May 19th, 2022
Sixth Circuit Weighs in on LIHTC Rights of First Refusal, Holds That General Partners Can Self-Trigger Below-Market Purchase Rights Held by Not-For-Profit Affiliates
The Sixth Circuit became the first federal appellate court to interpret a right of first refusal (ROFR) granted under the federal Low-Income Housing Tax Credit (LIHTC) statute, holding last week that Section 42(i)(7) of the Internal Revenue Code contemplates a broader purchase right than a traditional common-law ROFR. The decision is a win for general partners in the growing fight over what happens to LIHTC housing properties at the end of their initial 15-year LITHC compliance periods.
The case, SunAmerica Hous. Fund 1050 v. Pathway of Pontiac Inc., No. 21-1243 (6th Cir. May 10, 2022), involved the solicitation by a general partner of an offer to purchase a 150-unit elderly housing complex in Michigan for the purpose of triggering a below-market ROFR held by its not-for-profit affiliate. Section 42(i)(7) of the Internal Revenue Code allows not-for-profit entities and tenant associations to hold such below-market ROFRs without compromising the tax credits that flow to limited-partner investors in LIHTC properties. At issue was whether the general partner was allowed to self-trigger the ROFR without the limited partner’s consent, thereby allowing its affiliate to buy the property for less than its market price.
A growing number of state and federal courts have split on that issue in recent years. Some, such as the U.S. District Court for the Eastern District of New York, have held that Section 42(i)(7) incorporates the common-law definition of a ROFR. See Riseboro Cmty. P’ship v. SunAmerica Hous. Fund No. 682, 482 F. Supp. 3d 31 (E.D.N.Y. 2020). In most states, that requires both a bona fide third-party offer and an owner’s willingness to sell before a ROFR is triggered. Courts adopting the common-law view have held that a general partner may not self-trigger a below-market ROFR by unilaterally soliciting an offer solely for that purpose.
Other courts, such as the Supreme Judicial Court of Massachusetts, have held that a ROFR granted under Section 42(i)(7) must be interpreted within the context of the LIHTC program, which favors the continued affordability of LITHC-financed projects. See Homeowner’s Rehab, Inc. v. Related Corporate VSLP, L.P., 479 Mass. 741 (Mass. 2018). Courts adopting that view have held that an offer need not be “bona fide” to trigger a Section 42(i)(7) ROFR—any third-party offer and the owner’s willingness to sell are sufficient, neither of which requires limited-partner consent.
The lower court in Pathway of Pontiac subscribed to the former view. The U.S. District Court for the Eastern District of Michigan held that the parties’ dispute was governed by state common-law ROFR principles, which required a bona fide third-party offer and the owner’s intent to sell. The court held that a third-party offer solicited solely to trigger the ROFR was not bona fide, and that intent-to-sell requirement was not met because the general partner had no intent to sell to the third-party offeror (as opposed to the ROFR-holder). As such, the court held that the general partner’s attempt to effect the transfer of the property was a breach of its fiduciary duties to the non-consenting limited partner.
On appeal, the Sixth Circuit reversed. Drawing largely from the analysis of the Supreme Judicial Court of Massachusetts in Homeowner’s Rehab, the appellate court held that Section 42(i)(7) does not simply adopt wholesale common-law ROFR principles. If it did, the court reasoned, it would effectively nullify a ROFR granted under Section 42(i)(7), since no third-party buyer would make an unsolicited offer to purchase a LIHTC property with knowledge that a ROFR-holder could obtain the property no matter how good the offer. The court held instead that Section 42(i)(7) allows a general partner to solicit an offer from a “serious buyer” who knows a ROFR-holder will exercise its right.
The court also weighed in on the traditional ROFR requirement of the owner’s willingness to sell. Reversing the district court’s finding that the general partner’s intent to sell must be directed to a third-party offer, the court held that Section 42(i)(7) requires only that a general partner have a “general intent to sell the property.” A general partner’s intent to sell to its not-for-profit affiliate, the court noted, does not nullify the required intent to sell.
The Pathway of Pontiac case represents the highest federal decision yet on this heavily contested issue. LIHTC owners and investors should stay tuned as similar cases begin to reach appellate courts throughout the country.
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 .