Opinion ID: 803373
Heading Depth: 3
Heading Rank: 2

Heading: The Land Use Restriction Agreements

Text: In 2008, each of the Debtors entered into a land use restriction agreement (“LURA”) with the Kentucky Housing Corporation (“KHC”), the agency tasked with administering the federal lowincome housing tax credit program for the Commonwealth of Kentucky. The Debtors, and not their General Partners, administrative limited partners, or investor limited partners, entered into these LURAs as the owners of the properties. The LURAs entered into between the Debtors and the KHC in these cases provide that the restrictions set forth therein are covenants running with the land: Owner intends, declares and covenants, on behalf of itself and all future owners and operators of the Project during the term of this Agreement, that this Agreement and the covenants and restrictions set forth in this Agreement regulating and restricting the use, occupancy and transfer of the Project (i) shall be and are covenants running with the Project, encumbering the Project for the term of this Agreement, binding upon Owner’s successors in title and all subsequent owners and operators of the Project; (ii) are not merely personal covenants of Owner; . . . . (LURA § 2(b), Bankr. Case No. 10-53019, ECF Nos. 204-4, 204-8, 204-12, 204-16, and 204-20.) The LURAs further provide: (j) Subject to the requirements of Section 42 of the [Internal Revenue] Code and this Agreement, Owner may sell, transfer or exchange the entire Project at any time, but Owner shall notify in writing and obtain the agreement of any buyer or successor or other person acquiring the Project or any interest therein that such acquisition is subject to the requirements of this Agreement and the requirements of Section 42 of the Code and applicable regulations and the KHC Occupancy Restrictions. This provision shall not act to waive any other restriction on sale, transfer or exchange of the Project or any low-income portion of the Project. KHC may void any sale, transfer or exchange of the Project if the buyer or successor or other person fails to -5- assume in writing the requirements of this Agreement and the requirements of Section 42 of the Code. (k) Owner will notify KHC in writing of any sale, transfer or exchange of the entire Project or any low-income portion of the Project. (Id. at § 3(j) and (k).) Subject to limited exceptions not applicable here, the term of each LURA was for an initial compliance period of 15 years and then an additional 15 year extended period. (Id. at §§ 5(a) and 6(a).) As the lender for the construction and/or acquisition of the properties, the Bank was a party to each LURA. The sole purpose of making the Bank a party to the LURA was to subordinate the Bank’s debt to the restrictions contained within the LURA. All of the properties in this case were put into service in 2004 or 2005, and the tax credits have been used through 2010. As a result, there are 4 to 5 years of remaining tax credits and 24 to 25 years remaining on the rent restrictions. In accordance with 26 U.S.C. § 42(h)(6), the LURAs entered into between the Debtors and the KHC in this case provide as follows: THIS DECLARATION OF LAND USE RESTRICTIVE COVENANTS AND SUBORDINATION AGREEMENT, . . . [is] given by [each Debtor], a Kentucky limited partnership and its successors and assigns (“Owner”) . . . as a condition precedent to the allocation of Low Income Housing Tax Credits by KENTUCKY HOUSING CORPORATION . . . . (LURAs at 1, Bankr. Case No. 10-53019, ECF Nos. 204-4, 204-8, 204-12, 204-16 and 204-20.) Each LURA was recorded in the appropriate county recorder’s office. C. The Tax Credit Allocations and Partnership Agreements Once the KHC awarded and reserved the tax credits to each of the Debtors’ properties, the corresponding investor limited partner “syndicated the investment and tax credits opportunity to a pool of investors. Through the Investor LP, those investors then funded the ‘Investor Limited Partner Contribution’ in accordance with paragraph 3.4 of each Debtor’s Amended and Restated Agreement of Limited Partnership.” (Appellant Br. at 4.) All of the investments were made by the -6- investor limited partners in exchange for 99.98% of the equity ownership in the corresponding Limited Partnership. With respect to the tax credits, the partnership agreements provide as follows: [T]he Partners intend that Housing Tax Credits shall be allocated 99.98% to the Investor Limited Partner, 0.01% to the Administrative Limited [Partner] and 0.01% to the General Partner. (Amended and Restated Partnership Agreements at § 9.1(G)(v)(a), Bankr. Case No. 10-53019, ECF Nos. 214-1 through 214-15) (emphasis added.) In the event of a recapture of certain tax credits, then “Housing Tax Credits shall be recaptured by the Partners who originally claimed said Housing Tax Credits, in proportion to the ratio in