[Federal Register: October 16, 2006 (Volume 71, Number 199)]
[Proposed Rules]
[Page 60678-60681]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16oc06-10]
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FARM CREDIT ADMINISTRATION
12 CFR Part 613
RIN 3052-AC33
Eligibility and Scope of Financing; Processing and Marketing
AGENCY: Farm Credit Administration.
ACTION: Proposed rule.
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SUMMARY: The Farm Credit Administration (FCA or Agency) proposes to
amend its regulation governing financing of processing and marketing
operations by Farm Credit System (Farm Credit, FCS, or System)
institutions under titles I and II of the Farm Credit Act of 1971, as
amended (Act). Specifically, this proposal would revise the criteria
used to determine eligibility of legal entities for financing as
processing and marketing operations. FCA further proposes a non-
substantive technical correction to its regulation defining the term
``person.''
DATES: Comments should be received on or before December 15, 2006.
ADDRESSES: We offer a variety of methods to receive your comments. For
accuracy and efficiency reasons, commenters are encouraged to submit
comments by e-mail or through the Agency's Web site or the Federal
eRulemaking Portal. As faxes are difficult for us to process and
achieve compliance with section 508 of the Rehabilitation Act, please
consider another means to submit your comment if possible. Regardless
of the method you use, please do not submit your comment multiple times
via different methods. You may submit comments by any of the following
methods:
E-mail: Send us an e-mail at reg-comm@fca.gov. Agency Web
site: http://www.fca.gov. Select ``Legal Info,'' then ``Pending
Regulations and Notices.''
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Mail: Gary K. Van Meter, Deputy Director, Office of
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive,
McLean, VA 22102-5090.
Fax: (703) 883-4477. Posting and processing of faxes may
be delayed. Please consider another means to comment, if possible.
You may review copies of comments we received at our office in
McLean, Virginia, or from our Web site at http://www.fca.gov. Once you
are in the Web site, select ``Legal Info,'' and then select ``Public
Comments.'' We will show your comments as submitted, but for technical
reasons we may omit items such as logos and special characters.
Identifying information that you provide, such as phone numbers and
addresses, will be publicly available. However, we will attempt to
remove e-mail addresses to help reduce Internet spam.
FOR FURTHER INFORMATION CONTACT:
Barry Mardock, Associate Director, Office of Regulatory Policy, Farm
Credit Administration, 1501 Farm Credit Drive, McLean, VA, (703) 883-
4456, TTY (703) 883-4434;
or
Michael A. Anderson, Policy Analyst, Office of Regulatory Policy, Farm
Credit Administration, Denver, CO, (303) 696-9737, TTY (303) 696-9259;
or
Howard I. Rubin, Senior Counsel, Office of General Counsel, Farm Credit
Administration, McLean, VA 22102-5090, (703) 883-4029, TTY (703) 883-
4020.
SUPPLEMENTARY INFORMATION:
I. Background
Sections 1.11(a)(1) and 2.4(a)(1) of the Act authorize Farm Credit
Banks and associations to finance the processing and marketing
operations of bona fide farmers, ranchers, and aquatic producers or
harvesters that are ``directly related'' to the operations of the
borrower, provided that the operations of the borrower supply some
portion of the raw materials used in the processing or marketing
operation (throughput).\1\ Current Sec. 613.3010(a)(1) provides that a
borrower is eligible for financing for a processing or marketing
operation only if the borrower is eligible to borrow from the System or
is a legal entity in which eligible borrowers own more than 50 percent
of the voting stock or equity.
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\1\ 12 U.S.C. 2019(a)(1), 2075(a)(1). Each Farm Credit Bank has
transferred its title I authority to make long-term real estate
mortgage loans to Federal land bank associations pursuant to section
7.6 of the Act (12 U.S.C. 2279b).
