This conversation deals with the expanding role of corporate governance in today’s EB-5 world. EB-5 issuers will be eager to learn why corporate governance has just recently been a vital issue to the program. Should investors vote on all major issues? Should corporate governance occur at the document-drafting stage? How to deal with unexpected situations that couldn’t have been anticipated at the very beginning? John explains the difference between limited partnerships and limited liability companies, the influence of the Investment Advisors Act, and the two key fiduciary duties. He also explains where most lawsuits arise from. Read on to learn why corporate governance should be at the top of any issuer’s thinking, and when and why you need an expert in this field.
What is Corporate Governance in EB5?
John: Corporate governance is concerned with establishing the conditions for a firm’s managers to act in the interests of the firm and its equity holders. Now that can be a little ambiguous or lofty, so let me dive into it a little bit. Some of the concerns that flow from that primary concern are things like holding the managers accountable to investors, managing conflicts of interest between the managers and the investors, facilitating the provision of capital by non-managing investors and providing the CEO, or whoever is in charge of the day to day operation of the business, with access to perspectives and assessments that they wouldn’t get from the people they normally surround themselves with. That’s what corporate governance is concerned about. In EB-5, there’s not usually a lot of division between the CEO of an EB-5 fund and the governing body of an EB-5 fund, so that concern may not apply. But I’m finding that these fundamental concerns do apply particularly in situations that EB-5 funds are finding themselves in these days. Many of the same insights that I’ve been deploying in my corporate governance practice for decades, may now apply to EB-5 as well.
Why Don’t We Hear About Corporate Governance in EB5?
Kurt: John. I don’t hear much about corporate governance in EB-5, and yet when I brought the topic up to other securities attorneys, they all thought this was a really important topic. Why do you think we don’t hear much about it? John: I think the best explanation is by analogy to the EB-5 industry’s evolving posture towards securities laws. For those of us that have been around EB-5 awhile, we all remember the reluctant embrace of securities laws. Now everybody knows EB-5 offerings are securities and everybody makes some effort to comply with the securities laws. But it certainly was not always that way. When I got in the industry in 2012, there was quite a vibrant dialogue going on to the effect that EB-5 offerings were not securities and even people that didn’t go to the trouble of making a principled argument just didn’t comply with the securities laws. They just didn’t think it was a concern that affected them and it was an interruption to the way they were doing EB-5 deals – and not a welcome interruption. It’s human nature to simplify things wherever possible and I think the corollary of that is a natural impulse that people have to deny something that they don’t understand well, particularly if it’s complicated.
Breakdown in EB5. SEC Gets Involved
So EB-5 probably would’ve continued on the path it was on in the early part of the last decade if we didn’t have a breakdown. And the breakdown was that the SEC finally stepped in, which actually wasn’t until 2013 when the SEC brought its first enforcement action in EB-5. For context that was 20 years after the establishment of the EB5 regional center program, and at least three years after the beginning of large scale syndication of EB-5 investments. So people thought, well, you might be right that EB-5 investments are securities, but it never seems to show up in my life. And then it did. And then people had to deal with it. And it kept showing up in more and more costly and dangerous ways, and then everybody started dealing with it.
EB5 Seen Through Lens of Immigration
Rupy: And that was likely because EB-5 was perceived as an immigration program and investments weren’t sold in a conventional method by going through a broker-dealer. You were just dealing with immigration agents. So that may be the reason it wasn’t really perceived as having securities law implications. John: That is a great point. It was an immigration product so that’s absolutely understandable. And the benefit that people were seeking from these investments was a visa. It wasn’t a return on their investment. And it’s also absolutely true that in the early days there were no broker-dealers involved in the industry. But when a securities lawyer hears that explanation, we say well, it doesn’t work that way. A visa is a benefit and it isn’t any different than a monetary benefit. So that’s not going to get you out of the securities laws. And the fact that it isn’t sold through registered broker-dealers doesn’t mean anything, because these finders are acting just like broker-dealers and US law would consider them broker-dealers if it wasn’t for the fact that they were offshore. And now I think we’re going to see the analogy here with corporate governance where people think it doesn’t apply because, in their experience, they haven’t really seen it come up. But if you’re someone who specializes in corporate governance, you see it as a blinking red light. The reason it’s showing up in EB-5 now is because of the situation with retrogression and the associated need for redeployment. That was not a concern of EB-5 funds in the early days of the program, or even through the middle period of the program.
