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4000 - Advisory Opinions


Limited Partnership Can Be an "Affiliate" of a Bank Through Common Ownership or Control by One or More Limited Partners for Purposes of Section 23A of the Federal Reserve Act

FDIC--93--24

May 11, 1993

Joseph A. Genova Jr., Regional Attorney

Your memorandum dated September 18, 1992, requesting a legal opinion regarding the affiliate status of several companies to the [Bank] has been referred to me for response. At the time I received this assignment, I had other pending legal matters of a more pressing nature. I discussed the urgency of this matter with Review Examiner Jim Averitt. Together, we agreed that the inquiry did not need to be addressed immediately. Nevertheless, I apologize for the delay in responding to this inquiry.

Facts

Members of the [X] and [Y] families own 100 percent of [Holding Co.], a multi-bank holding company. [Holding Co.] owns: 94.54 percent of the voting stock of [Bank]; over 80 percent of the voting stock of [Bank A]; and over 80 percent of the voting stock of [Bank B]. Additionally, members of the [X] and [Y] families have substantial ownership interests in three other banks: [Bank C]; [Bank D]; and [Bank E]. The [X] and [Y] families also have substantial ownership interests in numerous other business entities. At the time of its most recent FDIC examination, [Bank] had made loans to at least two of these other business entities. Other banks in which the [X] and [Y] families have some degree of ownership interest periodically make loans to these other business entities.

Since 1990, FDIC examination staff has suggested that some of these other business entities should be considered affiliates of [Holding Co.] and one or more of the banks in which the families have an interest for purposes of section 23A of the Federal Reserve Act ("section 23A"), 12 U.S.C. 371c. During that same time, the [X] and [Y] families have restructured their ownership interest in the banks and in each of these business entities in an attempt to avoid affiliate status of section 23A. Among other things, the [X] and [Y] families have converted several of their business entities which had been partnerships into limited partnerships. These restructurings appear to be based on the theory that the general partners have exclusive control over the business of limited partnerships. As a result, the families contend that the limited partnerships are not affiliates of [Bank] because the limited partners do not "control" the limited partnerships for purposes of section 23A.

In the instant case, the conversion of partnerships into limited partnerships occurred only after the FDIC alleged that several of these partnerships were bank affiliates for purposes of section 23A. In each case, several of the partners who are members of the [X] or [Y] families apparently relinquished voluntarily their right to control the business of the partnerships. In most cases, at least one member of the [X] and [Y] families remained as a general partner of the resulting limited partnerships. However, each family member appears to have retained the very same percentage of ownership in the resulting limited partnerships as each one had in the original partnerships.

Attached to your inquiry was a document, apparently prepared in August of 1992 by FDIC examination staff, which details the various business entities in which the [X] or [Y] families have some degree of ownership interest. Several of these business entities are structured as limited partnerships. Among other things, the document indicates the percentage of each business entity which is owned by, or which may be attributable to, four individuals who are members of the [X] family and two individuals who are members of the [Y] family. The document also indicates whether each is an officer or director of the company. In the case of partnerships, the document also indicates whether each is a limited or a general partner.

Also attached to your inquiry was a letter dated August 15, 1990, from an attorney, [Z], which is addressed to [Mr. Y], in his capacity as chairman of the board of [Bank E]. Mr. [Z]'s letter indicates that it is in response to a request for an opinion as to the definition of an "affiliate" for purposes of section 23A. A copy of this letter was submitted to the FDIC as additional support for the contention that the restructuring of the [X] and [Y] business entities has avoided application of section 23A to those entities.

Applicable Portions of Section 23A

For purposes of section 23A, the term "company" includes, among other things, corporations, partnerships, business trusts, associations or similar organizations. The term "company" also includes a bank. 12 U.S.C. 371c(b)(6).

For purposes of section 23A, the term "affiliate" with respect to a bank includes any company "that is controlled directly or indirectly, by a trust or otherwise, by or for the benefit of shareholders who beneficially or otherwise control, directly or indirectly, by trust or otherwise, the . . . bank or any company that controls the . . . bank." 12 U.S.C. 371c(b)(C)(i).

