The Office of General Counsel issued the following informal opinion on August 22, 2005, representing the position of the New York State Insurance Department.

Re: Loan Participations as "Qualified Investments" - CAPCO Statute


Would the below-described loan transaction structured as a participation constitute a "qualified investment" under the New York certified capital company ("CAPCO") statute?


No, a participation in a loan does not satisfy the definition of "qualified investment" under the New York CAPCO statute.


The inquirer submitted for consideration by this office a draft loan agreement (the "Agreement") and a draft promissory note (the "Note") that the inquirer proposes using in connection with possible future investments by the inquirer’s CAPCO. The parties to the loan agreement (the "Agreement") would be Newtek Small Business Finance, Inc. ("Lender") and Wilshire Advisors LLC ("CAPCO"). The purpose of the arrangement the inquirer describes would be to enable the CAPCO to participate in the loans made by Lender, which is a Small Business Administration lender. Under the Agreement, the Lender would sell to the CAPCO an interest in a loan made by the Lender to a third party ("Borrower"). Pursuant to Section 8 of the Agreement, Lender would be obligated to repurchase the CAPCO's interest in the loan upon the demand of the CAPCO's demand, or at Lender's discretion at any time following 30 days from the purchase date.

The Note is between the CAPCO and the Borrower (referred to in the Note as the "Company"), and is intended to document the participation by CAPCO in a portion of the loan made by Lender to the Borrower.


The New York Tax Law provision governing New York’s CAPCO programs defines a qualified investment as follows:

(10) "Qualified investment" - the investment of cash by a certified capital company in a qualified business for the purchase of any debt, equity or hybrid security, of any nature and description whatever, including a debt instrument or security which has the characteristics of debt but which provides for conversion into equity or equity participation instruments such as options or warrants, provided however, in the case of certified capital programs three, four and five, that any such debt instrument have a maturity of at least twenty-four months from the date such debt is incurred; and further provided that a certified capital company, after the investment and assuming full conversion and exercise of any equity participation instruments, shall not own more than fifty percent of the voting equity of the qualified business, except in the case of a follow-on investment where a specific exemption is granted by the department under subparagraph (D) of paragraph one of subdivision (c) of this section. Furthermore, except in the case of a follow-on investment, if a certified capital company owns more than fifteen percent of the equity in a company or has a seat on the board of directors of such company, then a certified capital company cannot invest in such company unless the following conditions are met: (i) at least one other investor who is not an affiliate of the certified capital company participates in the same round of investment on the same terms and conditions as the certified capital company; and (ii) the certified capital company and its affiliates invest no more than fifty percent of the total investment made in that round of investment.

N. Y. Tax Law § 11(a) (10) (McKinney Supp. 2005) (emphasis supplied).

A review of the Agreement and the Note indicates that the proposed arrangement would not constitute a qualified investment under the CAPCO statute. First, the structure of the transaction appears to constitute a loan from the Lender to the Borrower or Company (the "Qualified Business"); a payment from the CAPCO to the Lender (for the purchase of the participation interest); and the execution of the Note by the Borrower in favor of the CAPCO. Under the terms of the Note, payments are required to be made by the Borrower to the CAPCO, but no funds are loaned by the CAPCO to the Borrower. Rather, the payments required under the Note are stated to "represent a portion of the debt included in the note executed by the Company and Newtek Small Business Finance, Inc." This arrangement does not comport with the statute, which defines a "qualified investment" simply as "an investment of cash by a certified capital company in a qualified business."

A further problem with the proposed arrangement is that the Agreement, at Section 8, provides that the "Lender shall have the obligation to repurchase Capco’s percentage in the Loan upon demand by the Capco, or at the discretion of the Lender, at any time following thirty (30) days from the Loan Origination Date." Given this provision, the purchase of the participation by the CAPCO from the Lender can be unwound by the Lender, in its sole discretion, a mere thirty days following the sale. Even if the transaction were otherwise considered to constitute the making of a qualified investment by the CAPCO, this provision would disqualify it, in that the CAPCO statute requires that any debt instrument representing a qualified investment have a maturity of at least twenty-four months.

In light of the above, the proposed participation arrangement does not satisfy the definition of "qualified investment" under the New York CAPCO statute.

For further information one may contact Supervising Attorney Michael Campanelli at the New York City Office.