which such recaptured Housing Tax Credits were claimed.” (Id. at § 9.1(G)(v)(b).) Section 6.6 of the Partnership Agreements also provides “[e]xcept for the Apartment Complex, the Housing Tax Credits, and the contractual rights referred to herein, the [Limited] Partnership [aka the Debtor] owns no other property, tangible or intangible, real or personal.” (Id. at § 6.6(A).) In the “Low Income Housing Tax Credit Certificate of Carryover Allocation” letters from KHC to the Debtors, KHC identifies the name of the “Taxpayer Receiving Allocations” as “Creekside Senior Apartments, Limited Partnership,” “Nicholasville Greens, Limited Partnership,” “Franklin Place Senior Apartments, Limited Partnership,” “Pennyrile Senior Apartments, Limited Partnership,” and “Park Row Senior Apartments, Limited Partnership.” (Tax Credit Letters, Bankr. Case No. 10-53019, ECF No. 204-29.) D. The Bankruptcy Cases The Debtors filed petitions for relief under chapter 11 of the Bankruptcy Code in September and October 2010. On January 10, 2011, the Bank filed proofs of claim as to each Debtor for the following amounts: 10-53019, Creekside: $1,2.72,589.36 10-53298, Nicholasville Greens: $7.14,857.43 10-53300, Franklin Place: $8.63,467.53 10-53301, Pennyrile: $4.66,294.67 10-53346, Park Row: $1,0. 7,461.15 3 -7- In each proof of claim, the Bank asserted that its claim was fully secured. On March 4, 2011, the Debtors and the General Partners filed a motion for a hearing to determine the value of the Bank’s secured claims pursuant to 11 U.S.C. § 506(a). The Debtors and the General Partners disputed the Bank’s assertion that each claim was fully secured and instead alleged that the claims were substantially undersecured. The Debtors and the General Partners further asserted that a valuation hearing was vital because “[t]he treatment of the secured and unsecured portions of the [Bank’s] Claims will be a critical component of the Debtors’ and the General Partners’ prospective plan.” (Mot. for Valuation Hr’g at 5, Bankr. Case No. 10-53019, ECF No. 164.) The Debtors filed their disclosure statement and plan on March 17, 2011. In Article IV, paragraph 4.1, the plan states that the Bank will have an allowed secured claim “equal to the fair market value of [the Bank’s] interest in the Estate’s interest in such Debtor’s Property as determined by the Court at the Valuation Hearing.” (Joint Plan of Reorganization” at ¶ 4.1, Bankr. Case No. 1053019, ECF No. 170.) Class 3 of the Debtors’ plan is comprised solely of the Bank’s allowed unsecured deficiency balance. The Debtors proposed to pay the Bank the “full principal amount of each of its Allowed Unsecured Claims” unless the Bank timely elected to be treated in accordance with the “Alternative Unsecured Claim Treatment.” (Id. at ¶ 4.3.) The Debtors and General Partners filed their First Amended Plan on August 11, 2011, which provided for the same treatment of the Bank’s claims as the original plan. On March 28, 2011, the bankruptcy court granted the Debtors’ request to schedule a valuation hearing. The bankruptcy court also set forth various deadlines for identifying expert witnesses, submission of written reports and/or appraisals, filing a list of witnesses, submission of testimony by affidavit, and other various pretrial issues. E. The Valuation Objection and Motion In Limine On July 25, 2011, the Debtors and its General Partners filed their Valuation Objection and Motion In Limine seeking to exclude portions of expert reports, the affidavit, and related testimony -8- of the Bank’s appraiser, David A. Donan. In their Valuation Objection, the Debtors argued that the valuation of the remaining tax credits in the Bank’s appraisals was critically flawed for three reasons. First, the Debtors alleged that the tax credits do not constitute property in which a security interest can be taken and, therefore, the credits are not part of the Bank’s collateral or its secured claims. Second, the Debtors asserted that the tax credits were held by the Debtors’ limited partners and not by the Debtors so the credits are not property of the Debtors’ estates. Last, the Debtors argued that the Bank’s loan and security documents failed to create a security interest in the tax credits “and, in fact, explicitly carve the Tax Credits out of the Bank’s collateral.” (Valuation Obj. at 1, Bankr. Case No. 10-53019, ECF No. 214.) In its brief on appeal, the Bank states, Bank of America has never stated that it does not hold a security interest in the Remaining Tax Credits. Bank of America has continuously maintained that whether it has a security interest in the Remaining Tax Credits themselves is irrelevant, as it holds a perfected security interest in the LIHTC real properties which cannot be separated from the Remaining Tax Credits for purposes of § 506 valuation. (Appellee Br. at 21, n.5.) A review of the pleadings filed in the bankruptcy