Homeowner's Rehab, Inc. v. Related Corporate V SLP, L.P.

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SJC-12441
HOMEOWNER'S REHAB, INC., & another1 vs. RELATED
CORPORATE V SLP, L.P., & another.2
Suffolk. February 6, 2018. - June 15, 2018.
Present: Gants, C.J., Lenk, Gaziano, Lowy, Cypher, &
Kafker, JJ.
Partnership, Limited partnership, General partner, Consent of
limited partner. Housing. Real Property, Right of first
refusal.
Civil action commenced in the Superior Court Department on
December 5, 2014.
The case was heard by Janet L. Sanders, J., on a motion for
summary judgment, and entry of judgment was ordered by her.
The Supreme Judicial Court on its own initiative
transferred the case from the Appeals Court.
Dennis E. McKenna for the defendants.
Karen E. Friedman (David E. Lurie also present) for the
plaintiffs.
The following submitted briefs for amici curiae:
Henry Korman & Daniel M. Rosen for Citizens' Housing and
Planning Association & others.
1 Memorial Drive Housing, Inc.
2 Centerline Corporate Partners V L.P.
2
W. Bart Lloyd, Gregory M. Katz, & Jonathan Klein for
Preservation of Affordable Housing, Inc., & another.
Stephen M. Nolan for Massachusetts Housing Investment
Corporation.
Roberta L. Rubin, Special Assistant Attorney General, &
Bruce E. Falby for Department of Housing and Community
Development & others.
Albert P. Zabin for Chinese Progressive Association, Inc.,
& another.
Charles R. Bennett for Holland & Hart LLP.
Christopher G. Caldwell, Michael D. Roth, & Kelly L.
Perigoe, of California, & William C. Jackson for Jonathan
Zasloff.
Christopher G. Caldwell, Michael D. Roth, & Kelly L.
Perigoe, of California, & William C. Jackson for Bradley Myers.
GANTS, C.J. The parties in this case are partners in a
limited partnership formed for the purpose of rehabilitating and
operating an affordable housing complex. The project was
eligible for financing under the Low Income Housing Tax Credit
(LIHTC) program set forth in the Internal Revenue Code, 26
U.S.C. § 42 (2012). Under the agreements executed in connection
with this project, the majority owner of the general partner, a
nonprofit organization, holds a right of first refusal to
purchase the partnership's interest in the property "in
accordance with" § 42(i)(7). The primary issue in this case is
when that right of first refusal may be exercised under the
terms of these agreements. The plaintiffs contend that the
right of first refusal can be exercised once a third party makes
an enforceable offer to purchase the property interest. The
defendants contend that the right of first refusal cannot be
3
exercised unless and until the partnership has received a bona
fide offer from a third party, and has decided, with the consent
of the special limited partner, to accept that offer. The
Superior Court judge in this case agreed with the plaintiffs,
and granted their motion for summary judgment. We affirm the
grant of summary judgment.3
Background. 1. The LIHTC program. Because the limited
partnership here was formed for the purpose of participating in
the LIHTC program, we begin by describing the program.
As set forth in the Internal Revenue Code, 26 U.S.C. § 42,
the LIHTC program is a Federal subsidy program designed to
promote the construction and rehabilitation of rental housing
that is affordable to low and moderate income households. It is
the most important source of financing for affordable housing in
Massachusetts and across the nation. See Joint Center for
Housing Studies of Harvard University, America's Rental Housing:
Expanding Options for Diverse and Growing Demand 32-33 (2015)
3 We acknowledge the amicus briefs submitted in support of
Homeowner's Rehab, Inc., by Preservation of Affordable Housing,
Inc., and The Community Builders, Inc.; Citizens' Housing and
Planning Association, Greater Boston Real Estate Board, and
Massachusetts Association of Community Development Corporations;
Massachusetts Department of Housing and Community Development,
Massachusetts Development Finance Agency, Massachusetts Housing
Partnership Fund Board, and Community Economic Development
Assistance Corporation; Massachusetts Housing Investment
Corporation; and Chinese Progressive Association, Inc., and
Chelsea Collaborative, Inc. We acknowledge the amicus briefs
submitted in support of Related Corporate V SLP, L.P., by
Bradley Myers, Jonathan Zasloff, and Holland & Hart LLP.
4
(LIHTC program now provides more affordable rental units than
are provided in public housing or with Section 8 housing
vouchers); Department of Housing and Community Development, Low
Income Housing Tax Credit Program, 2018-2019 Qualified
Allocation Plan 6 (since 1987, LIHTC program has helped finance
over 67,000 affordable rental units in Massachusetts and almost
3 million nationwide). Under § 42, tax credits are allocated to
each State based on population; the States, in turn, allocate
the tax credits to "qualified low-income housing projects" --
that is, residential rental properties that are rent-restricted
and have a certain minimum share of rental units set aside for
low and moderate income households. See 26 U.S.C. § 42(g),
(h)(3).4
The owners of these properties can claim the tax credits
annually over a period of ten years, thereby offsetting their
tax liability, but must continue to comply with rent
affordability restrictions for a period of fifteen years, known
as the compliance period, to avoid recapture of those credits.
See 26 U.S.C. § 42(a), (c)(2), (f)(1), (i)(1), (j). For any
4 In order to qualify for tax credits under the Low Income
Housing Tax Credit program, a property must meet one of two
criteria: either (1) at least twenty per cent of the units are
rent-restricted and occupied by tenants with incomes that are at
most fifty per cent of area median income (AMI), or (2) at least
forty per cent of the units are rent-restricted and occupied by
tenants with incomes that are at most sixty per cent of AMI. 26
U.S.C. § 42(g)(1).
5
LIHTC project allocated tax credits after 1989, the owner must
also agree to comply with the affordability restrictions for an
additional fifteen years, known as the extended use period, so
that the affordability restrictions remain in place for a total
of thirty years. See 26 U.S.C. § 42(h)(6).
Developers of affordable housing projects frequently use
the tax credits available under the LIHTC program as an
incentive to attract capital from private investors. Because
these projects rarely generate enough tax liability for the
developers to claim the full value of the credits themselves,
and because many of these developers are nonprofit organizations
and therefore tax-exempt, the tax credits are of little value to
them. By syndicating the project, however, these developers can
"sell" the tax credits to private investors -- in most cases
corporations with substantial and predictable tax liability --
in exchange for an equity investment in the project. See J.
