition the right of first refusal on a bona fide offer, then, would mean that it would almost never be triggered. We decline to interpret the agreements in a way that would so obviously contravene the purpose of § 42(i)(7).”

This is of course a limited ruling applicable no further than the state of Massachusetts and the particular terms of the partnership agreement before the Court.  As you point out, a Federal District Court in Senior Housing Assistance Group v. AMTAX Holdings 260 LLC held that a right of first refusal is a legal term of art and is triggered only if the owner receives a “bona fide offer from a third party, acceptable to the property owner.” You fail to note that this ruling is on appeal to the Ninth Circuit.

Because of the continued legal disputes around a clearly ambiguous statute, in 2017, the Housing Credit bar as represented by the Tax Credit Equity and Financing Committee of the American Bar  Association on Affordable Housing and Community Development (ABA Housing Forum) asked the IRS to clarify these issues that are in dispute.  The IRS declined to issue guidance so the authors of the Cantwell-DelBene bills in section 303 proposed clarifications of the issues identified by the Housing Credit bar with the objective of minimizing costly legal disputes.  It is not uncommon for Congress to respond to unclear statutory language by going back and modifying the statute to clarify the meaning, particularly to reduce the volume of unnecessary and wasteful litigation.

You characterize these clarifications as a “retroactive” change in law that deprives limited partners of their negotiated contractual rights, even though section 303 specifically includes language providing that the clarifications do not “supersede” contractual terms in the partnership agreement.  We strongly disagree with your assertion that a clarifying statute which specifically says it does not overrule existing partnership terms should be considered retroactive in the sense of altering the settled legal rights of the contracting parties. The proposed changes were carefully drafted so that existing negotiated agreements of the parties were not retroactively changed by statute. As an explicit clarification applicable where the agreements lack specific terms governing either the manner of execution or terms of a ROFR, Section 303 is an entirely reasonable approach by Congress to deal with these issues to minimize costly legal disputes that undermine the provision of affordable housing.  

You also suggest that the ease with which a nonprofit general partner may acquire full ownership under the proposed below-market purchase option may raise questions whether the investor is the true owner of the property and thus able to claim the tax benefits associated with the investment.  But there is no uncertainty here.  Regardless of general tax policy principles, Congress has the authority to determine what the tax law is and in section 42(i)(7), as currently existing or as amended by section 303, it can provide who receives the tax benefits notwithstanding the existence of a below-market purchase option.  Section 42(i)(7) is a safe harbor, providing that if the ROFR (and in the future the purchase option) is designed as provided in the law, “no Federal income tax benefit shall fail to be allowable to the taxpayer…”.

Finally, we want to take issue with your assertion that section 303 “disrupts the expectations of contracting parties from potentially decades earlier…”.  . In fact, the expectations of the contracting parties at the time of the partnership agreement – based on the clear intent of Congress -- has always been that the ROFR would operate to transfer full ownership of the property to the nonprofit general partner at the price set out in the statute.  And in the great majority of cases, this has worked as intended.  Investors bargained for a return  based on the tax  benefits provided, not on the receipt of cash at the back-end.   Most of the ROFR disputes that have arisen today are as a result of the entrance of new entities who have purchased the interests of syndicators holding a general partner interest in the upper tier fund.  They have taken advantage of the ambiguities in the law to claim a return not consistent with the expectations of the contracting parties.

Thanks for this opportunity to comment on your blog.

Enterprise Community Partners
Local Initiatives Support Corporation/National Equity Fund
Housing Partnership Network
National Association of Affordable Housing Lenders
National Association of State and Local Equity Funds
National Low Income Housing Coalition
National Housing Law Project
National Housing Trust
Stewards of Affordable Housing for the Future
National Housing Conference


Tony Freedman Responds to Qualified Contracts Blog

Mike and Dirk: 

I am writing in response to your recent blog post concerning the draft Save Affordable Housing Act of 2019 (SAHA), which would prospectively repeal the Qualified Contract exit provision in Code section 42 and modify the manner in which the statutory qualified contract purchase price is calculated for existing properties.  In particular, the blog states that “A consequence of SAHA being enacted would be most, if not nearly all, properties, arguably having [land use restriction] agreements inconsistent with the revised law.  If so, existing properties might not be eligible for LIHTCs due to their LURA containing an invalid qualified contract provision.”

