By Clem G. Turner,
Chiesa Shahinian & Giantomasi PC
There are many similarities between the EB-5 Immigrant Investor Visa Program and the Qualified Opportunity Zone Program.
With both, the federal government provides an added inducement for investors to finance qualifying projects. Additionally, while the incentives provided differ — a green card in the case of EB-5, and significant tax breaks in QOZs — the regulatory framework guiding both programs is similar.
EB-5 funds and QOZ funds typically aggregate capital from investors to deploy into qualifying projects;
The qualifying projects are located in underserved areas, either a Targeted Employment Area (EB-5) or an Opportunity Zone (QOZ);
Both EB-5 and QOZ investments must remain in their respective funds for a lengthy period of time, referred to as the “sustainment period;” and The federal government monitors both fund and investor compliance with respective program requirements throughout the sustainment period.
EB-5 and QOZ investors’ capital must be sustained in their respective funds for the requisite time period. However, the EB-5 funds and QOZ funds themselves are not required to maintain their investments in one asset for the duration of the sustainment period and are allowed to divest of one asset and, within a certain time period, reinvest their funds in another qualifying asset.
This is a beneficial provision, as the QOZ sustainment period is 10 years and that of EB-5 varies from approximately five to 15 years, depending on the investor’s nationality. The time period for redeploying EB-5 funds is a “commercially reasonable” period of time, with precedent suggesting a period of 12 months. Under QOZ regulations, the divested capital must also be reinvested within 12 months.
For several years, EB-5 funds have redeployed capital from one investment to the next. Some EB-5 funds have divested and reinvested capital successfully, while others have angered their investors, suffered reputational damage and faced lawsuits. QOZ fund managers should heed the experiences of successful EB-5 fund managers when the time comes for capital redeployment.
In redeploymentfund managers must honor their fiduciary duties to their investors. Managers should not redeploy fund capital into affiliated projects that, on terms and conditions, are more favorable to the manager at the expense of investors.
EB-5 fund managers have faced lawsuits from investors who have alleged breaches of this duty. Fund managers can redeploy capital into affiliated projects, but fairness to the investors should be maintained to avoid breaching fiduciary duties.
The second fiduciary duty is the Duty of Care, which requires fund managers to conduct reasonable due diligence on any potential redeployment opportunity and use sound business judgment in determining viable redeployment options. Fund managers who are not careful when reinvesting capital face liability from investors.
One way to minimize liability is to provide notice of redeployment to fund investors and move forward with the transaction only upon majority consent, but there are practical drawbacks to this approach. The consent request should be accompanied with significant disclosure providing the material facts of the redeployment alternative and the terms of the transaction.
If the QOZ investors reject the redeployment opportunity, in addition to lost time and resources, there is less time to find another redeployment project before the 12-month deadline expires.
However, seeking consent too early in the process — when diligence may not be complete and terms are still open for discussion — can lead to a subsequent challenge if the qualities of the redeployment opportunity or the terms of the final transaction differ materially from what was described in notice and consent documents.
A more nimble approach would be to have investors pre-approve investment guidelines, parameters and criteria for deployment and redeployment opportunities at the fund’s outset. This affords fund managers greater autonomy to identify, negotiate and close upon redeployment opportunities in a timely manner.
Implementing this solution should be considered even if the fund is only looking to purchase a single asset, as it is possible it may wish to divest of the asset before the end of the sustainment period.
While this approach affords speed and flexibility, it is critical that redeployment selections fit squarely into the predetermined criteria, or fund managers risk facing liability for redeploying funds without necessary authority.
Fund managers opting for a notice and consent process should identify redeployment options early on – and, if possible, prior to the divestment of the original asset.
Additionally, fund managers can reduce liability for a breach of fiduciary duty by utilizing third-party experts to analyze various redeployment options, and prepare a due diligence report or feasibility study. Third-party reports provide independent conclusions that fund managers may rely upon in meeting their fiduciary obligations.
The message is clear for EB-5 and QOZ fund managers alike: an initial determination should be made at the onset of the fund, regarding whether to be safe and require consent upon redeployment or be nimble and implement pre-approved redeployment investment guidelines.
The safer course of getting consent from the investors is costly and time-consuming, and might ultimately be responsible for the fund missing the 12-month redeployment window. However, the nimble choice exposes the manger to claims that the redeployed asset did not meet the necessary criteria. Further, investment criteria that is too broad may subject the manager to regulation as an investment advisor.
QOZ fund managers are urged to discuss redeployment processes with counsel prior to launching their funds. The positive and negative experiences of EB-5 fund managers should be utilized to prevent redeployment missteps that can harm reputations and lead to lawsuits.