Court Affirms Nonprofit's Ownership of LIHTC Site

As property values have increased, there’s been more litigation about what a below-market right of first refusal means.

On Sept. 15, the Third District Court of Appeals for the State of Florida affirmed a Florida nonprofit’s ownership of an LIHTC site. Specifically, the court affirmed the Opa-Locka Community Development Corporation’s (OLCDC’s) right of first refusal under Section 42 of the Internal Revenue Code to acquire and preserve the site for affordable housing [Opa-Locka Community Development Corp. v. HK Aswan LLC, September 2021].

According to Internal Revenue Code Section 42(i)(7), at the end of the compliance period, the nonprofit partner can have the right of first refusal to purchase the project for a price equal to outstanding debt plus associated exit taxes, which is usually lower than market value. This was written for the purpose of enabling nonprofit general partners to obtain full ownership of the affordable housing development after the compliance period of 15 years.

However, in recent years, as property values have increased in many areas, there has been increasing litigation around what a below-market right of first refusal means. Typically, in these cases, investors that have taken stakes in affordable housing projects are cashing out when the property appreciates, leaving nonprofit partners tied up in expensive litigation. This recent case worked out for OLCDC, the nonprofit partners, after the court ruled the nonprofit could buy the site by assuming its debt and paying the cost of taxes owed.

Background

In 2014, a Massachusetts-based real estate firm invested about $400K into a Miami-area affordable housing project. It made the investment after the tax benefit had been claimed, but before the 15-year compliance period was up. In LIHTC deals, the developer usually reaps its tax credits over a 10-year period, but it must agree to keep rental units affordable for 15 years.

The firm bought out Bank of America’s interest in the ownership group that owned the LIHTC site. Following this restructuring, the real estate firm owned 51 percent of the site, which entitled it to that percentage of the property’s cash flow, and the OLCDC owned 49 percent.

In January 2019, at the expiration of the compliance period, the real estate firm enlisted brokers to recruit potential buyers to take over its interests in three Florida LIHTC projects, which included the site partnered with OLCDC. A few months later, a potential buyer drafted a letter of intent to purchase the LIHTC site for about $21M in a deal structure that would have let both the firm and OLCDC get cash payouts of about $5M and potentially still retain small minority positions in the project. The real estate firm’s CEO signed the letter of intent and then sought OLCDC’s approval.

But OLCDC exercised its right of first refusal and moved to buy the property itself for debt plus taxes, which amounted to approximately $110,000. In its agreements with both Bank of America and the real estate firm, OLCDC secured this right of first refusal.

According to court filings, the real estate firm claimed that the nonprofit had initially been cooperative and had at one point signed an agreement saying that if it did exercise its right of first refusal, it would buy out the real estate firm for market value. However, that clause would be triggered only if OLCDC forced the sale, not if the real estate firm did.

The firm blocked the sale to the nonprofit. And OLCDC filed a lawsuit alleging breach of contract. The firm filed a counterclaim, accusing OLCDC of unjust enrichment. The firm claimed in court filings that its main reason for having invested was to improve the property and benefit from its increased value. 

Legal Reasoning

The real estate firm argued that the letter of intent didn’t legally constitute an “offer” and, therefore, OLCDC’s right of first refusal wasn’t triggered. The firm stated that it had merely been exploring exit options and hadn’t finalized a sale.

But a judge sided with the nonprofit, “finding that all that is necessary under [LIHTC rules] to trigger a LIHTC right of first refusal is for the owner of the development to manifest an intent or willingness to sell the development.” A contract or offer from a buyer is not necessary.   

The court found clear intent to sell and IRC Section 42 was clearly incorporated in the contracts between the firm and OLCDC. Therefore, the buyout price is defined by tax credit rules and not by the market price first offered by a third party. The judge’s ruling now allows the nonprofit to preserve the site for affordable housing. OLCDC can move ahead and buy the property for $110K, and keep all $11M of the equity in the property (which also carries $7M in debt).  

House Committee Bill Clarifies Rights Relating to LIHTC Building Purchase

On Sept. 15, the House Ways and Means Committee approved its portion of the $3.5 trillion Build Back Better reconciliation legislation. The legislation includes several LIHTC provisions that improve and expand the LIHTC program.

Among the proposals, the bill modifies the existing statutory right of first refusal and clarifies rights relating to building purchase. By doing so, lawmakers hope to address the issue of aggressive investors forcing nonprofits out of their planned and assumed eventual total ownership of an LIHTC site as found in the recent Opa-Locka Community Development Corporation case. The proposed bill converts the right to purchase into a purchase option. It would also be retroactive and apply to existing deals. For existing agreements, here are the proposed changes:

• Right to acquire the building includes the right to acquire all of the partnership interests relating to the building;
• Right to acquire the building includes the right to acquire assets held for the development, operation, or maintenance of the building;
• A right of first refusal may be exercised in response to any offer to purchase the property or partnership interests, including an offer by a related party; and
• A right of first refusal may be exercised without the approval of any owner of a LIHTC project; and
• The minimum purchase price excludes exit taxes.