Restructuring your NCE operating documents for redeployment

  • Written by Posted on March 27, 2020 | Updated on November 16, 2020 | 5 min read

Featuring special guest securities attorney  Mark A.Katzoff, – Hosted by Kurt Reuss and Rupy Cheema

Special guest is Mark A. Katzoff, senior counsel, corporate, with international law firm Seyfarth Shaw. Mark has been practicing business and securities law for more than two decades and is an EB-5 expert.

This discussion deals with the issues that NCE Managers and EB-5 investors face when re-deployment must be considered.

Many NCE’s did not made provisions for redeployment in their offering documents — so how do you allow investor funds to remain “at risk”? As most Managers aren’t registered investment advisors, under Securities rules, can they make a reinvestment decision? Learn what a Manager’s options and obligations are. Discover aspects that can determine similar risk profile. Can redeployment mean a higher rate of return? Learn what questions investors can ask — and what savvy ones can negotiate.

Rupy Cheema: What we’re discussing today is generally older NCEs (New Commercial Enterprises) that never made a provision for redeployment in their operating agreement or Limited Partnership agreement.

Mark Katzoff: So just to address why the issue is important, as we’ve seen with USCIS (U.S. Citizenship and Immigration Services) increased processing times for visa applications, the issue is that USCIS is requiring investors to maintain their funds “at-risk” until the conclusion of the sustainment period, which is the two-year-period after they’ve gotten their temporary visas, and given the processing times for I-526s that can be a while.

Many older funds did not make provisions in their offering documents for redeployment

Mark Katzoff: A lot of funds may have structured their initial investments to have a maturity date of five to seven years out, in the anticipation that all of their investors would actually have received Green Cards by then, and obviously with retrogression that hasn’t happened.

Funds may not have made provisions for a subsequent investment, so the initial consideration is if the fund agreement does not expressly permit reinvestment of the initial EB-5 investment, how do you address that to allow the fund to maintain the investor’s capital to be at risk over the sustainment period.

Unilateral amendments to comply with EB-5 requirements may be included in agreements

Most agreements tend to be structured to allow for unilateral amendment by the Manager to comply with EB-5 requirements; the Manager can presumably allow for re-investment without having to go back and obtain the consent of the members to make a re-investment.

Kurt Reuss: Because the members have already consented to it in the original documents?

Mark Katzoff: Right, by giving the Manager discretion to amend the documents as needed to comply to changes in the EB-5 rules.

Kurt Reuss: Is that typical? Do most of the documents that were drafted at a time when we weren’t really contemplating the length of time it would take for I-526 approvals typically give the Manager that kind of discretion?

Mark Katzoff: In my experience, yes.

Kurt Reuss: So are there an issues with that? Is it straightforward that if the Manager has that ability to make adjustments to the offering documents without investor consent, then we don’t have a problem?

Mark Katzoff: There shouldn’t be a problem under those circumstances because the immigration rules are clear that the funds need to stay at risk. I suppose the potential issue is if you have a project where the useful life cycle of the funds is already concluded and the Manager, rather than continuing to extend the term of the initial investment, wants to redeploy the funds into a different project, there may be a potential question of if they have the option of maintaining the funds in the original project, whether there’s a need for redeployment in order to satisfy the EB-5 visa requirements or whether it’s a matter of convenience.

Kurt Reuss: So the Manager at this point has the right to make an adjustment because EB-5 rules affect investors. So the question is whether it’s in the best interest of the investors that he make that adjustment, make that reinvestment decision?

Mark Katzoff: This is one of the criteria the Manager would need to consider, yes.

Kurt Reuss: In almost all cases, the Manager is not a registered investment advisor. Does that Manager have the right, under Securities Rules, to make a reinvestment decision on behalf of investors?

Mark Katzoff: Generally, the thinking is that the Manager of these funds, since they’re really just doing one-off  investments rather than really managing a portfolio of investments — for example, doesn’t need to be an investment advisor

When Managers can’t redeploy without investor consent

Rupy Cheema: So the next question is, if the Manager doesn’t have that discretion to make a reinvestment decision without the consent of the limited partners, what options do you typically suggest to the NCE?

Mark Katzoff: Well, the only real option, if the Manager does not have discretion and doesn’t have the option of maintaining the funds in the original project, or they would rather redeploy the money into a different project, is to obtain the consent of the investors to amend the agreement to allow for this.

Kurt Reuss: And is that a majority vote of investors? Is that the goal of the Manager to get more than half of the investors to acquiesce?

Mark Katzoff: It depends on how the agreement is drafted. Generally, I would expect the agreement would only require a majority.

How is a majority vote determined?

Mark Katzoff: In terms of counting the majority, there’s a couple of approaches in agreements. One is actually requiring the affirmative vote of the majority. You send out a request for consent and you need to get those requests returned by a majority of the investors.

