Michael Homeier: Balancing the EB-5 project Manager’s role and responsibilities and specifically the extent to which the Manager is obviously looking out for his own interests, but must also be aware of and must honor his legal obligations to look out for the interests of his investors at the same time.
It’s typical of EB-5 investments that the principals run the show and are the Manager of both the project company and the funding company, whether it be a direct investment with investors coming in as minority owners of the business, or as an indirect investment with investors investing into a funding company that intends to deploy the EB-5 funds to a separate project company.
Investors naturally have a concern that the Manager will be looking out for the Manager’s own interests, sometimes at the expense of the investors’ interests, and by making a passive EB-5 investment the investor is to a considerable degree at the mercy of management.
However it's important for investors to keep in mind that managing principals owe fiduciary duties to their investors, the duties of good faith, loyalty, and competence. Under the law, these duties cannot be waived or ignored, regardless of whether the investors are limited partners or LLC members or shareholders in a corporation. For instance, management cannot ignore the right of its investors to have access to information about their investment, often on demand.
The EB-5 Program requires that investors have a voice in management, albeit typically a restricted voice and a minority, non-controlling voice, but a voice nevertheless. So along with honoring the fiduciary duties, all the minimal rights need to be strictly observed by management, along with any additional rights that management may, by contract, have chosen to give to investors as part of the deal.
Rupy Cheema: In EB-5 it is fairly common that investors are reviewing draft documents, in many cases the loan or security documents have not yet been executed because the loan amount depends on how much money gets raised. Additionally, there may be minimum raise requirements of the loan that may affect the security interest. So, one ends up reviewing drafts of documents as the actual documents are not going to get executed until the EB-5 funds are in escrow. So, at that point investors are heavily relying on the Manager eventually executing all major agreements that are consistent with the terms disclosed to investors at the time of making the investment. So, what should investors be wary of at that point?
Michael Homeier: Yes. That's a great point and I think everyone would agree that the better practice would be for the EB-5 Managers to get the loan agreement and all other material agreements, signed before going out to the marketplace to solicit investors. Managers certainly have an obligation under the securities laws to disclose the status as well as the terms and provisions of all of the essential contracts of the deal at the time that the deal is “offered” in the marketplace, and then supplementing that with changes or updates thereafter.
When Managers are working off a Term Sheet, or Letter of Intent, or Memorandum of Understanding, while material terms are still being negotiated, the Managers need to tell investors the current status of the project, and there could well be a marketing penalty to the project as a result, as investors are naturally skittish about investing in a PPM that says, management believes it will get a loan on these terms, which it may or may not, and so the terms are as yet uncertain. Again, the issuer has a continuing obligation to keep investors updated as things progress to agreed terms and fully executed contracts.
Its even the case that showing an investor an unsigned draft with terms, believed to be final, may not be enough to give the investor sufficient comfort that this is the final form that's ultimately going to be signed.
If Managers change the offering documents after investors have signed up and if the change is material, management has to notify the investors of the change and give them the opportunity to approve or reject the changed terms. If they reject them, they are entitled to rescind their investment and withdraw from the deal. So there is a significant degree of tension involved in providing incomplete or draft documentation to investors. We've seen deals where the investors have been willing to accept the higher risk (investing based on drafts), but we've also seen projects where investors are not.
Robert Cornish: In terms of how management decisions are made, what should investors be looking at in terms of how management handles important business decisions?
Michael Homeier: The answer would be to look in the controlling corporate document, which would be the Limited Partnership Agreement, if the issuer is an LP, or the Operating Agreement, if the issuer is an LLC. Look in that agreement and see what is the voice or the voting rights of the investors, and in what circumstances and on what topics do the investors have some kind of control or at least the opportunity to have input about if not a unanimous vote of all investors required to pass certain actions. Those items are usually explicitly specified in significant detail, because as is expected the investors are not going to be running the show, however they must have a voice in management.
Typically investors’ rights are minimal, but they’re never non-existent. And its essential for the investor to look at those controlling documents to see in what areas that they do and don’t have a voice, and as to the latter where they're just going to be dragged along by management; and, by contrast, in what areas do they have a voice, especially on issues such as ‘what if the Manager has to be removed’ or ‘what if the Manager is no longer serving as Manager’, how does a replacement get picked? Those types of questions are always addressed in any legally sufficient controlling corporate document.