Mass. Supremes Uphold Right of First Refusal
By Mark Olshaker
8 min read
Predicting the impact of this decision
The Federal Low Income Housing Tax Credit statute provides that after the decade in which all tax credits have been claimed, and the 15-year compliance period in which they are no longer subject to recapture, the nonprofit partner generally has the right of first refusal to buy the property at a favorable price when an offer is made by a third-party. How that right is exercised when the investing partners are unwilling to sell at a below-market price was the subject of a June 15 decision by the Massachusetts Supreme Judicial Court.
Section 42 of the relevant U.S. Code sets the minimum purchase price as the amount equal to the outstanding debt on the property, excluding debt incurred in the five years preceding the sale, plus all federal, state and local tax liability.
The Facts of the Case
The case originated as a lawsuit brought in Massachusetts Superior Court by Homeowner’s Rehab, Inc. (HRI), a nonprofit developer specializing in affordable housing, and Memorial Drive Housing, Inc., general partner, which HRI controls as majority owner; against Related Corporate V SLP, L.P., limited partner, and Centerline Corporate Partners V L.P., special limited partner, the equity investors.
The partnership was formed in 1997 to rehabilitate and operate a complex at 808-812 Memorial Drive in Cambridge, MA. When the lower court granted the plaintiffs’ motion for summary judgment, it was appealed up the legal chain. On its own initiative, the state Supreme Court transferred the case from the Appeals Court.
The limited partners made capital contributions of approximately $7 million, for which they received 99.99 percent of the tax credits. According to the partnership agreement, the general partner, Memorial Drive Housing, would be responsible for maintaining and running the property.
The parties also entered into an option agreement, as recommended by IRS guidelines, granting the nonprofit developer the right of first refusal, which involves a “disposition notice” by the partnership to the nonprofit with all relevant terms and information about any third-party purchase offer and “a statement indicating whether the Partnership is willing to accept the offer.” Parsing out this last quote turned out to be crucial in the court’s decision.
A separate option agreement allows the nonprofit to purchase the property at market rate for a period of four years after the end of the compliance period. Obviously, under just about all conceivable situations, this option would not be in the nonprofit’s best financial interests.
Now, here’s where it gets a bit sticky: The partnership agreement clearly authorizes the general partner to sell the assets of the partnership, “provided, however, that except for a sale pursuant to the Option Agreement, the terms of any such sale…must receive the Consent of the Special Limited Partner before such transaction shall be binding on the Partnership.”
So, what constitutes an exception?
In January 2014, after the compliance period, HRI offered to purchase the limited partners’ interest for one dollar, plus assumption of outstanding debt, the minimum price consistent with the agreement. The limited partners rejected it, saying no offer had been made and therefore no first refusal could be exercised.
When, after several months, the parties were unable to agree on a price, HRI decided to take action that would trigger its right of first refusal, soliciting a third-party offer from Madison Park Development Corporation, another nonprofit affordable housing developer. According to the Supreme Judicial Court’s decision document, “Peter Daly, executive director for both the general partner and the nonprofit developer, asked the chief executive officer of Madison Park, Jeanne Pinado, to make an offer as a ‘favor’ to him.”
Pinado complied, submitting an offer of around $42 million. Though she knew Daly was likely to step in once her bid had been tendered, it was a good and enforceable offer and Madison Park was prepared to go through with the deal if HRI passed. Memorial Drive Housing, as general partner, then formally issued its disposition notice, stating the intention to accept Madison Park’s offer “subject to consent of the Partnership’s limited partner.” Centerline, the special limited partner, refused, knowing the agreement to sell to Madison Park would trigger HRI’s first refusal right at the far lower price.
Undeterred, HRI declared its receipt of the disposition notice and intent to purchase and went to Superior Court seeking a declaratory judgment of its right. The limited partners counterclaimed breach of fiduciary duty and lack of good faith and fair dealing.
The judge sided with the plaintiffs, granting summary judgment with the reasoning that “the option agreement should not be read in insolation, but must instead be construed together with the partnership agreement, in keeping with the intent of the parties and in the context of the statutory requirements of the LIHTC program.”
Part of the judge’s reasoning was somewhat legally esoteric, saying that the option agreement depended on the partnership’s willingness to accept the third-party offer triggered the right of first refusal, rather than the actual acceptance of the offer, which would have required the consent of the limited partners.
The Supreme Judicial Court Takes It On
The limited partners appealed and the judge entered an order enjoining the general partner from selling to HRI until the appeal was settled. That was when the state Supreme Court decided to take it on itself.
The court defined three key issues:
- Whether the right of first refusal can only be triggered by a bona fide third-party offer;
- Whether the partnership must decide to accept that offer in order for the nonprofit partner to exercise the right;
- Whether the general partner is authorized to make that decision for the partnership without the consent of the special limited partner.
The court noted that the agreements and governing statutes are clear as to intent, both in protecting the investing partners’ tax credit eligibility and providing affordable housing. While it is a principle of common law that an owner of property is entitled to profit from appreciation in value over time, the purpose of the LIHTC investment was mainly to achieve the tax benefits and the law is also intended to preserve affordable housing. Balancing these two intentions, Judge Janet L. Sanders ruled that as long as an enforceable third-party offer had been made, within the context of the LIHTC codes, the triggering test had been met.
On the second point, Judge Sanders specified the right of first refusal cannot be exercised unless the partnership decides to accept a third-party offer, but clarified that, “The decision to accept does not constitute an acceptance of the offer.” It need not even be communicated to the third-party.
The judge reasoned that if the limited partner could unilaterally prevent the sale, “The nonprofit developer could be denied any meaningful opportunity to acquire the property interest and the limited partner could simply hold out for a market offer. And the language of the agreement specifically excepts the need for limited partner consent “pursuant to the Option Agreement.”
Since the general partner’s actions were completely within the scope of the agreement, there was no evidence of breach of fiduciary duty or a failure of good faith and fair dealing.
Reactions and Implications
“My reaction is, we’re elated,” declares HRI’s Peter Daly. “It just confirmed what we’ve believed to be the case from Day One: that nonprofits have the right to buy at a price that would [allow the property] to comfortably stay affordable going forward. We fought this so hard because we know how tight the subsidy environment is.”
“At National Housing Trust [NHT], our mission is preserving affordable housing through policy work and development,” says Ellen Lurie Hoffman, the DC-based organization’s federal policy director. “So, we identify with the nonprofit and we’re heartened by this decision as a tool for affordable housing. The program was designed to preserve affordable housing and we would hope that folks understand that going in.”
Scott Kline, senior vice president of NHT and NHT-Enterprise, its nonprofit development affiliate, does not believe the decision will have a dampening effect on equity investors, despite the limited partners’ loss in court.
“When they make their go-no-go decisions, their evaluating their internal rate of return, tax credit benefits and passive losses. And it’s all pretty much zeroed out at the end of the [compliance] period. Therefore, it shouldn’t have any impact on the investment market.”
“I don’t think it’s going to stop any equity providers because this is what we all believed going in,” Daly says. “We’ve done many deals and it has always worked out the way we agreed upon. We hope this decision will set that straight.”
Story Contacts:
Peter Daly, [email protected]
Ellen Lurie Hoffman, [email protected]
Scott Kline, [email protected]
