Redeployment: The New Frontier
By Osvaldo F. Torres, Torres Law, PA
Redeployment of EB-5 capital is just one more of the current issues with which the EB-5 industry is struggling. It is a complex matter, one which suffers from a dearth of clear United States Citizenship and Immigration Services (USCIS) guidance. The danger of redeployment is that its shadow, its underbelly, is diversion. In other words, if redeployment is not addressed or properly treated in the offering and related operative documents and a redeployment is effected, we run the risk of it being deemed a diversion of EB-5 funds, which would likely lead to securities law liability. The other danger of redeployment is denial of investor petitions. Should USCIS adjudicate that the investment into which EB-5 funds were redeployed failed to meet the EB-5 program’s “at-risk” requirements, the investor’s Form I-829 petition would be denied.
In recognition of the topic’s emergence, USCIS issued a draft policy memorandum dated August 10, 2015 (USCIS Draft Memorandum) that attempts to, but does not definitively address, the main issues occasioned by redeployment. In fact, redeployment is so pressing that, coincidentally, just a few days ago a client emailed the following to me:
The redeployment term attached seems to mean that the fund[s] can be redeployed to [an]other project without EB-5 investors’ approval. Is this correct? If so, investors may ask what if the new project has high risk. Is this redeployment term widely used in EB-5 industry now? How do you explain to investors about this matter which doesn’t require investors’ consent in choosing another project?
The email raises important questions. What investor consent is needed? What if the investor funds are redeployed to a project with risk characteristics that materially differ from the original investment? This article attempts to elaborate on those questions as well as summarize the main securities laws concerns regarding proper disclosure.
Why this new Tension?
Redeployment emerges as an important consideration in an EB-5 offering due to the increasing visa backlog currently affecting investors born in Mainland China. A visa backlog occurs when the demand for visas in a particular category or country exceeds visa availability. For Mainland China investors, the visa backlog translates to a six-year (or longer) wait before a visa number is made available for immigration to the United States. This phenomenon is often (technically incorrectly) referred to as visa retrogression. The reader should now be asking why does that matter to my EB-5 project? The answer is because a visa backlog may interrupt or adversely impact the exit strategy for the project.
Most developers and creators of business opportunities seek a liquidity or capital event to cash in on gains. Typically, exit strategies contemplate a sale or refinancing after a prescribed or ideal period of time to hopefully unlock value and return profits and capital to owners. The “holding period” for the project (or the period during which there can be no exit from the project) in the typical EB-5 transaction is commonly tied to the maturity or term of the EB-5 loan made by the new commercial enterprise (NCE) to the project or job creating entity (JCE). Before visa backlogs became a prevalent problem, the typical EB-5 loan carried a term of five years, with perhaps a one-year extension. Today, common practice dictates that the EB-5 loan term extend to seven or even eight years to accommodate the likely possibility that an investor’s Form I-829 petition will not have been adjudicated within the customary five-year period due to visa backlogs. As developers are asked to suspend their exit from five to seven or more years, significant tensions arise because the prolonged wait may not coincide with the developer’s ideal exit or liquidity strategy.
In the client email noted above, the concerns center on the possibility of greater risk and lack of investor control or consent regarding the redeployment decision. However, while the possibility of greater risk might and should sound investor alarms, an investor should be equally concerned if the funds are redeployed in a “safe” investment that might not meet the EB-5 program’s “at-risk” rules, which would also result in a denial of immigration benefits. As noted in the USCIS Draft Memorandum, when a petitioner files the Form I-829 petition, pursuant to 8 C.F.R. 216.6(a)(4)(ii)-(iii), the petitioner must provide:
Evidence that the immigrant investor invested or was actively in the process of investing the required capital and sustained this action throughout the period of the immigrant investor’s residence in the United States. The immigrant investor can make this showing if he or she has, in good faith, substantially met the capital investment requirement and continuously maintained his or her capital investment over the two years of conditional residence. At this stage the immigrant investor need not have invested all of the required capital, but must have substantially met that requirement
As such, the petitioner must show that he or she continuously maintained the capital investment over the two years of conditional residence when filing the Form I-829 petition. According to the USCIS Draft Memorandum, the continuous maintenance or sustainment of the capital investment requires that the capital be “at-risk” throughout the sustainment period and sustained in the NCE. Additionally, the USCIS Draft Memorandum states that regardless of whether an NCE has deployed funds to a wholly-owned business, or in the regional center context, to a JCE, the funds must remain invested in the same NCE throughout the conditional permanent residency period.
