Remarks by:
Jeff H. Eckland, Esq.
Faegre & Benson, LLP
Minneapolis, MN
612.766.7060
www.faegre.com
THE PROGRESS OF THE LITIGATIONI am going to talk
about the state of the litigation, Franconia Assoc. vs. U.S. It is good — in fact, much better than I ever dreamed it would be at this point. Those of you who first heard me speak, all the way back in 1996, might recall I kind of predicted that, given that this kind of litigation averages at least ten years, Franconia would probably last on the short term seven years to a long term of fifteen years.
Here we are after only six years, and I never thought we would be in as good a position now as we are. There are several reasons for that.
As you know, we got the Supreme Court decision on June 10, 2002. I’ve been thinking the last few weeks, not only about the litigation, but about other things that have happened: proposed prepayment legislation, both versions over the past three or four years, and the new line of cases coming out of the Federal District Courts in Idaho — one is called Kimberly Associates, another Atwood Leisure — and also about some movement on the tenant front. There’s been a lot of opposition by the tenant groups to various issues and proposed legislation over the years.
There’s a very complicated mix of things going on. I thought I’d give you some perspective on what I’ve learned through the litigation, what I think are the issues that everyone will be looking at over the course of the next year. I’m not going to make any prognostications.
ELIHPAA little history. The first major decision we had in our litigation was in our first filed case, Adams v. U.S. To put everything in perspective, most of you understand that our litigation is the result of the Congressional abolition of your unrestricted prepayment rights. That first happened in 1988 when Congress passed the Emergency Low-Income Housing Preservation Act, which we fondly know as ELIHPA.
The effects of ELIHPA were to prevent owners from prepaying at their own option and at their own desired time. What that has meant is that on the date the owner intended to prepay (which the owner can no longer do until the maturation date of the mortgage, which is 40 or 50 years after the closing date of the project) that owner will be unable to raise the rents. That has a dramatic impact on the income-earning potential of the property. The owner cannot take the property to market and cannot earn fair market rents as long as it is participating in the low income housing program.
Lost IncomeOur cases are designed to compensate the owners for that lost income — to pay them, in other words, for the lost profits from the date that they would have prepaid until the date at the end of the mortgage when, in the normal course of events, they would finish their final installment. However, although the case is designed to ensure owners that compensation, a victory in the case will not get the owners out of the program.
In fact, because of ELIHPA and other related legislation, we in essence conceded in the Supreme Court, and we concede now, that the owners (unless something changes legislatively) will continue and are obligated to continue running the projects within 515 and to continue to house low income tenants for up to a total of 40 or 50 years. These cases, if we win at trial, will mean that the owners will be compensated for doing that.
We tried to win automatically before our trial in our first filed case. The judge in that case denied our motion for summary judgment, which means we ultimately need to go to trial; we cannot automatically win short of trial. The judge ruled against our motion for summary judgment on one of the sovereign immunities the government is entitled to raise in cases such as this. I won’t get into detail on the immunity issues, although they are important for liability. Suffice it to say, in one case or another (and we have five cases so far) each of these sovereign immunities has been soundly rejected by the Court.
Sovereign ImmunityMany people don’t remember that in Adams in 1998 Judge Horn rejected the first and probably most significant of these sovereign immunities, namely, the sovereign act immunity. Judge Horn recognized that the sovereign act defense does not apply in our case because the government has been improperly targeting the 515 contracts in an effort to save money. By compelling owners to continue housing low-income tenants for a total of 40 to 50 years, the Federal Government has saved significant amounts of money by not having to build new construction and not having to fund any form of voucher program to protect the tenants. Instead they compelled the current owners to continue housing the tenants in the current housing stock.
This was the silver lining in the Adams case. Several years later this case is still very significant for us, in large part because the Ninth Circuit Federal Court of Appeals ruled in late 2001 (in a case called Kimberly Associates) that, just as Judge Horn said in Adams, the sovereign act defense does not apply. That means that these cases are ripe for damage analysis. We don’t have to worry about this sovereign immunity.
