By Catherine DeBono Holmes and Ronald Fieldstone
Almost two years after USCIS adopted Policy Manual changes on June 14, 2017, requiring redeployment of capital contributions of EB-5 investors until the end of their two-year period of conditional permanent residency, a number of EB-5 investment funds have redeployed capital into new investments. Many more will do so in the future, as the original job-creating projects are sold or refinanced.
USCIS has offered no further clarification of the ambiguous statements made in the Policy Manual 2017 regarding redeployment, and there are still unanswered questions from an immigration perspective regarding the standards that will be applied by USCIS in determining whether a reinvestment is “within the scope of the business” of the EB-5 investment fund.
This article discusses the potential concerns by EB-5 investors in connection with redeployment, which in some cases can result in litigation or threats of litigation against EB-5 fund sponsors, and the means by which sponsors should seek to address these concerns and thereby reduce their risks of litigation.
CONCERN 1: EB-5 INVESTORS DO NOT HAVE THE RIGHT TO SELECT THEIR OWN REINVESTMENT
EB-5 investors made their original decision to invest in a specific EB-5 project based upon their own review of detailed offering documents describing the project, the developer, and other relevant facts. When their capital is redeployed, however, EB-5 investors have little, if any, choice in how their funds will be invested in one or more new investments. Even if an EB-5 sponsor offers more than one option for reinvestment and allows each EB-5 investor to select among those options, the investor does not have the ability to select a reinvestment outside of those pre-selected options.
EB-5 investors are understandably concerned that the reinvestment has been selected for the benefit of the EB-5 fund sponsor or the original project developer, and not necessarily with the best interests of the EB-5 investors in mind. In some cases, EB-5 investors have filed or threatened legal action against the sponsors of their EB-5 funds, claiming that the sponsors have selected reinvestments that have a higher level of risk than the original investment, and that the sponsors have made the selection for their own economic benefit.
CONCERN 2: EB-5 INVESTORS FACE LONG VISA WAIT TIMES AND AS A CONSEQUENCE LONGER DURATIONS THAT THEIR INVESTMENTS MUST REMAIN “AT-RISK”
The U.S. government’s visa control office first imposed the “retrogression” policy on EB-5 investors from mainland China in 2015, but it was not until 2018 that it was estimated the delay caused by this policy could be as long as 10 to 15 years for these investors. As a result of these extremely long anticipated delays, the children of some EB-5 investors will “age out” (meaning they will no longer be eligible for a visa based on their parents’ EB-5 application) before these EB-5 investors obtain their visas.
Some EB-5 investors have filed or threatened litigation against EB-5 fund sponsors, seeking a return of their capital on the grounds that they were never informed that they would have to wait so long to obtain an EB-5 visa. The difficulty is that while some EB-5 investors have abandoned their visa petitions and received a return of their capital, other EB-5 investors in the same EB-5 fund may wish to proceed with their visa petitions. Their capital must remain “at-risk,” according to USCIS policy, until they have completed their two-year sustainment period.
CONCERN 3: NOT ALL EB-5 INVESTORS WILL BE ELIGIBLE FOR RETURN OF THEIR CAPITAL AT THE SAME TIME
It is possible, and even likely, that some investors in an EB-5 fund will be eligible to receive a return of their capital in five years. Other investors in the same EB-5 fund may not be eligible for 10 or more years. Most EB-5 funds were originally designed to have the ability to make distributions of capital to all EB-5 investors at once when the original investment was repaid, but those EB-5 investors who are eligible to receive a return of their capital do not want to wait to be repaid until the last EB-5 investor in their fund is eligible for repayment. If an EB-5 fund does not provide for staggered distributions to EB-5 investors as they become eligible for repayment, the EB-5 sponsor is not authorized to make distributions in that manner. The sponsor could be subject to litigation if some EB-5 investors suffer losses while other EB-5 investors in the same fund do not because they were repaid earlier. Therefore, it may be necessary to amend the applicable corporate documents that were prepared when the issue did not exist to permit the change. Another position that could be taken, depending upon the language of the applicable operating/partnership agreement could be to allow the manager/general partner to amend the agreement to comply with EB-5 Program guidelines.
HOW TO REDUCE EB-5 FUND SPONSOR RISKS OF LITIGATION
The concerns of EB-5 investors regarding reinvestment are reasonable. EB-5 fund sponsors must address these concerns if they wish to avoid litigation and all of its attendant expense and reputational harm. To avoid litigation, EB-5 fund sponsors should adopt the following redeployment practices for the benefit of their EB-5 investors.
Use an independent review process and an independent investment advisor to select the reinvestment
An independent review of the proposed reinvestment is an essential element to establish fairness in the selection process. This is most important in cases where there is any affiliation between the EB-5 fund manager and the parties with economic interests in the project being funded with the reinvestment. If the party making the selection of the reinvestment will receive an economic benefit from the reinvestment in the project chosen, the EB-5 investors would have ample reason to question whether the choice of that project is fair to the investors. For this reason, the EB-5 sponsor could engage an independent third party to review the proposed reinvestment. This independent review should include due diligence on the project, the track record of the owner or developer of the project, the terms of the reinvestment, and any other financing used for the project. The EB-5 fund manager should consider the engagement of an independent registered investment advisor as part of this process. This is because it establishes not only the independence of the process but the qualifications of the reviewer to act as an independent party in the reinvestment process.