court supports the Bank’s assertion. Additionally, the mortgage documents provide that the Bank’s security interest includes: (j) To the extent not expressly prohibited by law or not inconsistent with the terms of the Partnership Agreement, all federal, state, and local tax credits, and other tax benefits related to the Property . . . . (Construction Phase Mortgage at 3, ¶1.1(j), Bankr. Case No. 10-53019, ECF Nos. 214-16, 214-18, 214-20, 214-22, and 214-24.) In their Motion In Limine, the Debtors argued that the bankruptcy court should exclude those portions of David Donan’s reports, affidavit, and related testimony which purport to include the value of the remaining low-income housing tax credits in the value of the Bank’s collateral. The Debtors alleged that those portions of Donan’s evidence “are not based on sufficient facts and data, are not based on and do not conform to accepted principles and methodologies in the industry, and are therefore not reliable.” (Mem. in Support of Mot. In Limine at 5, Bankr. Case No. 10-53019, ECF No. 215-1.) The Debtors also alleged that the testimony relating to the value of the remaining tax credits was irrelevant. -9- In response, the Bank argued that the value of the remaining tax credits was relevant to the valuation of its interest in the Debtors’ real properties for several reasons. First, the Bank alleged that 28 U.S.C. § 47(d)(7)(A)(ii) clearly provides that federal low-income housing tax credits cannot be separated from ownership of the LIHTC properties, and that once the property is sold the purchaser obtains the right to claim the remaining tax credits. As a result, the Bank argued the value of the remaining tax credits significantly impacts the price a willing buyer would pay to obtain the LIHTC properties at issue in this case. The Bank also alleged that excluding consideration of the value of the remaining low-income housing tax credits while including consideration of the impact the low-income rent restrictions on the value of the properties would lead to an “absurd result.” (Resp. to Obj. and Mot. In Limine at 1-2, Bankr. Case No. 10-53019, ECF No. 228.) Finally, the Bank asserted that the Debtors’ arguments “incorrectly attempt[] to divert the Court’s attention to whether security interests in the Remaining Tax Credits themselves are obtainable, as opposed to the real issue of § 506 valuation of [the Bank’s] security interest in the Debtors’ LIHTC real property and the impact the Remaining Tax Credits that go with the property have on value.” (Mem. of Law in Support of Bank’s Resp.to Obj. at 5-6, Bankr. Case No. 10-53019, ECF No. 229.) On August 15, 2011, the bankruptcy court overruled the Debtors’ Valuation Objection and Motion In Limine and held that evidence of the remaining tax credits was relevant to the issue of valuation (“In Limine Order”). The bankruptcy court also held that the Debtors’ arguments really went “to the weight of the evidence, not to its reliability.” The bankruptcy court observed that, as the trier of fact, it could determine the proper weight to give the evidence of the value of the remaining tax credits at the valuation hearing. (Id.) In overruling the Debtors’ Valuation Objection and Motion In Limine, the bankruptcy court stated: It is uncontroverted that the Bank holds a first mortgage on each Debtor’s LIHTC Property. It is further uncontroverted that each of those parcels of real estate is subject to a Land Use Restriction Agreement (“LURA”) entered into between the Debtor entity as “Owner” (not the individual limited partners) and the Kentucky Housing Corporation (“KHC”). It is through the LURA that the Debtor entities became entitled to the Tax Credits and each Debtor’s LIHTC Property became subject to the rent restrictions. The limited partners may have become entitled to the allocation of the Tax Credits through the respective partnership agreements, but they did not become the owners of the Tax Credits through those agreements. Both the -10- rent restrictions and the Tax Credits run with the land. Therefore, if the LIHTC Property is sold prior to the end of the compliance period and there are remaining tax credits, then [T]he credit allowable . . . to the taxpayer for any period after such acquisition shall be equal to the amount of credit which would have been allowable . . . for such period to the prior owner . . . had such owner not disposed of the building. 