Similarly, early last year, before the Supreme Court decided to take our case, the Chief Judge of the trial court we’re in rejected a second defense that the government raised in our case, another sovereign immunity defense related to the sovereign act defense, technically known as the unmistakability doctrine.
Three other nice things have grown out of the Grass Valley case. One is a recognition that the government has an obligation even when they pass laws to compensate contract holders harmed as a result of those laws. In the specific context of our cases, the Courts have recognized that where the owners are stuck now with an 8% return on their investment, which results in a very modest average of $4,000 to $5,000 a year, that that is a horrendous long term investment. Most owners would not have signed up for this program knowing that in the long term their return would be limited to this 8% plus the tax benefits which expired after 15 to 17 years. There had to be something else involved. That was the prepayment right.
Prepayment Right: MaterialThe Grass Valley court has also recognized — and this is very significant for the upcoming trials — that the prepayment right was a material contract term. Again, the owners would not have entered into their contracts if they didn’t have the prepayment right.
The Supreme Court indirectly has recognized all of this. The actual merits of the case were not specifically addressed by the Justices, but it is clear at least that the unmistakability doctrine was argued by both parties to the case. It was the first thing the Deputy Solicitor General who argued the case in front of the Supreme Court raised during oral argument. Franconia has been cited since it was decided for the proposition, not only that the cases that were involved here were improperly dismissed by the courts as being untimely — the Court said no, they’re not untimely and they can all proceed to trial — but the Court quite clearly, I think, recognized that the unmistakability doctrine does not apply in this case. The Opinion is almost as good for us on that score as the Kimberly Associates Opinion from the Ninth Circuit.
Ticking Clock? What the Supreme Court recognized in large part is that our contracts should be enforced just as contracts between private citizens are in fact enforced. The technical hold in the case involves the six year deadline for bringing the suit, which is still very important for any owner considering bringing a lawsuit. The six year period of time, according to the Supreme Court, begins to run when a prepayment request is rejected, or in the absence of any actual request having been made by an owner, on the 20 year anniversary. Let’s say you’re a post-1979 owner and you haven’t come up to your 20 year anniversary yet. You’re thinking about prepaying but you haven’t yet. Please know that the deadline has not started yet — post-1979s don’t have to worry about the deadline, the earliest they could start is 1999 because that’s 20 years from 1979. But for any pre-1979 owner, please know that the clock might be ticking. Time can be of the essence in deciding whether or not to bring a suit.
We are primed and ready for our first trial scheduled for April 22 in Des Moines, Iowa. The case has 41 projects. We have approximately 18 witnesses. The government has a handful of witnesses, I think three or four. The case is expected to last about three weeks. We are engaged in the final stages of defending depositions that the government is taking among our various clients. In fact, I was in Sioux Falls and will be in North Carolina for additional depositions. We don’t expect the trial date to slip much. It might slip in the last stages here by a few weeks or so, but I anticipate the trial will still go forward in spring 2003.
If anybody is interested in coming to the trial in Des Moines, please feel free to do so. Call us for more information.
Because of these decisions that I’ve just summarized, the case is largely a damages case. We will submit our proof on the contract and on some other issues in the case, but the focus of the lawyers’ examinations and of the witnesses, and the biggest task for the judge, is to calculate the amount of damages involved: How much have the owners lost by being unable to prepay their projects and go to market?
Damage EstimatesOur current damage estimates result in a range, depending upon various circumstances. In a typical 24-unit project, depending on the various factors, the damages for one project could range from a low of about $240,000 to as much as $720,000 or more. In Des Moines, for example, where we will try about 40 projects, we estimate the damages could approach as much as $30 million. Of course damage claims are smaller for smaller projects and larger for larger projects.
So the damages are large. If you take the 24% or 25% of the projects nationwide that have been estimated would prepay if they could prepay (there may be some difference of opinion on that figure, but I think it’s close), if you translate the number of projects by that figure nationwide and use our damage formula on that 24% to 25% nationwide, you get a very large number for the potential damages facing the Agency — somewhere in the vicinity of $1 billion.
