ZHANG Case Frees EB5 Investors to Use Loan Proceeds
The US presidential election isn’t the only source of excitement these days. The United States Court of Appeals for the District of Columbia Circuit has given the EB-5 industry something to get excited about. Its decision in Zhang v. USCIS https://cases.justia.com/federal/appellate-courts/cadc/19-5021/19-5021-2020-10-27.pdf?ts=1603809078 probably resolves conclusively what we knew all along: CASH IS CASH. That is, the proceeds of a loan can indeed be used as investment proceeds in an EB-5 setting, with some caution.
Let me give a little background vindicating my earlier thinking on the issue, and make a few suggestions as to how the Circuit Court decision affects the sourcing of EB-5 funds.
As an adjudicator at USCIS, I was always searching for a comprehensive framework within which I could apply the agency’s regulation and position prohibiting the use of the proceeds from unsecured loans. I wanted an internally consistent guide for my adjudication of the various circumstances that presented themselves. I assumed that USCIS’s duty to ensure that funds were lawfully obtained and to ensure the integrity of the process was the starting point for any well-considered policy on loans.
The best logic I could come up with was that, in the event of a default on a secured loan, the creditor on the loan would pursue the chattel or security interest, rather than the EB-5 investment corpus. I surmised that USCIS was trying to make sure that the investment was “irrevocably committed” to the EB-5 project. However, my logic was actually more comprehensive and systematic than USCIS’s internal practices. For example, the Investor Program Office (IPO) at USCIS seldom distinguished between secured loans perfected by a filing, and those loans where the security interest, while real, would actually provide little recourse for a creditor in the case of default. Furthermore, while I never researched it, I couldn’t imagine a situation where any law or court order, even one in a US bankruptcy court, could force a New Commercial Enterprise (NCE) in an EB-5 process to disgorge an investment under any circumstances.
As an example of the loan circumstance, under the laws of many states, secured interests in property must be recorded in a filing in order to receive priority against other creditors. However, USCIS seldom cared to verify that security interests were actually “perfected.” The second issue is one of preemption of US state and foreign law in favor of US federal laws governing immigration - an area clearly in the exclusive purview of the US government. Based upon 20 years of litigation experience, I consider it likely that a US District Court Judge would reflexively defer to intent of the EB-5 law if anyone tried to levy against invested EB-5 funds.
The term “lawfully obtained” is not well defined in EB-5 legislation or regulations, and the path of funds requirement is a regulatory add on. A good lawyer could argue that “lawful” means not in violation of a criminal statute. However, I do not believe that such a reading makes sense in the multi-national context of EB-5. For example, what if the method of obtaining capital is illegal in the origin country, but not in the US? How about the converse? What if the laws of two different countries applied to two different EB-5 investors would result in different outcomes? It seems unlikely that the EB-5 program intends to handicap one country’s investors in favor of another’s.
My conclusion, while not articulated by the IPO, was that lawfulness and path of funds requirements should be interpreted according to American concepts of civil and criminal fraud and misrepresentation, and not by reference to specific statutes or bodies of law. I think the Zhang decision is consistent with my approach.
Zhang infers that a lender typically considers the assets and ability of the borrower to repay the loan when the loan its made, and that USCIS should not be in the business of substituting its business judgement for that of a third-party lender. If a lender wants to make an ill-advised business decision, let it.
Therefore, the Zhang Court says:
As far as the enterprise is concerned, whether or how the investor’s loan was secured makes no difference; it can deploy the cash either way, and it faces no exposure if the investor defaults on any obligation to a third-party lender.
Nonetheless, I would caution against thinking that all loans are cash, even given the Zhang opinion. After all, USCIS is required to preserve the integrity of the EB-5 program. The proceeds of loans obtained through fraud or misrepresentation should not constitute cash, whether or not they are secured, because they are illegally obtained.
I recommend applying a bankruptcy concept to EB-5 fund sourcing. In a Chapter 7 bankruptcy proceeding in the United States, a bankruptcy trustee has the right to take back property or money that the debtor in bankruptcy improperly gave away before filing. "Clawback" is the term used to describe this power, which allows the trustee to regain assets that should have been part of the debtor's bankruptcy estate, but were removed or hidden from the trustee by the debtor by means of preferential or fraudulent transfers. As far as I know, there has never been a case where a bankrupt person - either under US or any other law - has had his/her EB-5 investment subject to a clawback, but I think it is a useful mindset for assessing lawfulness.
Concisely stated, I suggest as a general rule that loan proceeds are acceptable in an EB-5 setting only if the circumstances of the loan are such that an aggrieved creditor would not have recourse against the proceeds of that loan.
A caution: The Circuit Court goes a little too far, or drafted its opinion little loosely, where it says:
Start with “cash.” It means “[m]oney; in the form of coin, ready money.” Cash, Oxford English Dictionary (2d ed. 1989). This definition easily encompasses loan proceeds. When a person takes out a loan, he receives money in exchange for a promise to repay the funds. And when that person uses the funds to purchase goods, he buys them with cash. Imagine someone wishes to sell a used car for payment “in cash only.” If a buyer offered the cash proceeds of a loan, the seller would happily oblige, for the payment would be “in cash.” Cash is fungible, and it passes from buyer to seller without imposing on the seller any of the buyer’s obligations to his own creditors. The buyer’s source of cash—whether paycheck, gift, or loan— makes no legal or practical difference.
Given the context in which it appears in the opinion, I doubt that the Circuit Court was really making a considered statement that cash is truly fungible in the EB-5 context. While there is a policy argument that it should be, and the Trump Administration has argued that it is indeed fungible in other contexts - for example, see https://www.guttmacher.org/gpr/2016/10/fungibility-argument-center-40-year-campaign-undermine-reproductive-health-and-rights, if cash were truly fungible in an EB-5 context, it will blur the lines between visa eligibility and admissibility, and would beg an examination of the full profile of every person contributing to the source of funds. Carried to extremes, fungibility would mean that a donor or lender of investment proceeds to an EB-5 investor will be found to have illegally sourced his/her funds if they have increased the size of their purse by any unlawful conduct, even if they have ample lawful business activity from which to source the funds. While a strictly applied rule of fungibility would absolve the EB-5 investor of the requirement to detail the path of funds, the investor would have the burden of proving that the donor was pure - an incredibly broad and almost insurmountable hurdle in many cases.
Feel free to contact me for help in conforming your Source of Funds presentation to the requirements of the EB-5 program, consistent with my thinking here, which will hopefully continue to be vindicated going forward.