Khadduri, C. Climaco, & K. Burnett, United States Department of
Housing and Urban Development, What Happens to Low-Income
Housing Tax Credit Properties at Year 15 and Beyond?, at 2
(2012) (Khadduri et al.); M.I. Sanders, Joint Ventures Involving
Tax-Exempt Organizations 949-951 (4th ed. 2013).
Section 42 requires each State to set aside at least ten
per cent of its allocable tax credits for projects developed and
operated by qualified nonprofit organizations. 26 U.S.C.
6
§ 42(h)(5). In a typical project of this kind, the property is
owned by a limited partnership, formed solely for that purpose,
in which the general partner is a nonprofit organization holding
only a nominal equity interest (one per cent or less) and the
limited partners are private investors who hold almost all of
the equity (ninety-nine per cent or more). The nonprofit
general partner is responsible for the day-to-day management of
the property. The investor limited partners contribute capital
and, in return, are allocated the tax benefits flowing from the
project, including the LIHTC tax credits, deductions for
depreciation, and other tax losses. See Khadduri et al., supra
at 11, 25; Mittereder, Pushing the Limits: Nonprofit Guarantees
in LIHTC Joint Ventures, 22 J. Affordable Hous. & Cmty. Dev. L.
79, 83 (2013) (Mittereder).
At the end of the fifteen-year compliance period, when all
tax credits have been claimed and are no longer subject to
recapture, most investor limited partners will seek to leave the
project, usually -- but not always -- by selling their interest
to the nonprofit general partner. See Khadduri et al., supra at
29-31; Mittereder, supra at 83. Section 42 specifically
contemplates such sales, allowing nonprofit organizations to
hold a right of first refusal to purchase the property at the
end of the compliance period at a statutorily prescribed minimum
price, and protecting investors against the risk that their tax
7
credits will be disallowed or recaptured for that reason. Title
26 U.S.C. § 42(i)(7)(A) states:
"No Federal income tax benefit shall fail to be allowable
to the taxpayer with respect to any qualified low-income
building merely by reason of a right of [first] refusal
held by the tenants . . . or resident management
corporation of such building or by a qualified nonprofit
organization . . . to purchase the property after the close
of the compliance period for a price which is not less than
the minimum purchase price . . . ."
The "minimum purchase price" (§ 42 price) is an amount equal to
the outstanding debt on the property, excluding debt incurred in
the five years preceding the sale, plus exit tax liability,5 and
is typically below fair market value. 26 U.S.C. § 42(i)(7)(B).
See Khadduri et al., supra at 31.
Section 42 does not mandate that nonprofit organizations be
granted a right of first refusal, but the Internal Revenue
Service has issued guidance indicating that, in order to qualify
for tax-exempt status, a nonprofit organization participating as
a general partner in a LIHTC partnership must secure a right of
first refusal to acquire the property at the end of the
compliance period. Memorandum from Robert S. Choi, Director of
Exempt Organizations, Internal Revenue Service, Income Housing
Tax Credit Limited Partnerships 1, 3-4 (July 30, 2007).
5 Exit tax liability includes all Federal, State, and local
taxes attributable to the sale of the property. 26 U.S.C.
§ 42(i)(7)(B)(ii).
8
2. The agreements. The parties here are partners in a
limited partnership (partnership) created in 1997 to
rehabilitate and operate an affordable housing complex in
Cambridge (property) under the LIHTC program. The general
partner is Memorial Drive Housing, Inc., a corporation that is
majority-owned and controlled by Homeowner's Rehab, Inc.
(nonprofit developer), a nonprofit organization that specializes
in the development of affordable housing. The investor limited
partners are Centerline Corporate Partners V L.P., as limited
partner, and Related Corporate V SLP, L.P., as special limited
partner. The partnership owns a ninety-nine-year lease of the
property (property interest).6
Pursuant to the partnership agreement, the limited partners
made capital contributions of approximately $7 million. The
partnership agreement allocates 99.99 per cent of the tax
credits -- as well as the profits and losses of the partnership,
with some exceptions, and deductions for expenses, including
depreciation expenses -- to the limited partners.
The partnership agreement requires that, for the fifteen-
year compliance period, the property will comply with the
affordability restrictions and other requirements of § 42. In
6 The property, consisting of both the land and the
building, is owned by a charitable trust created by Homeowner's
Rehab, Inc. (nonprofit developer), which is the sole beneficiary
of the trust.
9
addition, the property is subject to certain long-term
affordability restrictions negotiated with local and Federal
housing authorities.
The partnership agreement also defines the rights and
obligations of the respective partners. Section 5.1 vests
"[t]he overall management and control of the business, assets[,]
and affairs of the Partnership" in the general partner. The
partnership agreement envisions only a limited managerial role
for the limited partners, providing that neither "shall take
part in the management or control of the business of the
Partnership."
The parties also entered into another agreement (option
agreement) outlining two potential mechanisms by which the
nonprofit developer could acquire the property interest. The
first mechanism is a right of first refusal, granted in
accordance with § 42(i)(7). Under section 2 of the option
agreement, the partnership cannot sell its interest in the
property "without it first being offered" to the nonprofit
developer; specifically, the partnership must deliver to the
nonprofit developer a notice (disposition notice) that states,
among other things, the third party "to whom the Partnership
proposes to make such disposition," the price to be paid and
"all other terms of the proposed disposition," and "a statement
indicating whether the Partnership is willing to accept the
10
offer." Upon receiving the disposition notice, the nonprofit
developer can exercise its right of first refusal and acquire
the property interest at a purchase price equal to "the lesser
of" (1) the § 42 price, (2) the price that the third party would
have paid in the proposed disposition, or (3) the "Restricted
Market Price" (market price), meaning the fair market value,
subject to certain restrictions encumbering the property.
The second mechanism by which the nonprofit developer can
acquire the property interest is an option to purchase, which
exists separately and "[i]n addition to [the] Right of First
Refusal." Under section 6 of the option agreement, for a period
of four years commencing at the end of the fifteen-year
compliance period, the nonprofit developer has an option to
purchase the property interest at the market price.
