By Ronald R. Fieldstone
Special attention must be provided to an EB-5 transaction that does not involve fraud and that otherwise encounters monetary issues that could jeopardize both the financial and immigration viability of the EB-5 investment. This does not happen very often, but the industry needs to be aware of the implications related to a so-called “troubled project” or a “troubled business”. These issues should be anticipated both in the offering documents, including the limited partnership/operating agreement, as well as the loan documents and the loan administration process.
There are two significant categories to be addressed, including immigration and financial issues.
From an immigration standpoint, the first priority is to create jobs and then maintain the at-risk component of the investment. If a project is in midstream of development that has not been completed or if the operating business does not create the budgeted revenues to create additional jobs, then this could pose a serious problem since without completion of construction or the execution of the business plan there may be a serious risk that the projected number of jobs will not create the number of jobs required to obtain I829 approval.
Other potential problems include situations where the actual funding of the project has not begun due to legal issues such as the termination of a lease for a project site, the inability to obtain senior financing, internal developer partner disputes that delay the start of construction, or other issues that prevent the funding of the loan or the contribution of equity.
The second part of the equation is the financial integrity of the investment and the ability of investors to receive a return of their capital. This would include the factors stated above as well as the following considerations: Background information on the developer is discovered that brings into play the ability of the developer to separately fund and/or complete the project. Project-related changes that may not be material from an immigration standpoint but will otherwise negatively impact the financial viability of the project, such as the developer not obtaining the projected brand for a hotel, the loss of a key tenant in a commercial transaction that impacts the revenue potential, significant cost increases or a change in financing terms for any senior indebtedness. The potential for an SEC investigation of the regional center, the developer and/or their principals.
ROLES THE VARIOUS PLAYERS HAVE IN THE EB-5 PROCESS
In connection with these issues, it is important to review the roles of the various players in the process and engage the appropriate professionals who can execute on a plan to salvage the project from both standpoints.
Immigration Attorney: Due to the sensitive immigration issues involving “Matter of Ho” compliance and the creation of jobs, especially given the status of the delay in investors obtaining visas from China, the issue of materiality must be taken into account. If there is a potential material change in the project prior to investors receiving their visas, this could negate the ability to proceed with the immigration process for those investors who have not received their temporary residency status. Once this status is obtained, then the issue of materiality should no longer be an issue.
Corporate Issues: The limited partnership and operating agreement needs to address how decisions are made when things do not go as planned. The general partner/manager of the NCE would need to become very proactive in managing the workout process and trying to salvage the investment for the investors. The applicable agreement needs to be reviewed to determine if the adequate authority to take action, or investor consent may otherwise be required. The voting provisions of the entity document needs to be carefully reviewed or drafted to determine the voting percentage required to approve major decisions.
Investor Consent: Investor consent may be required or appropriate to material changes in the project or the NCE’s proceedings to fund the EB-5 capital to the project once it has been released from escrow. The general partner or managers shall not want to take an undue risk of making an ultimate decision and being held responsible without investor consent.
Legal Protections: For a loan model, the issue is the ability of the NCE lender to take legal action to protect its interest of the NCE under the applicable loan documents. Has the developer/borrower defaulted under the loan agreement by failing to achieve certain targeted results? Has the senior lender declared a default under the senior loan or is the developer otherwise in non-compliance with the provisions of the senior loan? Is there an inter-creditor agreement and what restrictions or protections does it provide? Is there a developer-principal guaranty of completion that can be enforced? Do such principals have the ability to actually perform?
FINANCIAL ISSUES AND RESTRUCTURING
In a troubled project, there are financial issues that need to be addressed. Is there a shortage of capital to complete the project or operate the business and what opportunities exist to salvage the investment? Experienced regional centers or general partners/managers may have the capacity of obtaining outside capital and work out a deal for the NCE lender/equity provider to bridge finance what capital is required to complete the project. This can include even taking over operations based upon either an adverse action against the developer or a consensual arrangement where the NCE, and possibly a new investor, becomes the new financing partner and takes over control of the project.
It is generally unrealistic to assume investors will contribute additional capital to salvage the project. Therefore, a third-party funding source and an industry expert would be desirable to add to the project team.
Another concern is the senior loan and the applicable inter-creditor agreement that many times is in existence, which will not allow a junior lender with a mezzanine pledge or even a second mortgage to otherwise take action without paying off the senior loan. There are exceptions where the inter-creditor agreement would allow the NCE lender and/or equity provider to bring in a qualified joint venture partner to take over the position of the developer. This can potentially be negotiated even if the inter-creditor agreement restricts the ability to foreclose on the collateral. It is generally advisable for all parties to work together to try to effectuate the completion of the project as a priority in order to preserve jobs and then work out the related financial economics.
To the extent there is any elements of fraud, the SEC may be contacted to otherwise take affirmative action to the extent necessary in order the appoint a receiver to take over control of the asset if the developer is deemed to be adverse and otherwise acting inappropriately. The SEC will freeze assets and impose a procedure that will potentially enable a change of management. However, this procedure is expensive and can be time consuming and there is no assurance that jobs will ultimately be created. The SEC generally focuses on the financial issues and is less likely to be concerned about the job creation component. However, this philosophy has been reconsidered in the Jay Peak case where the SEC receiver has become mindful of the immigration issues in order to effectuate a plan that will ultimately create jobs in order to preserve the investors’ EB-5 status. Other receivers are likewise adopting this pro-active view of preserving both the immigration integrity and financial viability of the project.
With respect to a troubled business, there are unique issues that need to be addressed. For instance, if there is a significant shift in the market for a particular project due to regional factors, competitive environment, or a change in the industry itself, such as occurred during the recent recession, that presents a host of entirely different concerns. It is one thing to fix project problems, but another to fix business issues that may be based upon uncontrollable external factors. Accordingly, it is always advisable to have a backup plan to address these concerns. For instance, for a condominium project that confronts sales issues, can the project be converted to a rental to otherwise sustain the investment? The same would apply to other such real estate projects where the proposed use may no longer be viable and alternative uses need to be established. To the extent the project involves a non-real estate business, the volatility of such business presents additional risk factors that need to be addressed, such as a restaurant operation whose concept is not viable due to market conditions. Again, the goal here is to have a plan that has built-in flexibility to navigate these types of circumstances.
Given the fact that the EB-5 industry has expanded greatly over time, it is only natural that there will be more troubled projects and troubled businesses in the future. Therefore, the industry will need to address this process by accessing professionals to assist in the process and preserve the integrity of the investment from both an immigration and financial aspect.