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4000 - Advisory Opinions
Employee Stock Ownership Plan (ESOP)
FDIC-81-15
June 3, 1981
Joseph A. DiNuzzo, Attorney
BACKGROUND
In March 1978 *** established an Employee Stock Ownership Plan
("ESOP") as a means of improving its capital condition. In order
to effectuate the capitalization, the ESOP borrowed funds from a
certain lender. At that time the management of *** Bank was advised by
the FDIC that the bank could not guarantee the ESOP's debt without
violating section 332.1 of the FDIC's rules and regulations.
Consequently, the directors of the bank guaranteed repayment of the
ESOP's obligation in their individual capacities. Sometime thereafter,
however, the guaranties executed by the directors were released and
their responsibilities were assumed by *** Bank under a "continuing
guaranty agreement." Hence, *** an apparent violation of section
332.1 was scheduled.
Attempting to correct the violation, the management of ***
Bank has presented to the FDIC a proposed agreement which, it contends,
modifies the ESOP financing plan so as to comply with section 332.1.
The pertinent part of the proposed agreement imposes a direct
obligation upon *** Bank to make periodic payments to the ESOP (or to
the lender) equal to the total amount owed by the ESOP to the lender.
It also provides that *** Bank's failure to make the designated
payments will entitle the lender to a legal cause of action against ***
Bank for breach of contract.
{{4-28-89 p.4079}}
QUESTION PRESENTED
The issue is whether *** Bank's contractual obligation to pay the
ESOP (or the lender) an amount equal to that owed by the ESOP to the
lender constitutes a prohibited guarantee under section 332.1 of the
FDIC rules and regulations.
CONCLUSION
The proposed agreement imposes a direct obligation upon *** Bank to
pay to the ESOP (or to the lender) an amount equal to the sum owed by
the ESOP to the lender. This contractual obligation constitutes a bona
fide debt agreement and is legally enforceable. Inasmuch as the
agreement does not include a guaranty by *** Bank of the ESOP's debt,
there is no violation of section 332.1.
Even if the proposed agreement did include a guaranty by the bank to
pay the ESOP's debt, there would be no violation of section 332.1. This
is because the bank's existing obligation to pay the designated sum to
the ESOP would constitute a "substantial interest" in the overall
transaction so as to qualify as an exception to the general prohibition
against bank guaranties.
DISCUSSION
An ESOP is an employee benefit plan which is accorded special
treatment under the Internal Revenue
Code. 1
It is designed to enable an employer to make tax-deductible
contributions to an employee benefit plan and to have those funds
invested by the trustee of the plan in the employer's stock. The stock
purchased by the ESOP is held in trust for the employees and
distributed to them upon retirement.
The concomitant purpose of most ESOPs is corporate financing. An
ESOP may utilize the credit of an employer corporation for the purpose
of debt-financing its acquisition of employer stock. This allows the
employer to finance its capital growth with pre-tax corporate dollars,
while building ownership interests in its employees. The typical plan
operates as follows:
1) The ESOP borrows funds from a lender;
2) The employer guarantees the lender that the ESOP will repay
the loan and that each year the employer will pay to the ESOP an amount
sufficient to enable the ESOP to remit its annual payment;
3) The ESOP uses the borrowed funds to purchase employer
stock; and
4) Each year the employer makes a tax-deductible payment to
the ESOP equal to the amount due from the ESOP to the lender.
This financing plan enables corporate credit to be extended to
acquire employer stock for the benefit of employees, while enabling the
corporation to finance its capital requirements with pretax dollars.
A problem arises in using an ESOP as a capital-financing technique
when the employer is a bank. This is because banks, generally, cannot
serve as guarantors. With regard to state nonmember banks insured by
the FDIC, the operative regulation is 12 C.F.R. § 332.1. Section
332.1 provides that a state nonmember bank "shall not . . .
exercise, take, or assume the power . . . to guarantee . . . the
obligations of others. . . ." A recognized exception to this
prohibition applies, however, when the bank has a "substantial
interest" in the transaction in issue. In that case the bank may
extend itself as guarantor on an
obligation. 2
In accordance with this exception, the Legal Division has maintained
in past situations that a bank may guarantee the debt incurred by an
ESOP when the employer-bank has committed itself to pay to the ESOP an
amount equal to the sum owed by the ESOP to the lender. This legal
obligation by the bank is deemed to be a "substantial" enough
"interest" in the transaction so as to allow the bank to
guarantee the ESOP's debt without running afoul of section
332.1.
{{4-28-89 p.4080}}
The facts surrounding the *** Bank ESOP must be examined in this
light. Paragraphs two and four of the proposed agreement provide that
the bank will make payments to the ESOP in an amount equal to the sum
payable by the ESOP to the lender. 3
These provisions constitute a direct and primary obligation upon ***
Bank to remit a designated sum to the ESOP (or to the lender). Inasmuch
as it is supported by a valid
consideration 4
, this obligation is legally enforceable, providing the contract is
executed in the proper legal fashion. 5
Moreover, because the proposed agreement does not include a guaranty by
the bank of the ESOP's debt, there is no violation of section 332.1.
Even if the proposed agreement did include a guaranty by *** Bank of
the ESOP's debt, section 332.1 would not be violated. This is because
the obligation of the bank to pay the designated sum to the ESOP (or to
the lender) would constitute a "substantial interest" by the bank
in the overall transaction so as to qualify as an exception to the
general prohibition against bank
guaranties.
1 The plan must comply with section 4975(e)(7) of the Internal
Revenue Code. 26 U.S.C. § 4975(e)(7). Go Back to Text
2 This exception has been impliedly incorporated into section
332.1. The Comptroller of the Currency's regulations explicitly
incorporate the exception in 12 C.F.R. § 7.7010(a). Go Back to Text
3 A copy of the proposed agreement is attached. Go Back to Text
4 Paragraph one of the proposed agreement contains a legally
recognizable consideration. Go Back to Text
5 We do not believe there is any substantial legal question as
to the bank's authority to commit itself to make periodic payments to
an ESOP. In this regard, an ESOP appears to be no different from other
employee benefit plans, such as pension or profit-sharing plans or
health and welfare plans. Go Back to Text
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