The other approach, which is built into some of the agreements to try to provide more flexibility for the fund, particularly given the fact that we’re dealing with foreign investors, is a provision which states that unless an investor affirmatively votes against the request for an amendment within a set period of time, then they’re deemed to have voted in favor of the amendment.

Kurt Reuss: And is this language typically in the original documents where silence means consent?

Mark Katzoff: I would say it’s in the majority of the documents that I’ve seen.

Kurt Reuss: And even though it’s in those original documents, do you have any potential problem with that or do you think that the fact that it’s in the original documents gives the Manager the flexibility he needs?

Mark Katzoff: As long as this is clearly stated in the original documents, and as long as the Manager is providing a reasonable period of time to investors and not saying, you’ve got to turn this back around in two days — more like 10 days or two weeks, as a minimum, if not longer. I don’t think there’s an issue in relying on that. Obviously, it’s always better for the NCE when you have an investor affirmatively agreeing to the amendment because it makes it more difficult for the investor to challenge the amendment after the fact.

What are the Manager’s options & obligations?

Rupy Cheema: What are the manager’s options? Can the Manager decide “there’s a project that I like or I have vetted and this is the project we’re going to reinvest in,” or is the Manager required to give multiple options?

Mark Katzoff: That’s really up to the Manager, and what the Manager chooses to do can have an impact on the level of disclosure that would need to be provided to investors. The Manager may not have a particular project in mind and either define or not define parameters that they would need to meet for reinvestment, and basically tell the investors to give us the authority and trust us.

If they have a particular project in mind, for which they want to seek the consent of the investors, or they want to give the investors the chance to choose between multiple projects, then that would require the NCE to provide the investors with a reasonable amount of detail regarding the proposed projects. Essentially, the equivalent of what they provided in the original offering documents.

Rupy Cheema:  Does the Manager have an obligation to keep that redeployment in a very similar market or risk level?

Mark Katzoff: Again, it depends. There are some agreements which give them Manager some discretion for reinvestment and may require that the investment either be in a similar industry or of a similar risk profile. Basically, if the agreement is being amended and there is no particular guidance on that, then the Manager has a bit more flexibility.

One particular concern is under the USCIS guidance. The new investment has to be consistent with the scope of the NCE’s ongoing business. So if the NCE, in its initial purpose is very rigid and just talks in terms of the first investment, then as a matter of USCIS policy, the Manager would really be limited in terms of finding a subsequent investment consistent with the initial investment.

If the business purpose of the NCE is broader, and for some of these older NCEs there may not necessarily have been a reason to do that, then the Manager may need to find something that’s very similar to the initial investment.

Determining similar risk profile

Rupy Cheema: One of the challenges, considering the requirement that the redeployment be of a similar risk level is, who determines that? And getting that opinion, I imagine, would be costly, and it may be challenging to find something of a similar risk profile?

Mark Katzoff: Similar risk profile really is a very subjective term and it would be sort of difficult to find a 3rd party that would be able to say that without some degree of caveats.   The best you can do is look at some of the quantitative aspects of the project.

  • What is the type of the project?  
  • Is it similar to the type of project that the constituted the initial investment?  
  • Look at the financing. How is this capitalized? Are there any different risks there?
  • How are you structuring the investment? If you did a secured loan for the last investment backed up by a second mortgage on the real estate or some other form of security, are you going to get security for the second investment? Or are you going to try to structure it as equity as opposed to debt, which adds some additional risks in that the equity would be behind in priority to any debt in terms of recovering the money.

Does redeployment mean a higher rate of return?

So investors come to realize they won’t get their immigration benefits in that timeframe they expected, and the NCE realizes it needs to redeploy. Would an investor be entitled to a higher rate of return than they originally accepted?

Mark Katzoff: It wouldn’t necessarily be the case that they’re entitled to a higher rate of return. The Manager has the authority for redeployment unilaterally, in which case investors are stuck with whatever the original economic deal was. But, that original deal may have been structured so that the interest rate starts ballooning to provide the investors with an additional return for the risk; the longer it takes to get their EB-5 Green Card, then, arguably, the larger risk they’re taking.

Kurt Reuss: Well, we’re likely motivating the NCE to repay as quickly as possible or even the developer to repay as quickly as possible.

Mark Katzoff: Exactly!

Kurt Reuss: But now we’re in a situation where through no fault of the developer, and through no fault of the NCE, the investor needs to keep their money at risk.

It seems to me that that Manager is still in a pretty strong negotiating position with investors to say, “listen, if you want your money back before you get your immigration benefits and you want to abandon your petition, that’s fine, but if you want to maintain your investment, I’m going to need to reinvest it,” and I don’t see why the Manager has much motivation to increase the investor’s rate of return at that point.

