Breaking Down an Important Qualified Contracts Case

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Late this summer, the U.S. District Court for the District of Hawai’i granted a motion for summary judgment in Michael Tuttle, et al. vs. Front Street Affordable Housing Partners, et al., No. 18-00218 JAO-KJM, 2020 BL 305979, 2020 U.S. Dist Lexis 145071 (D. Haw. Aug. 12, 2020), a case brought by prospective low-income tenants seeking to reinstate an extended use agreement, which was released by the state agency at the end of the Low Income Housing Tax Credit compliance period following an owner’s request for a qualified contract. While a federal district court decision has limited precedential value, the decision is instructive for state allocating agencies, practitioners and LIHTC transaction participants, given the scarcity of cases involving qualified contracts since the enactment of Section 42(h)(6)(E)(i)(II).

Section 42 Rules
In 1989, Congress added the “extended use period” requirements to Section 42, requiring all projects that receive an allocation after December 31, 1989 to be maintained as affordable to low-income tenants throughout the “extended use” period, or 15 years after the end of the compliance period, for an overall 30-year affordability period. State allocating agencies are permitted to require affordability periods in excess of the statutory 30-year affordability requirement. The commitment of the project owner to maintain affordability throughout the extended use period is evidenced by a land use restrictive agreement (sometimes referred to as an extended use agreement, a declaration of restrictive covenants or regulatory agreement) recorded in the land records of the jurisdiction where the project is located (a LURA). The LURA must also be enforceable by tenants, former tenants and prospective tenants of the project.

In connection with the enactment of the extended use requirement, Congress provided a mechanism, the “qualified contract,” for an owner to free the project from the 15-year extended use period following the expiration of the initial 15-year compliance period.

The purpose of the qualified contract process was to encourage developers to participate in LIHTC projects by reassuring them that they would not be locked into an economically unviable project for a 30-year period.

Under Section 42(h)(6)(E)(i)(II), beginning in the last year of the compliance period, a project owner may request that the state agency find a purchaser to buy the project at a statutorily determined purchase price and to continue to operate the project as a low-income housing development for the remainder of the extended use period. If the state agency does not find a bona fide purchaser within a one-year period, the LURA encumbering the project and recorded in the land records of the applicable jurisdiction is extinguished, subject to a three-year “vacancy decontrol” period during which low-income tenants are permitted to remain in the project. The Code also permits a LURA to be extinguished during the extended use period in the event of a foreclosure (or instrument in lieu) of the project, again subject to the three-year vacancy decontrol.

Section 42(h)(6)(E) specifically permits state allocating agencies to adopt “more stringent” standards. Many state agencies require project owners to waive their right to request a qualified contract, or award extra points in the application process to project owners who agree to waive the right. Additionally, state agencies often require affordability periods that are longer than the 15-year extended use period required by the Code.

The Case
Michael Tuttle, Chi Pilaloha Guyer, Joseph Vu and Shazada Rayleen Yap (the Plaintiffs) were current or prospective tenants of Front Street Apartments. Front Street Apartments received an allocation of LIHTC and the project was encumbered by a LURA that required an extended use period of 51 years and required compliance with the requirements of Section 42 unless the LURA was terminated through the acquisition of the project through foreclosure or an instrument in lieu of foreclosure. Following the end of the compliance period, Front Street Affordable Housing Partners (the Owner) requested a qualified contract from the Hawai’i Housing Finance & Development Corporation (the HHFDC). The Section 42(h)(6) qualified contract price, not surprisingly, was substantially in excess of the appraised fair market value of the project. As a result, the HHFDC was unable to find a buyer for the project and the LURA was terminated. The Plaintiffs sued the Owner, the HHFDC and Craig K. Hirai, the executive director of the HHFDC (collectively, the Defendants), seeking to reinstate the LURA. The federal district court granted the Plaintiffs’ motion for summary judgment, finding that the LURA had been improperly terminated and reinstated the LURA.

The court agreed with the Plaintiffs’ argument that the qualified contract option was not available to the Owner. First, the court reasoned, the text of the LURA provided for early termination only in the event of foreclosure or an instrument in lieu of foreclosure. The LURA provisions regarding early termination made no mention of a qualified contract option.