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We believe that our current rule, focusing solely on the percentage
of eligible borrower ownership in a legal entity, is unnecessarily
narrow. Therefore, FCA proposes to add additional specific criteria for
determining what legal entities are eligible for financing for
processing and marketing operations in accordance with the provisions
in Sec. Sec. 1.11(a) and 2.4(a) of the Act. While potentially
expanding the pool of eligible legal entities, we believe that the
additional criteria properly ensure that there is a sufficiently strong
economic link--or identity of interests--between eligible borrowers and
the processing or marketing entity so that the financing can be
considered made and ``directly related'' to eligible borrowers and
their operations.
II. Need for Proposed Rule
FCA believes its amendment to Sec. 613.3010 will permit System
associations to more effectively meet the credit needs of eligible
borrowers in the face of changing agricultural and economic conditions
while remaining consistent with the Act. We recognize the increasing
importance of value-added agriculture and aquaculture and the changing
ownership structures in processing and marketing operations. As part of
these changing agricultural and economic conditions, FCA seeks to
ensure that affordable and dependable credit for businesses that add
value to farm and aquatic products and commodities remains available
for the benefit of agricultural and aquacultural producers (and the
rural communities in which they operate).
As farmers, ranchers, and producers or harvesters of aquatic
products look for opportunities to increase farm and aquaculture income
and diversify income sources, the importance of value-added agriculture
and aquaculture has emerged, benefiting both producers and rural
communities. Producers are pursuing value-added activities to gain more
direct access to markets and a greater share of the consumers' food
dollar. As such, farmers are increasingly relying on vertical
integration and coordination of production, processing, and marketing
to deliver products that meet consumer needs. These opportunities have
stemmed from increased consumer demands regarding health, nutrition,
and convenience; efforts by food processors to improve their
productivity; and technological advances that enable producers to
produce what consumers and processors desire. With the continuous
shifting to a global economy, the international market for value-added
products is growing.
Ownership structures within processing and marketing operations are
changing as substantial capital investments cannot be fully raised
[[Page 60679]]
through traditional methods. The farmer-owned sole proprietorships or
closely held entities prevalent in the past are often no longer
economically viable. Therefore, new forms of cooperatives, limited
liability corporations, limited liability partnerships, and other
ownership structures--requiring outside investment--are being used to
address equity and debt capital needs. For example, many of the new
ethanol plants are only partially owned by farmers; however, these
plants are usually directly related to the farmer-owners' operations
and provide significant benefits to the rural communities in which they
are located.
Moreover, even where sole proprietorships or closely held entities
are economically viable, they are often not advisable from a legal
liability, tax, or estate planning perspective. In fact, structuring a
processing or marketing operation with prudent legal liability
considerations protects borrowers' financial interests and is an
acceptable safety and soundness practice. We believe that our rules
shouldn't create a circumstance that forces eligible borrowers to
reject prudent legal, business and tax advice if they wish to continue
borrowing from their FCS lender.
Processing and marketing agricultural businesses are projected to
continue to evolve and grow within rural America. The entrepreneurial
spirit of farmers, ranchers, and producers of aquatic products will
require a reliable and flexible source of credit and financial
services. As value-added agriculture continues to grow, agricultural
producers are challenged by the need to attract substantial capital in
order to improve income for their benefit and the benefit of rural
America.
FCA recognizes the importance of these value-added enterprises to
producers and rural America and believes this proposed regulation will
help ensure dependable credit for businesses that add value to farm and
aquatic products and commodities, as well as the communities in which
they operate. We believe that revisions to this regulation will provide
the FCS with the additional flexibility to meet the existing and future
credit needs of processing and marketing entities upon which farmers,
ranchers, and producers or harvesters of aquatic products are
increasingly dependent for economic survival.