For purposes of section 23A, a company or shareholder is deemed to have "control" over another company if such company or shareholder: (A) directly or indirectly, or acting through one or more other persons, owns, controls or has the power to vote 25 percent or more of any class of voting securities; or (B) controls in any manner the election of a majority of the directors or trustees of the other company.1 12 U.S.C. 371c(b)(3)(A)(i) and (ii).

Preliminary Issues

Mr. [Z]'s letter questions the circumstances under which the ownership interests of several shareholders may be aggregated to reach the 25 percent threshold necessary to establish "control" under item (A) above. In addition, your staff has asked two specific questions as to whether certain ownership interests may be aggregated to reach the 25 percent threshold. Because the answers to these questions directly affect the determination of affiliate status, we will discuss these questions first.

Question #1  Can the ownership interests of several shareholders be aggregated to reach the 25 percent threshold in the absence of some finding that they are "acting together."

Mr. [Z]'s letter points out that Congress used the singular term "shareholder" in 12 U.S.C. 371c(b)(3)(A)(i) ("section 23A(b)(3)(A)(i)") instead of the plural form. Based on this observation, Mr. [Z] erroneously concludes that, for purposes of section 23A, "there can be no control by shareholders of a company unless they act together." However, 1 U.S.C. 1, among other things, expressly states that "[i]n determining the meaning of any Act of Congress, unless the context indicates otherwise--words importing the singular include and apply to several persons, parties, or things . . . ." Notably, nothing in section 23A(b)(3)(A)(i) evidences an intent to limit the application of section 23A to those cases in which a single shareholder owns 25 percent or more of a company's voting securities.

Mr. [Z]'s letter also points out that, for purposes of Regulation O of the Board of Governors of the Federal Reserve System ("Regulation O"), 12 C.F.R. Part 215, shares of multiple shareholders may be aggregated to achieve control if such shareholders are "acting through or in concert with one or more persons." However, Regulation O is the implementing regulation for sections 22(g) and 22(h) of the Federal Reserve Act, 12 U.S.C. 375a and 375b(7), not for section 23A. Moreover, section 23A has its own definition of "control," which differs substantively from the definition in Regulation O.

An FDIC advisory opinion states that:

[A] bank and another company are affiliated for purposes of section 23A . . . if the bank and the company have common shareholders who own, in the aggregate, at least twenty-five percent of the stock of each the bank and the company.

FDIC Advisory Opinion No. FDIC--92--3, reprinted in 1 Federal Deposit Insurance Corporation Law, Regulations and Related Acts (FDIC) at 4607 (January 14, 1992). This advisory opinion went on to say:

From 1933 until 1982, section 23A looked to the general definition of "affiliate" as contained in section 2(b) of the Banking Act of 1933 (12 U.S.C. 221a(b)). Clause two of that section covers common control by shareholders of a bank and another company without regard to any conspiracy or other joint action theory. Digest of 1933 Bulletin 501, reprinted in Published Interpretations of the Federal Reserve System Par. 4505. Although the definition of affiliate subsequently changed to what is found at section 23A(b)(1)(C), the change only lowered the percentage of ownership necessary for affiliation.

The advisory opinion also cited language contained in a Federal Reserve Board Staff Opinion dated February 5, 1990 ("FRB Staff Opinion"), 1 Fed. Reserve Regulatory Serv. (FRB) at 3*452.2, as further indication that conspiracy or joint action by shareholders was not a necessary predicate for aggregation of the shareholder's interests. The applicable portion of the Federal Reserve Board Staff Opinion states as follows:

Under subparagraph (b)(1)(C)(i), any company that is controlled by shareholders that control the member bank is an affiliate of the member bank. The statutory definition does not require that a familial, contractual, or other relationship exist between the shareholders in order that the company be deemed an affiliate; the only requirement is a commonality of ownership. Thus, any company that is owned by any group of shareholders that controls 25 percent of the voting shares of a bank is an affiliate of that bank for purposes of section 23A, even if no other relationship exists between the owners.