26 U.S.C. § 42(d)(7)(A)(ii) (emphasis added). This provision makes it clear that the limited partners do not own the Remaining Tax Credits. Those credits would be transferred to the purchaser of the Debtors’ LIHTC Properties. As such, the Remaining Tax Credits as well as the rent restrictions would affect the price any purchaser was willing to pay for the Debtors’ LIHTC Properties; and thus, their respective values. (In Limine Order at 4-5 and 8, Bankr. Case No. 10-53019, ECF No. 235.) F. The Valuation Hearing and Bankruptcy Court Determination The bankruptcy court conducted the valuation hearing on August 18, 2011. The Debtors’ appraiser and the Bank’s appraiser both appeared at the hearing. The Bank’s appraisals included a valuation of the respective properties and a separate valuation of the remaining tax credits prepared by its expert witness and appraiser, David A. Donan of Allgeier Company. The values placed on the Debtors’ properties by the Bank’s appraiser were as follows: LIHTC Property Bank’s Real Bank’s Tax Bank’s Total Value Estate Value Credit Value Creekside Senior Apartments $890,000 $350,000 $1,240,000.00 Nicholasville Greens Townhomes $495,000 $160,000 $655,000.00 Franklin Place Senior Apartments $535,000 $445,000 $980,000.00 Pennyrile Senior Apartments $575,000 $755,000 $1,330,000.00 Park Row Senior Apartments $825,000 $865,000 $1,690,000.00 (Valuation Order at 14, Bankr. Case No. 10-53019, ECF No. 252.) -11- Debtors’ appraisals, prepared by its expert witness and appraiser, Brad Weinberg of Novogradac & Company, LLC, were as follows: LIHTC Property Debtors’ Total Value Creekside Senior Apartments $593,000.00 Nicholasville Greens Townhomes $425,000.00 Franklin Place Senior Apartments $274,000.00 Pennyrile Senior Apartments $398,000.00 Park Row Senior Apartments $750,000.00 (Valuation Order at 14, Bankr. Case No. 10-53019, ECF No. 252.) Like the Bank’s appraiser, the Debtors’ appraiser considered the impact the restricted rents have on the properties’ values. (See Market Valuations at 3, Bankr. Case No. 10-53019, ECF Nos. 207-1, 207-3, 207-6, 207-8, 207-10.) Despite this similarity, the Debtors’ appraisals specifically excluded the valuation of the remaining tax credits because the Debtors “believed, and continue to believe, that the remaining Tax Credits are irrelevant to the valuation of the Bank’s secured claims, since the Tax Credits are not part of the Bank’s collateral.” (Appellant Br. at 7.) Both appraisers testified that the availability of remaining low-income housing tax credits can affect the value of a piece of property. The Bank’s appraiser included the value of the remaining tax credits as a component in his determination of the value of the properties; however, the Debtors’ appraiser stated that he did not include any consideration of the remaining tax credits in his appraisal because “under the scope of work my appraisal was of the real property only, that was the collateral for the basis of the bankruptcy and that was defined for me, and I – I completed the appraisal on that basis.” (Aug. 18, 2011 Tr. of H’rg at 72, Bankr. Case No. 10-53019, ECF No. 258.) When asked by counsel for the Debtors whether he thought there was a market for the sale of mid-stream tax credits associated with small properties in small, non-money center banking markets, the Debtors’ appraiser testified that his opinion was “no.” (Id. at 141-143.) The Bank’s appraiser disputed this conclusion and instead stated that the market for tax credits is “extremely busy” at the present time. (Id. at 174.) -12- The bankruptcy court issued a Valuation Order on September 12, 2011. In that order, the bankruptcy court weighed the two appraisals and arrived at values for the Debtors’ properties. In so doing, the bankruptcy court concluded that the Bank’s appraisals more accurately reflected the true value of the Debtors’ properties. The bankruptcy court recognized that “[b]oth appraisers stated substantially the same formula for calculating market value under the income capitalization method” although they disagreed on how each component of that formula was derived. (Valuation Order at 13, Bankr. Case No. 10-53019, ECF No. 252.) As to the vacancy and collection loss rate (“VCLR”), the Debtors’ appraiser stated that a minimum of 5% is the industry standard. (Aug. 18, 2011 Tr. of H’rg at 17, Bankr. Case No. 1053019, ECF No. 258.) The Debtors’ appraiser also pointed out that “while historical performance is important, lenders and buyers recognize that conditions can change over the life of the loan and simply will not factor in a vacancy and loss rate of less than 5%, in order to be conservative.” (Appellant Br. at 35.) The Bank’s appraiser, on the other hand, based his VCLRs on the historically low vacancy rates for most of Debtors’ LIHTC properties. With the exception of Nicholasville Greens, all of the Debtors’ properties had waiting lists at the time of the Bank’s appraisals. The bankruptcy court analyzed the VCLR for each property and concluded as follows: LIHTC Property Debtors’ Bank’s VCLR Bankruptcy Court’s conclusion VCLR Creekside 5% 3% 3%; based on historical vacancy rate, existing waiting list, and vacancy rates of comparable LIHTC properties Franklin Place 6% 3% 3%; (same as Creekside) Nicholasville Greens 9% 11% 11%; composed of 9% vacancy loss and 2% collection loss Pennyrile 5% 3% 