the immigrant investor at odds with the economic interest of the developer who wants to sell or refinance as early as possible to realize potential profit. The investor must comply with the investment sustainment requirements through the end of conditional residency. A critical issue, however, is that there exists no clear USCIS guidance as to whether that moment is (i) at the time the Form I-829 petition must be filed (i.e., within 90 days before the two-year period ending after the investor has entered into conditional residency), or (ii) at the time USCIS adjudicates an investor’s Form I-829 petition. Consequently, if the JCE engages in a capital event, the investor’s funds may not have been “sustained” for adjudication purposes for the requisite period if repaid or distributed to the NCE.
Redeployment attempts to address this problem by providing a mechanism for the reinvestment of investors’ funds upon a developer’s exit. If properly structured and disclosed, redeployment could permit the NCE to reinvest in another JCE the funds that are repaid or distributed to it, bolstering the position that investor funds were sustained at risk. However, whether the investment must remain at risk even after the investment has been sustained through the two years of conditional residence, is reasonably disputable. Importantly, what also remains unclear is what conditions or parameters must a reinvestment satisfy in order to avoid a material change that could affect an investor’s ability to immigrate under the EB-5 program. For instance, must the funds be redeployed within the same regional center and/or targeted employment area, etc.?
Although we may not yet definitively know what will suffice for immigration purposes, what is clear is that offering and operative documents must address redeployment if there is any likelihood that the developer will seek an exit before the complete adjudication of all Form I-829 petitions. The following is sample disclosure text addressing redeployment:
Subject to compliance with the requirements of the EB-5 Program, if all or a portion of the principal balance of the Loan is repaid to the Fund prior to the date that all Limited Partners have received final adjudication of their I-829 Petitions, the General Partner will, in its sole discretion, reinvest the proceeds of the Loan repayment, or that portion of the proceeds that is required to remain “at risk” under USCIS policies for those Limited Partners who have not received final adjudication of their I-829 Petitions, without further consent of the Limited Partners. The General Partner will use commercially reasonable efforts to reinvest the proceeds in an investment that qualifies as “at risk” under USCIS policies and that permits the Limited Partners to receive the return of their Capital Contributions as soon as reasonably possible following final adjudication of their I-829 Petitions. The Limited Partners will not have the ability to approve the nature or risks of the new investment made by the General Partner at the time of the reinvestment. The reinvestment of the Limited Partners’ Capital Contribution may result in additional or different risks of loss of the Limited Partners’ investment in the Fund than are described in this Memorandum.
While the sample text above may be deemed adequate, it still begs the question of whether it goes far enough? Should additional parameters be included that would effectively limit the power of the General Partner to reinvest? In light of such concern, the following example attempts to provide more structured approach:
Subject to compliance with the requirements of the EB-5 Program, if all or a portion of the principal balance of the Loan is repaid to the Fund (via a sale or refinancing of the Project by the Project Company) prior to the I-829 Petition adjudication for a Limited Partner whose Capital Contribution was used to fund such portion of the repayment of the Loan, the proceeds from any such repayment will be redeployed by the Fund into alternate investments (which may be owned and/or controlled by affiliates of the Fund) (“Alternate Investments”) within 180 days for the purpose of maintaining the “at-risk” nature of such Limited Partner’s Capital Contribution as required under the EB-5 Program (a “Redeployment”). The General Partner, in its sole discretion, will be responsible for identifying Alternate Investments, and as of the date of this Memorandum, no Alternate Investments have been identified. The General Partner will use its best efforts to identify Alternate Investments that involve a project: (a) where the total capitalization would not result in a loan-to-value ratio that exceeds 85% (when combining the Redeployment proceeds with the senior financing in the Alternate Investment); (b) that has similar collateral to the Project. Additionally, the General Partner will attempt to identify Alternate Investments that include the same or similar terms as the Loan to the Project Company, including but not limited to: (a) an annual preferred return equal to approximately 0.25%; and (b) a service and/or management fee equal to approximately 5%. Limited Partners will not have the ability to approve the nature or risks of Alternate Investments identified by the General Partner, and as such, a Redeployment may result in additional or different risks with respect to the loss of the Limited Partner’s investment in the Fund, other than those described in this Memorandum. In the event of a Redeployment, the Alternate Investment may provide for additional returns, however, any such additional return is not guaranteed and the EB-5 Investor is not entitled to receive a return greater than the Preferred Return. Additionally, instead of a Redeployment into an Alternate Investment, the Manager Partner may effect a Redeployment into an at-risk money market account for the benefit of the Fund. Such account may result in different risks and returns with respect to the EB-5 Investor’s investment in the Fund other than those described in this Memorandum. Notwithstanding the foregoing, in no event shall the Fund be permitted to effect a Redeployment if such Redeployment would affect the status of any EB-5 Investor’s I-829 Petition and/or any EB-5 Investor’s immigration status under the EB-5 Program.
