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Defining At Risk, Debt Arrangement, and Guaranteed Redemption

Understanding Employee Qualifications for Direct EB-5 Investments

In the past, attorneys have brought cases against U.S. Citizenship and Immigration Services (USCIS) when the agency challenged the validity of EB-5 petitions, often claiming that the investment was either not at risk, was a debt arrangement, offered a guaranteed redemption, or some combination of the three. Curiously, the USCIS often confuses or applies all three terms to one situation. By successfully demonstrating the differences between these terms and focusing on nuances in legal documents, legal counsel can often present arguments that successfully overturn decisions made by USCIS.

Because any of these situations would invalidate an EB-5 investment, and consequently destroy the chances of the investor and their immediate family gaining permanent residency in the United States, a better understanding of these terms and how they negatively impact the EB-5 Visa process is important for both current and potential EB-5 investors. Most significantly, it is incumbent upon the investor to understand all terms and conditions pertaining to the successful operation of an EB-5 project; such an investor cannot rely upon ignorance as a defense with such costly outcomes at stake.

An Overview of EB-5 Investments

Over the past decade, the increased awareness of the EB-5 Immigrant Investor Program as a viable, and often desirable, financial resource for developers has kept the program running at maximum capacity. In fact, the window of opportunity for a successful EB-5 petition by a foreign national remains brief, often reaching its annual maximum in April.

The EB-5 program has proven to be an effective immigration method with a higher rate of success than many of the older, more traditional systems that have been under fire since the 9/11 tragedy shifted American attitudes away from lenient immigration standards and policies. As contrasted with most immigration programs, EB-5 rates popularly among Americans because of its high cost of entry: successful applicants must invest $1,000,000 ($500,000 for investments in Targeted Employment Areas) into a new commercial enterprise which, in turn, must prove its worth by creating a minimum of 10 new jobs per $1,000,000 investment.

As a reward for successfully satisfying these EB-5 requirements, investors, along with their immediate family members (spouse and children under age 21), are granted permanent residency and enjoy the rights and privileges granted to all American citizens. For America, the rewards are equally fruitful—thanks to the EB-5 Immigrant Investor Program, billions of dollars have been infused into the economy, many areas suffering from high unemployment have experienced visible improvement, and new jobs have sprung up across the nation.

An Overview of EB-5 Risk Factors

While this opportunity is mutually beneficial, it is up to the USCIS to govern and monitor the program to prevent abuse or manipulation of the rules or procedures. Emphasis is placed upon adhering to the entrepreneurial spirit which the EB-5 program encourages: investments must be directed to projects that entail the natural risks of any business venture. In other words, funds must be “at risk” and subject to normal losses or gains depending upon internal and external factors or conditions.

Because most of the EB-5 funds are channeled to regional center investments, where the EB-5 petitioner is a limited partner in a large project representing pools of funds often exceeding $1 billion, the ultimate success of the project is beyond the control of the limited partners. Cautious and conservative investors would like to have some guarantees included, but any agreement to redeem the investor’s money because of market failure is an attempt to mitigate or eliminate risk. Therefore, a guaranteed redemption clause runs contrary to the “at risk” requirement.
Another aspect of an investment is the element of equity. Equity is a value that can and does fluctuate; it can even be wiped out if market conditions or other factors cause a decrease in prices and the asset is encumbered with debt. Those holding debt secured by the asset are made whole before an equity holder will realize any return on their investment. For this reason, anything that has the look and feel of a debt arrangement, whereby the investor is offered a preferred or protected position upon liquidation, would also be a violation of the “at risk” character expected of an investment.

Differentiating Between Investors, NCEs, and JCEs

There is more than one financial relationship in EB-5 regional center investments. There is, of course, the investor, who creates a relationship with a regional center by investing in the New Commercial Enterprise (NCE) which is structured to meet the USCIS requirements concerning EB-5 projects. The NCE is empowered to deploy those funds to meet the EB-5 job creation requirements. A Job Creating Entity (JCE) will borrow the funds raised and managed by the NCE and initiate projects intended to generate the economic growth and new employment needed to satisfy EB-5 conditions.
All investor funds raised by the NCE must be placed with a JCE to ensure that 100% of investor funds are placed at risk. When these funds are loaned, the NCE can formulate terms that require the JCE to guarantee repayment without violating the debt guarantee conditions monitored by the USCIS. The reasoning is that the concern of debt guarantee relates between the investor and NCE only and not between the NCE and JCE.