The partnership agreement specifically references and
incorporates the option agreement, which, as defined in the
partnership agreement, is not limited to the option to purchase
but also includes the provisions governing the right of first
refusal. Section 5.4 of the partnership agreement outlines the
procedure for the sale of partnership assets, stating:
"Except as may be otherwise expressly provided . . . in
this Agreement, the General Partner[] . . . [is] hereby
authorized to sell . . . all or substantially all of the
assets of the Partnership; provided, however, that except
for a sale pursuant to the Option Agreement, the terms of
any such sale . . . must receive the Consent of the Special
11
Limited Partner before such transaction shall be binding on
the Partnership."
That section further states:
"The Partnership and [the nonprofit developer] agree that,
with respect to the Option Agreement, it is their intention
that the purchase price under the Option Agreement be the
minimum price consistent with the requirements of
[§] 42(i)(7) of the [Internal Revenue] Code."
Section 5.4 also sets forth an interpretation of certain terms
in § 42(i)(7) that will govern the exercise of the right of
first refusal "so long as [the nonprofit developer] provides
evidence reasonably satisfactory to the Partnership and the
Limited Partner that [such] interpretation[] will not adversely
affect, or cause any material risk of recapture of, any Credits
previously taken by such Limited Partner."
The closing documents to the agreements include a
memorandum from the accounting firm Reznick Fedder & Silverman
(Reznick memorandum) providing financial projections for the
partnership over the fifteen-year compliance period. The
Reznick memorandum also projected the return on investment the
limited partners would receive if the property interest were to
be sold at the end of the compliance period for a purchase price
of one dollar plus outstanding debt; it estimated that, after
cumulative tax savings of about $19 million, the limited
partners would stand to receive approximately $10 million, which
would be $3 million over their initial $7 million investment.
12
3. The parties' dispute. The following facts in the
summary judgment record are not materially in dispute.
Over the fifteen-year compliance period, the limited
partners claimed approximately $7.5 million in tax credits and
over $24 million in tax losses through the partnership. In
January, 2014, after the compliance period had ended, the
nonprofit developer offered to purchase the limited partners'
interest in the property for one dollar, plus the assumption of
outstanding debt, which it contended was the minimum price
consistent with § 42(i)(7). In March, 2014, the limited
partners rejected the offer, claiming that the nonprofit
developer could purchase the property interest at the § 42 price
only if it were to exercise its right of first refusal, which it
could not do because the conditions for exercising that right
had not been satisfied.
Despite further negotiations, the parties were unable to
agree upon a purchase price for the property interest, and were
also unable to agree on their interpretation of the right of
first refusal.
In the fall of 2014, the nonprofit developer decided to
trigger its right of first refusal according to its own
interpretation by soliciting a third-party offer from Madison
Park Development Corporation (Madison Park), another nonprofit
developer of affordable housing. Peter Daly, executive director
13
for both the general partner and the nonprofit developer, asked
the chief executive officer of Madison Park, Jeanne Pinado, to
make an offer as a "favor" to him. In November, 2014, Madison
Park submitted a written offer to purchase the property interest
for approximately $42 million. Pinado understood that Daly had
solicited the offer in order to trigger the right of first
refusal. She also knew that Madison Park's offer was subject to
the nonprofit developer's right of first refusal, which the
nonprofit developer was likely to exercise. But Pinado
testified that Madison Park had made "a good offer" that was
"appropriate . . . for [the] property," and that, in the event
that the nonprofit developer did not exercise its right of first
refusal, Madison Park was willing and able to honor its offer.
Having received Madison Park's offer, the general partner,
acting on behalf of the partnership, issued a disposition notice
to the nonprofit developer and to the limited partners, stating
that the partnership was "willing to accept the offer subject to
consent of the Partnership's limited partner." The notice also
stated that the estimated market price for the property interest
was $46 million. In response, the special limited partner
issued a notice stating that it did not consent to the proposed
sale to Madison Park and that the general partner therefore
lacked the authority to issue the disposition notice.
Undeterred, the nonprofit developer issued a notice informing
14
the partnership that, having received the disposition notice, it
intended to exercise its right of first refusal to purchase the
property interest.
4. The action for declaratory judgment. Because it was
apparent that the limited partners would continue to oppose the
sale, the nonprofit developer and the general partner commenced
an action against the limited partners in the Superior Court,
seeking a declaratory judgment as to the parties' rights under
the relevant agreements. In their answer, the limited partners
asserted a counterclaim alleging that, by attempting to trigger
the nonprofit developer's right of first refusal without the
special limited partner's consent, the general partner had
committed a breach of its fiduciary duty to the limited partners
and the implied covenant of good faith and fair dealing.
Following discovery, the plaintiffs moved for summary
judgment on their claims for declaratory relief and on the
limited partners' counterclaim. The judge allowed the
plaintiffs' motion as to all claims. The judge determined that
the option agreement should not be read in isolation, but must
instead be construed together with the partnership agreement, in
keeping with the intent of the parties, and in the context of
the statutory requirements of the LIHTC program. The judge
concluded that under those agreements the general partner could
solicit a third-party offer and issue a disposition notice --
15
thereby triggering the nonprofit developer's right of first
refusal -- without the consent of the special limited partner.
In reaching this conclusion, the judge pointed to two
specific provisions in the agreements. First, the judge noted
that, under section 2 of the option agreement, the disposition
notice must state "whether the Partnership is willing to accept
the [third-party] offer" (emphasis added), indicating that "the
offer need not be accepted by the Partnership . . . in order to
trigger the [right of first refusal]." Second, the judge also
noted that, under section 5.4 of the partnership agreement, the
general partner need not obtain the consent of the special
limited partner for a sale "pursuant to the Option Agreement."
The judge interpreted this to mean that the general partner need
not obtain such consent before soliciting an offer or before
issuing a disposition notice to trigger the right of first
refusal.
The judge also rejected the limited partners' contention
that Madison Park's offer was not a bona fide offer and
therefore could not trigger the right of first refusal.
Emphasizing that the nonprofit developer's right of first
refusal was "not a typical right of first refusal but rather a
statutorily defined one designed to allow non-profit entities to
buy back property . . . at a preset price," the judge concluded
16
that the right could be triggered by any enforceable third-party
offer and that Madison Park's offer qualified as such.
The judge concluded that this interpretation "would not
deprive the defendants of the benefit of their bargain,"
finding, based on the Reznick memorandum, that the limited
partners' expected benefit from their investment was limited to
the tax credits and other tax benefits -- which they did receive
-- and did not include any residual value from the property in
the event of a sale.