3%; (same as Creekside) Park Row–residential 4% 2.5% 2.5%; based on average historical vacancy rate of 2.45% for 2008 - 2010 -13- Park Row–commercial 10% 15% 15%; one of two commercial units would have to be built-out for light and heat prior to being rented (Valuation Order at 15-17.) The parties disagreed on two other figures used in determining the proper value of the Debtors’ properties. First, although the parties agreed that a management fee based on 5% of effective gross income was the proper measure for 4 of the 5 properties, they did not agree on that percentage for Nicholasville Greens. Instead, the Debtors’ appraiser calculated a management fee of 4% of effective gross income, while the Bank’s appraiser used a management fee of 5%. Because the management fee for Nicholasville Greens averaged 4.875% over the last four years, the bankruptcy court used the Bank’s figure of 5%. (Id. at 17.) Second, the parties disagreed as to the proper real estate tax expense to use in valuing the Debtors’ properties. Although both appraisers stated “that the Debtors’ real estate taxes were significantly higher than they should be as reflected by comparable LIHTC Properties,” the bankruptcy court concluded that only “[t]he Bank’s Appraiser reduced the real estate tax expense to an amount that would be consistent with his opinion of the market value of the Debtors’ real estate for each particular LIHTC Property before any adjustments for the Remaining Tax Credit Value.” (Id. at 18-19.) The Debtors’ appraiser only reduced the expense for three of the five properties. The bankruptcy court found the Bank’s appraiser’s testimony “that a fair market purchaser will consider the effect of the purchase price on future property taxes in his decision regarding the value of (and thus price to pay for) the property” to be more credible. (Id. at 19.) However, because the Bank’s appraiser failed to complete all of the necessary “calculation[s] once the effect of the Remaining Tax Credits was included in his opinion of fair market value, . . . the Court adjusted the real estate tax component . . . to arrive at the annual real estate tax that is consistent with the Court’s findings regarding the fair market value of each property.” (Id.) The bankruptcy court used the assessment rates set forth in the Bank’s appraisals in order to do these calculations since the Bank’s appraisals contained the most current information. (Id. at 19, n. 14.) -14- Turning to the issue of the remaining tax credits, the bankruptcy court stated: The Remaining Tax Credits are not being valued as if they are being sold. As previously held, the Remaining Tax Credits cannot be separated from the Debtors’ LIHTC Properties and sold separately. . . . “Although market participants often talk casually about “selling” the tax credits, they are actually referring to selling a partial ownership interest in the entity that owns the real estate. The tax credits themselves cannot be severed from the ownership of the real estate.” Appraising Low-Income Housing Tax Credit Real Estate, 10/1/10 APPRAISAL J. 350 (emphasis added). .... . . . Debtors chose to ignore the fact [that] the Remaining Tax Credits impact the value of the property, are owned by the Debtors and that any rights/benefit/burdens of the Remaining Tax Credits which inure to the limited partners do so only as a result of their ownership/partnership interests in the Debtors. If the LIHTC Properties are sold, all proceeds of a sale belong to the respective Debtor with any benefits of the Remaining Tax Credits flowing through the new entity to the owners of that new entity. (Id. at 20-22.) Because the Bank “provided the only detailed, substantiated evidence of the impact of the Remaining Tax Credits on the market value of the Debtors’ LIHTC Properties,” the bankruptcy court included the value of the remaining tax credits in its § 506(a) valuation of the Debtors’ property. (Id.) After considering all the evidence, the bankruptcy court set the following values for the Debtors’ real properties: LIHTC Property Value of Real Value of Tax Total Value Estate Credits Creekside Senior Apartments $708,718.67 $350,000 $1,058,718.67 Nicholasville Greens Townhomes $307,475.86 $160,000 $467,475.86 Franklin Place Senior Apartments $371,244.42 $445,000 $816,244.42 Pennyrile Senior Apartments $446,188.44 $755,000 $1,201,188.44 Park Row Senior Apartments $727,427,01 $865,000 $1,592,427.01 -15- (Id. at 23-28.) After the valuation hearing, but prior to entry of the Valuation Order, the Debtors and their General Partners had filed a notice of appeal and a motion for leave to appeal the bankruptcy court’s In Limine Order as it related to the Debtors’ Valuation Objection. On September 26, 2011, the Debtors and General Partners filed an amended notice of appeal to include an appeal of the bankruptcy court’s Valuation Order. This appeal was timely.