LIHTC Partnership Agreements (for Developers)
By John W. Gahan III
11 min read
An Old-Timer’s Hints for Reviewing and Tweaking Your Investor’s Agreement
The goal of a Low Income Housing Tax Credit partnership is not to negotiate and execute the world’s most perfect partnership agreement. But a well-drafted agreement benefits both sides by being fair and evidencing balance – appropriate control and restrictions favoring investors while the development is being built and as it earns the tax credits the investor is paying for and then slowly, over time, relinquishing elements of control to the developer, enabling the sponsor/owner to make its own business decisions.
While the legislation respecting the LIHTC has not changed much since it was enacted in 1986, the documenting of the relationship among partners utilizing the credit has. For years, there were only a few law firms representing investors; LIHTC partnership agreements were fewer than 60 pages. As more firms got involved, agreements mushroomed to well over 100 pages. Why?
Here is how it happens. A problem bubbles to the surface in a specific deal . . . lawyers draft a “solution.” Other industry lawyers and their developer clients hear about the problem and the proposed solution . . . and, in this copycat world, soon some form of the “solution” appears in almost everyone’s boilerplate partnership agreement. Predictably, one size does not ever fit all . . . a nuance of the original problem arises, which then gets addressed with some form of “provided, however . . .” followed by the inevitable “notwithstanding anything to the contrary . . .” And on and on it goes. The result is partnership agreements, which are seldom, if ever, “wrong,” but they are also rarely examples of clear, focused, coordinated drafting.
By now, decades later, every investor’s first draft covers the same core subjects and bakes the terms of a deal-specific letter of intent into a form. Without minimizing the need to read every provision carefully, I have also learned to focus attention on a half dozen or so often ignored areas. Here are some guidelines that have worked to benefit my developer clients:
• Start by reading the clean version (not the red lines). You will be surprised how many questions a careful read will raise.
• Definitions are important in LIHTC agreements. I recommend that definitions should all be in one place and not buried in the body of the agreement; definitions, which relate to a document should not describe or parse the substance of the document they are identifying; and definitions should not include representations or covenants.
In LIHTC partnership agreements, definitions, such as Completion Date and Final Closing, are tied to installment payments of investors’ equity. Others, for example Debt Service Cover Ratio, include conditions on how a metric is calculated. Therefore, my guidance is to read the definitions section carefully and be sure you fully understand them. They are substantive.
• Never guess what a definition or provision means. Do not assume you know what particular words mean. If on the first read, you don’t grasp what a particular word or provision means, it is probably because the provision isn’t clearly written. You should never have to ask yourself, “what does this mean?”
Take, for example, a common definition of the word affiliate. In many agreements, “affiliate” is linked to a familial relationship or to an element of control. But what does “control” mean? I’ve seen it defined as “the power to direct management . . . directly or indirectly . . . through ownership of voting securities, by contract or otherwise.” Really clear, huh? Does power just mean the ability to influence a decision or the legal authority to do so? And adding “or otherwise” in conjunction with “directly or indirectly” means to me that someone gets to make up their reason later.
When Dealing with Transfer Restrictions, “Get What You Give”
Needing your limited partner’s consent before taking certain actions is both understandable and reasonable. However, in some instances, the need for consent should be mutual. The expression “what’s good for the goose is good for the gander” has notable application to restrictions on transfers of partnership interests. My advice is “get what you give.”
Investor limited partners restrict (if not outright prohibit) transfers of interests by the general partner, emphasizing that “we are making this deal with you . . . it is critical to us that we know who our General Partner (GP) is . . . reputationally, financially, etc.” The exact same reasoning supports a corresponding restriction on Limited Partner (LP) transfers, but most LPs want to be able to freely assign/transfer the LP interest (usually by not addressing the subject at all). Developers choose to do business with a specific investor entity. Why then should a GP be forced to accept anyone else as its partner? I urge developers to draft the transfer provision so that the LP cannot transfer its interest (or change the holders of the LP interest) without GP consent. Transfers to investors’ true affiliates/subsidiaries are an exception to this rule.
Don’t be surprised if your suggestion of a requirement of consent to an LP transfer leads to further discussion. Some investor counsel counter with “reasonable consent” or “consent not to be unreasonably withheld,” which then focuses scrutiny on “what is reasonable/unreasonable.” I itemize what is deemed reasonable, or, better yet, what is deemed “not unreasonable” (for example, consent need not be given if the proposed transferee has (a) fewer than X number of years in the business, (b) been involved in litigation it initiated against a LIHTC developer, or (c) been rejected by any state credit awarding agency, etc.). I have even gone so far as to name names of prohibited transferees.
Notwithstanding clear language, LP interests are often transferred without compliance with the partnership’s covenants. Why? Because the parties to the transfers are willing to risk what, to them, is merely a breach of contract. I recommend “muscling up” by:
• Making such transfers void ab initio;
• Subjecting the receiver of any monetary consideration with disgorgement of 100 percent of the consideration;
• Requiring the transferee to re-transfer what it received, at no consideration; and
• Making the parties to the unauthorized transfer pay all costs and attorneys’ fees.
