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Zajicek Completes New Markets Tax Credit (NMTC) Loan

December 16, 2011

David E. Zajicek, a lawyer in the Commercial Transactions Group at Hinshaw & Culbertson LLP, completed a New Markets Tax Credit (NMTC) loan representing a major regional bank as the lead (leverage lender). A leading bank-held community development corporation and other investors were also involved.

The NMTC is part of the Federal Community Renewal Tax Relief Act of 2000. It authorizes billions of dollars in federal income tax credits spread over seven years equal to 39 percent of qualified equity investments (QEIs) made to qualified active low-income community businesses (QALICBs). Census data is used to determine the boundaries of a “low-income community” and detailed criteria are used to determine whether a business qualifies as a “low-income community business.” The particular QALICB in this case was a charter school serving minority students.

Part of the complexity of the transaction was related to the “waterfall” flow of the $5.3 million loan made by the regional bank (the leverage loan) and the $3.2 million of investments by others, all of which flowed several tiers below to the ultimate borrower (i.e., the QALICB). After seven years of market-rate interest only payments, the regional bank will be repaid on its $5.3 million loan and the QALICB will enjoy a tax-free forgiveness of the remaining $3.2 million contributed by the other investors. The amount of the investment forgiven is generally calculated to represent the present value of a seven-year stream of tax credits for the amount invested, plus the amount of the leverage loan. Thus, the investors obtain tax credits on borrowed money in order to leverage up “investment” tax credits.

The key in representing the leverage lender stems from IRS Rev. Rule 2003-20, which permits the use of borrowed funds to make QEIs, so long as the leverage loan is not secured by any direct interest in the ultimate borrower, the QALICB. This creates the fiction of an “investment” rather than a “loan.” Accordingly, the leverage lender’s security interest is an assignment of membership interests down the waterfall of intermediary tax credit entities and intricate provisions in the loan agreements and operating agreements, assuring the leverage lender’s right to collapse the entities and ultimately succeed to the ownership of the mortgage and other collateral given by the QALICB to its immediate lender at the bottom of the waterfall.

Mr. Zajicek is a highly experienced attorney whose practice includes the representation of both corporations and commercial lending institutions with respect to mergers, acquisitions, leveraged buy-outs and all types of commercial financing including federal New Markets Tax Credit program financing and aircraft financing.

Hinshaw & Culbertson LLP is a national law firm with approximately 500 attorneys providing coordinated legal services across the United States and in London. Hinshaw lawyers partner with businesses, governmental entities and individuals to help them effectively address legal challenges and seize opportunities. Founded in 1934, the firm represents clients in complex litigation and in regulatory and transactional matters.

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