Securities Laws Clearly Pertain to EB5
Kurt: John, how did you come to start speaking about corporate governance in EB-5? John: If we again wind the clock back to 2012, I’d been practicing securities laws for almost 20 years at that point. My first exposure to EB-5 was while we were representing a borrower of EB-5 funds and a partner at Sheppard Mullin wondered whether the lender or the borrower potentially had securities law issues they needed to be concerned with. So he asked me as a securities lawyer in the firm. And from my perspective, I saw securities law issues everywhere in the loan program he was describing. Now I certainly wasn’t the first to see that, but in that era, there were only a few people speaking publicly about this, and the industry was largely treating those people as kind of “Chicken Littles” saying the sky is falling, but nobody ever saw the sky fall. Fortunately, a lot of those people that took the brunt of that abuse survived in the industry, even thrived, and they’ve become the major EB-5 securities lawyers that we all know.
Why is Corporate Governance in EB5 Crucial Now?
Now if you fast forward to maybe late 2017, early 2018, we have a new situation, and that’s EB-5 loans and successful projects that were originated in the 2014 to 2016 time period getting paid off, and at least some of the investors are still in their sustainment periods, meaning they can’t get their capital back without forfeiting their immigration benefits. So the funds have to be redeployed. So now we say, all right, what do the offering documents say about redeploying funds? And we find out that it’s all over the board. Some documents don’t contemplate redeployment at all. Some expressly prohibit redeployment, they say you can only invest in the original loan. Some actually anticipated the issue and provided for a means of redeploying or maybe rules around it, at least in some fashion. Some of the documents expressly required investor votes. Others contemplated redeployment but were silent on how a redeployment would actually be approved. So there was simply no industry standard as to what people would do. So people checked with their lawyers and they came to people like me and my colleagues in the industry and everybody correctly saw this as a securities law issue. One certainly does need to consider securities law exposure on redeployment decisions, based on whatever you represented in the offering documents. If the offering documents said one thing and you proceed to do another, you can anticipate some problems under securities laws. But from my point of view, there was another more appropriate lens through which to look at this. And that’s corporate governance in EB5. And I saw that angle because that’s a large part of my legal practice outside of EB-5. I regularly represent both public and private companies concerning major governance matters, such as fiduciary duties, mergers and acquisitions, dealing with management crises and resolving deadlocks. Those are all EB5 corporate governance issues that I deal with every day. So it was no great insight for me to see the redeployment issue as a corporate governance issue. But for those who don’t regularly practice in this area (corporate governance) and don’t regularly deal with fiduciary duties and things like broad-based investor votes, it just didn’t appear to them that way because that’s not usually what they do.
Investors Must Have Right to Vote. Right?
Kurt: John, can you give us an example. John: Sure. I remember when this issue first arose I would hear people on panels at major EB-5 conferences say in kind of a preachy way that an EB-5 fund should always get an investor vote before redeploying funds. And when I heard that I thought, that’s funny. My public company clients virtually never go out for an investor vote when something unexpected happens in the business. That is unless an investor vote is expressly required. For example, Amazon didn’t seek an investor vote when it decided to allow third-party vendors to sell stuff on its platforms, and that was competing against their primary business. That was a major decision that had dramatic consequences for investors. Early investors in Amazon probably had no reason to expect that would ever happen. And they didn’t vote on it. In that case, of course, it worked out great, but it might not have. And the important point here is that in the domain of corporate governance, this isn’t something that the Amazon board would say, we should go out to shareholders and ask about. Instead, they would say, that’s our job. It’s our job to do what we think is best for running the business. Some of the reasons that a board reasonably thinks that way is that their investors often have quite divergent goals. Some may be long-term investors, some may be short-term investors. They may have different reasons for investing in the company. So a majority vote, while it sounds good, is not necessarily meaningful. It doesn’t necessarily guide you on what’s best for your shareholder base.