The Difference Between Puts and Calls

Another area of confusion arises between the differences of puts and calls and how they are used in EB-5 investment contracts. If an EB-5 operator includes a provision allowing them to buy out an investor’s interest under specific terms and conditions, this is considered a call option, also called a buy option. The important term here is “option.” The EB-5 general partners have the right to purchase the investor’s interest but are under no obligation to do so. This avoids the label of guaranteed redemption while offering extra incentive to an investor who may be hesitant about committing to an EB-5 project.

On the reverse side, sometimes an EB-5 agreement has a clause allowing investors to exercise a put option, or sell option. This option does confer rights to an investor that allows for a redemption of their investment, but even a put option can be structured so it is not deemed a guaranteed redemption. Specifically, if the put option can only be exercised upon a contingency related to the success or failure of the EB-5 project, it will not be categorized as a guaranteed redemption, since no one can guarantee the occurrence of a contingency.

Sustaining the “At Risk” Requirement

There have been questions in the past as to how long an investment must sustain its “at risk” characteristic. It has been successfully argued that once the job creation requirement has been satisfied, the investment has met its EB-5 requirement and no longer needs to sustain its “at risk” status. This argument holds up well, as USCIS regulations concerning the I-526 petition (Immigrant Petition by Alien Entrepreneur, filed at the beginning of the EB-5 process) specifically address the “at risk” requirement, while USCIS regulations regarding the I-829 (Petition by Entrepreneur to Remove Conditions on Permanent Resident Status, filed upon satisfaction of the job creation obligation) does not reference the “at risk” requirement.

Some legal experts have argued that sustainment of “at risk” does not apply during the two-year period when conditional residence takes place; only that the investment ownership is sustained during that provisional period. Although this situation is not specifically addressed in the USCIS policy manual, investors are advised to err on the conservative side—they should assume that the investment must be at risk at least during the qualification period of the first two years of the EB-5 investment.

“At Risk” Requirements for Redeployed Investment Funds

Since long wait lists have become more common, the sustainment requirement gets a little more complicated. In these cases of lengthy wait periods, often, the money has already been put to work and may be in the process of attaining the goal of creating 10 new jobs. Once the wait period ends, investors may be required to redeploy their funds until they reach their two-year conditional residence wait period. It has been successfully argued in the past that if those redeployed funds have already met the job creation requirement, they are no longer required to remain at risk.

By redeploying funds into another investment that remains engaged in a trade or form of commerce, experts believe this further strengthens their case that funds are being used for their intended purpose and “at risk” factors are less important in the overall picture. Since this situation has not been litigated often in court, and has reached various rulings, it remains somewhat cloudy; nevertheless, most legal council finds that a proactive approach in the courts typically ends on a positive note for immigrant investors.

The Difference Between Debt and Equity

Of all the risk factors, identifying the difference between debt and equity may be the clearest and easiest to prove in a court of law. A good start is by using the definition from Black’s Law Dictionary which defines debt as an “obligation of a debtor to pay,” along with the “right of a creditor to receive and enforce payment,” and is often used in conjunction with IRS codes addressing differences between debt and equity. If this is challenged by the USCIS, hiring a CPA as an expert witness to explain generally accepted accounting principals concerning debt structure as compared to equity positions usually produces positive results. Normally, the onus is upon the USCIS to prove that an investment is structured as a secured debt by providing documentation that irrefutably proves their assertion.

Avoiding Guaranteed Redemptions

While most investors prefer to mitigate their risk by having some guarantees put into place in the investment, one of the biggest red flags is the inclusion of a form of guaranteed redemption in the investment agreement. To determine if a guaranteed redemption exists, the USCIS studies the investment contract to see if it includes an absolute pledge to purchase the interest of an investor at a predetermined price at a determined future date. There has been some success by attorneys in arguing that all three conditions (the unconditional promise, the fixed price, and the set date) must be present to meet the guaranteed redemption definition, but the USCIS is likely to disagree and litigate the issue in a court of law. Investors should carefully review their investment agreement to see if it addresses this potential problem and, if so, ensure that no ambiguous language is used.

Understanding the Matter of Izummi

One legal case, the Matter of Izummi, has been carefully and thoroughly studied and is often referenced by attorneys as it involved an EB-5 investor dealing with all three issues: the “at risk” status, debt and equity positions, and guaranteed redemptions. While legal opinions are not law, previous views stated by judges often lay the foundation for actual rulings in future cases. Most immigration attorneys believe the Matter of Izummi case offers excellent opinions and arguments in support of the immigrant investor.

For those foreign nationals already involved in an EB-5 project, and for those desirous of participating in future EB-5 investments, gaining a clearer grasp of the subtleties of “at risk” investments, knowing the difference between debt and equity holdings, and understanding the complexity of guaranteed redemptions is imperative to selecting a qualified EB-5 investment that meets their goals without raising possible legal entanglements that could disqualify them from earning permanent residency in the United States.