This is the tip of the iceberg, the first of five cases that are coming up to trial. We may have our second case tried as early as late this year or early next year. We are very excited about them. We expect to win. We expect to win big.
Possible Solutions?I want to take you through the history of the program up to where we are today, and touch on the way on what I think the intent of the program was from the beginning, what has happened to it in the interim, and what some of these proposed solutions floating out there mean for the program.
The 515 program was generated back in the early Sixties. In 1962 the Housing Act of 1949 was amended to provide for the 515 program, accompanied by the prepayment right. What would happen is Congress was appropriating to the FmHA Agency and the money was loaned to owners, who along with very modest down payments of a middle range of five figures would develop the low income housing. The government at that time could have gone to some form of Vouchers, I assume, but I don’t think Housing Vouchers were on many people’s minds in the Sixties.
You either house tenants by permitting them to live where they currently live or by constructing new housing. One of the issues involved in the early days was that nonprofits and public agencies were really the only entities the government could get interested in building affordable housing. The 515 program was unique in the early Sixties in that it designed the prepayment right which was intended to attract private investors into the program. This was the first time that this happened.
Prepayment Right as InducementIt worked. Private investors were willing to invest their money and to borrow huge sums of money from the government in order to build low income housing. Sure, they got low interest loans, but as you all know those loan benefits mostly devolved to the tenants because they merely permit project finances such that the tenants can pay low rent. Owners are limited to their minimal 8% return on their down payment — literally about $4,000 to $5,000 a year, sometimes more, sometimes less.
There were some tax benefits, but by 20 years the tax benefits are gone. The key inducement to these owners was the prepayment right. The prepayment right was designed to induce the private sector to get involved. Of course when the owners decided to prepay, this low income housing “graduated” (as the Agency called it) to conventional housing. It was when the housing became conventional housing that the owners could raise the rents and earn the returns that induced them to get into the program.
Effect of PrepaymentThe problem in all this, of course, is that when the owners started to prepay, to exercise their contractual rights, this low income housing is lost to the portfolio because as it graduates to conventional housing the low-income housing converts. Those tenants who cannot afford increased rents need to be taken account of in some fashion. The government’s plan to do that was that these prepayment monies would in part be recycled, along with other Congressional appropriations, to new owners, some of whom might be the old owners, but certainly including an additional batch of private investors who invest more of their own monies plus the prepayment monies coming from the prepayment of the old projects. This would generate new low incoming housing which would be based on the current needs of the tenants nationwide.
This second batch of owners would have the prepayment right. Then as those owners prepaid, the housing would “graduate” again and be converted to conventional housing, and the owners would earn their return upon those prepayments.
To Develop Rural AmericaThat’s how the system was initially designed to work. Why they wanted to do this was because private investment was geared to further develop rural America. Another way of looking at this is that as the housing “graduated” into conventional housing this whole process would result in the building of affordable housing in rural areas and ultimately moderate and even higher income housing.
The Agency and everyone else involved recognized, I think, that it was just difficult to get banks to commit to financing the construction of low income housing. What happened was that for some reason Congress got cold feet. Instead of appropriating the monies required to continue this very successful program of constructing new low income housing with a batch of new owners, Congress decided to eliminate much of the funding for new construction.
When the owners started to exercise their prepayment rights, this elimination resulted in the loss of this low income housing into conventional housing, and without any pipeline to replace it. This became a matter of grave concern to the Agency, Congress and the tenants. When the owners prepay, the tenants lose this portfolio of housing, and in many cases, unless Vouchers are appropriated or new construction comes about, they may have no place to go.
When Congress eliminated the new construction binge, the exercise of the prepayment right caused lots of problems. That’s why ELIHPA was passed in 1988 to eliminate the prepayment right and stop the loss of this low income housing. They eliminated the prepayment right and that eliminated the graduation program. The loss of the prepayment right meant not only that owners could not get paid for their inability to raise rents, but that the low income housing was left stagnant. The result is we have a lot of housing that is not maintained properly, and the tenants have nowhere to go and are stuck in this low income housing.
