The employment-based fifth preference category (EB-5) visa program was initially created by the Immigration Act of 1990 for the express purpose of creating new jobs for U.S. workers and boosting the U.S. economy via an influx of new foreign capital. The program provides a method by which wealthy immigrant investors can achieve lawful U.S. permanent resident status as green card holders by investing in projects that create jobs for U.S. workers.
Over the past five years, EB-5 investments, which provide access to substantial sources of foreign capital to fund various development projects in the United States, have become an increasingly popular financing avenue among U.S. developers. A number of EB-5 projects have also been targets of fraud.
The EB-5 program is administered by the U.S. Citizenship and Immigration Services (USCIS), an agency within the Department of Homeland Security. Although EB-5 investments are not exempt from U.S. securities laws—an investor’s equity ownership in an enterprise is generally regarded as a security for purposes of those laws1—the SEC’s practical ability to regulate them is limited since the bulk of investors are located overseas.
Initially, EB-5 required foreign investors not only to invest capital in a “new commercial enterprise” but also to “engage in the management of the new enterprise” by creating, at minimum, 10 full-time jobs for U.S. citizens or lawful permanent residents.2 Under the original EB-5 program, the standalone program, the foreign investment capital had to directly create new U.S. jobs.3 The visa given to such investors was referred to as an “alien entrepreneur’s visa” because of these requirements.
Congress amended the EB-5 visa program in 1993 to add the Pilot Immigration Program (PIP), which allows foreign nationals to invest in preapproved public or private regional centers.4 Regional centers, in turn, were to drive economic growth by, among other things, helping to spur increased export sales, job creation, and domestic capital investment.
Investments within regional centers allow foreign investors to count both direct jobs, those created by the business receiving the investment, and indirect new jobs, those created through the center’s broader economic impact, alleviating the stricter job-creation requirements imposed in the original EB-5 program.5 At present, more than 95 percent of EB-5 investments are made through regional center programs.
The EB-5 program requires a minimum $1 million investment to finance a business in the United States that will employ at least 10 U.S. workers. However, the minimum is $500,000 for investments made in “targeted employment areas” (TEAs). Unsurprisingly, most EB-5 investors place their money in TEAs, which are responsible in part for the growing popularity of the EB-5 program. TEAs were originally intended to stimulate investment in economically distressed areas. They are defined as areas that are rural or have jobless rates that exceed the national average by 150 percent or more. However, regions and states seeking development and employment have become adept at manufacturing acceptable TEAs by gerrymandering districts to combine high-unemployment tracts with other, wealthier areas to boost jobless rates for those well-to-do areas and allow developments there. As a result, most EB-5 projects can qualify for TEA status.
Proposed legislation and regulations may alter this practice by raising investment minimums, but for now TEA investments remain a relatively inexpensive source of foreign investment capital.
Both the unique challenges provided by EB-5 projects and the structure of the EB-5 program have made the EB-5 investments a target of fraud. In 2013, a drastic rise in Ponzi schemes involving EB-5 investments prompted the Securities and Exchange Commission (SEC) to notify foreign immigrant investors of warning signs of fraud in the EB-5 context. The SEC has also used the Dodd-Frank whistleblower program6 to a limited extent to incentivize the reporting of EB-5 fraud.
Arguably the largest Ponzi-like scheme tied to the EB-5 investment program involved Jay Peak Resort, a popular ski area in Vermont that raised more than $350 million from 700 foreign investors from 74 different countries to expand its amenities and create jobs. Investors were told that their contributions would finance various construction projects at the Jay Peak Resort and a biomedical research facility near Jay, Vermont.
On April 12, 2016, the SEC filed a complaint in U.S. District Court for the Southern District of Florida against Jay Peak and others alleging fraud and seeking an emergency motion to freeze all assets. The SEC alleged that Jay Peak Inc. and its affiliates; Ariel Quiros, a Miami-based businessman; Q Resorts Inc., a company owned by Quiros; and several other limited and general partnerships misused more than $50 million in EB-5 investor capital to buy another ski resort and to fund personal expenses, including the purchase of two New York City luxury condominiums.