Are EB5 Investors in a Position To Act in Company’s Best Interest?
Another problem is lack of expertise of investors to make these decisions. Would Amazon shareholders really be able to give good advice on whether the company should allow competing vendors to sell on their platform? Do they really have the expertise? Even if Amazon sends out a 250-page proxy statement to them and it says: here are the pros and the cons. Is it really likely you’d get a better answer by majority vote on that than you would from a board of directors that presumably has experts that are deep inside the business? It’s not obvious that you would. I’m not saying you wouldn’t, but it’s certainly not obvious that you would. There’s also a major expense and delay associated with seeking investor approval. You have to write that 250-page document, and in EB-5 it may not be that long, but it’s not trivial. And that expense and delay just may not be in the interest of investors. And then the final thing I’ll say is, what if you don’t get the approval? Where are you then? And that’s something you really need to think through.
Perspective on Redeployment. Through Corporate Governance Lens
So in the example of redeployment, you have to redeploy funds or investors are going to lose their USA investor visas. If you can’t get the investors by whatever vote was required in the operating agreement, or whatever vote you think is appropriate, to approve a redeployment decision, the result may be worse for all the investors then proceeding with a redeployment deal that they didn’t initially like. So you have to think through these kinds of things. And we do think through these issues in the EB5 corporate governance arena. And we usually don’t have kneejerk solutions to problems. Problems are complex, and we view them through nuanced lenses. So for me, when I heard that statement at the conference, I’m like, well that’s just not how we think about these things in corporate governance in EB5. And I think that that has played out because people are now very concerned about these investor votes and nobody is blasé about them anymore.
How to Integrate Corporate Governance into an EB5 Investment?
Kurt: So is corporate governance something that happens at the very beginning in the drafting of the EB-5 project documents, or is it also something that happens at the point where we have a decision to make on how to proceed? Is that still considered corporate governance? John: It shows up in both places. The way I have been speaking about it so far has really been about what happens down the road when something unexpected comes up or something meaningful comes up that requires a governance decision that couldn’t have been made at the beginning, because it’s a new situation. That’s redeployment in a nutshell, right? Redeployment is a new EB-5 investment, very meaningful to investors, but there’s no way you could have advised them of that particular investment issue five years before, because that particular investment didn’t exist five years prior. I’ve been speaking about it as something that comes up over time in the management of an entity, but it does also come up at the beginning stages of designing documents because you need to think about your governance rules at the beginning. Whatever rules you establish, you’re going to have to follow them later on. So, things like whether fiduciary duties are going to get waived, or whether certain redeployments can be done without investor consent — you do need to think about those things up front and then those will have an impact on your offering. So it does really apply in both places.
Limited Partners v. Members of LLC
Kurt: Most investors in EB-5 offerings, at least the ones I’ve looked at, are joining as limited partners. And my understanding is that a limited partner has a very limited role in the company’s decision-making. Can you explain what role do they have in decision-making? When do they get a chance to have their voice heard and when don’t they. John: It’s a good question. Most EB-5 funds are either limited partnerships or limited liability companies (LLCs). The rules are somewhat different for the two. More recent funds are almost always limited liability companies. Limited partnerships used to be preferred because it wasn’t immediately clear in early USCIS guidance that any other form of entity would meet the management requirements or the active investor requirements of the EB-5 rules. But recently it became clear that limited liability companies, or LLCs, that is designed in a typical way do meet those rules, so now we see a lot more LLCs. There are legal limitations on the abilities of limited partners to manage. USCIS said that that was okay, that if they manage only within their limited scope, which is being able to vote on certain major matters, that was okay for their active management requirements. But it certainly is the case that if they do more than that, they can lose the limited liability associated with a limited partnership. LLCs do not have that issue. There isn’t a concern of over-managing by the members causing them to lose their limited liability. So the concerns that we see in LLCs and in Limited Partnerships is actually, what sort of duties are defined that the manager has to the limited partners or members? And in the case of LLCs, Delaware law allows a waiver of fiduciary duties and a very broad waiver of fiduciary duties. You cannot waive the duty of good faith, but the duty of good faith is really a pretty slim duty. It only covers what the manager does when the documents don’t specifically provide for something. It wouldn’t cover redeployment if the documents actually contemplated redeployment. If your operating agreements said the manager may redeploy funds in its discretion and then it waived all fiduciary duties, that would be effective, at least in the current state of Delaware law, it would be effective. So if the documents contain a fiduciary duty waiver, absent some sort of blatant self-dealing, there really would be no fiduciary duties associated with how the manager goes about selecting a redeployment. But not all EB-5 funds waive fiduciary duties; some do, some don’t. There are a couple of overlays on that.
