In Historic Boardwalk Hall, LLC, New Jersey Sports and Exposition Authority, Tax Matters Partner v. Commissioner of Internal Revenue, the U.S. Court of Appeals for the Third Circuit invalidated the allocation of federal historic tax credits (HTCs) to the tax credit investor, calling into question long-standing, industry-standard syndication structures for not only HTCs but also low-income housing tax credits (LIHTCs) and other federal tax credit programs. The decision has potentially far-reaching effects because the court held that the tax credit investor was not a true partner for tax purposes in the limited liability company owning the convention center (the “Owner”).
The HTC syndication at issue in the Third Circuit’s opinion stems from the rehabilitation of an Atlantic City convention center (known as East Hall) and appears to have played out along fairly standard industry lines. After being approached by a tax credit consultant on the East Hall project, the project’s sponsor, the New Jersey Sports and Exhibition Authority (the “Sponsor”), decided to raise additional funds through an HTC syndication. A large corporate tax credit investor (the “Investor”) agreed to make a capital contribution to the Owner, in return for a 99.99% membership interest (including a 3% preferred return) in the Owner and an allocation of the underlying HTCs. The Investor was obligated to make its capital contributions based on the achievement of progress milestones, while the Sponsor provided construction completion, operating deficit, environmental and tax credit recapture guarantees. In due diligence, projections demonstrated non-tax economic returns to the Investor, although the court did note that some of the assumptions were overly optimistic and, in practice, the Owner ran substantial operating deficits.
The Investor could exit the Owner under various option arrangements. If the HTC syndication went to its full five-year term as contemplated, then, under the exit put/call option (secured by a guaranteed investment contract), the Investor would receive (under either the put or the call leg) for its Owner membership interest the greater of fair market value of, or any unpaid preferred return on the membership interest. If there were a material Owner default or a managerial deadlock prior to the full five-year term, then the Investor could put (in the event of a material default) or be bought out (in the event of deadlock) for an amount equal to the then-present value of any yet-to-be realized projected tax benefits and cash distributions due to the Investor through the end of the five-year tax credit recapture period.
The court noted that the Owner did not need the Investor’s capital contribution to complete the East Hall rehabilitation. Most of the Investor’s capital contribution was used to pay a developer fee to the Sponsor. This developer fee became part of the syndication package once it was determined that the Investor’s capital contribution, together with the preexisting financing sources, would generate funds in excess of the initially contemplated construction cost.
The Court’s Analysis
Based on the bundle of downside protections, guarantees and buyout arrangements, the court ruled that the Investor was not a true partner for tax purposes in the Owner. The various contractual relationships interwoven into the overall syndication structure severed the Investor from risks and rewards of the Owner’s construction and operation of the East Hall real estate. In reaching this conclusion, the court relied on the following factors:
Historic Boardwalk Hall, LLC raises doubt about the current syndication structures used to offer tax credits to equity investors. The result in this case raises some difficult questions, including the following: