Letter concludes that an ESOP is a "company' for purposes of 12 U.S.C. 371c and that an ESOP that controls at least 25% of a bank's voting stock is an "affiliate" under sec. 371c (supersedes existing OCC interpretive letter #261). (10/26/89)

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Comptroller of th• Currency

Admlnlstr1tor of N1t1on11 Banks

Washington, D.C. 20219

Interpretive Letter No. 719

October 26, 1989

May 1996

12 U.S.C. 371C-B

This is in response to your letter dated October 12, 1988, on

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behalf of your client,

(•Bank•), involving the transaction described below•

According to your letter, the Bank established an employee stock

ownership plan (•Esop•).

The ESOP is administered by an

administrative committee appointed by the Bank's board of

directors.

The administrative committee currently consists of

some of the Bank's directors (but not a majority of the Bank's

directors).

The Bank's contributions to the ESOP are held and

managed by an employee stock ownership trust (•EsoTw).

The

ESOT's trustees currently consist of certain of the Bank's

executive officers.

The ESOT has or will be qualified under the

Internal Revenue Code Section 401, 26 u.s.c. I 401.

The ESOP proposes to borrow money to purchase the Bank's stock.

In this regard, it is a leveraged ESOP.

The loan is to be made

by a third-party lender (•Lender•) that is not affiliated with

the Bank or the ESOP.

The Lender has requested that the Bank

guaranty the debt of the ESOP or agree to purchase the ESOP's

note from the Lender.

Finally, the Lender may desire the Bank

to commit to fund a specified dollar amount to the ESOP over a

specified number of years.

You have represented that the ESOP

will initially purchase not more than five percent of the Bank's

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You have asked the followinq questions with reqard to the above

described transaction:

(1) Is the ESOP an affiliate of the Bank for

purposes of 12 u.s.c. s 37lc;

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(2) May the Bank guarantee the debt of the

ESOP to the Lender and, if so, would the

guarantee constitute a covered transaction

requiring the collateral requirements of·l2

u.s.c. A 37lc(C) to be met1

stock •

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You have asked the followinq questions with reqard to the above

described transaction:

(1) Is the ESOP an affiliate of the Bank for

purposes of 12 u.s.c. s 37lc;

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(2) May the Bank guarantee the debt of the

ESOP to the Lender and, if so, would the

guarantee constitute a covered transaction

requiring the collateral requirements of·l2

u.s.c. A 37lc(C) to be met1

(3) May the Bank enter into an agreement to

purchase the ESOP's note from the Lender at

any time upon demand, whether or. not ther:e

was a default and, if so, would.such an

agreement constitute a covered transaction

requiring the collateral requirements of 12

o.s.c. I 37lc(C) to be met; and

(4) May the Bank commit to the Lender to

fund a specified dollar amount to the ESOP

for a specified number of years, and if so,

would such a commitment be a transaction

with an affiliate.

Your questions will be addressed individually •

With regard to your first question, you argue that based on

Interpretive Letter No. 261 by Charles Byrd, Acting Director,

Legal Advisory Services Division, dated June 16, 1983,.reprinte<i

.in (CCH) Fed. Banking L. Rep. t 85,425, an ESOP is not an

affiliate for purposes of 12 u.s.c. s 371c.

Interpretive Letter

No. 261 concluded that an ESOP is not an •affiliate• for

purposes of 12 u.s.c. 5 22la.

The conclusion was based, in

large part, on a Michigan Supreme Court case interpreting 12

u.s.c. 5 221a.

However, on reconsideration of this issue, it is my opinion that

an ESOP may be an affiliate of a national bank for purposes of

12 o.s.c. • 371c.

The term •affiliate•_is defined, in pertinent

part, as:

(C) any company ­

t an ESOP is not an •affiliate• for

purposes of 12 u.s.c. 5 22la.

The conclusion was based, in

large part, on a Michigan Supreme Court case interpreting 12

u.s.c. 5 221a.

However, on reconsideration of this issue, it is my opinion that

an ESOP may be an affiliate of a national bank for purposes of

12 o.s.c. • 371c.

The term •affiliate•_is defined, in pertinent

part, as:

(C) any company ­

(i) that is controlled directly or

indirectly, by a trust or otherwise, by

or for the benefit of shareholders who

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beneficially or otherwise control,

directly or indirectly, by trust or

otherwise, the member bank or any

company that controls the member

bank; or

(ii) in which a maj~rity of its

directors or trustees constitute a

majority of the persons holding.any

such office with the member bank .or any

company that controls the member bank.

12 O.S.C. 5 37lc(b)(l)(C).

The term •company• is defined to include a •corporation,

partnership, business trust, association, or similar

organization.• It is my opinion that for purposes of 12 u.s.c.

I 37lc, an ESOP should be included in this definition. This is

because ESOPs are designed to be business related entities like

that of a business trust.

In this regard, ESOPs may be used to

borrow money for capital improvements and other corporate

investments. .see 129 Cong. Rec. 51,629, 51,636 (statement by

Senator Long that leveraged ESOPs are a •technique of corporate

finance.•) and First Nat'l Bank of.Blue Island y. Bd· of

Goyemors of the Fed. Reserve Sys;, 802 F.2d 291 (7th Cir 1986)

(discussing the purpose of an ESOP and finding that for purposes

of the Bank Holding Company Act, 12 u.s.c. S 1841 .ct JiiS., an

ESOP is a •business trust or similar organization•).