As to the limited partners' counterclaim, the judge
concluded that because the general partner's actions were
authorized by the agreements, there was no breach of fiduciary
duty or of the covenant of good faith and fair dealing.
Accordingly, the judge issued a judgment declaring, inter
alia, that the general partner was authorized to solicit an
offer from Madison Park and to issue a disposition notice
without the special limited partner's consent, that this
disposition notice triggered the nonprofit developer's right of
first refusal, that the general partner was authorized to sell
the property interest to the nonprofit developer without the
special limited partner's consent, and that the general partner
did not commit a breach of its fiduciary duty to the limited
17
partners. The limited partners appealed.7 We transferred the
case to this court on our own motion.
Discussion. We review a grant of summary judgment de novo
to determine whether, viewing the evidence in the light most
favorable to the nonmoving party (here, the defendant limited
partners), the moving party (here, the plaintiff general partner
and nonprofit developer) is entitled to judgment as a matter of
law. See Pinti v. Emigrant Mtge. Co., 472 Mass. 226, 231
(2015). On appeal, the limited partners make three claims of
error. First, they claim that the judge erred in her
interpretation of the agreements and that the right of first
refusal cannot be exercised without the consent of the special
limited partner. Second, they claim that the judge
impermissibly relied on extrinsic evidence, specifically the
Reznick memorandum, in interpreting the agreements. And third,
they claim that the judge erred in concluding that the general
partner had not committed a breach of its fiduciary duty to the
limited partners or the implied covenant of good faith and fair
dealing.
With respect to the agreements, the parties here agree that
the partnership agreement and the option agreement incorporate
On the limited partners' motion, the judge entered an
7
order enjoining the general partner from selling the property
interest under the option agreement pending the outcome of the
limited partners' appeal.
18
each other by reference, and must be read together as an
integrated whole. See Phoenix Spring Beverage Co. v. Harvard
Brewing Co., 312 Mass. 501, 505 (1942) ("[W]hen several writings
evidence a single contract between the parties, they will be
read together in order to arrive at an interpretation of the
contract"). They also agree that these agreements were
carefully negotiated and crafted by sophisticated parties, and
that the language of these agreements is unambiguous -- although
each side contends that that unambiguous language favors their
own position.
The limited partners contend that the right of first
refusal cannot be exercised unless triggered by a bona fide
third-party offer, and then only if the partnership, with the
special limited partner's consent, has agreed to accept that
offer. The general partner and nonprofit developer contend that
the right can be triggered by any enforceable offer from a third
party, and can be exercised when the general partner decides to
accept it on behalf of the partnership, without the special
limited partner's consent. There are therefore three discrete
issues that we must resolve: first, whether the right of first
refusal can only be triggered by a bona fide third-party offer;
second, whether the partnership must decide to accept that offer
in order for the nonprofit developer to exercise the right; and
third, if so, whether the general partner is authorized to make
19
that decision on behalf of the partnership without the consent
of the special limited partner.
Where both sides agree only that the language of the
agreements is unambiguous, we must interpret that language in
the context in which it was written and "with reference . . . to
the objects sought to be accomplished," mindful that "a contract
should be construed [so as] to give it effect as a rational
business instrument and in a manner which will carry out the
intent of the parties." Starr v. Fordham, 420 Mass. 178, 190,
192 (1995), quoting Shea v. Bay State Gas Co., 383 Mass. 218,
223 (1981), and Shane v. Winter Hill Fed. Sav. & Loan Ass'n, 397
Mass. 479, 483 (1986). Here, that context is § 42 of the
Internal Revenue Code, which offers tax credits as an incentive
to invest in affordable housing. The purpose of the
partnership, as stated in section 2.5.A of the partnership
agreement, is to "invest[] in real property and . . . provi[de]
. . . low income housing." Participating in the LIHTC program
serves the interests of all the partners, enabling the general
partner to fulfil its mission of providing affordable housing,
while providing the limited partners with a return on their
investment, primarily in the form of tax credits allocated under
§ 42.
This mutuality of interest is reflected in the language of
the agreements. The partnership agreement makes clear that the
20
amount of the limited partners' capital contributions was tied
to the amount of tax credits allowable under § 42, which were
allocated almost entirely to the limited partners. Many
provisions in the agreement reflect the critical importance of
ensuring that the limited partners obtain those credits. For
example, section 5.2.B requires the general partner to "operate
the [property] . . . in such a manner that [it] will be eligible
to receive" tax credits with respect to a certain minimum
percentage of units, while section 5.5.B(xv) prohibits the
general partner from taking any action that would result in a
disallowance or recapture of credits unless it obtains the
special limited partner's consent. Other provisions reflect the
importance of providing affordable housing in a manner that
complies with all requirements of the LIHTC program. Section
2.5.A(v) authorizes the partnership to rent units "in accordance
with applicable Federal, [S]tate[,] and local regulations, in
such a manner so as to qualify for [tax credits]," while
section 4.1.A requires the general partner to act in compliance
with all applicable laws during the compliance period to ensure
the allowance of tax credits and avoid their recapture.
We therefore examine the agreements with these mutual
interests in mind. As earlier stated, the option agreement
outlines two separate mechanisms by which the nonprofit
developer can acquire the partnership's property interest: the
21
right of first refusal, and the option to purchase. At common
law, the distinction between these two forms of purchase rights
is well established. See, e.g., Bortolotti v. Hayden, 449 Mass.
193, 201 (2007); Uno Restaurants, Inc. v. Boston Kenmore Realty
Corp., 441 Mass. 376, 382 (2004). An option to purchase
entitles the holder to purchase the property from the owner at a
specific price; the holder can exercise it unilaterally, thereby
compelling even an unwilling owner to sell. See Uno
Restaurants, Inc., supra at 382 & n.3. See also 25 R.A. Lord,
Williston on Contracts § 67:85, at 502 (4th ed. 2002). In
contrast, a right of first refusal is only a preemptive right,
prohibiting the owner from selling the property to a third party
"without first offering the property to the holder . . . at the
third party's offering price." Uno Restaurants, Inc., supra at
382. The holder of the right may then decide whether to
purchase the property by matching that price. Id. at 383. Also
unlike an option to purchase, a right of first refusal cannot be
exercised unilaterally, but can only be exercised where two
conditions are met. First, the right of first refusal must be
triggered by "a bona fide and enforceable offer to purchase" the
property, Roy v. George W. Greene, Inc., 404 Mass. 67, 69
(1989), meaning an offer that is made "honestly and with serious
intent." Uno Restaurants, Inc., supra at 383, quoting Mucci v.