Question #2  Should shares of stock in a company owned by an individual both directly and as custodian or trustee for others be aggregated to determine total ownership or control of that company by that individual?

Attached to your inquiry was a partial stock ownership list for [Holding Co.] which shows that numerous shares of [Holding Co.] stock are held by members of the [X] and [Y] families as custodians for minor children of the [X] and [Y] families under what appears to be either the Uniform Gifts to Minors Act ("UGMA") or the Uniform Transfers to Minors Act ("UTMA") as enacted in several states. Additionally, several members of the [X] and [Y] families hold shares of [Holding Co.] stock as trustee for various trusts.

An adult person may make a gift to a minor by transferring securities or money to a custodian in the manner provided by the UGMA or the UTMA. Such gifts are irrevocable and convey to the minor indefeasible vested legal title to the security or money given subject, however, to the broad managerial powers of a custodian. 38 Am. Jur. 2d Gifts § 15 (1968). The custodian is given powers and duties which are somewhat similar to those of a trustee. I W. F. Fratcher, Scott on Trusts, § 16A (4th ed. 1987). Thus, we believe that, for purposes of section 23A, gifts made under the UGMA and/or the UTMA are analogous to and should be treated in the same manner as trusts.

The February 5, 1990, FRB Staff Opinion referenced above also considered whether, for purposes of section 23A, stock which is held in trust should be aggregated with stock which the trustee holds in his/her individual capacity, or should be aggregated with stock which the beneficiary holds in his/her individual capacity. The applicable portion of the FRB Staff Opinion states as follows:

A trustee who controls the shares of a company in a trust must aggregate the shares that he or she controls as trustee with any additional shares owned in his or her individual capacity. The "control" and "affiliate" definitions of section 23A do not distinguish between shares that are controlled by a trustee in a fiduciary capacity and shares owned by the trustee in an individual capacity. In fact, subparagraph (b)(1)(C)(i) specifically includes in the definition of "affiliate" companies that are controlled "directly or indirectly, by a trust or otherwise. . . ." Thus, the shares that a trustee owns in a fiduciary capacity must be aggregated with the shares the trustee controls as an individual to determine if a company is an affiliate.

The opinion goes on to state that:

Similarly, the shares that a beneficiary owns through a trust must be aggregated with the shares the beneficiary owns as an individual to determine if the affiliate relationship exists between the two entities, because "affiliate" includes companies that are controlled "by or for the benefit of shareholders who beneficially or otherwise control directly, or indirectly by trust or otherwise, the member bank."

Federal Reserve Board Staff Opinion dated February 5, 1990, 1 Fed. Reserve Regulatory Serv. (FRB) at 3*452.2.

The following examples show the operation of this FRB Staff Opinion:

EXAMPLE 1

T owns 100 percent of the voting stock of XYZ Bank and 10 percent of the voting stock of QRS, Inc. T is the sole trustee of a trust created for the benefit of B ("Trust"). The assets owned by the Trust include 15 percent of the voting stock of QRS, Inc. In his capacity as trustee, T has the power to vote the stock owned by the Trust. Because T, in his capacity as trustee, controls the right to vote the stock owned by the Trust, the QRS, Inc. stock owned by the Trust is aggregated with the QRS, Inc. stock which T owns. Therefore, QRS, Inc. is an affiliate of XYZ Bank.

EXAMPLE 2

B owns 100 percent of the voting stock of ABC Bank and 10 percent of the voting stock of LMN, Inc. B is the sole beneficiary of a trust of which T is trustee. The assets owned by the Trust include 15 percent of the voting stock of LMN, Inc. Because the Trust is "for the benefit of" B, the LMN, Inc. stock owned by the Trust is aggregated with the LMN, Inc. stock which B owns. Therefore, LMN, Inc. is an affiliate of ABC Bank.

Question #3  In limited partnerships, is control attributed to only the general partner or also to the limited partners?

