When I closed my first NMTC deal in August 2006, my expectation was that seven years plus one day later a one-page Put Option Notice would be followed by a short series of emails exchanging sig pages, and within a few hours a deal that had taken two+ years to close would un-wind. Easy as pie.
In fact, that particular unwind took over a year and a lot of emails and teleconferences to complete. I’ve found that unwinds often divert from simplicity somewhere along the way, and even when they don’t, exiting a complex NMTC transaction requires substantial planning, execution, and closure to ensure that every transactional partner maximizes the benefit of their bargain. The final posture of the deal and transaction should be neat & tidy for the CDE, the tax credit investor and the QALICB. Indeed, the project with all its strengths and foibles will ramble on down the road with a new capital structure, but the NMTCs have done their work and it’s wise to leave the structure in broom-clean condition to ensure that no hazards arise in the future.
Here’s a framework of unwind transaction touchstones in digest form:
What’s the worst that can happen?
Short year Redemption & Sub-all mishaps. Routine sub-all and redemption testing should NOT be assumed to be routine after the sixth anniversary of any QEI, in large part due to technical idiosyncrasies of Treas. Reg. §1.45D with respect to testing periods and intrinsic ambiguities in the regulations. To be sure, unwinds are not typically compliance train-wrecks waiting to happen, but there are certainly situations with avoidable compliance head-aches.
Unintended, unexpected or deleterious tax results. Aside from acute NMTC compliance ailments, transactions can have very different tax results under the Internal Revenue Code depending on how transfers of cash and other property are timed and documented. In addition, known down-side impacts can be re-visited and transactionally accommodated to soften (or delay) the blow. Pre-close memoranda that iterate transaction steps and describe intended outcomes with good technical acuity are a good idea.
What else matters?
Survival of indemnitees. Indemnity obligations to the NMTC investor will survive the unwind transaction and are generally accompanied by a re-statement or ratification of the original indemnitees in a new transaction document. Potential expansion or modification of the obligation is a transaction nuance that needs attention, particularly where the CDE and TCI are on their maiden unwind voyage together.
Off-cycle reporting obligations. There are multiple reporting overlays impacted by the short-year exit, including: intra-structure reporting between and among the QALICB, the CDE and the TCI; IRS compliance reporting (e.g., form 1065); and implications to CDFI related reporting, including CIIS and Sub-CDE wind-down. These reporting regimes need to be addressed and calibrated to one another.
Back-end business arrangments. Seven to ten (or more) years after the initial closing, it’s not unusual for substantial changes in staffing at the QALCIB, CDE or TCI, and a deal nuance buried in an Operating Agreement sub-section, Loan Agreement, or some stand-alone document that prior to the unwind has no functional purpose, will either be forgotten or be unknown to folks new to the deal. A thorough review of the closing book is imperative to shake any details out of the bushes, and several techniques to accomplish that are discussed below.
Replacement finance arrangements. The loans which received so much attention as “true debt” at origination don’t simply evaporate at the close of the unwind, and a new finance structure will replace the NMTC structure that is being unwound – this is true regardless of whether the deal was self-leveraged or included third-party financing. The opening of a refinance escrow with escrow agents who have no knowledge of NMTC financing is commonplace, and fitting the unwind transaction into their jigsaw puzzle will require some attention. Where there is no new financing, the transfer of debt to new holders also requires some attention, and itself can have deleterious tax consequences avoidable with planning.
Variance from the Model. The quality of financial projections and models finalized prior to origination of the deal in compliance Year 1 are excellent 99.99% of the time, but any variation from projected-to-actual can compound into a material difference that must be resolved during the unwind process. This is an area where increasing the length of the glide-path is a good idea, and initiating negotiations in the tax year prior to the final tax year is a good practice. An item that was cast-aside might not be too easily overcome when a transaction partner is facing the reality of a final write-off – perceived values tend to expand when there’s no tomorrow, and very few people willingly leave money on the table. If that party holds any keys to the unwind, their leverage increases exponentially and sometimes disproportionately.