Mark Katzoff: Well, if the increase is already built into the documents, then the Manager has essentially two choices. One is to go to an investor and say, “this is taking longer than we all expected and we need to redeploy. In order to be able to redeploy successfully, we need to maintain the lower initial interest rate,” and get the investors to agree to amend the agreement to keep the interest rate where it is for a few years.

The flip side to this is the investors decide they want to play chicken, to the extent that the Manager is seeking their consent for reinvestment, and they say “if you want our consent then we want a higher return to give you an incentive to try to return the funds as soon as possible.”

Kurt Reuss: Obviously, the number one goal with the reinvestment decision is the preservation of capital. No one wants to lose the money, but the jobs have been created, so we’re not desperate about creating jobs anymore. We’re just looking for a place to put the investors money that’s going to meet the guidelines that USCIS has laid out.

But I still don’t see how these investors have any leverage to negotiate a higher return. In fact, if the Manager decided that to placate investors and offer them a higher rate of return, they might need to make a more risky investment. Right?

Mark Katzoff: I would say yes. Again, the investors may want to try to negotiate for a bigger piece of whatever’s available for the return on investment in exchange for the right to reinvest.

When operating documents haven’t contemplated redeployment

Kurt Reuss: Going in a different direction for a moment. As a securities attorney, Mark, you are going to have to help create the documents to address this situation. What are some of the things that you have to look at when you’ve got a situation where the documents didn’t originally contemplate redeployment?

Mark Katzoff:  If there was absolutely no contemplation of redeployment in the documents, then likely that also means that there was no discussion of the risks of redeployment. So in a scenario where the NCE has decided to go to the investors and get their consent for authority for redeployment, you want to have some discussions of the risks involved, and especially when they’re not seeking authorization for a specific project, but basically a blank check consent to allow the NCE to re-invest the funds.

Kurt Reuss: And what percentage of the documents out there do you think will require this adjustment?

Mark Katzoff:  It’s hard to come up with an exact percentage but I suspect that most of the documents had at least some provision for redeployment. It may be the case that what they’re allowed for in terms of timeframes may not be adequate under the current retrogression scenarios.

It may be the case that even if there was some authority to redeploy, there may be a requirement that the life cycle of the redeployment investment is still too short to continue to allow the funds to be maintained at risk during the full sustainment period. I think that’s the likelier scenario.

Kurt Reuss: So to summarize, we talked about the offering documents and whether they contemplated redeployment or didn’t fully contemplate the situation we’re currently in, and we’re considering what kind of consent we need from investors or whether we need any at all.

And if we do, then how do we get that consent. And consider whether consent might require some negotiation with investors. Is that accurate and is there anything else that we can add to that.

Mark Katzoff: That’s all accurate.

Redeployment & agent interests

Kurt Reuss: What about a situation where agents are expecting to get a portion of the rate of return each year? How much does that come into play in the situations that you’ve seen.

Mark Katzoff: That is another potential factor. If the agents are getting a portion of the return then they obviously would resist any attempt to reduce that return.

Kurt Reuss: Do they become part of the negotiating parties, where investors want a higher rate — and may not have even known what their agents were earning when they signed up and now documents need to be revised?

So, is it your experience that you’ve got a three way conversation, where the Manager is attempting to make an investment that is as safe as possible — which is in the benefit of the investors, not necessarily in the benefit of agents, although they do have a reputation that they want to protect — but the agents are also trying to maintain this recurring revenue stream that they’ve been getting, for as long as possible? Have you seen this play out?

Mark Katzoff: I haven’t seen a lot of circumstances where it’s played out that way, but again, certainly the agents could find themselves, as they often do, arguing in what they view to be the best interest of the investors, but is also, as it turns out, in their own best interest. 

Kurt Reuss: So what is your experience thus far in this ménage à trois between the agent, the investors, and the Manager, all looking after their own interests?

Mark Katzoff: I think under the circumstances the agents would tend to argue that their interests are, for the most part, aligned with the investors.

Kurt Reuss: Doesn’t it seem just the opposite. That they’re actually completely not aligned, because the investor wants as much as he can get, with as little risk as possible, and the agents probably are more concerned with a higher rate of return.

Mark Katzoff: Well, the other scenario I suppose is the investors are interested in getting their funds back as quickly as possible and depending on how the agreements are structured, if the advisor is continuing to get a fee as long for as long as the funds are invested, then they actually have an interest in seeing the funds stay invested for as long as possible.

Kurt Reuss: Right. So the agent motivation might be to have another long-term duration, where the investors want as much liquidity as possible.

Mark Katzoff: Well, the Manager, depending on their proposed use of the funds, may want to have a little longer time frame to fully utilize the funds. The advisors, they’re happy to see an extended timeframe of the return of the money, and the investors would like to see their money returned as soon as possible.