Proper EB5 Documentation
One is there’s a securities law concern which is that if your waiver of fiduciary duties is buried deep in your LLC agreement — say it’s two thirds the way through a 40-page agreement — and you don’t mention it anywhere in your PPM or don’t mention what it means to investors, you potentially have a securities law issue; an argument that you didn’t provide full and adequate disclosure to investors of what they were investing in. So that’s something that you have to look at. The other sort of overlay on this is the Investment Advisers Act, even for funds that are exempt because they don’t meet the monetary thresholds to register as an Investment Adviser. There are anti-fraud and fiduciary duty provisions in the Investment Advisers Act that will still apply so long as the manager meets the definition of an Investment Adviser, even if the manager is exempt from registration. It’s something people need to be aware of and think through.
Fiduciary Responsibilities of Corporate Governance in EB5
Kurt: What are some of your thoughts about fiduciary responsibilities. John: Generally speaking, fiduciary duties are a creature of common law meaning the courts have created fiduciary duties over many decades, if not centuries. And the key fiduciary duties are the ‘duty of care’ and the ‘duty of loyalty’.
Duty of Care
The ‘duty of care’ is the duty to manage the firm in a reasonably prudent way. Probably the most important thing about the duty of care is that the law gives managers a lot of latitude in discharging their duty of care. There’s something called the ‘business judgment rule’, which is the principle that courts will not second guess business decisions no matter how stupid they might seem in hindsight. Companies constantly face difficult decisions and the courts just can’t be in a position to second guess every one of them when they don’t work out. So there’s tremendous latitude in terms of how directors discharge their duty of care.
Duty of Loyalty ||abc|| Conflicts of Interest
The duty of loyalty requires the firm’s managers to put the firm’s interests above their own. It’s concerned with conflicts of interest, and managers face much more scrutiny in the duty of loyalty issues. The courts are not so deferential in terms of how managers manage the conflicts of interest they have. And most of the law and most of the thinking in fiduciary duties is around duty of loyalty and conflict of interest issues. Because that’s where people can have lawsuits that really have some legs.
The last piece of this that I’ll talk about, and if we were talking about public company mergers and acquisitions, this would be an entire course, is that Delaware courts have situations where they apply what’s called ‘enhanced scrutiny’. And those are particularly important decisions that often involve conflicts of interest. So the courts will establish a higher standard for looking at it and the most frequent example we see is called ‘entire fairness’ review. So that’s a different standard of review than the normal ‘business judgment rule’ standard, and it basically says that court is going to, on its own, make a judgment as to whether the process of the decision making was fair and whether the result was fair. So this is the court actively second-guessing the board’s process and decision making, something that they’re very reluctant to do in most situations. But in certain situations, where you’ve got a controlling shareholder and they’re doing a deal that has fundamental conflicts of interest, the court says, we can’t rely on them to make these decisions the right way. Unless they put in certain protections that I’m not going to get into here.
Avoid Having Judges Make Crucial Decisions
Shareholders are going to be able to take them to court and the judges are going to sit and decide for themselves whether it was the right decision. So that’s something that companies really want to avoid. And there’s a whole area of practice around avoiding that ‘entire fairness’ review. And that kind of thing can come up in EB-5. I haven’t seen it come up in an actual case, but it certainly can. In the case where the EB-5 fund manager is also the developer on a redeployment project and they’re going to deploy funds into their own project, that is the kind of fundamental conflict of interest where I’d expect plaintiffs to argue that the entire fairness might apply. So that’s the basic of fiduciary duties. I’d actually I like to travel to where EB-5 is a little bit different than corporations if that’s okay? Kurt: Of course.
