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Nonprofit LIHTC Developer Allowed to Exercise Right of First Refusal Despite Investor Objections
Posted in Tax and Finance

In a recent case that is great news for nonprofit developers in low-income housing tax credit (“LIHTC”) transactions, a Massachusetts Superior Court granted summary judgment to a nonprofit developer allowing it to exercise a right of first refusal (“ROFR”) despite the investor’s claims that the ROFR constituted a breach of fiduciary duties and could not be enforced.

Nonprofit LIHTC Developer Allowed to Exercise Right of First Refusal Despite Investor Objections

In Homeowner’s Rehab, Inc. and Memorial Drive Housing, Inc. vs. Related Corporate V SLP, L.P. and Centerline Corporate Partners V L.P., Civil Action No. 14-3807-BLS2, the parties were Homeowners’ Rehab, Inc. (“HRI”) and Memorial Drive Housing, Inc. (“Memorial Drive,” collectively with HRI, the “plaintiffs”), and Related Corporate V SLP, L.P. (“Related”) and Centerline Corporate Partners V. L.P. (“Centerline,” collectively with Related, the “defendants”). The case involved a LIHTC project (the “Project”) that was owned by an unnamed limited partnership (“Partnership”) in which Memorial Drive served as the sole general partner, Centerline was the investor and sole limited partner, and Related was the special limited partner, all pursuant to a limited partnership agreement by and among Memorial Drive, Centerline and Related (the “Limited Partnership Agreement”).

As part of the initial closing, the Partnership and HRI, the nonprofit sponsor of the project, entered into a Right of First Refusal and Option Agreement (the “ROFR/Option Agreement”) which gave HRI the right to purchase the Project by either exercising a ROFR or by exercising an option to purchase the Project (the “Purchase Option”). The ROFR and the Purchase Option were distinct and were addressed in two different sections of the ROFR/Option Agreement.

If the ROFR was exercised, the purchase price would be the lesser of (i) outstanding debt on the Project plus any exit taxes owed to Centerline (the “Section 42 Price”); (ii) the price a third party was willing to pay pursuant to an offer that triggered the ROFR (“Third Party Price”); or (iii) fair market value, subject to certain restrictions encumbering the Project (“Restricted Market Price”).

HRI could also acquire the Project by exercising the Purchase Option after the end of the 15-year compliance period, but the purchase price was set at the Restricted Market Price. The Section 42 Price and the Third Party Price were not available under the Purchase Option.

After the 15-year compliance period had run, HRI contacted Centerline about acquiring its limited partnership interest in the Project for the Section 42 Price. Initially, HRI indicated that it was not attempting to exercise the ROFR, but was instead trying to purchase Centerline’s interest in the Project for the Section 42 Price without going through the lengthy process of obtaining an offer and complying with the ROFR procedural requirements set forth in the ROFR/Option Agreement.

Centerline indicated that if HRI wanted to acquire the Project, it had to be done through HRI’s exercise of the Purchase Option, not through the ROFR. Centerline also claimed that the ROFR only applied if the Partnership was willing to sell to a third party, which required Related’s consent. Related was not willing to consent to a possible third party sale. Centerline also claimed that without Related’s consent, Memorial Drive, as general partner, was not in a position to solicit or entertain any third party offer that would be required to trigger the ROFR.

After much back and forth between Memorial Drive and Centerline, Memorial Drive solicited an offer to purchase the Project from Madison Park Development Corporation (“Madison Park”), a nonprofit organization based in Boston that develops affordable housing projects. The offer was less than the Restricted Market Price, but more than the Section 42 price. Madison Park also made a $10,000 deposit in conjunction with its offer.

The plaintiffs then brought suit claiming that the defendants’ interpretation of the Partnership Agreement and the ROFR/Option Agreement effectively prevented HRI from exercising its ROFR. The defendants counterclaimed, alleging, among other claims, that the plaintiffs’ attempt to trigger the ROFR breached the plaintiffs’ fiduciary duties to the defendants.

Initially, the plaintiffs’ motion for judgment on the pleadings on the defendants’ counterclaim was denied. After discovery was conducted, the plaintiffs moved for summary judgment. This time, the court granted the motion for summary judgment.