Un-projected Fees and Expenses. The rush to close new deals in the weeks prior to December 31 is a common occurrence for all transactions that include tax impacts as primary drivers. At the back-end, however, it’s not uncommon for those old deals to be pushed aside in favor of fresh originations. A trap for the unwary is that the old deals didn’t anticipate a new round of fees for a calendar year past the projections, and it’s not uncommon to find no source of cash to cover un-projected compliance expenses.
How to Get Started.
Deal refresher & walk-through. Step One: Open the closing. Locate and thoroughly review the original closing book by identifying back-end provisions which relate to transfers of money or other property. These will be included in provisions buried in large documents such as Operating Agreements, Loan Agreements, and Promissory Notes, as well as in issue specific documents such as Put Option Agreements. Step Two: Square up the documents with financial models and projections to shake out back-end deal points and fully resolve discrepancies, such as projected outcomes that aren’t easily or obviously traceable to identifiable document provisions and vice-versa.
Unwind Matrix. Deal points and transactional postures and outcomes should be digested into a table that references the documents to form a matrix of parties, timing, and outcomes. The rigor of the matrix forces a transactional walk-through, and provides the basis for guiding the unwind process and closing memorandum. The matrix should include descriptions of post-close wind-down activities, including reporting requirements and provisions for QALICB, Sub-CDE, and IF shut-down.
Compliance testing. Careful projections, including evaluation of pro rata accruals, temporary timing differences, provisions for elimination of any balance sheet carry-over of prior year distribution errors, and LTD and projected cash-flows should be part of the exit off-ramping process for both the CDE and the investor. Uniformity of assumptions between and among the CDE, the TCI, and their respective accountants and lawyers is a must. And don’t wait too long – end-of-life compliance testing should be undertaken at least one tax year prior to the projected final tax year to ensure an adequate glide-path for mid-course corrections. The short-year financial statements and tax returns must be clean-as-a-whistle since there’s no tomorrow.
Set a date. Much of the tax and financial analysis pivots around an end-date. Including a date assumption at the outset is a practical necessity for that reason, and has the side effect of forcing the transaction onto calendars. Date slippage is what it is, but the delta is more easily accommodated than attempting to model a closing of indeterminate date. Getting a closing date on transaction calendars ensures recognition that the unwind is a must-close transaction with important timeframes and consequences.
Loan Servicing & Up-flows. There are decisions to be made as the closing date for the unwind nears, including how to handle debt service and distributions. These decisions are dependent on the underlying structure – self-leveraged deals vary from 3rd party financed deals, for example – as well as administrative convenience, tax & compliance necessities derived from the end-of-life compliance projections, and good common sense. The outcome of the decisions should be folded into the loan servicing regime at the appropriate time interval so the benefits of convenience are realized and the costs of inattention avoided.
Final deal Fees & Expenses. Put Option prices, transaction and closing costs, back-end fee arrangements and so on should be included in a Funds Flow spreadsheet to track cash and provide a common base of information for insertion into documents and wiring instructions. These funds flow items are themselves captured from the pre-close review process, which is itself articulated in the Unwind Matrix.
Clean up the Balance Sheets. The Funds Flow XLSX is also the basis for proposed journal entries which will result in the target balance sheet outcome of ending account balances consistent with the Unwind Matrix and that typically result in little or no money or other property remaining at the Sub-CDE and Investment Fund. Of course, YMMV, but in every case walking through journal entries is the ultimate assurance that there will be a smooth landing from a financial statement standpoint and, in time, an easier ride on the final audit. The Funds Flow should include work papers that reconcile cash-to-accrual and timing differences.
At the close of the unwind, the Unwind Matrix and Funds Flow XLSX should be converted to a Post-close Transaction Summary which incorporates any final and last-minute changes to the deal. The Summary will also drive post-close wind-down / shut-down activity. As is the case with the original closing, the temptation to flee the scene post-close must be supplanted by a systematic march toward zero-balance balance sheets, final reporting and data-storage, and entity dissolution.
_____________________________________________________________________________________Neal Sacon, J.D.., LL.M. is Principal of the SkyBlue Center for Community Development, LLC, and provides legal services, structured finance, and portfolio management solutions to community development organizations, investors and developers. firstname.lastname@example.org https://skyblue.us.com.