Brockton Bocce Club, Inc., 19 Mass. App. Ct. 155, 158 (1985).
22
Second, the owner of the property must have decided to accept
that third-party offer. See Bortolotti, supra at 204 (right of
first refusal "arises only when a property owner receives, and
is prepared to accept, a bona fide offer"); Roy, supra at 71
(right of first refusal can be exercised "only when the owner
has decided to accept" third-party offer). See also Williston
on Contracts, supra ("[A] right of first refusal has no binding
effect unless the offeror decides to sell").
The limited partners contend that, in granting the right of
first refusal, the agreements here incorporate these common-law
limitations on its exercise. What they fail to acknowledge is
that the right of first refusal in this case is not purely a
creation of the common law but, as stated in the preamble to the
option agreement, was granted "in accordance with [§] 42(i)(7)
of the Internal Revenue Code," and must be understood in the
context of agreements designed to secure tax credits under the
LIHTC program. Section 42(i)(7) provides that tax credits will
not be withheld "merely" because a nonprofit organization holds
"a right of [first] refusal . . . to purchase the property after
the close of the compliance period for a price which is not less
than" the statutorily prescribed, typically below-market § 42
price. 26 U.S.C. § 42(i)(7)(A). Section 42(i)(7) provides a
safe harbor for property owners, allowing them to grant such
rights without disqualifying them from the tax credits that are
23
the key economic incentive for their investment in affordable
housing.
This safe harbor is necessary because of a long-standing
principle of tax law that limits the tax benefits attributable
to property ownership -- including tax credits -- to the true
owner of that property. See Frank Lyon Co. v. United States,
435 U.S. 561, 572-573 (1978). Under the economic substance
doctrine, "the objective economic realities of a transaction,"
rather than its legal form, determine who is an owner for tax
purposes. Id. at 573. See, e.g., Rev. Rul. 72-543, 1972-2 C.B.
87 (in sale-leaseback arrangement where "burdens and benefits of
ownership" remain with seller, seller deemed owner for tax
purposes). Traditionally, one of the core benefits of property
ownership has been the right to profit from appreciation in
value. See Dunlap v. Commissioner of Internal Revenue, 74 T.C.
1377, 1436-1437 (1980), rev'd and remanded on other grounds, 670
F.2d 785 (8th Cir. 1982). Thus, in many contexts, an option to
purchase property at a below-market price -- which shifts the
right to appreciation from the legal owner to the option holder
-- is deemed to transfer ownership to the option holder, thereby
disqualifying the legal owner from tax benefits. See, e.g.,
Rev. Rul. 55-540, 1955-2 C.B. 39, § 4.01(e) (transaction is
sale, not lease, where there is "a purchase option at a price
24
which is nominal in relation to the value of the property").8
Against this background, § 42(i)(7) serves to clarify that,
notwithstanding traditional principles of tax law, a nonprofit
organization's right of first refusal to acquire the property at
the typically below-market § 42 price will not deprive the
property owner of tax credits.9
By creating this safe harbor, § 42(i)(7) also furthers one
of the key policy goals of the LIHTC program, which is to ensure
that affordable housing remains affordable in the long term.
Nonprofit organizations are more likely to continue to operate
properties as affordable housing, even after the affordability
restrictions are lifted, because it is their mission to do so.
See Khadduri et al., supra at 41. Congress therefore designed
§ 42 to encourage nonprofit involvement, first by requiring at
least ten per cent of tax credits to be allocated to projects
8 For other examples where a below-market purchase option is
deemed to transfer ownership for tax purposes, see 26 C.F.R.
§ 1.761-3(d) (2017) (where option to purchase partnership
interest is "reasonably certain to be exercised," for example
because of below-market strike price, option holder should be
treated as partner); and Rev. Rul. 85-87, 1985-1 C.B. 268, 269
(where strike price is below fair market value of stock, put
option is "in substance a contract to acquire stock").
9 This clarification is especially important given that the
Internal Revenue Service has stated in its regulations
interpreting 26 U.S.C. § 42, that the tax credits available
thereunder "may be limited or disallowed under . . . principles
of tax law," including the "'economic substance' analysis" and
the "'ownership' analysis" articulated in Frank Lyon Co. v.
United States, 435 U.S. 561 (1978). 26 C.F.R. § 1.42-4(b)
(2017).
25
involving nonprofit organizations, 26 U.S.C. § 42(h)(5), and
second by facilitating the transfer of properties to nonprofit
organizations through § 42(i)(7). Allowing the transfer of
properties at below-market prices frees up cash flow, which
nonprofit organizations can then use to preserve the properties
as affordable housing into the future. See Khadduri et al.,
supra at 30.
The legislative history of § 42(i)(7) confirms that it was
intended to facilitate the inexpensive transfer of properties to
nonprofit organizations. See Report of the Mitchell-Danforth
Task Force on the Low-Income Housing Tax Credit 19 (Jan. 1989)
(Mitchell-Danforth Report). Lawmakers were concerned that
properties financed under the LIHTC program would not remain
affordable in the long term, because their owners would convert
them to market-rate housing -- or sell them to third parties who
would -- as soon as the affordability restrictions were lifted.
See id. at 13. Their proposed solution was to make it easier
for nonprofit organizations to purchase the properties. See id.
at 19. Indeed, an earlier version of § 42(i)(7) would have
allowed a nonprofit organization to hold an option to purchase
the property at a below-market price.10 S. 980, 101st Cong., 2d
10The 1989 amendments to § 42 were based in large part on
the recommendations of the Mitchell-Danforth Task Force on the
Low-Income Housing Tax Credit, which was formed to review the
LIHTC program and make recommendations for its improvement.
26
Sess. (1989) (§ 2[y] of proposed bill). However, this version
was rejected, apparently due to concerns that a below-market
purchase option would, in substance, render the nonprofit
organization the owner of the property and thereby run afoul of
traditional rules of tax law. See Kaye, Sheltering Social
Policy in the Tax Code: The Low-Income Housing Credit, 38 Vill.
L. Rev. 871, 893 (1993).11 Instead, Congress chose to enact a
safe harbor only for a right of first refusal. See Pub. L. No.
101-239, Title VII, Subtitle A, § 7108(q), 103 Stat. 2321
(1989).12 In so doing, Congress understood that a right of first
These recommendations became the basis for the Low-Income
Housing Tax Credit Act of 1989, S. 980, 101st Cong., 2d Sess.
(1989), which would have allowed nonprofit organizations to hold
a below-market option to purchase. See Kaye, Sheltering Social
Policy in the Tax Code: The Low-Income Housing Credit, 38 Vill.
L. Rev. 871, 883-885 (1993) (Kaye).
The proposed language would have amended § 42(i) to include
the following subsection (7): "[T]he determination of whether
any qualified low-income building is owned by the taxpayer shall
be made without regard to any option by a qualified nonprofit
organization . . . to acquire such building at less than fair
market value after the close of the compliance period . . . ."
S. 980, 101st Cong., 2d Sess. (1989) (§ 2[y] of proposed bill).
11Professor Tracy A. Kaye, who served as tax legislative
assistant to Senator John. C. Danforth, one of the leaders of
the Mitchell-Danforth Task Force, later explained the decision
to reject this initial version of § 42(i)(7), writing: "There
was congressional concern that the grant of a below-market
option . . . was a substantial enough relinquishment of one of
the benefits of ownership such that true ownership was at
issue." Kaye, supra at 871, 893.
12As originally enacted in 1989, § 42(i)(7) (then
§ 42[i][8]) allowed only tenants to hold a right of first
27
refusal -- in contrast to an option to purchase -- could not be
exercised unilaterally by the holder. In the accompanying House
committee report, the right of first refusal in § 42(i)(7) was
described as a right to "purchase the building, for a minimum
purchase price, should the owner decide to sell (at the end of
the compliance period)." H.R. Rep. No. 101-247, 101st Cong.,
1st Sess., at 1195 (1989). See Kaye, supra at 897 (Congress did
not give nonprofit organizations "the power to compel an
unwilling owner to sell"). Although in other contexts Congress
has abrogated the traditional rule that tax benefits must follow
ownership, in this case it chose not to make an exception. See
id. at 893-894.13
Section 42(i)(7) therefore represents a compromise,
facilitating the inexpensive transfer of property to nonprofit
organizations, but in a way that does the least violence to the
traditional rules of tax law. The right of first refusal
described in § 42(i)(7) is not a typical right of first refusal,
refusal. Pub. L. No. 101-239, Title VII, Subtitle A, § 7108(q),
103 Stat. 2321 (1989). Congress later amended the provision to
also allow tenant cooperatives, resident management
corporations, and qualified nonprofit organizations to hold a
right of first refusal. Pub. L. No. 101-508, Title XI, Subtitle
D, § 11407(b)(1), 104 Stat. 1388-402 (1990). See Pub. L. No.
101-508, Title XI, Subtitle G, § 11701(a)(10) 104 Stat. 1388-
507.
13In fact, Congress is currently considering an amendment
to § 42(i)(7) that would replace "a right of [first] refusal"
with "an option." S. 548, 115th Cong., 1st Sess., Title III,
§ 303 (2017).
28
for the obvious reason that it favors the nonprofit organization
with a statutorily prescribed, often below-market price. At
common law, a right of first refusal allows the holder to
purchase the property only by matching the price offered by a
third party. See Bortolotti, 449 Mass. at 201. In contrast, a
right of first refusal under § 42(i)(7) allows the holder to
purchase the property at the § 42 price, even if it is far below
the third-party offer. See Bortolotti, supra (distinguishing
between typical right of first refusal and "fixed price right of
first refusal"). Yet, a right of first refusal under § 42(i)(7)
is not completely unanchored from its common-law meaning. In
enacting § 42(i)(7), Congress relied on the common-law
distinction between an option to purchase, which can be
unilaterally exercised, and a right of first refusal, which
cannot. Congress specifically chose to allow one but not the
other, recognizing that a right of first refusal -- which cannot
be exercised until the owner decides to sell -- is for that very
reason a less serious curtailment on ownership rights.
With this statutory background in mind, we now turn to the
right of first refusal at issue here. It is important to
remember that, although § 42(i)(7) permits a nonprofit
organization to hold a right of first refusal, it does not
mandate such a right. Here, the parties specifically chose to
include a right of first refusal in the option agreement. It is
29
also important to note that the right of first refusal here is
even more generous to the holder than § 42(i)(7), because it
allows the nonprofit developer to acquire the property at a
price equal to the lesser of the § 42 price, the price offered
by the third party, and the market price. Consequently, in the
event that the third-party price or the market price is lower
than the § 42 price, the nonprofit developer can purchase the
property at the most favorable price.
1. Bona fide offer. The first issue we must consider is
whether the right of first refusal can only be triggered by a
bona fide offer. Although the agreements are silent on this
issue, we conclude that such a limitation would be inconsistent
with the statutory scheme of § 42 and with the specific terms of
the agreements. See Roy, 404 Mass. at 70 (term "right of first
refusal" understood to require bona fide offer "unless the
context of the agreement dictates otherwise"). Because a right
of first refusal granted under § 42(i)(7) -- like the one here -
- allows the nonprofit organization to purchase the property at
a below-market price, even if it is lower than the price offered
by the third party, it is difficult to imagine why a third party
would make a bona fide offer for the property, knowing that the
nonprofit organization has this right and is likely to exercise
it. See Bortolotti, 449 Mass. at 204 (fixed-price right of
refusal "would burden the property by discouraging bona fide
30
offers"). With a typical right of first refusal, a third party
can still prevail against the holder by overbidding -- that is,
by offering a price so high that it cannot be matched. But a
right of first refusal under § 42(i)(7) eliminates even that
possibility, because the holder need not match the third-party
price. To condition the right of first refusal on a bona fide
offer, then, would mean that it would almost never be triggered.
We decline to interpret the agreements in a way that would so
obviously contravene the purpose of § 42(i)(7). We therefore
conclude, as the judge did, that the right of first refusal here
need not be triggered by a bona fide offer, and requires only
that the partnership have received an enforceable offer from a
third party. See Roy, supra (right of first refusal not
triggered until "owner has received an enforceable offer"). We
also agree with the judge that there is nothing in the
agreements that bars the general partner from soliciting such
offers.
