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Nonprofit prevails in Section 42 ROFR case but issue still unresolved/appeal filed

A recent Massachusetts Superior Court case has clarified the right of a nonprofit sponsor to exercise its Section 42 right of first refusal to acquire an affordable housing project financed under Low Income Housing Tax Credit (LIHTC). In Homeowner’s Rehab Inc. v. Related Corporate V SLP LP and Centerline Corporate Partners V LP, the court upholds the expectations of the nonprofit sponsor to be able to buyout the investor limited partner at the end of the 15 year tax credit compliance period for the favorable “debt plus exit taxes” price permitted under Section 42(i)(7) of the Internal Revenue Code.

The court made three findings that have implications to the reading of partnership agreements in Section 42 low-income housing transactions:


(1) In interpreting the right of first refusal drafted under Section 42 (i)(7), courts should look to the intent of Congress and policy goals of Section 42 to inform their analysis including the notion that the nonprofit should have a favorable purchase price.

(2) The investor’s primary bargained for benefit was the low-income housing tax credits and not in the ultimate resale value of the project.

(3) The court concludes that, because the right of first refusal is a statutory mechanism, the investor parties must accept any offer that is enforceable and submitted in accordance with the terms of the partnership agreement and Section 42 (i)(7) as a bona fide offer to trigger the right.


A Notice of Appeal of the court’s decision was filed on 11/3/16. No hearing date has yet been set for the appeal.

This issue may also be addressed in the next Congress. The Cantwell-Hatch tax credit reform legislation may further impact the reading of Section 42 (i)(7). Section 303 of the bill would convert the nonprofit’s current right of first refusal to an option to purchase either the property or the partnership interest of the owner.

Further Analysis
In 1997, the parties entered into a partnership in furtherance of an affordable housing project. The agreement included an option agreement and right of first refusal, which provided two mechanisms for Homeowner’s Rehab, the nonprofit sponsor, to acquire the property owners’ partnership interest in the project at the end of the compliance period.

The first mechanism was a right of first refusal, drafted in compliance with Section 42 (i)(7). If triggered by a bona fide offer, the partnership must first offer the project to the nonprofit sponsor for the lesser of three prices: a) the principal amount of outstanding indebtedness secured by the building and all taxes attributable to such a sale as defined by 26 U.S. Code 42(I)(7) (the “Section 42 Price”); b) the third party price; and c) the market price as defined by the agreement (the “Section 42(i)(7) Price”). The nonprofit sponsor also had a right to purchase the property for the fair market value as defined in the partnership agreement.

At the end of the compliance period, the nonprofit sponsor offered to acquire the project at the Section 42(i)(7) price. The investor partners rejected this offer on grounds that the right of first refusal had not been triggered and therefore the nonprofit could only acquire the project under the second mechanism. The nonprofit sponsor sought an offer from Madison Park Community Development Corporation in order to trigger the right of first refusal exercise. In response, the investor partners refused to accept the offer claiming the Madison Park offer was not a bona fide offer and, therefore, did not properly trigger the right of first refusal.  Nonprofit sponsor filed suit against investor partners to force the contract right.

Section 42 and Section 42 (i)(7)
Section 42 of the Tax Code provides tax credits to developers of affordable housing. Generally nonprofits, as tax-exempt agencies, can’t utilize tax credits, therefore, investor partners, who can use the benefits, join with nonprofit developers as majority equity holders in projects to take advantage of the tax incentive. Projects have a mandatory 15 year compliance period, after which they may be sold.

Under Section 42 (i)(7)(A), projects may not fall to a nonprofit through a right of first refusal for “a price which is not less than the minimum purchase price.” The minimum purchase price is “the principal amount of outstanding indebtedness secured by the building (other than indebtedness incurred within the five year period ending on the date of the sale to the tenants)” and “all Federal, State, and local taxes attributable to such sale.” [Section 42 (i)(7)(B)].

Nonprofits’ argument
Homeowner’s Rehab argued in their complaint that they were entitled to acquire the project at the Section 42(i)(7) price because the Section 42 right of first refusal was properly triggered with a bona fide offer.

Investor Parties’ argument
Related and Centerline asserted in their answer and counterclaim that the right of first refusal was never triggered because the contract requires investor consent before an offer is made, and the offer submitted was not, therefore, a bona fide offer to trigger the provision.

Court’s Decision
The judge granted Homeowners Rehab’s motion for Summary Judgment, concluding that the nonprofit did properly trigger the right of first refusal. To interpret the provision, the judge determined that the parties’ intent should be informed by the overall goal and policy of Section 42 because “the primary purpose of the partnership is to provide affordable housing so that purpose is relevant in interpreting its provisions.” The court concluded that the investor parties cannot block a transaction whereby the nonprofit is exercising its Section 42 right of first refusal because “Section 42 explicitly envisions that qualified nonprofit developers or sponsors may be granted a right of first refusal to acquire the project back from a partnership for a minimal purchase price” and “transfer of the right of first refusal at the Section 42 price thus contributes to the overall goal of promoting the continuing availability of affordable housing.”

Further, the court established that this reading did not deprive the investors of their bargained-for benefits because it is in line with the financial interest and expectations they had when they entered into the partnership. Finally, the court concluded the investor parties cannot contest the validity of an enforceable offer submitted to trigger the right of first refusal. The court established that the right is a “statutorily defined one” and limited only by the terms provided by the statute. In making this determination, the judge affirmed that the intent of the offer is immaterial because, as the court stated, “anyone familiar with LIHTC projects … would be unlikely to make an offer if it were not solicited.”


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