In recent weeks, there have been two separate court decisions involving the right of first refusal (ROFR) to acquire low-income housing tax credit (LIHTC) properties.
These cases and others involving ROFR issues are important to the affordable housing industry, which in recent years has been seeing a new type of investor that is challenging the ability of nonprofit housing organizations to exercise their right of first refusal to purchase a LIHTC property at the end of its 15-year compliance period at a minimal cost.
For 36 years, the successful LIHTC program has relied on partnerships between developers and housing credit investors to build needed affordable housing across the country. A key tool driving the production of affordable housing, the housing credit has helped develop or preserve approximately 3.6 million homes for low-income families and individuals.
Under the LIHTC program, there’s a provision for nonprofit general partners that facilitates their taking ownership of a development at a minimum price after 15 years when the investor has completed claiming the tax credits for which they invested.
Over the years, nonprofits have regularly exercised this right of first refusal, and investors have smoothly exited deals. The ROFR has been seen as an important tool for the preservation of affordable housing because nonprofits are likely to maintain the properties for low-income residents as part of their missions.
However, a few private companies, limited partners in a deal, have begun challenging a nonprofit’s ROFR. This is troubling because a small nonprofit may lack the resources to fight the challenge and so it may feel pressure to pay a substantial buyout to keep a development, a move that could deplete reserve funds and prevent the property from being rehabbed. Or, the organization may even surrender the property, according to observers.
In some cases, investors have held the limited partner interests in a development from the beginning. But, more recently, the industry has seen new firms come in to acquire investor interests in a large number of properties, often after most or all of the tax credits have been earned. These companies have been dubbed “aggregators.”
One attorney estimates that there are approximately a half dozen cases involving a nonprofit’s ROFR rights in various courts. There are also cases involving disputes with for-profit developers and owners.
A Case at the Fund Level
In May, the Delaware Court of Chancery issued a decision in JER Hudson GP XXI, LLC, and Hudson Housing Tax Credit Fund XXI, LP, v. DLE Investors, LP.
This case is distinct from other recent litigation because it involves a firm, DLE Investors, which had acquired a limited partner interest in a tax credit fund. When a nonprofit developer of one of the projects the fund invested in exercised its ROFR, DLE took the position that it was the fund general partner’s fiduciary and contractual duty to challenge the nonprofit’s exercise of its ROFR.
As a result, this case involved a dispute at the fund level unlike other recent cases that involve a project partnership.
The Delaware court concluded that the fund general partner had no such contractual or fiduciary duty, and that DLE improperly attempted to remove the general partner for refusing to challenge the nonprofit’s ROFR.
In this case, plaintiff Hudson Housing Tax Credit Fund XXI is the fund that holds indirect interests in other limited partnerships, each of which in turn holds a LIHTC property. The other plaintiff is JER Hudson GP XXI, the fund’s general partner.
The fund was created in 2002, but defendant DLE Investors became a limited partner in 2007. By 2020, Hunt Capital Partners had taken control of DLE and sought a buyout of its fund interest at fair market value, according to court documents.
The Hudson team declined and tried to negotiate the fund’s exit from the project on terms acceptable to DLE and the nonprofit developer. When the negotiations failed, the nonprofit developer exercised the ROFR to the surprise of Hudson and DLE. The fund general partner, on the advice of counsel, decided not to challenge the transfer, says the court.
However, “DLE purported to remove the Fund GP as general partner of the fund, asserting its inaction was a breach of fiduciary and contractual duties, including a duty to seek DLE’s consent,” reads the court opinion.
Hudson contended there was no breach and fought its removal from the fund.
In a 101-page opinion, the court found in favor of the plaintiffs, who were represented by attorneys from Holland & Knight, saying DLE lacked cause to remove the general partner because DLE failed to demonstrate the Fund GP breached its fiduciary or contractual duties.
Sixth Circuit Overrules District Court
In May, the U.S. Court of Appeals for the Sixth Circuit issued a decision in SunAmerica Housing Fund 1050 v. Pathway of Pontiac, Inc., PV North, LLC, and Presbyterian Village North.
This case involves whether the conditions precedent to trigger a nonprofit’s ROFR to buy a LIHTC property had been met. In 2021, a federal district court in Michigan determined that the conditions had not been satisfied and granted summary judgment in favor of SunAmerica Housing Fund 1050. But the appeals court reversed the earlier judgment and remanded the case for further proceedings consistent with the new decision.
