Judge James Selna of the United States District Court for the Central District of California has given another win to low income housing credit aggregator Alden Torch in Centerline Housing Partnership V Palm Communities. As I read the filings I may need to find a substitute for the “a” word as in one of the final motions Alden Torch’s counsel claims that “aggregator” is a pejorative term that was coined to impugn Alden Torch’s reputation and commitment to affordable housing and the low-income housing tax credit (LIHTC) program. Overall Alden Torch’s adversaries have been more active in the metaphorical court of public opinion. In actual courts, overall, it seems that Alden Torch has been winning in federal courts, but in state courts not as much.
The Big Picture Issue
The Section 42 low-income housing tax credit (LIHTC) is the major way that the federal government promotes the creation and preservation of affordable housing. Every year each state gets credits based on population which are allocated by the state’s designated agency. Projects typically have investor limited partners (sometimes just one). They are designed so that the lion’s share of the credit goes to the investor LP. There may also be losses.
The credit is doled out over a ten year period which is followed by another five years in which it is subject to recapture. That makes for a fifteen year compliance period. Restrictions to assure affordability continue for another fifteen years, but those are enforced by state housing agencies. Not for profit sponsors have an edge in getting credit allocations.
Section 42 includes an optional mechanism for a not for profit sponsor to take out the limited partner for less than fair market value in Year 15. It is a right of first refusal (ROFR) to buy the project for outstanding debt plus whatever tax cost the investor might have on exit. In many cases sponsors have been effectively treating the ROFR as if it were an option. And investors who were, in essence, buying the credit have been OK with that.
Alden Torch and other, if you will excuse the expression, aggregators have acquired partnership interests in the tail end of the compliance period. They have been insisting that a ROFR is not the same as an option and have not been going gently into that good night in the way the sponsors anticipated.
Frederick And 52 II Limited Partnership (the partnership) owns a 72 unit apartment complex in Coachella CA known as Orchard Villages II. The general partners are Palm Communities (Palm) and Housing Corporation of America (HCA). HCA is a not-for profit. Centerline is the limited partner, which is indirectly owned by Alden Torch.
Centerline brought the action to block exercise of the ROFR. Other issues were the refinancing of the property, Palm breaching its financial duty to the limited partners, the limited partners not following through on an implied covenant of good faith and fair dealing and Alden Torch tortuously interfering in the partnership.
The ROFR is really the heart of the matter. It came out in the litigation that there was an “Agreement of General Partners” that would shift the benefit of the ROFR exercise from HCA to Palm for a nominal sum – $15,000. In a LIHTC deal only a not-for-profit is supposed to benefit from the ROFR. The other issue, which comes up in other deals, is that Palm solicited an offer and indicated that they were interested in accepting it purely for the purpose of triggering the ROFR.
Judge Selna ruled that the ROFR was not triggered. He noted that every federal court that has addressed the issue has found that a Section 42 ROFR cannot be triggered without meeting the common law requirements that include a legitimate intent to actually sell to a third party.
More generally Judge Selna ruled that a ROFR is purely a defensive right and can never be used to compel a sale. He found that Palm and HCA could not refinance the property without the written consent of the special limited partner and that Palm had breached its fiduciary duties to the limited partners. There was no breach by the limited partners and no tortious interference by Alden Torch, since Alden Torch’s interest were aligned with the limited partners.
Overall it is a big win for Alden Torch. The only consolation to the other side is that in a subsequent ruling the damages for the breach were found to be nominal.
One Sided Coverage
As noted above Alden Torch is moving to exclude evidence purporting to disparage Alden Torch for activities that do not relate to the action. According to the attachment to the motion Palm and HCA were accusing Alden Torch of being part of a “larger, nationwide trend causing peril to the LIHTC program”. In discussing this issue they indicate that “aggregator” in the LIHTC context is pejorative. The mention “unfair and one-sided articles” cited by the general partners in various pleadings. Among those articles is After The Low Income Housing Tax Credits Are Done, Investors Want More by Peter J Reilly. That article includes a statement from Alden Torch. Just saying.
Build Back Better
There is proposed legislation to change the definition of ROFR. It was included in Build Back Better and I suspect will show up in some other vehicle if they ever actually pass anything. I am very skeptical about Congress being able to say that thirty years ago when it used a common law term (i.e. right of first refusal), it really meant something else.
On the other hand a right of first refusal is usually an opportunity to meet somebody else’s offer rather than the right to a possibly bargain price.
Here is a roundup of my other previous coverage of the ROFR issue.