As a result of the misuse of investor funds, the biomedical facility and other construction projects were undercapitalized and had little money to complete construction. Unsurprisingly, the developers sought to raise more EB-5 capital to complete the unfinished projects. In addition, other companies owned by Quiros failed to contribute $30 million to the Jay Peak project, which, in turn, jeopardized the EB-5 investors’ financial returns and their qualifications for U.S. permanent residency.7
In a 2018 proposed settlement, Quiros agreed to personally repay $81 million of the misused funds, pay a $1 million penalty, and forfeit $417,000 in cash that the court froze when the SEC filed the case. Moreover, he agreed to relinquish ownership of the two New York City condominiums he purchased with EB-5 investor capital and forgo his interest in other real estate, including Jay Peak Resort. The real estate would be turned over to the court-appointed receiver to sell for the benefit of the defrauded investors. The court has not yet approved the settlement as of this writing. (Case No: 16-21301; U.S. District Court for the Southern District of Florida; Apr. 12, 2016.)8
EB-5 investments have also featured prominently in a number of recent bankruptcy cases. Green Valley, the first hospital in Green Valley, Arizona, filed for Chapter 11 relief in U.S. Bankruptcy Court for the District of Arizona on April 3, 2017. In 2012, McDowell Enterprises LLC of Scottsdale sought to develop the hospital for $70 million. McDowell solicited more than $55 million, nearly 80 percent of the capital structure, from foreign nationals in China, Brazil, France, Russia, Taiwan, and Ukraine.
Due to poor financial management and inadequate leadership, the hospital experienced heavy fiscal woes believed to be caused by investors’ secondary interest in turning a profit. The bankruptcy proceedings have made the project’s EB-5 investors fearful that the project might not survive Chapter 11 and yield U.S. permanent residency. However, proponents are hopeful Green Valley will emerge from Chapter 11. The case is not yet closed. (Case Nos: (Jointly administered) 4:17-bk-03351, 4:17-bk-03353, and 4:17-bk-03354; U.S. Bankruptcy Court for District of Arizona; Apr. 3, 2017.)
The Lucky Dragon & Casino LLC, a Las Vegas-based, Chinese-themed resort developed by Andrew Fonfa of ASF Realty and Investments, filed for Chapter 11 protection on February 16, 2018—less than 18 months after opening its doors. The first-day motions asserted that Lucky Dragon’s capital structure consisted of an appraisal value of $143 million, $89.5 million of which came from EB-5 investors and two loans from Snow Covered Capital LLC secured by a deed of trust.9 (Case No: 18-10792; U.S. Bankruptcy Court, District of Nevada; Feb. 16, 2018.)
About a year after opening, Lucky Dragon was in financial distress10 and moved to close its casino and restaurants. Soon after that, it defaulted on nearly $48.9 million in Snow Covered Capital loans and faced foreclosure on the property. Debtor’s counsel argued that Chapter 11 restructuring relief “preserves jobs, pays creditors, and protects EB-5 investor interests.” However, opponents of the project argue the investors’ interest to obtain U.S. permanent residency rather than to procure a profit led the company to a financial abyss. Attorneys are uncertain how the restructuring would affect the EB-5 stakeholders. The Bankruptcy Court stayed the foreclosure proceedings, and the case is pending.11
The SLS Las Vegas casino resort, primarily owned by Stockbridge Capital Group LLC, is defending itself in a lawsuit brought by 60 Chinese investors alleging fraud and breach of contract, among other things. (Case No: BC685035; Superior Court of the State of California, County of Los Angeles, Central District; Nov. 30, 2017.)12 The complaint states that between 2013 and 2014, Stockbridge solicited $300 million to $400 million in loan capital from Chinese investors via the EB-5 visa program with promises of U.S. green cards and a return on their investment. None of the Chinese were accredited investors. They had limited English proficiency and were not represented by independent U.S. legal counsel.
