May 27th, 2022
Delaware Court of Chancery Issues Ambitious Opinion Synthesizing LIHTC Exit-Dispute Caselaw, Finds General Partner Did Not Breach Duties by Allowing Below-Market Right of First Refusal Over Limited Partner’s Objection
It has been an eventful month for observers of Low-Income Housing Tax Credit (LIHTC) exit-dispute litigation. As discussed in our last post, the Sixth Circuit became the first federal appellate court to weigh in on the meaning of rights of first refusal (ROFRs) granted under the federal LIHTC statute, holding that Section 42(i)(7) of the Internal Revenue Code contemplates a broader purchase right than a traditional common-law ROFR. That decision was a win for general partners in the growing fight over what happens to LIHTC housing properties at the end of their initial 15-year compliance periods.
Not to be overlooked, however, is another LIHTC decision issued earlier this month by the Delaware Court of Chancery. That decision, in JER Hudson GP XXI LLC v. DLE Inv’rs, LP, Case No. C.A.2021-0478-MTZ (Del. Ch. May 2, 2022), is the most ambitious attempt yet to synthesize the existing body of LIHTC exit-dispute caselaw from state and federal courts throughout the country. While the court’s holding resulted in part from the unique business structure at issue in that case, the opinion—from perhaps the nation’s most influential court when it comes to internal business disputes—is sure to be widely cited in future exit-dispute litigation.
The case involved the efforts of a limited partner to block the below-market sale of a LIHTC property to a housing not-for-profit pursuant to a ROFR granted under Section 42(i)(7) of the Internal Revenue Code. That provision allows not-for-profit entities and tenant associations to hold below-market ROFRs without compromising the tax credits that flow to limited-partner investors in LIHTC properties. In this case, the LIHTC partnership did not directly own the property in question, but rather owned several lower-level entities that each owned a single LIHTC property. In dispute was the general partner’s refusal to object when one of those single-purpose entities transferred its property to an affordable-housing non-for-profit by self-triggering a Section 42(i)(7) ROFR. In response, the limited partner attempted to remove the general partner for cause, claiming the general partner’s failure to object to the transfer was a breach of its fiduciary and contractual duties.
The Court of Chancery sided with the general partner, holding that its refusal to object was not a breach of its duties to the limited partner or the partnership. The court relied in part on the fact that the partnership did not own the property itself, but rather owned an interest in the lower-level entity that owned the property. As a result, the court reasoned, the general partner had no obligation to prevent the transfer of the property itself.
More significant than the unique ownership structure at issue in the case, however, was the court’s extensive discussion of the nature and purpose of a LIHTC partnership. Drawing from the analyses of several other state and federal courts that have decided similar disputes involving LIHTC partnerships, the Court of Chancery concluded that the purpose of such partnerships is to preserve the tax credits that flow from a LIHTC property over a period of 10 years. While that holding is not controversial, the court went a significant step further, also holding that the purpose of a LIHTC partnership is not to maximize the equity value of a LIHTC property after those tax credits are fully harvested and no longer subject to recapture.
The latter holding is sure to be celebrated by general partners responding to pleas to obtain the highest possible return for LIHTC properties at the end of their 15-year initial compliance periods. On the other side of the issue, limited partners seeking to maximize the value of their partnership interests will no doubt try to limit the court’s holding to specific ownership structure and partnership agreement provisions at issue in this case. Either way, followers of LIHTC exit-dispute litigation should expect to see JER Hudson heavily cited in future disputes.
Grammata Law Firm is well equipped to help clients navigate LIHTC exit disputes and other disputed tax-credit matters. For more information, contact Grammata at 202-937-0458 or .