If a project by the same developer as the original project is available, consider the benefits of that investment to the EB-5 investors
Many EB-5 investors selected their EB-5 investment based on their confidence in the developer of the project in which their capital was originally invested. These EB-5 investors may therefore prefer that their capital be reinvested in a project with the same developer because of their familiarity with the developer, the fact that their original investment was successfully repaid, and the ease of transition from the original investment to a new investment, perhaps with the same forms of investment documents as the original investment. In addition, the fact that the reinvestment is with the same developer may provide some immigration benefits by demonstrating that the reinvestment is “within the scope” of the EB-5 fund’s business.
Consider and compare other reinvestment opportunities
EB-5 fund managers should consider whether there are other reinvestment opportunities that are reasonably available that would better protect the interests of the EB-5 investors. There are several redeployment programs and funds created by experienced third parties that offer multiple reinvestment options and are open to any EB-5 fund seeking to reinvest capital. Some of these programs offer independent review, ongoing due diligence and administration as part of their program, as well as a selection of potential reinvestment options. There are also experienced regional center operators that have established their own redeployment funds in which EB-5 proceeds from multiple EB-5 funds are pooled and reinvested into multiple projects. This practice offers the benefit of diversification of investments and, in some cases, more liquidity than investing in a single loan or equity investment.
Review the EB-5 fund’s governing documents and follow the procedures required by those documents for reinvestment
If the partnership or operating agreement of the EB-5 fund does not authorize the general partner or manager to select a reinvestment at all, or if it only allows reinvestment with the consent of the EB-5 investors, then the consent of the EB-5 investors must be obtained. Rather than asking for approval of a specific reinvestment option, it may be preferable to request approval of an amendment to the partnership or operating agreement to allow the general partner or manager to select all reinvestments for the EB-5 fund, subject to defined standards that apply to selection of the reinvestment. These standards should include an independent review process. The benefit of this approach is that it covers not only the first reinvestment, but all future reinvestments that may be necessary for as long as the EB-5 fund has EB-5 investors who are not eligible for repayment.
Provide written disclosure to EB-5 investors prior to reinvestment of the material terms of the reinvestment
Whether or not an amendment is required to approve reinvestment, an EB-5 fund manager should provide written notice to EB-5 investors prior to every reinvestment, informing them of the repayment of the original investment and the details of the proposed reinvestment. The notice should include a disclosure of the project in which the reinvestment will be made, the experience of the owner or developer of the project, the terms of the reinvestment, the process used by the EB-5 fund manager to select the reinvestment (including any independent advice and reports obtained as part of the process), and the reasons why the EB-5 fund manager selected or recommended the particular reinvestment for the fund.
Allow EB-5 investors who have withdrawn their I-526 Petitions to give notice and receive a return of their investment prior to redeployment
As previously described, some EB-5 investors, particularly those from mainland China who are now subject to substantial delays in obtaining their visas under the EB-5 program, have or will choose to withdraw their visa petitions rather than continue the immigration process. Any investor who has withdrawn his or her visa petition would be eligible to receive a return of their investment. EB-5 fund sponsors should offer those EB-5 investors who have withdrawn or desire to withdraw their visa petitions an opportunity to give notice to the EB-5 fund, so that their investments may be repaid from their share of the repayment proceeds, rather than having their capital reinvested.
It is important to note that this is not a guaranty of repayment, because repayment would only be made to EB-5 investors if and when the EB-5 fund receives repayment of its investment, and only to the extent of each EB-5 investor’s pro rata share of the repayment. Therefore, allowing EB-5 investors to receive repayment, rather than reinvesting proceeds, should not be considered an impermissible guaranty of repayment by USCIS. In addition, each EB-5 investor who notifies the EB-5 fund that he or she has withdrawn or desires to withdraw his or her I-526 petition should be required to provide evidence of withdrawal in order to receive the refund. Providing EB-5 investors who have withdrawn or desire to withdraw their visa petitions an opportunity to receive repayment prior to reinvestment is one of the most important ways for EB-5 sponsors to avoid potential litigation with EB-5 investors.
Review the EB-5 fund distribution provisions and modify, if necessary, to allow for staggered payments to EB-5 investors
Because of the long waiting periods that may be experienced by some EB-5 investors, it has become necessary to restructure EB-5 funds to allow for distributions of capital to be made to individual EB-5 investors at different times, rather than to all EB-5 investors at once. However, if the EB-5 fund partnership or operating agreement does not allow for that method of distribution, the EB-5 fund manager could be subject to litigation for making distributions that are not in accordance with the fund’s governing agreement. Therefore, as part of the reinvestment process, the EB-5 fund manager should consider whether an amendment should be made to the fund’s governing agreement to allow for repayment of capital to each EB-5 investor who is eligible for repayment from the proceeds of repayment of each investment and reinvestment, as well as whether investor consent is required in connection with same.
Following best practices for redeployment should protect EB-5 investors and reduce litigation risks for EB-5 sponsors
The EB-5 reinvestment requirement imposed by USCIS has resulted in EB-5 investors having reasonable concerns about the manner in which their capital is being reinvested. EB-5 fund sponsors must appropriately address these concerns to fulfill their duties to the EB-5 investors, thereby mitigating the potential risks of litigation.