“This has significant meaning to our clients in the case because it puts them back in a place where they’re going to have the opportunity to execute on their right of first refusal, as was always intended by the original participants,” says attorney David Davenport of BC Davenport, who represented Pathway of Pontiac, PV North, LLC, and Presbyterian Village North.
In a broad way, “it also says to the industry the efficacy of the program depends upon the efficient transfers of investor partner interests at the end of the compliance period because we’re trying to preserve affordable housing,” he says.
In this case, nonprofit Presbyterian Village North (Presbyterian) organized a partnership to rehabilitate and operate a 150-unit affordable housing development for seniors in Pontiac, Michigan. Presbyterian owned the property before forming the partnership to help finance its rehabilitation. The partnership originally consisted of Presbyterian and Pathway Senior Living of Michigan (PSL).
After the partnership received housing tax credits in 2002, SunAmerica, a large institutional investor, joined as a limited partner, acquiring 99.9% of the partnership in order to acquire 99.9% of the tax credits and other tax-related benefits. To facilitate SunAmerica’s receipt of its expected tax-related benefits, Presbyterian and PSL withdrew from the partnership, and Pathway of Pontiac, Inc. and PV North—an affiliate of Presbyterian—entered as general partners, collectively owning 0.01% of the partnership, according to court documents.
Presbyterian, the original owner of the property, was then granted a nonprofit ROFR as part of this process.
In late 2017, about a year before the end of the LIHTC compliance period, Presbyterian expressed its desire to reacquire the property in accordance with its ROFR. “SunAmerica responded that it would prefer to hold off discussions concerning the sale of the property until the compliance period lapsed,” according to the background in the recent court opinion. “By early 2019, the general partners and SunAmerica had discussed the conditions necessary to trigger the ROFR.”
However, the partners disagreed on the interpretation of the conditions.
In 2019, a large affordable housing firm sent a letter of intent (LOI) indicating a desire to buy the development. Shortly after, PV North reached out to another third-party entity, Lockwood Development Co., about another offer. A PV North representative also reportedly shared a concern with the new third-party entity regarding whether the first offer satisfied the ROFR conditions. “Specifically, there was concern that the LOI was not sufficiently binding and would not trigger the ROFR. PV North then instructed Lockwood to ‘consider’ this advice when drafting its own LOI,” explains the appeals court opinion.
Lockwood submitted an offer to buy the property. Among other things, the proposal contained a clause providing for a 60-day investigation period during which it could terminate the agreement “for any reason or no reason.” The general partners then told SunAmerica that it had received a bona fide offer and would exercise its ROFR. In response, SunAmerica filed a lawsuit.
The district court granted summary judgment to SunAmerica last year, reasoning that to exercise the ROFR, two conditions had to be met: The partnership needed to receive a bona fide offer, and the general partners needed to manifest a true intention to sell. The district court held that the Lockwood offer “did not constitute a bona fide offer because it was undisputed that the offer was solicited for the purpose of triggering the ROFR, and because the offer was not legally enforceable.” It further held that the general partners breached their contract by exercising the ROFR and, as a result, breached their fiduciary duties to SunAmerica. The general partners and Presbyterian appealed.
On May 10, the Court of Appeals for the Sixth Circuit overruled the district court. It pointed out that there’s a distinction between common law rights of first refusal and a ROFR for a LIHTC development. “When interpreting such an ROFR provision, we must account for Congress’s goals expressed in LIHTC, including its intention to make it easier for nonprofits to regain ownership of the property and continue the availability of low-income housing,” says the opinion. “Thus, those Congressional intentions confirm that the general common law understanding of bona fide offer cannot be substituted for the ROFR mechanism created by Congress in LIHTC.”
According to Davenport, the lawsuit began when SunAmerica was part of AIG. Blackstone Real Estate Income Trust agreed to acquire interests in an AIG’s affordable housing portfolio of approximately 80,000 units last year, and the case has continued.
The Nixon Peabody law firm, which represented DLE Investors and SunAmerica Housing Fund 150, in the recent cases, declined to comment on ongoing litigation.
While the recent decisions may offer some new insight into ROFR challenges as well as for negotiating new deals, some industry members expect these disputes to continue and more litigation to come.