Banking Interpretations

January 11, 2002


To: Murielle Saint-Preux
Community Financial Services Division

From: Alvin A. Narin
Legal Division

Subject: [                                ] – Proposed Equity Investment

The [                             ] (“Bank”) submitted a letter request for approval to become a limited partner (“LP”) in a private investment fund (“Fund”).  The Fund was formed by [                                                  ] (“[   ]”) and has been organized as a Delaware limited partnership and has been approved by the Small Business Administration (“SBA”) for a license as a Small Business Investment Corporation (“SBIC”) under the Small Business Investment Act of 1958 (as amended) (“SBIA”), 15 U.S.C. §661, et. seq.[1][2]

Due to SBA requirements, [   ] formed a wholly owned New York limited liability company to serve as the Fund’s general partner (“GP”) and [   ] will act as an adviser to the GP.[3]  Further, the GP will have the entire management responsibility for the Fund. [  ] committed $3 million in capital to the Fund and the Fund hopes to raise additional $27 million in private capital from the LP’s.  By raising $30 million in private capital, the Fund will be permitted pursuant to the SBIA to access up to $77.5 million of additional capital from the SBA in the form of debentures issued by the SBA.  The Fund’s primary investment vehicle will be to provide mezzanine capital, typically in the form of subordinated debt with equity participation features, i.e. warrants, to companies that meet the SBA definition of a “small business” to be used for business expansion, acquisitions or recapitalizations.  The Fund may also invest in equity securities of certain companies but it is anticipated that such investments will be less than 7.5% of the Fund’s total investments.

The Fund anticipates in investing in well-run companies in the manufacturing, distributions and service industries and will not invest in industries requiring a high level of technical expertise to understand the business model or in emerging technology companies.  A typical investment by the Fund will be in the form of subordinated debt having an annualized coupon in excess of 10% and a final maturity of three to seven years.  In addition, the Fund will receive warrants to purchase common stock in the company plus certain financial covenants and the Fund will have Board representation and/or observation rights.  The Fund’s investment evaluation process will follow the model developed at [   ], which includes several rounds of due diligence review of a company as well as review and approval of the investment by a [   ] committee consisting of senior level credit officers not involved in the transaction.

The Bank expects its proposed $1.7 million equity investment in the Fund to be drawn down over five years and remain outstanding for up to ten years.  This is the Bank’s only commitment to an SBIC and the Bank’s Board of Directors and Investment Committee have reviewed and approved the proposed transaction.  Since the Bank will be a LP in the Fund, its obligation resulting from the capital investment in the Fund is limited to the amount of its commitment.

The SBIA permits member banks of the Federal Reserve System and nonmember insured banks to invest in an SBIC to the extent permitted under state law, but limits the amount of such an investment to no more than 5% of the Bank’s capital and surplus.  See, 15. U.S.C. §682(b).

Section 2001(2)(f) of the Banking Law provides that, subject to any limitations or other specific statutory provisions contained in either the Banking Law or other New York statutes, a bank may be a partner in a business enterprise.  Accordingly, there is no legal prohibition to the Bank becoming an LP in the Fund. However, the Bank could only be a partner in the Fund if the Fund makes investments that are legally permissible for the Bank.  Therefore, ownership of equity securities of said companies, whether through exercise of a warrant or direct investment, must comply with the provisions of Banking Law §97(4-b) in order for the Bank to have an interest in those investments.  Given that there is a possibility that many small business in which the Fund will invest would not have their stock registered on a national exchange as required by Banking Law §97-(4-b)(a), the equity investment may not be legally permissible for the Bank.[4]  Additionally, the exercise of any warrants received by the Fund would present the same issue.  Finally, the Bank’s participation in the issuance of the subordinated debt by the Fund will be subject to the lending limit provisions of Banking Law §103.

Based on the foregoing, I have no legal objection to the Bank becoming an LP in the Fund.  Additionally, I have attached a letter that I drafted to be signed by Manuel Kursky, Deputy Superintendent, Community Financial Services Division, to Mr. Yang describing the conditions that the Bank must meet should it participate in the Fund.

Noted:   ________

[1]  Section 681 of Title 15 of the United States Code (“U.S.C.”) requires an SBIC to be an incorporated body, a limited liability company or a limited partnership organized and chartered or otherwise existing under State law solely for the purpose of performing the functions and conducting the activities contemplated under the SBIA.

[2] In addition to the Bank’s letter application, on December 20, 20001, representatives from the Bank and [   ] made a presentation regarding the Fund to members of the Department’s US Financial Services, Community Financial Services and Legal Divisions.

[3] Although LP’s will have no management responsibilities for the Fund, there will be a limited partner advisory committee that will review and approve the valuation of the Fund’s investments and potential conflicts between the Fund and other business activity of [   ].

[4] However, it should be noted that Banking Law §97(5) permits a bank or trust company to acquire the stock of any corporation in settlement or reduction of a loan, advance of credit or investment when acquisition of such stock is necessary to minimize or avoid loss in connection with such loan, advance of credit or investment.