How is Corporate Governance Unique in EB-5?
John: So the main reason EB-5 is different is because of something I said a little bit earlier, which is that EB-5 funds are pretty much never corporations. They are always limited partnerships or limited liability companies and those are entities that can waive or modify the fiduciary duties, at least under Delaware law, that are owed to their investors. So most of the law in this area has developed around corporations and it may or may not apply to these alternative entities. That’s where the expertise of those in corporate governance is really important because they can help make the judgments about where traditional corporate governance applies and where it doesn’t to a limited liability company or a limited partnership. We also have to consider the overlay of the Investment Advisers Act, as I mentioned, and also potential securities law liabilities associated with the initial offering documents. We have to look at all of these things and make judgments. And, you get quite a complex analysis that in my experience kind of starts with this knowledge that we have developed over time for corporations, but often diverges because of the animals that we’re actually dealing with.
Should You Involve a Corporate Lawyer?
Kurt: Is involving a corporate lawyer helpful in these situations? John: Absolutely. Not only is it helpful, but in my mind it’s essential. A company with a lot of money at stake normally would not attempt to do these things without talking to someone who understands it. In the early days of EB-5, people did these offerings without a securities lawyer even looking at these things. And that was just crazy to people who practice securities law. And I think it’s kind of the same thing here. To try to make decisions about fiduciary duties and the Investment Advisers Act without someone with a deep understanding of those things is really crazy in my view. And not all people that call themselves securities lawyers have that expertise. Some do. People that represent public companies tend to have both securities law expertise and corporate governance expertise because they tend to overlap for public companies. But in the private offering space, they really don’t overlap much in practice. There are a lot of attorneys that are very well versed in the exemptions from registration, that are well versed in the broker-dealer laws that apply to selling real estate investments, but really don’t have a lot of experience in the corporate governance issues and fiduciary duties. So that’s something you really want to check out and make sure you have the right professionals advising you. And you certainly do want to have professional advice. There is a lot of law and there’s a lot of exposure associated with these kinds of decisions.
Fiduciary Role and Process of Decision Making
Kurt: Am I correct that an aspect of the fiduciary role and the way it’s judged by a court encompasses a ‘process of decision making’? John: Yeah, that’s a great question. So let’s take a redeployment decision and let’s just say that that decision was subject to ‘entire fairness’ review. That would only happen if there was a significant conflict of interest. So let’s play out an example where the NCE fund manager is also the developer and they redeploy funds into their own project. A court would look at two things. They’d say, “Is it a fair deal?” It might be, but it might not be. So the court would just look at it and say, all right, the terms are this, the security is this, the rate of return is this, the maturity of the loan is this; is that fair? So they’d reach their decision on that. Kurt: They would make that decision based on the general market, or would they be comparing it to EB-5 investments typically? John: That’s a great question, and nobody knows the answer in EB-5. There may well be cases that would be instructive in other contexts. If this is in Delaware courts, Delaware judges are very, very smart and sophisticated and it would not be like them to close their eyes and not recognize the sort of real context of an EB-5 investment. They certainly treat major mergers and acquisitions with their eyes open as to what’s really going on, and I would expect the same thing in EB-5, but it’s really hard to say how an actual lawsuit would play out. What standards should it be compared against is a really great question? I think there would be expert witnesses that both sides would put on. And one expert might say, “we only need to look at EB-5 investments.” I’m making this up, but I’m having fun, so I’m going to keep going. Another expert might say “Well that’s not really the case in redeployment because we don’t have to create jobs anymore. So these investors look just like investors in any other real estate fund.”