Back At the BeginningSo, in many senses of the word, we are all stuck back in the beginning. This is where we started. Except that now there seems to be great reluctance to appropriate any monies of the type that would be required to start a new construction program or even a Voucher program. Reestablishment of the prepayment right by some form of legislation, for example, would result in the further loss in the existing portfolio of housing. Plus, the prepayment legislation that did not make it on the floor of the House but that did make it through the Committee last session has a clause in it that would make it applicable only to those owners who have not accepted an incentive, so it would only apply to owners who either rejected an incentive or did not apply for any.
But prepayment doesn’t really satisfy those owners who have already lost out on dollars because prepayment only permits you to get out at the time the legislation is passed. It doesn’t compensate owners for damages in the past. Another practical problem I see with restoration of prepayment is that the tenants are generally opposed to it because it means the loss of low income housing. Sure, the institution of some sort of Voucher program may permit the tenants to continue living either at the existing housing or some other housing, but tenants generally are opposed to Voucher programs of many different kinds in large part because such programs need to be funded permanently or at least on an annual basis. Tenants are not quite confident this will always occur. Tenants also like project-based financing rather than the so-called Sticky Vouchers because they like the communities that these projects make available to them.
Other Solutions?Some of the other solutions that are out there and some of the things that are happening include the so-called “quiet title” actions that the Kimberly Associates case represents. This case is quite different from our litigation. It is not designed to compensate the owners for their lost prepayment rights, but to compel the Agency to accept prepayments and actually release the mortgage titles and cede full and free title to the owners. Those cases have been very successful. More than 40 projects by recent orders of Federal District Judges are entitled to force the Agency to accept their prepayments. These actions are in fact another weapon in the arsenal of the owners.
There are other potential solutions out there. But I think one of the things that hasn’t been focussed on is the fact that the tenants have a very vested interest in existing low income housing and are quite opposed to Vouchers or prepayment legislation. The underlying theme I see, or potential solution I see, that I haven’t seen written about anywhere and I’ll just throw it on the table for people to talk about, is if you go back to the beginning where there’s no prepayment right, no new construction, no Voucher program on a large level, what we have are the existing owners who have been compelled to continue maintaining an aging portfolio of low income housing where the tenants currently live with Congress appropriating very little money for new construction and the Agency kind of sitting in the middle of this looking at bygone days and wondering what they can do.
Present Value of Future DamagesOur litigation will pay the owners, assuming we win. These payments, however, are not, to my mind, nearly as expensive as a Voucher program or new construction would be. Much of the damages are future damages which would be paid on a present value basis, so they’d be discounted to present value. The outlay of money I see by the government, bottom line to the government, the payment of the lost compensation to the owners is a far smaller amount of money than either a Voucher program or new construction would entail. Keep in mind that Vouchers are a generational thing. I think tenants would favor new construction over any of the various solutions, but I don’t see any money for new construction. I think it’s a tough nut to get money for any Voucher program. Keep in mind, the Voucher program is kind of keyed into the prepayment legislation which was proposed last year.
Consider a combination of a payment by the government to the owners of their lost revenues, the lost income because of their inability to raise rents. Consider in conjunction with that some proposal wherein the existing low income housing would be transferred to nonprofits or public housing entities which would continue to run the existing portfolio of affordable housing within the existing confines of the 515 program. The Agency’s approval would obviously be needed for the assumption by nonprofits or public agencies of the low income housing, but it wouldn’t affect tenants — they would stay where they are. This could be done with the transfer of lost compensation to the owners on a discounted basis. Those owners who for whatever reason may want to continue owning the low income housing could do so. Those who really want to get out of the program might be permitted by legislation to do so.
Litigation will give the owners compensation but it won’t get them out of the program. Legislation will get them out of the program but won’t give them compensation. The tenants are affected in various ways. But this is the only solution I can think of that I’ve not seen any discussion about. This kind of accords with the interests of everybody: tenants, owners, the Agency and Congress.
I just throw this out there.
Thank you.
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