Strange Bedfellows

4 min read

Protecting the GP from new investors

Imagine that you woke up one morning, expecting to see the person whom you married 14 years ago lying in bed beside you and instead you found a brand new spouse. In a figurative sense, this is what has happened to some tax credit developers. They went to bed as the general partner in a tax credit partnership, comfortably associated with an investor limited partner they had known and done business with for years, and woke up attached to a new investor. All of the sudden, all of the implicit understandings, the myriad of “give-and-take” exchanges that guided how the GP has operated the project, and more importantly, what the GP can do going forward, have lost their meaning.

Most tax credit investment documents require developers to get consent from their investor partners for just about every substantive action they may wish to take.  In most instances, the requirement of investor consent makes perfect sense. The investor protects its substantial economic investment by staying apprised of actions that affect the partnership and exercising control over actions that may affect the investor’s interest. There is one case in which it makes just as much sense for a developer to have a reasonable consent right:  the assignment of partnership interests.

Most partnership agreements contain some variation on the following provision:  “The General Partners/Managing Member shall have no right…to sell, assign, transfer or encumber its Interest without the consent of the Investor.” Consent is often defined, usually required to be in writing and often coupled with words empowering the investor to grant or withhold consent “at its sole/absolute discretion.”  In other words, a General Partner can only transfer its interest if the investor agrees to it.

In contrast, transfers by the investor are usually permitted as of right, with language like, “Each Investor shall have the right to assign its Interest…without the consent of the General Partner/Managing Member.” Armed with that language, an investor can sell its interest to an entity that is not affiliated with the existing partnership and require the general partner to accept the transferee as the new investor partner.

This will rarely be an even trade. All developers are not equal and neither are investors. To developers’ great consternation, the differences among investors as to how they approach “Year 15” and exits is an ever-widening chasm. Some investors place a premium on continuing relationships; others emphasize short-term economic return, in part because there is no historic relationship between developer and investor. And, what if the new investor is an entity with which the General Partner/Managing Member has an unpleasant (or even litigious) history?

Investors insist on a consent right by telling the general partner “we made the deal with you.” But developers similarly made the investment deal with a specific “them.” Most developers negotiate the level of control they are willing to cede to the investor based on their specific relationship with that investor. Absent a prior relationship, a developer is unlikely to agree to the same terms with an investor that it would if it has done multiple deals with the same investor. Familiarity breeds trust in the tax credit marketplace.

Developers can mitigate the risk of waking up next to a new investor partner when they negotiate a partnership agreement. An appropriate balance between the consent rights of investors and developers can be reached by a combination of the following:

  1. Investors should have the ability to freely assign their interests to affiliates.
  1. Assignments by investors to non-affiliates should be subject to the consent of the General Partner/Managing Member not to be unreasonably withheld.
  1. If an Investor wishes to sell its interest to exit the partnership and/or make money, the General Partner/Managing Member should have a right of first refusal to buy what the investor is selling on the same terms as a third-party offeree.
  1. No transferee from the investor should have a right to force amendments to the partnership/operating agreement.

Carefully drafting provisions regarding assignments protects against the developer waking up in the morning to be told “hello, I am your new spouse and…”

For over 35 years, John has concentrated his practice in the development of real estate projects. While his clients have come from a broad range of diverse industries, most of John’s day-to-day representation involves housing. John’s clients have built, owned and/or managed hundreds of thousands of multi-family housing units, including housing for the men and women who serve in our armed forces. John has extensive experience in complicated financing structures including syndication of State and Federal Low Income Housing Tax Credits, State and Federal Historic Credits, New Market Tax Credits, Brownfields Credits, energy-related credits and other state credits. Working with owners, lenders investors, industry groups, as well as municipal, state, federal, governmental and regulatory agencies to obtain approvals and support for proposed developments, John’s skills and experience have earned him the reputation as a lawyer who “gets the deal done.” John currently serves on the Board of Directors of Preservation Massachusetts and the National Housing & Rehabilitation Association (NH&RA). He assisted in drafting laws and regulations dealing with affordable housing properties to better facilitate the advancement of his clients’ projects, including the preservation law, enacted in 2009, in the Commonwealth of Massachusetts (Chapter 40T – An Act Preserving Publicly-Assisted Affordable Housing). John continues to serve on the advisory committee which provides advice and recommendations relative to the implementation of Chapter 40T. He also serves, or has served, on the boards of a number of local community banks, hospitals and other social organizations.