III. Section-by-Section Analysis
The two criteria contained in existing Sec. 613.3010(a)(1) and
(a)(2) are retained in paragraphs (a)(1) and (a)(2), with paragraph
(a)(2) making clear that it only applies to a legal entity that does
not qualify for financing under paragraph (a)(1) as a bona fide farmer,
rancher, or producer or harvester of aquatic products. However, as
discussed above, we believe that a limitation based solely on the
percentage of voting stock held by eligible borrowers--representing
pure numerical voting ``control'' of the entity--is an unnecessarily
narrow way of looking through a legal entity to determine whether a
loan can be viewed as made to an eligible borrower or ``directly
related to'' an eligible borrower's operation. Therefore, the proposal
would add new paragraph (a)(3) to provide alternative ways of
determining actual eligible borrower ``control'' over a legal entity
where the eligible borrower owns 50 percent or less of the voting stock
or equity, new paragraph (a)(4) to provide eligibility for legal
entities where eligible borrowers have a significant equity stake and
provide a substantial amount of the throughput, and new paragraph
(a)(5) to provide financing for legal entities that are a direct
extension or outgrowth of an eligible borrower's production operation,
regardless of the amount of eligible borrower ownership of the legal
entity. A legal entity will need to meet one of these criteria in order
to borrow from an FCS association.
A. Section 613.3010(a)(3)--Majority Voting, Management, or Actual
Control
Under proposed Sec. 613.3010(a)(3), if eligible borrowers own 50
percent or less of the voting stock or equity and one or more of those
eligible borrowers/owners regularly produce some portion of the
throughput used in the processing or marketing operation, then one of
the following criteria must be met:
1. Majority Voting Control
Proposed Sec. 613.3010(a)(3)(i) provides that a legal entity is
eligible for financing under this paragraph if eligible borrowers under
Sec. 613.3000(b) own 50 percent or less of the voting stock or equity,
regularly produce some portion of the throughput used in the processing
or marketing operation and ``exercise majority voting control over the
entity.'' An example of this is a corporation with separate classes of
voting stock, where the eligible farmer-owned class of stock exercises
actual majority voting control regardless of their overall percentage
ownership of stock. Another example would be where holders of a
majority of voting stock agree, by contract or otherwise, to allow
eligible farmer-owners to exercise voting control. This provision would
also encompass a legal entity in which eligible borrowers have the
voting power to elect at least 40 percent of the entity's board of
directors (or general partners of a limited partnership, or managing
members of a limited liability company) and non-eligible investors can
elect no more than 40 percent, with the remainder to be elected through
mutual agreement.
2. Management Control
Proposed Sec. 613.3010(a)(3)(ii) would authorize financing for a
legal entity in which eligible borrowers under Sec. 613.3000(b) own 50
percent or less of the voting stock or equity, regularly produce some
portion of the throughput used in the processing or marketing operation
and ``exercise control over management of the legal entity.'' Eligible
borrowers could exercise control over management by ``constituting a
majority of the directors of a corporation, general partners of a
limited partnership, or managing members of a limited liability
company.'' In these circumstances, eligible borrowers are exercising
actual management direction and control over the entity, even though
they may not own a majority of the voting stock or equity.
3. Actual Control
Proposed Sec. 613.3010(a)(3)(iii) would authorize financing for a
legal entity in which eligible borrowers under Sec. 613.3000(b) own 50
percent or less of the voting stock or equity, regularly produce some
portion of the throughput used in the processing or marketing operation
and ``exercise the documented power and authority to directly determine
and implement the policies, business practices, management, and
decision-making process of the legal entity.'' This is intended to
cover unusual circumstances where the borrower does not meet the
specific criteria of paragraphs (a)(3)(i) or (a)(3)(ii) but where,
through contractual agreement or otherwise, eligible borrowers have
``documented power and authority'' over the legal entity.
B. Section 613.3010(a)(4)--Substantial Ownership Interest and Supply of
Throughput
Proposed Sec. 613.3010(a)(4) would authorize financing for a legal
entity ``in which eligible borrowers under Sec. 613.3000(b) own at
least 25 percent of the voting stock or equity and supply 20 percent or
more of the throughput used in the processing or marketing operation.''
Under this provision, eligible borrower-owners do not need to exercise
voting control over the entity
[[Page 60680]]
because the substantial ownership requirement coupled with the 20-
percent throughput requirement ensures that eligible borrowers have
both a significant investment in the entity and the operation is
``directly related to'' eligible borrowers' operations.