The real question posed by this inquiry is whether a limited partnership would be an affiliate of a bank for purposes of section 23A where one or more of the limited partners owns 25 percent or more of the limited partnership and also owns or controls 25 percent or more of a bank's voting stock. This appears to be a question of first impression. There are currently no regulations or guidelines directly on point and research has uncovered no interpretation. Absent regulations, guidelines or interpretations to the contrary by the Federal Reserve Board or a contrary interpretation by our Washington Office, we will follow the interpretation expressed herein.

For the reasons set forth below, it is concluded that it is possible for limited partners to exercise "control" over a limited partnership for purposes of section 23A. Accordingly, a limited partnership can be an "affiliate" of a bank through common ownership by one or more of the limited partners. Under section 23A, "control" may be exercised directly or indirectly. If neither direct nor indirect control can be established, section 23A will not be applicable. Whether one or more limited partners "control" a limited partnership for purposes of section 23A can only be determined by analyzing the facts in each particular case.

A.  Direct "Control"

To determine the extent to which limited partners may have direct control of a limited partnership for purposes of section 23A, the statutes governing limited partnerships and the particular partnership agreement in question must be analyzed.

Limited partnerships are governed by state law. In every state, except Louisiana, the statute is either the original 1916 Uniform Limited Partnership Act ("ULPA") or the 1976 Revised Uniform Limited Partnership Act ("RULPA"), although with variations in most cases. 59A Am. Jur. 2d Partnership § 1233 (1987). Some states have adopted the 1985 amendments to the RULPA.

As expressed in both the ULPA and the RULPA, control over the management of a limited partnership is vested in the general partners.2 The presumption created by this maxim is absolute, i.e., it is not subject to rebuttal. In addition, both the ULPA and the RULPA also create the presumption that limited partners do not have control over the management of a limited partnership. Notably, however, the presumption created respecting limited partners is not absolute; it is subject to rebuttal.3

As noted above, section 23A contains an express definition of "control." As defined in section 23A, "control" includes, but is not limited to, the type of control which may be exercised by general partners under the ULPA and the RULPA. Both the ULPA and the RULPA permit limited partners to engage in certain "safe harbor" activities which, for purposes of the ULPA and/or the RULPA, do not constitute "control" over the business of the partnership.4 However, such activities may evidence the limited partners' "control" for purposes of section 23A.5

The partnership agreement for a particular limited partnership may limit the actions limited partners may exercise respecting the limited partnership by expressly prohibiting them from engaging in some or all of the "safe harbor" activities enumerated in the ULPA or the RULPA. On the other hand, the partnership agreement may also expand the actions the limited partners may exercise respecting the limited partnership by allowing other activities which go beyond the scope of the "safe harbor" activities expressed in the ULPA or the RULPA. These acts may also provide sufficient evidence of "control" for purposes of section 23A.

A.  Indirect "Control"

As noted, direct ownership or control of a company is not a requirement for purposes of section 23A. Section 23A is also applicable where a company is indirectly owned or controlled.

The limited partnership has been described as a hybrid--it is neither a partnership (as that term is usually defined) nor a corporation, though it bears a strong resemblance to both. 59A Am. Jur. 2d Partnership § 1245 (1987). A limited partner is not, in any true sense, either a partner or a principal in the business of the partnership; rather, he is an investor. 59A Am. Jur. 2d Partnership § 1307 (1987). The relationship between the general and limited partner is a fiduciary one similar to that existing between a corporate director and a shareholder.6 59A Am. Jur. 2d Partnership §§ 1240, 1307 (1987). The principal-agent relationship which generally exists between members of an ordinary partnership is not, per se, present between general and limited partners. The duty which a general partner owes to limited partners has also been likened to that owed by a trustee to trust beneficiaries. 59A Am. Jur. 2d Partnership §§ 1307, 1333 (1987). A trustee is not necessarily subject to the control of the beneficiaries with respect to property which he holds for their benefit. If he is subject to their control, the trustee is also an agent. 59A Am. Jur. 2d Partnership § 1307 (1987).