Dispute Resolution
Disputes among LIHTC partners were quite rare for the first 30 years of the program. Now, not so much.
Litigation has exploded, over valuations of interests, fiduciary duties of GP and LP alike, forced sales and rights of first refusal (nonprofit and otherwise). Examination of these cases reveals the overwhelming majority involve “successor” partners (not the original parties to the partnership agreement). That fact is another reason to carefully draft transfer restrictions. Equally apparent is that most disputes could have been avoided entirely by clear drafting of the agreement. Remember, words matter.
If all else fails, what can the parties do? Consider mediation with a qualified professional mediator experienced in the domain of a particular dispute. I recommend a provision that before either party can commence litigation, they must first describe explicitly the issue in writing to the other side, state specifically what resolution they would accept and agree to mediate the dispute.
Valuations and “Fair Market Value”
Partnership agreements have many places where “valuation” comes into play. The sale of the property itself and the sale of a partnership interest are two examples – and they are very different. Fair market value in each circumstance needs to be carefully spelled out.
Real property valuations usually rely on what a willing buyer and seller would agree on if each knew all the facts related to the property. Disputes are commonly settled by appraisals. (Appraisal clauses can run several paragraphs and there are many kinds of appraisal processes.) Valuing a partnership interest, particularly LP interests, should focus on the exact characteristics of the interest, which is being transferred. Does it share in cash flow, does it have priority returns on sale/refinancing, does it have any operational control over day-to-day activities, can it force a sale, as well as whether the interest itself is freely transferable or otherwise restricted? These are different factors and result in a different valuation than a sale/flow-through analysis.
In my opinion, the true value of an LP interest is not what an LP would receive if the property were sold at its fair market value and proceeds distributed in accordance with the “waterfall” because the agreement should not permit the LP to have a self-executing way of securing that result. Absent forced sale rights, sales would only happen when the GP wants a sale (and a critical factor for the GP would be how much each partner receives and then the GP can decide whether to sell that based on what the LP would receive).
Consent
When should LP consent be required? Should the requirement of obtaining LP consent last forever or expire/terminate (a) over time, or (b) if certain agreed conditions are met?
Over time, I have emasculated one-sided LP consent requirements by either reaching an agreement on what metrics, if satisfied, obviate the need to seek consent; or identifying when the LP is deemed to consent. An example of the first circumstance is the refinancing of debt; category two includes agreeing to certain successors (by name or relationship) who are, in essence, pre-approved.
For refinancings, I recommend a provision that if the refinancing meets certain reasonable and agreed-to thresholds (debt service ratio, total debt, maximum interest rate, etc.) consent is not required.
Investors often limit changes in the general partner/developer organizational structure. Agreement on pre-qualified successors neuters the need for later consent.
Exits
Most marriages don’t last forever. Your LIHTC partnership should include its own form of prenup agreement, an exit process acceptable to both. Think about exits (when and how you want to unwind the relationship) when drafting the agreement and while thinking of splitting up, decide who gets what.
My career has mostly been on the developer/GP side. To them, I say, “Remember whose property it is and who is financially (or reputationally) at risk if things go bad.” Consequently, to me, the winnings should track. I recommend:
• No forced sale right in favor of LP; and
• Purchase options to remove LPs from the partnership.
Unasserted Claims Shouldn’t Last Forever
Several litigation proceedings involve claims made by successor holders of LP interests (i.e., not original investor partners). My first rule is “don’t let them in!” But, if you find yourself dealing with successors, prevent them from asserting claims that (a) arose before they acquired their interests, and/or (b) were not asserted by their assignors.
In other words, don’t let unasserted defaults or unasserted grounds for removing the GP stay active forever – “use it or lose it.” Make it a habit to ask for/obtain estoppel certificates from counterparties certifying that as of a specific date, there are no defaults by the GP or the developer. Do not accept a “to the best of my knowledge” qualifier unless it is accompanied by “after diligent review by the persons expected to have the most knowledge.”
Similarly, monetary penalties for failure to file reports on time should lapse if not asserted within the fiscal year in which the failure occurred.
Style Isn’t More Important Than Substance. But It Counts for Something.
How to negotiate successfully is almost as important as what you negotiate. After 40 years of everyone using the same core agreement, the substance of most LIHTC partnership agreements is pretty standardized. How then do you improve your chances of getting those changes to the other side’s agreement that you feel are important?
I suggest:
• Meet and negotiate in person – it is easy to say no to a piece of paper. Face-to-face promotes dialogue and generally leads to more give and take;
• Never let a speedbump become a roadblock (you don’t have to win every negotiation – repeat business is almost always better than “one and done”); and
• Stay in touch with the other side, even when no deal is imminent.
Years ago, I initiated a negotiating principle when dealing with the same counsel and their standard form agreement. We would meet periodically and, methodically and meticulously, go through the then-current form of agreement with the common goal of improving it. We exchanged and worked off our respective wish lists. The result was and always is a more cohesive document.