2. Partnership's decision to accept the offer. The second
issue we consider is whether, having received an offer from a
third party, the partnership must decide to accept that offer in
order for the nonprofit developer to exercise its right of first
refusal. Section 2 of the option agreement states that, before
the right of first refusal can be exercised, the partnership
must deliver to the nonprofit "notice of an offer to purchase"
31
from a third party. This disposition notice must state, among
other things, "whether the Partnership is willing to accept the
offer" (emphasis added). The judge interpreted this language to
mean that the partnership need not have decided to accept the
offer in order to trigger the right of first refusal. We
disagree with this interpretation because it effaces the common-
law distinction between a right of first refusal and an option
to purchase, which, as discussed, Congress relied upon when it
enacted § 42(i)(7). A right of first refusal cannot be
exercised unless the owner of the property (here, the
partnership) has decided to accept the third party's offer. The
decision to accept does not constitute an acceptance of the
offer -- it need not be communicated to the third party -- but a
decision must be made. See Roy, 404 Mass. at 71. This is why a
right of first refusal does not run afoul of traditional tax
principles, and why Congress chose to allow a right of first
refusal rather than an option to purchase. Where the agreement
was intended to operate "in accordance with" § 42(i)(7), we must
interpret its provisions consistently with Congressional intent,
and Congress intended for nonprofit organizations to exercise
their right of first refusal only when "the owner decide[s] to
sell." H.R. Rep. No. 101-247, supra at 1195. We therefore
conclude that the right of first refusal here cannot be
32
exercised unless the partnership decides to accept an offer from
a third party.14
3. Authority of the general partner to decide to accept
the offer. The third issue is whether the general partner has
the authority to decide to accept the third-party offer on
behalf of the partnership, without the limited partners'
consent. The limited partners contend that the general partner
does not have such authority, and that the special limited
partner must consent before the partnership can decide to accept
an offer or issue a disposition notice that would trigger the
right of first refusal. In effect, this would mean that the
nonprofit developer cannot exercise its right of first refusal
without the limited partners' consent. If this were the case,
one would expect that the limited partners would withhold their
consent unless they were willing to sell the property interest
at the § 42 price. But, if they were in fact willing to sell
the property interest at that price, they would have no reason
14While it is true that the disposition notice must state
"whether the Partnership is willing to accept the offer," not
that it is, we note that this is not the only instance where the
parties chose to use the word "whether," when the word "that"
would have been more appropriate. For example, section 4 of the
option agreement states that, in order to exercise its right of
first refusal, the nonprofit developer must issue a "Purchase
Notice" stating, among other things, "whether the [nonprofit
developer] intends to exercise the Right of First Refusal"
(emphasis added) -- even though there would be no need to issue
a "Purchase Notice" unless the nonprofit developer did, in fact,
intend to exercise the right.
33
to wait for a third-party offer to trigger the right of first
refusal; they could simply sell to the nonprofit developer at
that price. Consequently, if we were to interpret the right of
first refusal to require the consent of the special limited
partner, the nonprofit developer could be denied any meaningful
opportunity to acquire the property interest at the § 42 price.
In cases where the limited partners are unwilling to sell at the
§ 42 price, the nonprofit developer would be able to purchase
the property only by exercising its option to purchase at the
market price. Moreover, because both the right of first refusal
and the option to purchase were set to expire four years after
the end of the fifteen-year compliance period, the nonprofit
developer would have had to exercise its option to purchase
before then or lose the right to purchase the property interest
at any price without the consent of the special limited partner.
The limited partners contend that this is precisely what
was agreed to and expressed in the unambiguous language of the
agreements, which would mean that -- contrary to the
congressional intent behind § 42(i)(7), to facilitate the
inexpensive transfer of properties to nonprofit organizations --
the parties had negotiated an agreement that could bar the
nonprofit developer from ever purchasing the property at a
favorable price. But that is not what is reflected in the
language of the agreements.
34
As stated, the partnership agreement confers broad powers
on the general partner, while circumscribing the powers of the
limited partners. The partnership agreement identifies only a
few actions that the general partner cannot take without the
consent of the special limited partner. Of relevance here,
section 5.5.B(iv) prohibits the general partner from "sell[ing]
all or any portion" of the property, "except with the Consent of
the Special Limited Partner." This prohibition is "subject to
the provisions contained in Section 5.4," which grant the
general partner the authority to sell "all or substantially all
of the assets of the Partnership; provided, however, that except
for a sale pursuant to the Option Agreement, the terms of any
such sale . . . must receive the Consent of the Special Limited
Partner before such transaction shall be binding on the
Partnership."
The limited partners concede that, under section 5.4, the
special limited partner need not consent to the terms of a sale
if the sale is pursuant to the option agreement, for example
where the nonprofit developer has exercised its right of first
refusal. The limited partners nevertheless contend that the
special limited partner must consent to the terms of a sale if
the sale is to a third party, which is what triggers the right
of first refusal, before the general partner can issue a
disposition notice. But section 5.4 states only that the
35
special limited partner must consent to the terms of a sale
"before such transaction shall be binding on the Partnership."
As stated, the decision to accept a third-party offer does not
itself constitute an acceptance of the offer. Thus, the mere
issuance of a disposition notice does not bind the partnership
to sell to the third party or even to accept its offer if the
nonprofit developer were for some reason to fail to exercise its
right of first refusal. Section 5(a) of the option agreement
provides that, if the nonprofit developer fails to exercise its
right of first refusal, the partnership "may thereupon
consummate the sale to the [third party] upon the terms of the
offer" (emphasis added). Section 5(a) specifically recognizes
the possibility that the partnership will not consummate the
sale, and provides in such an event that the nonprofit
developer's right of first refusal would then apply to any
subsequent third-party offer. To be sure, the partnership could
not consummate a sale to a third party without the consent of
the special limited partner, but that does not mean that the
special limited partner must consent to the terms of an offer
before the disposition notice can be issued.