Smart investors can negotiate when they get their money back

There’s actually another potentially interesting piece. As a negotiating point among the parties, a lot of the agreements provide that investors can only get their money back on I-829 approval, as opposed to at the end of the sustainment period, because nobody contemplated a few years back that USCIS would allow funds to be returned at the end of the sustainment period.

So to the extent that agreements don’t allow for it, if I’m a savvy investor and I’m saying, you’re asking me to amend the agreement to allow for reinvestment. Maybe investors start pushing for an adjustment to the term of when they get their money back.

So long as we’re amending, we ought to also allow for earlier return of the funds since it’s not compromising our I-829s.

Kurt Reuss: Sounds like a nice tidbit for savvy investors.

First, review the NCE’s original purpose

Kurt Reuss: It seems that relative to a redeployment decision, the very first thing that investors and Managers need to discuss with their attorneys is how tightly bound are they are to the original NCE’s purpose?

Mark Katzoff: Correct.

Kurt Reuss: Once you’ve defined what the NCE was set up to do, should Managers come up with a number of options of how the NCE can stay within that scope and still provide reinvestment options that offer safety and liquidity for the benefit of the investors?

Mark Katzoff: Yes. Now there may be provisions in the agreement to deal with it. In some of the agreements I’ve worked on there have been specific requirements in terms of how redeployment needs to be structured and what types and the timing of liquidity the redeployed investments have to provide for.

Kurt Reuss: So that’s the framework that we need to work within?

Mark Katzoff: Yes.

Different investors can get their money back at different times

Rupy Cheema: Mark, this is may be a bit off the topic but I’ve seen where investors can be liquidated at different times as they become qualified to get their money back. But I always wonder, if some investors get liquidated, and then the fund loses its investment and the remaining investors don’t get their money back, what are the consequences? Doesn’t the NCE have to treat all the investors equally?

Mark Katzoff: Well, it depends on how the agreements are structured. EB-5 is sort of an unusual case. Under most conventional funds one would expect that distributions would be made to all investors at the same time.

In the case of the EB-5 funds, investors wind up being eligible for return of their funds at different times and the agreements generally provide for that by saying, “to the extent we have money to return capital to investors, we can only return the capital to investors who are eligible to receive their return of capital without compromising their visa applications.” So that’s something which is already built into the EB-5 documents.

And as long as at the time the company is making the distributions it’s solvent and it’s at a later date that suddenly the NCE loses the rest of its investment, it’s not necessarily an issue that they previously were able to return funds to just some of the investors.

Guidance for issuers who haven’t contemplated redeployment

Rupy Cheema:  Mark, do you have any overall guidance for issuers who are in this situation where they hadn’t made the provision and are having to redeploy now?

Mark Katzoff: The first consideration is to take a careful look at your agreement and to the extent that you’re comfortable that you’re able to make the changes unilaterally to permit redeployment without needing the consent of investors. But to the extent that you do go to the investors for their consent, make sure that you couch it in a way where you’re providing them with adequate disclosure of what it is you’re planning to do, because in the end, consent is meaningless unless it’s reasonably informed.

Guidance for investors who are being asked for consent

Rupy Cheema: And what would be your advice to investors who are being asked by the Manager for their consent?

Mark Katzoff: If that’s all they’re asking for, I think the question is, if you’re worried about the prospects of another investment, start by asking, can the funds stay in the initial investment? If the answer is no, whether because the recipient of the funds has a right to repay, then ask about what the intention is with respect to the redeployment. What types of investments, how is it structured? How is it going to impact on my ability to get my money back?

Restructuring your NCE operating documents for redeployment: a Summary

For NCE’s that haven’t contemplated redeployment, they must look at the original agreement to determine if they are comfortable making unilateral changes. To be aligned with that agreement, and to meet USCIS requirements, managers need to tread carefully. Here are some key takeaways from this podcast:

  • Managers don’t have to be investment advisors to make a one-off investment decision
  • the first question a Manager should ask is, how tightly bound are they to the original NCE’s purpose?
  • a reasonable amount of time for an investor vote is at least 10 days to two weeks, if not longer
  • if a Manager has a particular redeployment project in mind, they should provide investors with a level of detail equivalent to that in the original offering documents
  • USCIS requires that the new investment be consistent with the scope of the NCE’s ongoing business
  • to determine a similar risk profile, look at the quantitative aspects of the project: is it similar to the initial investment project? Look at financing — how is it capitalized and what are the risks?
  • redeployment doesn’t often offer a higher rate of return — though some investors may choose to withhold consent for a higher rate
  • if the NCE needs investor consent, they should discuss the risks involved
  • the first question an investor should ask is, can the funds remain in the initial investment?
  • when asked for consent, savvy investors can renegotiate when they get their money back