Although the latter text provides for more redeployment restrictions and may be adequate for disclosure purposes, no precedent or guidance exists confirming whether redeployment in such a manner would satisfy USCIS requirements. Importantly, it should be noted that in both examples the investor is not provided with consent rights over the reinvestment decision, which right is expressly granted to the General Partner. The purpose for this is two-fold: (i) if the investor has the right to decide, that might be construed as the making of a new investment decision (which would require a new offering or at least an adequate offering supplement); and (ii) avoid, as best as possible, the inference that a “material” change has occurred for immigration purposes.
Additionally, redeployment provisions may create new risk factors that should be noted and at the very least described in an operative document. Following is sample text to consider:
Redeployments by the Fund carry risks associated with unspecified transactions.
Any Redeployment of proceeds in Alternate Investments increases the financial risk to EB-5 Investors because there is no information about the nature and terms of such Alternate Investments that EB-5 Investors can evaluate. EB-5 Investors, therefore, will be relying solely on the ability of the Fund, General Partner and their respective affiliates and management personnel to identify such Alternate Investments. Accordingly, there can be no assurance that a Redeployment into an Alternate Investment will be successful. The failure by the Fund or the General Partner to identify and effect a Redeployment into an Alternate Investment may have a material adverse effect on the Fund’s business, financial condition and results of operations, including its ability to repay all or any portion of an EB-5 Investor’s investment.
The Fund may invest in Alternate Investments upon early repayment of the Loan.
In the event all or a portion of the principal balance of the Loan is repaid to the Fund prior to the I-829 Petition adjudication for a Non-Managing Member whose Capital Contribution was used to fund such portion of the repayment of the Loan, the proceeds from any such repayment will be redeployed by the Fund into Alternate Investments for the purpose of maintaining the “at-risk” nature of such Limited Partner’s Capital Contribution as required under the EB-5 Program.
Alternate Investments will be selected by the General Partner, in its sole discretion, and as of the date of this Memorandum, no Alternate Investments have been identified. However, Limited Partners will not have the ability to approve the nature or risks of Alternate Investments identified by the Fund, and as such a Redeployment may result in additional or different risks with respect to the loss of the Limited Partner’s investment in the Fund, other than those described in this Memorandum. An Alternate Investment may result in a delay in the repayment of Capital Contributions to the Limited Partners by the Fund. Alternate Investments are speculative and therefore EB-5 Investors should be aware that such investments may increase the duration of their investment with no certainty of return and that the possibility of a partial or total loss of the Fund’s capital and EB-5 Investors’ Capital Contribution exists. Furthermore, there is no assurance that any Alternate Investment would satisfy the EB-5 Program or enable an EB-5 Investor to apply for a visa and residency in the United States.
Redeployment may be a viable solution to some of the challenges presented by visa backlogs. However, until USCIS issues authoritative guidance, there will be uncertainty. To reduce exposure to securities law liability, effective operative provisions and sensible disclosures must be considered to render redeployment a potentially effective tool. Because a new investment decision could be triggered by an improperly drafted redeployment provision, the mechanics and disclosures with respect to redeployment should be described in a manner that would provide adequate parameters for the investment so as to alleviate the need for investor consent.