C. Section 613.3010(a)(5)--Extension or Outgrowth of Production
Operations
Proposed Sec. 613.3010(a)(5) would authorize financing for a legal
entity that regularly processes or markets some portion of an eligible
borrower's throughput and whose operations are a direct extension or
outgrowth of that eligible borrower's operation. This is intended to
cover entities--regardless of ownership--in which an eligible borrower
has significant involvement, that fulfill the eligible borrower's
business needs, and that are functionally integrated with the eligible
borrower's production operation. Under paragraph (a)(5), the legal
entity's financial condition is necessarily dependent upon the
continued involvement of the eligible borrower. This mutual
interdependency in financial performance is further indicia that the
processing and marketing operation is part, or an ``extension or
outgrowth,'' of the eligible borrower's production operation.
As discussed above, many farming operations are evolving to include
value-added processing and marketing operations. In many instances,
value-added processing and marketing operations are formed by, and for
the direct benefit of, eligible borrowers, their families, or other
individuals with direct ties to an eligible borrower's production
activities. In these instances, the processing or marketing operation
is truly part of--or a ``direct extension or outgrowth'' of--the
production operation. However, the ownership structures of these value-
added operations are typically crafted to meet tax and liability
concerns--rather than FCS requirements--and consequently may not
satisfy the requirements of our current rule. Moreover, family members
owning and operating value-added businesses may not themselves qualify
for financing as ``bona fide farmers.'' However, the economic reality
is that these value-added operations are integrated with and
inextricably linked to an eligible borrower's production activities.
Under the Act and our rules, the processing or marketing financing
must be a credit need of the eligible borrower. Therefore, paragraph
(a)(5) provides that the eligible borrower must establish the necessary
link between the processing and marketing entity and the eligible
borrower's operation.
The first specific element that an eligible borrower must
demonstrate under paragraph (a)(5) is that ``the legal entity was
created and operates with the active support and involvement of the
eligible borrower.'' An example of this is the eligible borrower who
assists a family member or friend in a start-up processing or marketing
company in which the eligible borrower does not have any legal
ownership; however, the start-up company provides an opportunity for
the eligible borrower to manage production risk through product control
for the benefit of that eligible borrower. The eligible borrower's
``active'' involvement (meaning more than a token investment of money,
time, resources, or throughput) in the creation of the legal entity and
continued active involvement in the operation of the legal entity is
evidence that the operation is truly an ``extension or outgrowth'' of
the eligible borrower's production operation. Where the financing is
for a start-up venture, the eligible borrower should be able to
demonstrate, through a business plan or otherwise, the eligible
borrower's intent to remain actively involved in the processing and
marketing operation.
The second specific element that an eligible borrower must
demonstrate under paragraph (a)(5) is that ``the legal entity fulfills
a business need and supports the operation of the eligible borrower
through product branding or other value-added business activity
directly related to the operations of the eligible borrower.''
Regardless of direct ownership by an eligible borrower, a processing or
marketing operation may be so integral to the eligible borrower's
operation and economic well-being that without it, the eligible
borrower would not receive the same economic benefit. This processing
or marketing operation may support the eligible borrower's business
needs through product branding, product customization to meet specific
contract requirements, or any other value-added activity that meets the
needs of the user or consumer and benefits the economic well-being of
the eligible borrower.
The third criterion an eligible borrower must demonstrate is that
``the legal entity and the eligible borrower coordinate to operate in a
functionally integrated manner.'' This coordination may be evidenced by
shared resources (such as management expertise, employees, or assets)
or other indicia of integration. We believe that Congress intended for
the System to provide financing to assist eligible borrowers in the
upward vertical integration of their operations.
The fourth requirement implements the statutory mandate that the
eligible borrower must provide some throughput to the processing or
marketing operation.
IV. Technical Correction
We are also proposing to correct an omission that inadvertently
occurred during the January 30, 1997, regulatory amendments \2\ by
adding the words ``a legal entity or'' to the Sec. 613.3000(a)(3)
definition of ``[p]erson''. This does not provide any additional
authority and is in accord with our stated intent published in the 1997
Federal Register final rule preamble.
