4000 - Advisory Opinions
Guarantee of Small Business Administration Loan Payment
July 27, 1983
Todd E. Norton, Regional Attorney
You have requested that I research the applicability of section 332.1 of the FDIC rules and regulations (12 C.F.R. § 332.1) (which in general terms prohibits a state nonmember bank from guaranteeing the obligations of others), to a Small Business Administration (SBA) Subordination Agreement currently being used in this region. The Subordination Agreement, copy attached, provides that prior existing indebtedness on the part of the SBA-client borrower to the SBA will be subordinated to a further extension of credit by the bank. In the case presented the SBA agrees that its $167,200 loan to the business borrower is subordinated to the * * * additional extension of credit in the amount $191,847.67. In return for agreeing to this subordination, the SBA requires that the primary lender agree to guarantee the payment of a particular installment due on the original (SBA's) loan, in this case an installment of $20,797 due December 15, 1983 and to pay immediately the December 15, 1982 payment of $16,797. It is in the guarantee of the 1983 installment payment by the borrower to SBA that the issue arises regarding section 332.1.
There is no question that the bank, by agreeing to this subordination agreement, is guaranteeing the obligation of the debtor; the transaction would therefore seem to fall within the scope of Part 332. However, two exceptions to the strict language of Part 332 have been recognized in addition to the exception for acceptance, endorsements, and letters of credit made or issued in the ordinary course of business, that is found in a footnote to section 332.1. These exceptions are (1) when the bank has a substantial interest in guaranteeing the transaction or (2) the bank maintains a segregated deposit fully covering any liability that may be incurred by way of the guarantee. These two exceptions, while not codified in any regulation or policy statement, have become well established over time. The correspondence of the Legal Division reflects the evolution of the "substantial interest" exception as a response to specific (albeit rare) factual situations in which the strict prohibitions of Part 332 work to the detriment of a bank, and in such cases such prohibitions have been softened in order that a bank may participate in an otherwise-prudent transaction, particularly to acquire or maintain a valuable asset. Thus, for example, the Legal Division has ruled that a state nonmember bank may guarantee the loan made by bank insiders such as a group of directors at some other lending institution whereby the insiders acquire funds to purchase real property upon which the guaranteeing bank intends to locate a branch. In another example, banks under FDIC supervision were allowed to guarantee the loan that the employees' stock option plan (ESOP) made to acquire bank stock for the benefit of employees. In factual circumstances analogous to ours, a state nonmember bank was permitted to guarantee payment by their borrower of five percent of a loan which was being participated, in return for the participating bank's acceptance of the participation. The Legal Division reasoned that the bank was in no worse position for having agreed to absorb a percentage of the loss and was in fact in a better position, in the event of default, than if the loan had not been participated out under the subject agreement; nor was the bank undertaking any greater exposure than it would otherwise be exposed to as a result of originating the loan.
The * * *, in return for the substantial benefit of receiving subordination of an otherwise prior SBA loan in the amount of approximately $167,000 to the bank's proposed extension of credit in the amount of approximately $191,000, is increasing its exposure under the guarantee by only approximately $21,000. This relatively low level of exposure constitutes a completely acceptable trade-off in relation to the amount of income which conceivably can be derived from this extension of credit, particularly in light of its higher priority position in regard to available collateral. Accordingly, I would apply the "substantial interest" exception to this factual situation and allow the bank to enter into the proposed subordination agreement in spite of the otherwise applicable prohibition against guaranteeing the obligations of others contained in FDIC rules and regulations section 332.1.