Second, the court relied upon the fact that the language of Section 42(h)(6)(E)(i)(II) provides that the qualified contract option “shall not apply to the extent more stringent requirements are provided in the LURA or in State law.” Since the HHFDC required a 51-year extended use period, longer than the statutorily-required period, the LURA contained a more stringent requirement, and thus, the qualified contract option should not be available. The

Defendants argued unsuccessfully that the language refers to the modification of the qualified contract option to make the option more stringent and that the 51-year term was not “more stringent” than Section 42 requires, because the language of Section 42 sets the extended use period as the greater of 30 years or what is provided in the agreement with a state agency.

Third, citing another recent case on the availability of a qualified contract, Creekside Ltd. V. Alaska Hous. Fin. Corp., No. 3AN-18-06143CI, 2019 WL 4806180, the court reasoned that “the agreement was silent on the qualified contract option (and instead provided only for foreclosure and an instrument in lieu of foreclosure as terminating events) and thus made unambiguously clear that the agreement’s ‘silence on the qualified Contract Option shows that the Qualified Contract Option [was] not available.’” The Tuttle court disagreed with the Defendants argument that the qualified contract right of Section 42 had been incorporated into the LURA by reference. While the LURA contained many references to Section 42, and the Owner’s obligations and limitations under the requirements of Section 42, the court found no specific reference to the qualified contract right provided under Section 42(h)(6)(E)(i)(II).

As we noted earlier, the Tuttle decision has little precedential value, but is instructive for those seeking to preserve their rights to seek a qualified contract at the end of the compliance period and the release of restrictions imposed by Section 42 and the LURA, including deeper targeting. The LURA should explicitly refer to the possibility of early termination of the LURA through the qualified contract process. If a state agency wants to permit an owner to seek a qualified contract at the end of the Compliance Period or at some later point in the extended use period, it should explicitly reference the qualified contract right and when it is exercisable by the owner in the LURA. Purchasers of LIHTC projects intending to utilize the qualified contract process to convert the project to market-rate or workforce housing should verify that the LURA contains an explicit reference to termination through the qualified contract procedure to preserve their rights. For those seeking to prevent loss of affordable units through the qualified contract process, Tuttle and Creekside offer a strategy to prevent conversion if the LURA does not explicitly reference termination in the event of a failed qualified contract offer. Finally, a general reference to Section 42 requirements is not sufficient to incorporate the qualified contract rights of Section 42(h)(6)(E)(i) into the LURA. A clear and specific reference to the right, and the consequences of the agency’s inability to find a purchaser must be included in the LURA. With an estimated 500,000 affordable units reaching the end of their extended use period in the next decade, there are valid policy reasons for a state agency to require a waiver of qualified contract rights. Where it has not required such a waiver, however, and the owner does not intend to waive its rights to seek a qualified contract, it is important to ensure that the right is not inadvertently lost through silence in the LURA.

Corenia Burlingame and Jerry Breed are principals in the Miles & Stockbridge office in Washington, DC.

Jerry Breed focuses his practice on tax planning and the structuring of low-income housing tax credit, historic rehabilitation tax credit, new markets tax credit and renewable energy transactions. Mr. Breed has closed many low-income housing, historic rehabilitation, new markets tax credit and renewable energy transactions that permit his clients to maximize tax benefits and investment returns, all within the framework of the client's business goals. He has substantial experience in the taxation of community development and new markets credit investments. Mr. Breed also has represented clients with respect to audits of tax credit investments. Clients of Mr. Breed include syndicators and investors in low-income housing, historic rehabilitation, new markets tax credit and renewable energy transactions as well as developers of these credit projects. In the New Markets Tax Credits area, Mr. Breed represents the owners of qualified active low-income community businesses and community development entities. Mr. Breed also represents state housing authorities that allocate low-income housing tax credits. Frequently, these federal credits include state credits and other federal, state and local subsidies. Mr. Breed has given presentations at numerous seminars and conferences on the low-income housing, historic rehabilitation, new markets tax credits and renewable energy credits including presentations on partnership taxation, and real estate tax issues. He also is author of a number of articles on tax credits and other federal income tax matters.