As previously indicated, for purposes of section 23A, the term "affiliate" with respect to a bank includes any company "that is controlled directly or indirectly, by trust or otherwise, by or for the benefit of shareholders who beneficially or otherwise control, directly or indirectly, by trust or otherwise, the . . . bank or any company that controls the . . . bank." [Emphasis added]. For purposes of section 23A, it is immaterial whether one considers the relationship between a general and a limited partner to be most similar to the relationship which exists between: (A) a corporate director and a shareholder; or (B) a trustee and a trust beneficiary; or (C) an agent and his principal. The important consideration is that in each of these relationships, including the limited partnership, one party is under a fiduciary duty to control a business and/or assets for the benefit of another party.

Because general partner(s) are under a fiduciary duty to operate a limited partnership for the benefit of the limited partner(s), it would be unusual to have a situation where limited partners who own 25 percent or more of a limited partnership do not also have indirect control. Nevertheless, the facts of a particular case may establish that the general partner(s) is operating the limited partnership in breach his fiduciary duty. In such cases, absent direct control by the limited partners, section 23A would not apply.

Analysis

Your staff orally requested that we address whether the two business entities, known as [Company] and [Partnership] are affiliates of [Bank].

[Company] ____________________________________________

The documents which accompanied your inquiry indicate that *** [X], *** [X], *** [X], and *** [X] and *** [Y], each own 20 percent of the voting stock of [Company] ("Company"). Further, the documents indicate that, the same five individuals, respectively, control 17.72 percent, 20.00 percent, 20.00 percent, 18.90 percent, and 20.00 percent of the voting stock of [Holding Co.]. We understand that a large portion of the [Holding Co.] stock, and possibly some of the Company stock, has been attributed to these individuals because they control such stock in their capacity as trustee of a trust or as a custodian under the UGMA or the UTMA. Each individual controls, both directly and by attribution, less than 25 percent of both the Company and [Holding Co.]. Thus, under subsection (b)(3)(A)(i) no one individual is deemed to control both the Company and [Holding Co.]. However, where a commonality of ownership interest exists, the interests of several shareholders are aggregated even though they are not "acting together." After such aggregation, it is apparent that 100 percent of the Company is controlled by shareholders who also control 96.62 percent of [Holding Co.]. Therefore, the Company is an affiliate of [Bank] for purposes of section 23A.

[Partnership] ____________________________________________

The documents which accompanied your inquiry indicate that the ownership interests of [Partnership] ("Partnership") are divided between *** [X] (23.94 percent), *** [X] (17.00 percent), *** [X] (16.30 percent), *** [X] (10.50 percent), *** [Y] (7.20 percent), and *** [Y] (1.56 percent). The documents also indicate that *** [X] is the sole general partner of the Partnership. Again, it is possible that a portion of the ownership interests in the Partnership have been attributed to these individuals because they control these interests in their capacity as trustee of a trust or as a custodian under the UGMA or the UTMA. In addition to the stock ownership of [Holding Co.] which was detailed above, the accompanying documents indicate that *** [Y] owns or controls 3.38 percent of [Holding Co.]'s voting stock. Thus, 76.50 percent of the Partnership is owned or attributable to five limited partners and one general partner who also own or control 100 percent of [Holding Co.].

We have been informed that the Partnership is probably a Kansas limited partnership, but this information has not been confirmed. If this information is correct, the Kansas version of the ULPA, Kan. Stat. Ann. §§ 56--101 to 56--151 (1983) would be applicable to limited partnerships formed before January 1, 1984, and the Kansas version of the RULPA, Kan. Stat. Ann. §§ 56--1a101 to 56--1a607 (Supp. 1992), would be applicable to the limited partnerships formed on or after January 1, 1984. For limited partnerships formed on or after January 1, 1984, Kan. Stat. Ann. § 56--1a203 (Supp. 1992) permits limited partners to vote on a number of matters, including the admission, removal, or retention of a general partner.