I do not share this concern.  While section 42(h)(6) does “[b]roadly speaking” describe a lot of what goes into an extended use agreement (EUA) or LURA with the applicable housing credit agency, its requirements for these agreements are specifically set forth at section 42(h)(6)(A) and (B).  Subparagraph (A) simply provides that no credit is allowed for a building in a year “unless an extended low-income housing commitment is in effect” by the end of such year.  Section 42(h)(6)(B) then tells us what must  be in the EUA in order for it to be “an extended low-income housing commitment.”  Those mandatory provisions are set forth in clauses (i) through (vi) of that subparagraph, including, at clause (i), that the agreement must require “that the applicable fraction (as defined in subsection (c)(l)) for the building for each taxable year in the extended use period will not be less than the applicable fraction specified in such agreement and which prohibits the actions described in subclauses (I) and (II) of subparagraph (E)(ii).” 

As a technical matter, nothing in the SAHA language changes 42(h)(6)(B) or the cross-referenced subparagraph (E)(ii).  Therefore, nothing in the proposed bill language would, it seems, affect whether a LURA containing the provisions required in 42(h)(6)(B) is, in fact, “an extended low-income housing commitment” for purposes of qualifying for credits.  As a practical and substantive matter, all that the SAHA language would do is make it more difficult to exercise a provision under which an owner can terminate the “extended low-income housing commitment,” which would otherwise remain in effect.  It is, therefore, difficult to see how such a change would impair that commitment and, consequently, affect a project’s eligibility for credits. 

In this respect, note, too, that subparagraph (D) of 42(h)(6) explicitly authorizes housing credit agencies to designate longer extended use periods, and further, that many agencies include numerous other requirements in their EUAs, which they often feel free to modify by agreement with the owner. 

It is also worth noting that, if SAHA is enacted as written, the legislative history could make clear that the changes made to 42(h)(6) do not have the effect of causing an EUA that contains language specifically reflecting the prior Code provisions to cease to constitute “an extended low-income housing commitment” when applied in the context of the modified Code. 

I suspect that the example giving rise to the concern expressed in your post was the release of the non-eviction rule of Rev. Rul. 2004-82.  But there are critical distinctions from this instance.  Most importantly, the non-eviction rule directly implicated a mandatory provision of 42(h)(6)(B) for extended low-income housing commitments - clause (i).  If a LURA failed, whether directly or by reference, to include the non-eviction rule, it could not be an extended low-income housing commitment.  This threatened immediate consequences for existing LURAs, since they were entered into in an environment in which the overwhelming consensus of the community had been that the non-eviction language of (E)(ii)(I) and (II) only applied to the 3-year "vacancy decontrol" period following termination.  Instead, 2004-82 said that the Code had - all along - required the non-eviction rule to operate throughout the extended use period.  As a result, we needed to rely on 42(h)(6)(J) to save existing agreements and had to modify many of those agreements in order to bring them into compliance.  Indeed, the Service published Rev. Proc. 2005-37 in order to give time for owners and states to comply and to provide guidance for implementation.

None of those concerns is present here.  Each existing EUA stands as written, and all that is changed is the manner in which one exit route is applied.

It is certainly appropriate for interested parties to discuss the soundness of the policies embodied in SAHA, and to consider whether issues might be raised about the constitutionality of such changes under the contracts or due process clauses.  Those matters, however, ought to be the focus of consideration of this provision, rather than an irrelevant and incorrect technical point.

Anthony Freedman 
Holland & Knight LLP