July 1, 1996 PRESERVATION LETTER NO. 8 MEMORANDUM FOR: DIRECTORS OF HOUSING MULTIFAMILY HOUSING DIRECTORS MULTIFAMILY PRODUCTION CHIEFS MULTIFAMILY ASSET MANAGEMENT CHIEFS PRESERVATION COORDINATORS /s/ FROM: Nicolas P. Retsinas, Assistant Secretary for Housing - Federal Housing Commissioner, H SUBJECT: Definition and Review of a Related Party under the Low- Income Housing Preservation and Resident Homeownership Act of 1990 Section 231 (c) of the Low-Income Housing Preservation and Resident Homeownership Act of 1990 (LIHPRHA) describes what is generally referred to as the "related party" rule. The related party rule is relevant in a sales transaction when the current owner of a LIHPRHA-eligible project proposes to transfer ownership of its project to another party. The related party rule in Section 231 (c) was created to assure that legitimate, independent nonprofits would have special purchase rights while preventing for-profit owners from setting up sham nonprofits for the purpose of buying back their own projects in pre-arranged sales transactions between related entities. In the current environment where sales to nonprofits are a very high priority for funding in the Fiscal Year 1996 LIHPRHA program, the Department is concerned that field office staffs and program participants are reminded of the statutory requirement and that field offices pay particular attention to the review of this aspect of a sales transaction very closely. To that end, the following guidance is offered. I. WHAT IS A RELATED PARTY/ THE RELATED PARTY RULE Definition. Except as outlined below, the related party rule generally prohibits direct or indirect, whole or partial control or ownership, or any financial interest between the owner of a LIHPRHA-eligible project and a purchaser. Section 231 (c) of LIHPRHA defines "related party" as follows: o Except as provided in subsection (d) [management exception], the terms "qualified purchaser" and "priority purchaser" do not include any entity that, either directly or indirectly, is wholly or partially owned or controlled by the owner of the housing being transferred under this subtitle, is under whole or partial common control with such owner, or has any financial interest in such owner, or has any financial interest in such owner or in which such owner has any financial interest. The Secretary shall issue regulations appropriate to implement the preceding sentence. Prohibition against financial interest. Examples: there can be: a. no common stock ownership between the owner and a purchaser; b. no loans between the owner and a purchaser, except as provided for in 24 CFR Section 248.101 (related party definition), and c. no donation of funds between the owner and the purchaser, except that nonprofit owners who were involved in developing the eligible low-income housing shall not be prohibited from buying out the interest of its limited dividend or for- profit partners in connection with the sale of such housing under LIHPRHA as long as the sale is made on an arms length basis and the partners who sell their interest completely divest themselves of any input in the continued operation of the project. Prohibition against direct or indirect, whole or partial, ownership or control. Examples: there can be: a. no voting common board members between the owner and purchaser; b. no general or limited partner, shareholder, director with voting rights or compensation, officer, employee or authorized representative in common between the owner and a purchaser, and, c. no general or limited partner, shareholder, director with voting rights or compensation, officer, employee or authorized representative of the owner or purchaser can directly or through one or more intermediaries control or influence the decisions or policies of the other, except that the definition of "related party" under the regulations [24 CFR Section 248.101] permits owners and former owners to be members of the board of directors of nonprofit purchasers as long as the owners and former owners are nonvoting members, sit in their personal capacity and do not receive any compensation for their board membership. Examples are illustrations. The examples provided above are for illustrative purposes only and are not intended to be an exhaustive list of the elements that may trigger the related party rule. As questions arise regarding whether an interest triggers the related party rule, you should consult with your local counsel or with members of the Headquarters Preservation staff. II. THE POINT OF APPLICABILITY OF THE RELATED PARTY RULE IN THE LIHPHRA PROCESS Relevance of Point in Time. In determining whether a super priority, priority or qualified purchaser is a related party to the seller, the point in time at which the parties divested their mutual interests is essential. This point of reference is very useful in cases where the purchaser and the seller were once related parties and now assert they are no longer related parties. There has been some confusion among owners and prospective purchasers of Preservation-eligible projects and field offices regarding the point in time related parties must have divested their mutual interest. As a result, the guidance provided below shall be used in making the determination whether purchasers are qualified to purchase a Preservation-eligible project. Purchaser's Responsibility. 24 CFR Section 248.157(e)(1) requires a purchaser to submit to HUD, "a statement identifying the priority purchaser as a State or local government agency, a nonprofit organization or a resident council." This statement is required to accompany the purchaser's Expression of Interest (EOI). To make such a statement, the purchaser must assess its status pursuant to the definition of a priority purchaser which states, in part, "an entity that is not a related party to the owner . . ." and should describe any current or past affiliations it has or may have had with the owner. HUD's Responsibility. 24 CFR Section 248.157(f) of the regulations requires the Department to establish the priority status of purchasers within 30 days of the submission of the EOI. Specifically, HUD must advise the purchaser as to whether it qualifies as a resident council, community-based nonprofit organization or State or local government and in so doing, must assess whether or not the purchaser and owner are related parties. What happens if the determination was not made at the EOI stage. It has come to our attention that some purchasers have failed to submit the required information regarding their priority status and or that Field Offices have not been reviewing purchasers' status to determine whether they are eligible purchasers under the related party rule. For such transactions, where the determination of priority status was not made at the EOI stage, the Department hereby makes a finding, pursuant to 24 CFR Section 248.7, that good cause exists to waive 24 CFR Section 248.157(f) to the extent necessary to permit field offices to determine the purchaser's priority status at the submission of the Bona Fide Offer (BFO) stage for purchasers that have already submitted an EOI and the 30-day review process has elapsed. The waiver of Section 248.157(f) is necessary due to inconsistent application by field offices of the review process and to prevent inequitable treatment of program participants who, nevertheless, were approved to proceed to the BFO stage of the sales process. Divestment. To prevent program participants from being unfairly penalized but to comply with the related party rule under Section 231(c) of LIHPRHA, the Department will permit purchasers who were related parties to an owning entity, but who divested that interest prior to the submission of the BFO, to continue with processing for incentives. Therefore, for purchasers who have already submitted an EOI to the field office and the field office has approved such purchasers to negotiate with owners for the purchase of a Preservation-eligible project, the field office should determine whether the seller and the purchaser divested any mutual interest prior to the submission of the BFO by the purchaser to the field office. If the divestment did not occur prior to the submission of the BFO, the purchaser is considered a related party and does not qualify as a priority purchaser. III. RULES FOR TRANSACTIONS WHERE EOI HAS NOT BEEN SUBMITTED OR HUD HAS NOT COMPLETED REVIEW OF THE EOI On a going forward basis for transactions where the EOI has not yet been submitted or HUD s review of the EOI has not yet been completed, purchasers and field offices should follow the provisions in Sections 248.157 (e) and (f) of the regulations. At the time prospective purchasers submit an EOI, the field office should, within 30 days from the submission, determine whether the purchaser and the seller are related parties. If the parties are related, the purchaser does not qualify as a priority purchaser. Questions regarding the foregoing may be directed to the Preservation staff at 202-708-2300.