We have not been provided with a copy of the partnership agreement for the Partnership. Thus, we do not know whether the partnership agreement limits the powers the limited partners would have under Kan. Stat. Ann. § 56--1a203 (Supp. 1992). If it does not limit their power, the five limited partners own 60 percent of the Partnership and would, therefore, have the power to control the election of a majority of the general partners. Further, if the partnership agreement permits the limited partners to vote on certain partnership matters as provided in Kan. Stat. Ann. § 56--1a202 (Supp. 1992), the limited partners may be in a position which is analogous to a class of voting securities of a corporation. If their position is analogous, the five limited partners control more than 25 percent of that class of voting securities. Thus, a strong possibility exists that the limited partners have direct control of the Partnership for purposes of section 23A. If so, the Partnership is an affiliate of [Bank] and [Holding Co.].

Further, even if the partnership agreement actually precludes direct control by the limited partners, the Partnership may still be an affiliate of [Holding Co.] and [Bank] as a result of the limited partners indirect control. The general partner, *** [X], has a fiduciary duty to operate the Partnership for the benefit of the limited partners. To the extent that he operates the Partnership for their benefit, the limited partners have indirect control of the Partnership. To show that indirect control does not exist, the parties would have to establish that *** [X] operates the Partnership in breach of his fiduciary duty. As indicated above, such a situation would be very unusual. Thus, a strong possibility exists that the limited partners also have indirect control of the Partnership for purposes of section 23A. If so, the Partnership is an affiliate of [Bank] and [Holding Co.].

1There is another definition of control which requires a Federal Reserve Board determination, but that definition has no relevance here. Go back to Text

2In Greenberg v. Board of Governors of the Federal Reserve System, 968 F.2d 164, 170 (2nd Cir. 1992), one of the issues presented was whether several limited partnerships were affiliates of a bank for purposes of section 23A. The Greenbergs argued that they did not "control" the limited partnerships because their combined equity interests were less than 25 percent of each limited partnership. The Board of Governors found that the Greenbergs were the general partners of several limited partnerships. In light of the special rights accorded general partnership interests concerning management, capital contributions and distributions, the Board of Governors concluded that the Greenbergs' interests in each limited partnership should be treated as analogous to a separate class of voting shares for purposes of applying the control test of 12 U.S.C. § 371c(b)(3)(A)(i). The Court agreed with the Board's interpretation. Go back to Text

3Both the ULPA and the RULPA recognize that a limited partner can exercise an impermissible degree of "control" over the business and management of a limited partnership. In such cases, the ULPA and the RULPA provide that certain parties may petition the appropriate court to declare that this limited partner has become a de facto general partner. 59A Am. Jur. 2d Partnership § 1365 (1987). For purposes of section 23A, a de facto general partner would have the same ability to exercise "control" over a limited partnership that any other general partner would have. Go back to Text

4Under both the ULPA and the RULPA, a limited partner may engage in certain specified activities with regard to a limited partnership without becoming a de facto general partner. See, 59A Am. Jur. 2d Partnership § 1369 (1987) (copy appended). Among those activities are voting to amend the partnership agreement and voting to admit or remove general partners and/or limited partners. Go back to Text

5For example, in limited partnerships where the limited partners have the power to admit or remove general partners, any group of limited partners who own a majority interest in the limited partnership will be in a position which is analogous to that of shareholders who control the election of a majority of the directors of a corporation.
  Further, under section 23A, a shareholder is "deemed to have control" of a company if, among other things, he "has the power to vote 25 percentum or more of any class of voting securities." [Emphasis added]. Notably, corporations are permitted to establish separate classes of voting securities which have limited or restricted voting rights. 5 Fletcher Cyclopedia Corporations § 2026 (1987). Thus, where limited partners are permitted to vote on certain partnership matters, the limited partners may be in a position which is analogous to a class of voting securities of a corporation. Go back to Text

6Indeed, where a limited partnership has a cause of action which the general partner refuses to act upon, the courts have permitted limited partners to take action by instituting a legal proceeding on behalf of the partnership which is similar to a shareholder's derivative action instituted by a corporate shareholder. 59A Am. Jur. 2d Partnership § 1395--1401 (1987). Go back to Text


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