SLS Las Vegas failed to turn a profit from day one and is on the “verge of bankruptcy,” according to the lawsuit. Stockbridge seeks to sell the SLS Hotel, but the investors claim the sale as structured would violate many EB-5 program restrictions, eliminating the Chinese investors’ green cards. The case is pending.
EB-5 related investments become targets for fraud for several reasons. First, investors’ primary goal, obtaining a green card, is noneconomic. An investment that offers a minimal return but creates jobs may generate permanent residency status for the investor; a lucrative investment that fails to create jobs will not.13 Moreover, because most EB-5 investors live overseas, policing abuse is more difficult than with domestic investors. Many foreign investors are generally ill-equipped to understand U.S. laws or may rely upon their migration brokers or interested parties to perform due diligence on their behalf. English is not the first language of most EB-5 investors, which can make it difficult to educate them before they invest and to help them if they are defrauded.
The very structure of EB-5 investments can also contribute to risk. There are typically five key players involved in an EB-5 project:
EB-5 investments can take the form of secured debt, unsecured debt, or equity.15 An investor who places capital as equity can invest directly in the developer or indirectly through the RC investco, which, in turn, invests in the developer.16
Although EB-5 capital can be either equity or debt, the investments are most commonly structured as loans.17 Foreign investors believe features of a secured loan increase the likelihood of recovering on their investments because they provide a fixed maturity date and a default remedy. While better than being merely unsecured, most of these secured loans are nonetheless junior to other secured loans.18
In addition, to meet EB-5 requirements, debt investors must first buy equity in an RC investco, which pools equity from EB-5 investors and loans money to a developer. An EB-5 investor directly loaning to a developer would violate the “at-risk” requirement of the program.
The parallels between an EB-5 investor and a limited partner in a real estate private equity project are obvious, inasmuch as both have few legal rights to control their investment once documents are signed. The practical differences, however, are enormous. U.S. citizens who are limited partners in a typical domestic real estate deal (leaving aside investors who invest through crowdfunding portals or platforms) are not “matched” by a third party, such as a regional center, and do not invest with unknown general partners (also known as sponsors; the EB-5 analog being the owner of the developer). Rather, U.S. limited partners in such deals are not only accredited investors, as that term is defined by U.S. securities laws, but are typically also quite sophisticated and know and trust the general partners in whose projects they invest.
Projects are rarely financed solely by EB-5 investors. In fact, EB-5 financing typically constitutes only 10-30 percent of all the capital invested in a particular deal. The remainder is from more traditional financing, which is provided by parties who do care about their financial return.
In addition, several of the entities involved in an EB-5 project may be controlled by the same one or two people. However, the very structure of many EB-5 investments creates risk and provides fertile grounds for misuse of funds even if there is no common control or ownership.19
Compounding these various problems is the fact that EB-5 investors get very little information before or after they invest. Simply stated, there is little if any transparency. With this context, it is easy to understand why an EB-5 investor’s money is very much at risk the moment it leaves his or her hands and passes through a broker or agent on its way to a regional center.
The risks for investors and others involved with EB-5 projects have been manifested in default and failure rates. The default rate on projects financed with 100 percent EB-5 money was recently 2.5 times greater than the default rate for commercial mortgage-backed securities.20 Chapter 11 cases that touch the EB-5 world appear to be increasing as well.
When a developer EB-5 project fails, whatever the reason, the dynamics involved in trying to restructure it are complicated by many factors. In the context of a workout, EB-5 investors must also be concerned that agreed changes to the project or its capital structure might disqualify them from obtaining green cards. For example, the requirements by new capital to prime old capital, something quite common and understandable generally in a restructuring context, can jeopardize the investors’ immigration benefits. Given the substantial rate of default associated with EB-5 investments, insolvency practitioners should be aware of these unique factors.
The authors thank their colleague Hajar Jouglaf for her invaluable assistance with this article.