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\2\ See 62 FR 4441 (Jan. 30, 1997).
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V. Regulatory Flexibility Act
Pursuant to section 605(b) of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.), the FCA hereby certifies that the proposed rule
will not have a significant economic impact on a substantial number of
small entities. Each of the banks in the System, considered together
with its affiliated associations, has assets and annual income in
excess of the amounts that would qualify them as small entities.
Therefore, System institutions are not ``small entities'' as defined in
the Regulatory Flexibility Act.
List of Subjects in 12 CFR Part 613
Agriculture, Banks, banking, Credit, Rural areas.
For the reasons stated in the preamble, part 613 of chapter VI,
title 12 of the Code of Federal Regulations are proposed to be amended
to read as follows:
PART 613--ELIGIBILITY AND SCOPE OF FINANCING
1. The authority citation for part 613 continues to read as
follows:
Authority: Secs. 1.5, 1.7, 1.9, 1.10, 1.11, 2.2, 2.4, 2.12, 3.1,
3.7, 3.8, 3.22, 4.18A, 4.25, 4.26, 4.27, 5.9, 5.17 of the Farm
Credit Act (12 U.S.C. 2013, 2015, 2017, 2018, 2019, 2073, 2075,
2093, 2122, 2128, 2129, 2143, 2206a, 2211, 2212, 2213, 2243, 2252).
Subpart A--Financing Under Titles I and II of the Farm Credit Act
Sec. 613.3000 [Amended]
2. Amend Sec. 613.3000(a)(3) by adding the words ``a legal entity
or'' before the words ``an individual''.
3. Revise Sec. 613.3010(a) to read as follows:
[[Page 60681]]
Sec. 613.3010 Financing for processing or marketing operations.
(a) Eligible borrowers. A borrower is eligible for financing for a
processing or marketing operation under titles I and II of the Act only
if the borrower:
(1) Is a bona fide farmer, rancher, or producer or harvester of
aquatic products who regularly produces some portion of the throughput
used in the processing or marketing operation; or
(2) Is a legal entity not eligible under paragraph (a)(1) of this
section in which eligible borrowers under Sec. 613.3000(b) own more
than 50 percent of the voting stock or equity and regularly produce
some portion of the throughput used in the processing or marketing
operation; or
(3) Is a legal entity not eligible under paragraph (a)(1) of this
section in which eligible borrowers under Sec. 613.3000(b) own 50
percent or less of the voting stock or equity, regularly produce some
portion of the throughput used in the processing or marketing operation
and:
(i) Exercise majority voting control over the legal entity; or
(ii) Exercise control over management of the legal entity, such as
constituting a majority of the directors of a corporation, general
partners of a limited partnership, or managing members of a limited
liability company; or
(iii) Exercise the documented power and authority to directly
determine and implement the policies, business practices, management,
and decision-making process of the legal entity; or
(4) Is a legal entity not eligible under paragraph (a)(1) of this
section in which eligible borrowers under Sec. 613.3000(b) own at
least 25 percent of the voting stock or equity and supply 20 percent or
more of the throughput used in the processing or marketing operation;
or
(5) Is a legal entity not eligible under paragraph (a)(1) of this
section that is a direct extension or outgrowth of an eligible
borrower's operation. To obtain financing for a legal entity under this
paragraph, the eligible borrower must establish that:
(i) The legal entity was created and operates with the eligible
borrower's active support and involvement,
(ii) The legal entity fulfills a business need and supports the
operation of the eligible borrower through product branding or other
value-added business activity directly related to the operations of the
eligible borrower,
(iii) The legal entity and the eligible borrower coordinate to
operate in a functionally integrated manner, and
(iv) The legal entity regularly processes or markets some portion
of the eligible borrower's throughput.
* * * * *
Dated: October 11, 2006.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
[FR Doc. E6-17170 Filed 10-13-06; 8:45 am]
BILLING CODE 6705-01-P