Corporate Governance Helps Ensure a Fair Process
Kurt: But we don’t have any major precedents at this point. John: Not that I know of. So that is the ‘fair price component’ of ‘entire fairness’. It’s called the fair price component but it really encompasses the deal itself. But Kurt your question was about ‘fair process’. So let me keep playing out this example. Let’s say the court said that, okay, it’s a fair deal. it’s fair by whatever standard we’re looking at it. The court could still invalidate it or say that the investors are entitled to damages because, well, “we think it’s fair, but the process was terrible.” “The manager never even looked at any other deal nor was there any type of negotiation on behalf of investors. The only thing that happened,” and again I’m making this up, “the only thing that happened was somebody on the development team for this new project said I’d sure like a loan on these terms, typed up a term sheet, handed it to the fund manager, who was in the office next door. And the fund manager said, okay.” A Delaware court might say that’s not a fair process. They should’ve gone out shopping for other redeployment opportunities. Maybe there were development deals, or maybe municipal bonds, whatever. But they could say the Manager should have done these other things. And they could say the process wasn’t fair. And even though we think the deal was fair, we’re still gonna let these investors have some damages because they can speculate that they might’ve gotten a better deal. This is something to be avoided. A large part of the practice of corporate governance in EB5 is to avoid this kind of thing whenever possible. You don’t want to be at the mercy of a Delaware court making these decisions for you.
Document Your Thinking
Kurt: And you want your corporate governance attorney to advise you that this is probably something you should not only think through but document so that if we had to end up in court, we can eliminate at least the ‘process’ pillar of their argument. John: Exactly. So let’s say that we can’t avoid entire fairness, and there would be a discussion about how we can avoid it, but let’s say we can’t. Then we’re going to say, all right, let’s have a fair process. Well, what does a fair process look like? Well, we’re going to take some guidance from cases that said something was or wasn’t fair. Then we have to think, alright this guidance exists. So what kind of fair process can we design that’s realistic for our situation? And in EB-5you have to redeploy the funds within a reasonable time. So whatever you do, it has to be doable within a reasonable time. If it’s not, it doesn’t matter what the Delaware courts say about it. You’re just going to be thoughtful about how do we create a defendable, fair process? And then at the same time let’s make sure the terms are defendable, whatever that means. And there’s going to be a lot of discussion about what that means.
Fair Process Is Not a Requirement if Explicitly Stated
Rupy: So John, you’re saying that this fair process wouldn’t be an issue if the offering memorandum originally, explicitly stated that the developer will redeploy into their own projects or bridge to other projects? John: Yes. There’s some favorable case law in Delaware, favorable to fund managers that is, that indicates that if two things are true, then there’s not going to be a breach of fiduciary duty claim. And the two things would be fiduciary duties were waived, that’s number one. And number two, whatever the manager decided in a self-interested way, was expressly contemplated by the operating agreement. So Rupy, for your question, if the LLC agreement for an EB-5 fund had a waiver of fiduciary duties, which many of them do, and also said that the manager is free to redeploy into their own projects in their sole discretion. Maybe it’s got some criteria around that, but if that criterion is met then they’re free to do it. There is favorable case law in Delaware that says that’s the end of the questions. That’s what the parties contemplated. Now, there may still be Investment Advisers Act issues. That’s a different body of law that we haven’t really seen those show up in EB-5 yet. But it is a wild card.
Redeployment – Clearly an Issue of Corporate Governance
Kurt: So, John, could walk us through the times that you think an EB-5 issuer should strongly consider having a corporate governance attorney involved in the EB5 green card process. John: The one that’s now showing up almost universally is redeployment decisions. And this isn’t a mystery. When you’re going to have a redeployment issue, I recommend people get like a year ahead of when you’re expecting the loan to be repaid. That is my mind is the time to have your initial conversation with a corporate governance attorney about what you’re going to do. Kurt: Is there any time when you don’t feel it’s worth the issuer’s while to have a corporate governance attorney come in prior to making redeployment decisions?. Is there any kind of circumstances that you can envision where you’d say, in this circumstance, you probably wouldn’t need a corporate governance attorney? John: I can’t envision any circumstance. I mean even in the situation that I just talked with Rupy about, where the documents clearly let you do something, I still think it’s worth a conversation. It ought to be a short conversation, but maybe there’s something else going on. And if you don’t talk to somebody, you won’t know if things have changed. State law fiduciary duties are always coming out. Every fund has got its own facts. Let me give you a fact pattern you might see right now in the world.
