As the shutdown continues, more properties may find that they have needs exceeding funds available in reserves which could pose an imminent risk to continuity of properties operations due to lack of funds. In such cases, project owners may want to consider advancing funds to the affected projects to cover reasonable and necessary operating expenses.  Here’s how.

As the partial Federal government shutdown extends into its 4^th week with uncertainty over when normal HUD operations will resume, an estimated 1175 project-based rental assistance (PBRA) contracts with December 2018 and January 2019 expiration dates will not be able to be renewed until after the shutdown, with Section 202/811 PRAC projects comprising the majority of impacted contracts.  While some funding may be available to help the Section 8 and 811 properties for at least through January, already 440 Section 202 PRAC contracts representing 20,944 units are being told their contracts cannot be renewed during the shutdown and that they must rely on reserves.

HUD has already permitted owners of affected properties to tap reserve for replacement escrows to augment cash flow and address immediate project needs during the shutdown. Reserves are expected to be replenished from federal appropriations once they become available.

For those properties with insufficient reserve funds, imminent threats exist, including the risk that some properties may cease operations due to lack of funds. In those cases, project owners may want to consider advancing funds to the affected projects to cover reasonable and necessary operating expenses.

However, in order to avoid such advances being characterized as non-refundable equity contributions and/or to minimize the risk that future repayments of advances may be characterized as unauthorized distributions, which may subject the owner to civil money penalties, it is imperative to follow the HUD guidelines. This poses a challenge during the shutdown because HUD staff are unavailable to advise on, or possibly even to approve, owner advances.

The primary HUD guidance regarding owner contributions and advances is detailed in Chapter 2 of Handbook 4370.1, Reviewing Annual and Monthly Financial Reports. Section 2-21(F)(3)(b) provides an exception to the usual rule that owner advances may only be paid from surplus cash at the end of the annual or semi-annual period if projects are in “critical situations”. In these cases, the HUD guidance anticipates approval of “short-term operating advances made on behalf of the welfare of the tenants,” to avoid a lender claim for insurance benefits, to address a mortgage default, or to cover non-payment of operating expenses, such as taxes or utilities.

Advance HUD approval of owner advances made to protect projects in “critical situations” is required and is done on a case-by-case basis. Additionally, if approved by HUD, monthly repayment of owner advances are allowed and are not considered to be owner distributions. Note, however, that properties already in financial default may be ineligible to receive repayments if existing workout agreements would be adversely affected.

In light of the HUD shutdown, however, obtaining prior HUD approval of advances made to address critical project needs is not guaranteed. And, in the absence of appropriated funds to cover necessary project operations, inaction may result in significant threats to human safety and/or property.  So it’s a balancing act.

Therefore, before making any advance of funds to affected properties, we suggest thoroughly documenting the need for the advance to reflect the applicable HUD guidance. Owners may wish to adopt the following practices:

• Prepare a request addressed to the property’s HUD Account Executive* for permission to advance funds to address critical needs of the property.
• Document the need for the advance. We suggest adding language that states the lapse of appropriated funds has created a critical shortage of funds needed to maintain necessary project operations as required by HUD business agreements.
• Detail the reasonable and necessary operating expenses to be funded by the advance.
• Describe the critical situation the advance would address:
  • To protect tenant welfare;
  • To avoid a lender insurance benefit claim;
  • To address an owner default under the mortgage; or
  • To pay project operating expenses (e.g., taxes, utilities)
• Request that repayment of all advances be made to the owner upon receipt of appropriated funds.
• State that the request would have been made prior to the need for the advance of such funds, however the partial government shutdown hindered the owner’s ability to seek advance approval, and request a waiver of this provision.
• Retain all documentation submitted to HUD and also in support of the request (bills, invoices, notices, etc.)

When ready, owners should send their request to the appropriate Account Executive (who is likely on furlough) and to the appropriate Regional and Satellite Office Contacts identified by HUD to approve access to reserves during the shutdown:

Be sure to keep track of dates and contacts to whom the requests have gone.  And, as owner preference to maintain operational continuity may demand, move forward with the advance absent an approval – again, noting the special circumstance caused by the shutdown.  Because obtaining advance HUD approval is not guaranteed, but as these all are “reasonable and necessary” operating expenses, it is expected that owners should at a minimum be able to regain payment at the end of the project fiscal year, if not secure repayment upon restoration of federal payment of subsidies. 

Finally, before making any advances under these circumstances, we suggest that owners obtain legal and other professional advice, including that of an independent CPA to avoid potential audit findings, in order to account for the unique facts and situations that each property presents.

DISCLAIMER: This article was written for general informational purposes only and does not constitute legal advice and should not be relied upon as legal advice. The information offered does not create a lawyer-client relationship between Reno & Cavanaugh, PLLC and the recipient or reader. Recipients should not act upon the information without obtaining legal or other professional advice. Reno & Cavanaugh, PLLC expressly disclaims all responsibility and liability for any actions taken or not taken on the basis of any of the content in this article.