Because the issuance of the disposition notice does not
bind the partnership to sell to a third party, and because a
sale pursuant to the option agreement is specifically excluded
from the requirement of consent by the special limited partner,
36
we look to other provisions of the partnership agreement to see
if there is any restriction on the general partner's authority
to issue the disposition notice. The only relevant restriction
is contained in section 5.5.B(xv), which prohibits the general
partner from taking any action that would threaten the limited
partners' tax credits. In order to secure the tax credits, the
partnership must continue to own the property interest
throughout the compliance period. Moreover, the safe harbor
under § 42(i)(7) provides that the right of first refusal can be
exercised only "after the close of the compliance period." 26
U.S.C. § 42(i)(7)(A). Thus, although the option agreement
allows the nonprofit developer to exercise its right of first
refusal at any time during the first nineteen years of the
project, including during the compliance period, section
5.5.B(xv) effectively prohibits the general partner from
triggering that right during the compliance period. Once the
compliance period has ended, however, there is nothing in the
partnership agreement that restricts the general partner's
authority to issue a disposition notice, or that requires it to
obtain the consent of the special limited partner before issuing
such notice.
Examining the language of the agreements in their
statutory and practical context, we conclude that the general
partner is authorized to trigger the nonprofit developer's right
37
of first refusal by soliciting an enforceable offer from a third
party and, upon receipt of such an offer, issuing a disposition
notice if the general partner has decided, on behalf of the
partnership, to accept the offer. In reaching this conclusion,
we emphasize that we are only interpreting the language of the
agreements that the parties executed here. We are not declaring
that every partnership participating in the LIHTC program must
permit a right of first refusal that can be exercised under
these circumstances. We have stated that, unless otherwise
negotiated between the parties, a right of first refusal granted
in accordance with § 42(i)(7) can only be exercised, consistent
with congressional intent, when the owner of the property has
made a decision to accept an enforceable third-party offer.
Where the owner of the property is a limited partnership, how
the partnership makes that decision is a matter of contract.
The parties are of course free to negotiate a different
allocation of rights under their partnership agreement, or a
different mechanism for triggering the right of first refusal.15
15Of course, any such agreement would have to conform to
the requirements of § 42 and related regulations in order to
ensure the allowance of tax credits. The limited partners and
amici have suggested that, if a nonprofit organization were to
hold a right of first refusal that it could exercise
unilaterally, this would raise doubts about the ownership of the
property and potentially preclude the investor limited partners
from receiving their tax credits. We do not express a view as
to whether this is true. Our task here is to interpret the
38
For example, they may include language in their agreements
requiring the consent of the investor limited partners before
any right of first refusal is triggered.16 The parties here did
not include any such language in their agreements, and we must
enforce the language they chose.
We also note that we reach this conclusion without any
reference to the Reznick memorandum. Because our review of a
decision to grant summary judgment is de novo, we need not
determine whether the judge erred in considering that
memorandum. We recognize that a court may consider extrinsic
evidence only when the meaning of the contract is ambiguous,
because "extrinsic evidence cannot be used to contradict or
agreements before us, not to opine on the risk of unintended tax
implications.
16We doubt that parties will often negotiate such
provisions, because nonprofit developers will be reluctant to
accept provisions that would effectively deny them a meaningful
opportunity to acquire the property at a favorable price.
Moreover, it is usually in the investor limited partners'
economic interest to leave the project at the end of the
compliance period. The primary economic benefit to the limited
partners is in the form of tax credits, and most LIHTC
properties, because they are subject to long-term affordability
restrictions, have little residual value beyond debt. See J.
Khadduri, C. Climaco, & K. Burnett, United States Department of
Housing and Urban Development, What Happens to Low-Income
Housing Tax Credit Properties at Year 15 and Beyond?, at 31
(2012). Unsurprisingly, studies have shown that in the majority
of LIHTC projects, the limited partners willingly leave at the
end of the compliance period by transferring the property to the
general partner, often for little or no consideration over
outstanding debt. See id. at 29-31; Mittereder, Pushing the
Limits: Nonprofit Guarantees in LIHTC Joint Ventures, 22 J.
Affordable Hous. & Cmty. Dev. L. 79, 83 (2013).
39
change the written terms, but only to remove or to explain the
existing uncertainty or ambiguity." General Convention of the
New Jerusalem in the U.S. of Am., Inc. v. MacKenzie, 449 Mass.
832, 836 (2007).
Finally, we also conclude that the judge correctly granted
summary judgment to the plaintiffs on the defendants'
counterclaim alleging that the general partner committed a
breach of its fiduciary duty to the limited partners as well as
the implied covenant of good faith and fair dealing. Because
the contours of fiduciary duties are defined with reference to
the terms of the contract, there can be no claim for a breach of
fiduciary duty where a partner's "contested action falls
entirely within the scope of a contract" between the partners.
Fronk v. Fowler, 456 Mass. 317, 331-332 (2010), quoting Chokel
v. Genzyme Corp., 449 Mass. 272, 278 (2007). Nor can the
covenant of good faith and fair dealing "be invoked to create
rights and duties not otherwise provided for in the existing
contractual relationship." Uno Restaurants, Inc., 441 Mass. at
385. The only contested action here was the solicitation of an
offer from Madison Park and the issuance of the disposition
notice. Because the general partner was authorized to take
these actions under the terms of the agreements, we conclude
that these actions, without more, cannot constitute a breach of
40
fiduciary duty or of the covenant of good faith and fair
dealing.17
Conclusion. The judgment arising from the allowance of the
plaintiff's motion for summary judgment is affirmed.
So ordered.
17In so holding, we emphasize that the general partner here
sought to trigger the right of first refusal only so that the
nonprofit developer could purchase the property interest at a
price not less than the § 42 price. This was in line with the
parties' intention, which, as stated in the partnership
agreement, was for the purchase price under the option agreement
to be "the minimum price consistent with the requirements of [§]
42(i)(7)." However, the option agreement also allows the
nonprofit developer to purchase the property interest at the
price offered by the third party if it is lower than the § 42
price or the market price. Reading the option agreement in
isolation, this would mean that the general partner could
theoretically solicit a third-party offer at an artificially
discounted price, lower even than the § 42 price, and that the
nonprofit developer could then exercise its right of first
refusal at that discounted price. In such cases, the general
partner may be constrained by its fiduciary duty to the limited
partners. Here, however, there is no allegation that the offer
from Madison Park was artificially discounted. Moreover, the
nonprofit developer has stated that, in exercising its right of
first refusal, it intends to purchase the property interest by
assuming the total amount of outstanding debt, for an amount
that exceeds both Madison Park's offer and the § 42 price.