When it’s said that the EB-5 Immigrant Investor Program is among the fastest and easiest ways to immigrate to the United States, that doesn’t mean an EB-5 investment isn’t without its risks. All EB5 investments are inherently subject to immigration risk, and one of the EB-5 program requirements is that the EB-5 investment capital remain subject to financial risk (the possibility for both loss and gain) throughout the investment period. While most EB-5 projects are successful and earn the investor and their dependents U.S. permanent resident status, some do fail, and the COVID-19 pandemic has accentuated this risk. In particular, hotels and other hospitality businesses are experiencing distress, with some project owners defaulting on their loans. What happens to the new commercial enterprise (NCE) funneling EB5 investment capital into a project when the project defaults?
Since EB-5 investments can be structured in numerous ways, there’s no one simple answer to this question. Different options are available for different types of EB5 investments, but generally, the terms are not overly favorable for the NCE.
If the NCE Is Secured by a First-Lien Mortgage
Most EB5 investments are not secured by a first-lien mortgage, but some are, and this is by far the best situation for an NCE to find itself in upon default by the project owner. In this case, the NCE has the right to hold a foreclosure sale on the project, either taking ownership of it itself or selling it to a third party. Each state follows its own foreclosure laws that NCEs must abide by, which generally means hiring a foreclosure expert to conduct the sale.
In the foreclosure sale, the NCE may bid up to the full amount of its loan. If the NCE does so, and if no other bids exceed this amount, the NCE pays nothing and assumes ownership of the project. If, however, a third party does outbid the NCE, they will have to pay cash at the foreclosure sale, allowing the NCE to receive full repayment for its loan. Any excess cash goes to the project owner, who must pay it out to other creditors.
If the NCE Is Secured by a Second-Lien Mortgage
NCEs with loans secured by a second-lien mortgage have similar rights to first-lien mortgage lenders, but they are subordinate to the first-lien mortgage lenders. In other words, NCEs with a second-lien mortgage on an EB-5 project may call a foreclosure sale, but only if the senior lender chooses not to.
If the senior lender does choose to exercise this right, however, the junior lender cannot receive any repayment until the senior lender’s loan has been repaid in full. If the excess funds cannot cover the junior lender’s loan amount, the NCE loses its second-lien mortgage and the rights associated with it. In cases where the defaulting project owner cannot fully repay the junior loan with the proceeds from a foreclosure sale, the NCE may obtain a monetary judgment against the project owner that can be satisfied with other assets the project owner possesses, but generally, the project owner’s sole asset is the EB-5 project, leaving the NCE with little recourse to recover its loan.
An additional factor complicates matter further—generally, a junior lender is required to sign an intercreditor agreement with the senior lender. Usually, this agreement disallows the second-lien lender from taking enforcement action against the project owner until the senior loan has been entirely repaid. This often means the only option is for the NCE to repay the senior loan itself or find a third party willing to do so while keeping the NCE’s junior lien intact. However, most NCEs have no additional funds to pay off the senior loan, rendering this solution inviable. The best practice for junior lender NCEs in this case is to work with the project owner to avoid a senior-lien foreclosure and sell the project at a high enough price to pay off both the senior and junior loans.
If the NCE Is Secured by Pledges of Membership Interest
Many EB-5 investments are secured by pledges of membership interest, either by the project owner, the entity that owns the project owner, or another entity above the NCE. Such a loan structure offers the NCE the right to hold a foreclosure sale of the membership interests, which operates similar to a regular foreclosure sale in that the secured party may bid up to the full amount they are owed. Should no other bids exceed this amount, the NCE obtains ownership of the membership interests.
However, like with junior lenders, NCEs with loans secured by pledges of membership interest are usually required to enter into an intercreditor agreement that prohibits them from holding a foreclosure sale on the membership interests until the senior loan has been fully repaid. To make matters worse, if the senior lender holds a foreclosure sale, the membership interests may be rendered useless—and if the entity pledging the membership interests is above the project owner in the chain of command, the project owner must first repay all unsecured lenders before the NCE. Thus, NCEs with loans secured by membership interests should work with the project owner to avoid a foreclosure sale.
If the NCE Is Unsecured
An NCE with an unsecured loan has no rights to hold a foreclosure sale, leaving the only recourse to file a complaint in court against the project owner to obtain a monetary judgment. After the monetary judgment is obtained—which can take months or years—the NCE would have to file a writ of attachment on any assets the project owner might have, allowing them to be sold to help fund the repayment of the NCE’s loan. Since assets that the project owner has already pledged to other creditors would first have to satisfy their loans, it could be a lengthy or even impossible process for an NCE with unsecured loans in a defaulting EB-5 project to receive repayment.
The Third-Party Rescue
In all above-described scenarios other than the one in which the NCE is the senior lender, the NCE cannot receive its repaid funds until the senior lender’s loan has been repaid. In such cases, the NCE may locate a third-party entity—often called a “white knight”—to either purchase the project or repay the senior lender’s capital and take their position as the first-lien mortgage lender while maintaining the NCE’s interest in the project. To make this arrangement financially attractive for the white knight, the deal is usually structured such that the NCE is not repaid until the white knight receives their full repayment and a specified return and all other creditors have been repaid. While this almost inevitably represents a higher-risk investment for the NCE, it’s still preferrable to losing the entire investment to a foreclosure sale.