Non-Profit Right of First Refusal on Section 42 Project – Relevant Court Case

Many nonprofit organizations participate in the development of Section 42 Low-Income Housing Tax Credit (LIHTC) properties on the condition that the nonprofit has a right of first refusal to purchase the project at the end of the Section 42 compliance period. What constitutes a right of first refusal and the circumstances that apply to such rights has been the subject of much discussion and some controversy over the years. A recent court decision out of the Western District of Washington state may help clarify some of the issues.

On March 27, 2019, the court released its “Findings of Facts and Conclusions of Law” in the case (Housing Assistance Group v AMTAX Holdings 260, LLC, et al., W.D. Wash. No C17-1115 RSM”).The court held that an exercise of right of first refusal (ROFR) under §42(i)(7) must also comply with applicable state law requirements that generally apply to a ROFR.

In order to encourage non-profit participation in the LIHTC program, §42(i)(7) allows a nonprofit partner to hold a contractual ROFR to purchase the LIHTC property at the statutory minimum price, which is often referred to as “debt plus taxes.” This price is often below market value.

The dispute in this case was whether the nonprofit Senior Housing Assistance Group (SHAG) validly triggered and exercised its ROFR on four disputed properties in order to take advantage of the beneficial ROFR price allowed in Section 42.

The court ruled in a bench trial that SHAG’s attempt to exercise its ROFRs was insufficient as a matter of law and that SHAG failed to prove that it was entitled to declaratory relief because of its “unclean hands.” Without delving into all the facts of the case, the basic concept that the court relied on in reaching its decision was that in order for a §42(i)(7) ROFR to be properly triggered, it must also comply with applicable state common law requirements. The court looked at the following ROFR principles under Washington state law, which are similar to the laws of other states:

  1. The owner must have a genuine intent to sell the property;
  2. The owner must receive a “bona fide offer from a third party, acceptable to the property owner;”
  3. To constitute a bona fide offer, the offer must be “made in good faith, without fraud or deceit” and must be “sincere” and “genuine,” (i.e., not designed simply to trigger the ROFR); and
  4. Even if a third party’s interest in the property is genuine, to constitute an offer the communications in question must be enforceable and not merely an expression of interest or invitation to negotiate.

In this case, the court held that SHAG’s attempted exercise of its ROFRs failed at least one of the principles noted above. According to the court, SHAG “could only exercise its ROFR if all the elements necessary to trigger the ROFR under common law had been satisfied.” Even though the investor partner had agreed to give up consent rights as the limited partner in connection with SHAGs exercise of its ROFRs, the court noted a distinction between a ROFR and an option, effectively holding  that SHAGs treatment of the ROFR would impermissibly convert the ROFR into an option. The court also found SHAG to have unclean hands because they solicited sham offers or otherwise attempted to induce offers in bad faith solely to trigger the ROFR.

While this ruling does provide an indication of how state courts may interpret the requirements relating to exercising a ROFR, the Massachusetts Supreme Judicial Court in Homeowner’s Rehab, Inc. v. Related Corporate V SLP, L.P., 479 Mass. 741 (Mass. 2018) concluded that no bona fide offer was required in order to trigger the ROFR.

Exercising of ROFRs is an evolving area of the law, but this recent Washington case provides a clear indicator of how future courts may interpret disputed efforts with regard to ROFRs. Any nonprofit with a ROFR clause in their partnership agreement should carefully review both these cases prior to exercising a ROFR.