Other Corporate Governance Considerations in EB5
This is a real one, not a hypothetical one. There are a lot of rabble-rousers out there in EB-5. Sometimes they are investors in a fund and sometimes they are external, such as plaintiff’s lawyers or other people that seem to have some economic incentive to stir up a lot of trouble with investors. They get on WeChat, they get on whatever other social media that investors are using and they whip up a lot of discontent amongst investors. If you’ve got that going on, and many people do, simply following the documents you have might still be a problem. At the least, you might face one of these plaintiff’s attorneys filing a meritless lawsuit. They’re going to lose because the law is not on their side, but that doesn’t mean they won’t file it. Now, I’m not saying that EB-5 funds shouldn’t do anything that people might sue about, because that’s ridiculous. People sue and you just have to live with it. But you want to be thoughtful about it. If it’s likely you’re going to get sued, even though you’re doing everything right, you want to be thoughtful about it. There are things you might be able to do to put yourself in a better position in that lawsuit, even though your documents are clear. Kurt: Every EB-5 issuer that has to redeploy should certainly have a conversation with a corporate governance attorney. Do you think that an issuer in preparing his documents should involve a corporate governance attorney? John: I would say at a minimum, make sure you ask the attorney you have about issues concerning redeployment and fiduciary duties. You should ask that, and make sure that you understand how you’re proposing to handle those things. And are they adequately disclosed? So that at a minimum that’s a conversation to have with the securities lawyer that’s preparing your initial documents.
EB5 Loan Workout Issues in EB5
One other situation that comes up where I think you absolutely have to talk to someone who knows corporate governance in EB5 is loan workout issues.
The loan isn’t doing well and you’ve got to consider what to do. Perhaps the loan is going to default and you’ve got to consider default remedies, like foreclosure. Or maybe the borrower comes to you and says, “all right, I can’t pay you back in five years because I just don’t have the money, but I can go out and do this other thing as long as you’re willing to subordinate and give me another three years.”These conversations go all different directions, and there’s a way it’s looked at from a typical commercial lending perspective and commercial real estate lending lawyer’s perspective, about how to renegotiate those things in a workout scenario. But in EB-5, there’s also this governance scenario, which is you’re about to make a decision that has a significant impact on your investors. What guidelines do you have for that decision? Is it going to get second-guessed? An important thing to remember about second-guessing is that it always happens with the benefit of hindsight. So if you work out a loan and you give the borrower an extra two years, and that’s within everybody’s sustainment period and the borrower pays it back, you’re certainly not going to face a lawsuit at that point in time. You’re going to look like a hero. However, if two years later you did the best you could in a difficult situation and it didn’t work out, and the loan doesn’t repay, now you’ve got everybody complaining and everybody going back and looking at the decisions that you made two years ago and questioning them. That’s a reality of governance that we have to deal with.
Corporate governance: A Summary
Issuers today really need to involve lawyers with corporate governance expertise early on to establish the rules that will be later referred to, especially concerning redeployment, fiduciary duties and loan work outs. Here are some key takeaways from this conversation:
- Corporate governance was ignored by the EB-5 world till recently, when SEC enforcement made it a pressing issue
- Redeployment should be addressed in the offering documents and be contemplated in the light of securities law
- Having shareholders vote on redeployment may not be in their best interest
- Governance rules established in the beginning are vital in dealing with unexpected issues later
- Most EB-5 funds are limited partnerships or limited liability companies; they have different rules, especially regarding the scope of management
- The Investment Advisors Act has anti-fraud and fiduciary provision that apply to EB-5
- Most lawsuits are related to the duty of loyalty and conflict of interest issues
- Do courts make a decision based on the general market or other EB- investments? There’s no consistent answer
- A court, in reviewing a redeployment decision, could determine a deal was “fair” but still award the investors damages because of a bad “process”
This EB5 ProTalk article features hosts Rupy Cheema and Kurt Reuss. Rupy is CEO ||abc|| founder of EB5 Diligence; Kurt is a broker-dealer representative and CEO of EB5 Marketplace.