In reaching its decision, the court did not focus solely on the ROFR/Option Agreement, but interpreted both the Partnership Agreement and the ROFR/Option Agreement as a whole, and used Section 42 of the Internal Revenue Code as the backdrop for interpreting the documents. The court also indicated that it had some difficulty determining who had the better argument for interpreting the ROFR. The defendants claimed that the plaintiffs’ interpretation of the ROFR made it difficult to see the purpose of the Purchase Option and what additional rights it gave HRI. The plaintiffs claimed that the defendants’ interpretation of the ROFR, which required Related’s consent to any event that would trigger the ROFR, rendered the ROFR meaningless since it would never be in the defendants’ best economic interest to allow HRI to exercise the ROFR.

The court determined that the ROFR/Option Agreement could not be read in isolation and had to be construed in connection with the Partnership Agreement, the intent of the parties at the time these documents were executed, and the purpose behind the LIHTC program in general.

In examining the LIHTC program, which is found at 26 U.S.C. § 42, (the “LIHTC Program”), the court noted that one of the real incentives for Memorial Drive to participate in the LIHTC Program was the ability to buy the Project back from the Partnership at the end of the 15-year compliance period for the Section 42 Price. The court also noted the LIHTC Program explicitly envisions that nonprofit developers such as HRI be given a ROFR to acquire the Project for the Section 42 Price at the end of the 15-year compliance period.

In interpreting the Partnership Agreement, the court noted that the stated purpose of the Partnership was to provide affordable housing. The court then discussed the powers that were given to Memorial Drive as general partner under the Partnership Agreement and focused on its power to sell or dispose of the Project and the circumstances under which Related’s consent would be required.

In interpreting the ROFR/Option Agreement, the court found that the ROFR is triggered when the “Partnership delivers a notice to the Holder (HRI) that there is an offer to purchase the Project.” This notice (the “Disposition Notice”) needed to specify the terms of “any executed or proposed agreement” from a potential purchaser, as well as “a statement indicating whether the Partnership is willing to accept the offer” (emphasis added). The court interpreted this to mean that the Partnership did not need to accept the offer or be ready and willing to accept the offer to trigger the ROFR, even though the notice stated that it was subject to Limited Partner consent.

The court stated that the question before it was “whether Memorial Drive could solicit or otherwise entertain this offer and issue the Disposition Notice without first getting the Limited Partner’s consent.” The court concluded that Memorial Drive could do this, based on its reading of the Partnership Agreement.

The court noted that the Partnership Agreement gave Memorial Drive very broad powers regarding the management and operation of the Project, including the power to “sell, lease, exchange, refinance or otherwise transfer, convey or encumber all or substantially all assets of the Partnership so long as it has the consent of the Special Limited Partner before such transaction shall be binding on the Partnership.” The one exception to the consent requirement was a sale pursuant to the Purchase Option, which did not require Related’s consent.

The court concluded that if Related could not hold up a sale of Project pursuant to the Purchase Option, they could not hold up a transaction in which HRI was exercising the ROFR. To construe this otherwise would mean that Centerline/Related could hold up a sale to HRI under the ROFR, which was clearly prohibited by the Partnership Agreement.

The defendants counterclaimed, arguing that HRI’s contact with Madison Park and HRI’s offering of the Project for sale to Madison Park was a sham and part of a secrete scheme to trigger the ROFR, which breached Memorial Drive’s fiduciary duty to the defendants. The court noted that there was nothing in the agreements to prevent soliciting an offer, which was the only way to determine if HRI intended to exercise the ROFR. The Court also noted that Madison Park was an experienced developer and made a written offer with all essential terms accompanied by a $10,000 deposit. The defendants did not produce any evidence to show that Madison Park did not have the financial resources to go through with the purchase or did not intend to go through with the purchase if HRI did not exercise the ROFR.

In reaching its conclusion, the court relied on a variety of factors, including the exact wording of both the ROFR/Option Agreement and the Partnership Agreement, the intent of the LIHTC Program and the court’s determination that the third party offer to purchase that triggered the ROFR was made by a bona fide unrelated third party with the apparent ability to consummate the purchase. While this decision is good news for nonprofit LIHTC developers attempting to exercise a ROFR, given the number of factors considered and the unknown weight the court gave each of these factors, caution is encouraged in relying on this case.



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