Accordingly, for purposes of 12 o.s.c. s 371c, an ESOP is

included within the definition of •company.•

Since an ESOP is included in the definition of •company,• it may

be an affiliate of the Bank when the ESOP is in •control• of the

Bank

of an ESOP and finding that for purposes

of the Bank Holding Company Act, 12 u.s.c. S 1841 .ct JiiS., an

ESOP is a •business trust or similar organization•).

Accordingly, for purposes of 12 o.s.c. s 371c, an ESOP is

included within the definition of •company.•

Since an ESOP is included in the definition of •company,• it may

be an affiliate of the Bank when the ESOP is in •control• of the

Bank.

The term •control• is defined to include the power to

vote twenty-five percent or more of any class of voting stock of

the Bank, the power to appoint a majority of the board of

directors or trustees of the Bank, or the power to influence the

management and policies of the Bank.

.a.£.e 12 u.s.c.

SS 371c(b)(3)(A)(i) - (iii). If the ESOP is in control of the

Bank, then it is an •affiliate• and subject to th• constraints

of 12 u.s.c. I 37lc. Accordingly, in this respect Interpretive

Letter No. 261 ls superseded.

In the Bank's particular case, you have represented that the

ESOP will initially own no aiore than five percent of the Bank's

stock. This amount will not place the BSOP in control for

purposes of 12 u.s.c. s 31lc. It is also presumed that the ESOP

will not have the power to elect a majority of the boanl of

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directors of the Bank nor the ability to influence the

management or policies of the Bank.

Accordingly, if this

exists, it will not be an affiliate of the Bank for purposes of

12 u.s.c. • 371c.

However, if the ESOP eventually •controis•

the Bank, it would become an affiliate and subject to 12 u.s.c.

! 371c.

With regard to your second question, there are three possible

answers. First, if the debt which the Bank would guarantee is

collateralized by the Bank's stock, then the Bank may not make

the guarantee because the Bank may end up owning its ~wn stock.

li.c.C 12 u.s.c. S 83.

Second, if the debt is not collateralized

by the Bank's stock and the ESOP does not become an affiliate of

the BanJt, then the Bank may guarantee the debt of the ESOP

three possible

answers. First, if the debt which the Bank would guarantee is

collateralized by the Bank's stock, then the Bank may not make

the guarantee because the Bank may end up owning its ~wn stock.

li.c.C 12 u.s.c. S 83.

Second, if the debt is not collateralized

by the Bank's stock and the ESOP does not become an affiliate of

the BanJt, then the Bank may guarantee the debt of the ESOP.

A

national bank may guarantee the debts of another when the bank

has a substantial interest in the performance of the

transaction. ~ Interpretive Ru1inq 7~7010, 12 C.F.R.

I 7.7010.

In this particular case, the Bank would have a

substantial interest in the performance of the ESOP because it

relates to the retirement benefits of the Bank's employees.

Finally, if the debt is not collateralized by the Bank's stock

and the ESOP becomes an affiliate of the Bank, then the

guarantee would be a •covered transaction• and subject to 12

u.s.c. • 371c. ~ 12 u.s.c. s 371c(bJ(7)(E).

However, in

order to avoid such a result, the ESOP could have the Bank's

holding company (provided one exists) guarantee the debt•

With reqard to your third question, there are three possible

answers. First, if the notes are collateralized by the Bank's

stock, the Bank may not purchase them because like the guarantee

situation above, it may encl up owning its own stock. ~ 12

u.s.c. s 83.

Second, if the notes are not co1lateralized by the

Bank's stock and the ESOP is not an affiliate of the Bank, then

the Bank may purcbase the ESOP's notes from the third-party

lender.

The buying and selling (~, the discountinq and

negotiating) of promissory notes is a core banking paver. ~

12 u.s.c. I 24(Seventh). Finally, if the notes are not

collateralized by the Bank's stock and the ESOP is an affiliate

of the Bank, then the purchase of the ESOP's notes would be

subject to 12 u.s.c. a 37lc

Bank, then

the Bank may purcbase the ESOP's notes from the third-party

lender.

The buying and selling (~, the discountinq and

negotiating) of promissory notes is a core banking paver. ~

12 u.s.c. I 24(Seventh). Finally, if the notes are not

collateralized by the Bank's stock and the ESOP is an affiliate

of the Bank, then the purchase of the ESOP's notes would be

subject to 12 u.s.c. a 37lc. ke Federal Reserve Regulatory

Service 3-1131 (indicating that all purchases of affiliates'

notes are loans or extensions of credit to the afei1iated

organizations and subject to 12 u.s.c. • 37lc).

With regard to your final question, absent an unsafe or unsound.

banking practice, there is nothing in the federal banking laws

which would prohibit the Bank from committinq to fund a

specified dollar amount to the ESOP for a specified number of

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years.

Whether the commitment would constitute an unsafe or

unsound banking practice would be based on an analysis of the

size of the commitment as measured against the size and

condition of the Bank. It is presumed that this commitment

would be in the form of a capital contribution by the Bank to

the ESOP.

However, this commitment alone may not be the basis

for servicing the debt to the third-party lender.

'If this were

the case, then the commitment would be the functional equivalent

o'f a guarantee and, therefore, governed by the interpretation

set out above.

I trust this is responsive to your inquiry.

Very truly yol.1rs,

/s/

Peter Liebesman

Assistant Director

Legal Advisory Services Division

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