United States: Debt Previously Contracted ("DPC") Investments: Equity By Accident Or Safe And Sound M&A For Lenders?

Last Updated: August 3 2018
Article by Gerald A. Francese and Zayne Ridenhour Tweed

Banks have several weapons in their arsenal to prevent corporate loan defaults, including foreclosure and acting on collateral. As a potentially less draconian step, which could serve to augment rather than strain relations with the borrower, when loans become distressed (or are expected to become distressed), bank lenders and their affiliates have the authority to restructure loans to include an equity "kicker" for the lender under the authority to resolve debts previously contracted ("DPC Authority").1

Pursuant to DPC Authority, national banks may accept equity securities in lieu of (or in addition to) existing or restructured loans with a view to a subsequent sale or conversion of the equity into money to make good or reduce anticipated losses. Such transactions are not considered dealing in securities, but as compromises in good faith to resolve a debt.2 Typically, the lender would reduce either or both of the loan payment stream and/or principal balance to amounts that the borrower can demonstrate are serviceable, and then make up the difference in value with equity valued at the then-current fair market value of the borrower entity. This way, the borrower can continue to service the loan, the lender can remove the debt from its default status, and both borrower and lender will enjoy upside if the restructured debt provides the borrower with a path to growth and financial stability. Under this structure, the interests of the lender and borrower are aligned for the success of the borrower. As described in greater detail below, under DPC Authority, lenders are permitted to provide substantial assistance to borrowers to manage and operate the business back to health and profitability.

DPC Authority

A national bank's authority to take property under DPC Authority emanates from two sources. First, banks have express statutory authority to take real property in satisfaction of DPC.3 Second, the powers incidental to carrying on the business of banking include the power to acquire and manage personal property taken in satisfaction of DPC.4 Under these combined statutory authorities, a bank may acquire DPC securities and, in good faith, hold, manage, and ready those assets for sale as would any other prudent owner.5

DPC Authority is premised on the bank's good faith business judgment and is implied whenever a bank is faced with a loss. It is not necessary that the borrower be in default.6 Likewise, the property taken in satisfaction of DPC need not be the borrower's original collateral. The Office of the Comptroller of the Currency (the "OCC") and the federal courts have recognized that banks may acquire and hold various types of real and personal DPC property – including equity securities – not given as collateral for the original loan.7

Banks may also engage in activities that, absent underlying DPC Authority, are generally beyond the implied powers of a national bank. For example, banks have been permitted to operate chemical production facilities, complete the construction of residential properties, and fund new development within existing properties to mitigate losses on loans pursuant to DPC Authority.8 More importantly, where a bank takes corporate stock as part of its DPC Authority, it has the implied power to operate the corporation's business and perform other necessary and reasonable acts to preserve the value of the business when its resale value depends on uninterrupted operation. The bank may also advance additional funds to improve the business and increase its ultimate recovery.9 By contrast, under the merchant banking powers granted by the Bank Holding Company Act, such acts are generally prohibited absent extreme distress circumstances.10

Even so, there are two key limits to DPC Authority. First, DPC Authority must be exercised in good faith. It cannot be used as a cloak to cover unauthorized practices, including speculation on the future value of the DPC asset. When done in good faith, such activity is not ultra vires, but is deemed incidental to the business of banking.11

Second, a bank can only hold DPC assets (including securities) for five years, subject to one additional five-year extension.12 Regulatory authorities will only grant an extension upon a clearly convincing demonstration of need, and subject to a substantial charge to the bank's Tier 1 capital. For this reason, banks should balance their extension needs against an additional hit to Tier 1 capital for the extension period, as well as the loss of a favor from regulators that may be better used elsewhere.

It is important to keep in mind that DPC Authority is not exclusive of other bank powers. In some cases, it may not be the best fit for the bank. Accordingly, DPC Authority should be weighed against other bank powers – such as merchant banking authority or Sections 4(c)(6) and 4(c)(7) of the Bank Holding Company Act – to manage regulatory requirements, supervisory expectations, and transaction needs. 

Acquisition of a Non-Controlling Interest in an Entity to Hold DPC Assets

Banks in a syndicate often acquire DPC interests via an entity – usually a limited liability company (an "LLC") – that holds DPC assets (including equity securities).13 No prior regulatory notice is required for such an investment, but the bank must document the satisfaction of four criteria: (1) the activities of the LLC are limited to those that are part of, or incidental to, the business of banking; (2) despite not having control of the LLC, the bank is in a position to prevent the LLC from engaging in activities that do not meet this standard; (3) the bank's loss exposure is limited, as a legal and accounting matter, and it does not have open-ended liability for the LLC's obligations; and (4) the investment is convenient and useful to the bank's business.14 Criteria 1 and 4 are satisfied where the investment is made pursuant to a good faith exercise of DPC Authority. Criteria 2 and 3 are addressed in the transaction documents. The bank must document satisfaction of these criteria for its examiner to review.

Formation of a Subsidiary to Hold DPC Assets

When a bank acquires corporate stock pursuant to DPC Authority, the corporation does not become the bank's operating subsidiary.15 However, where a bank establishes a separate subsidiary to hold its DPC assets (including equity securities), the entity will be considered an operating subsidiary subject to the OCC's prior notice requirements if any of the following apply:

  • The bank has the ability to control the management and operations of the entity, and no other person exercises effective control over the entity or has the ability to influence its operations to an extent equal to or greater than the bank.
  • The bank holds 50 percent or more of the voting or controlling interests in the entity.
  • The entity is consolidated with the bank under generally accepted accounting principles ("GAAP").16

The bank may be eligible for after-thefact notice with respect to formation of the operating subsidiary if the bank: (1) is "well capitalized" and "well managed"; (2) is commencing new activity in the entity; (3) controls the entity; (4) holds more than 50 percent of the voting interests in the entity; and (5) consolidates its financial statements with the entity under GAAP. In many cases, forming an operating subsidiary to hold DPC assets is tempting. But there are drawbacks, chief among them that the bank will be subjected to additional reporting, corporate governance, and regulatory burdens.


Consistent with the powers and limitations imposed on national banks under federal laws and OCC guidance, banks may acquire, hold, and manage many forms of real and personal property – including equity securities – to recover investments on a doubtful loan pursuant to DPC Authority. Of course, the exercise of DPC Authority is not without obstacles and risks. Regulatory authorities, including the OCC and the FDIC, may take different positions based on the same, or similar, facts and circumstances cited in prior interpretive guidance or based on supervisory purposes irrespective of established legal precedent. Prior to engaging in DPC activities, contact Troutman Sanders LLP to discuss how acquiring DPC assets can benefit your bank.


1 See generally 12 C.F.R. § 1.7 (securities held in satisfaction of DPC) and OCC Interpretive Letter No. 517 (Aug. 16, 1990) (as activity incidental to business of banking, national banks permitted to accept stock and stock warrants in addition to or in lieu of interest on loans).

2 Pursuant to Federal Deposit Insurance Corporation ("FDIC") guidance and state parity statutes, state banks may take advantage of DPC Authority to the same extent. Generally, equity investments acquired by an insured state bank pursuant to DPC Authority are not covered by the activities restrictions under 12 C.F.R. Part 362 so long as the bank does not hold the DPC asset for speculation, takes only such actions as would be permissible for a national bank, and disposes of the property within the statutory holding period. See 12 C.F.R. § 362.1(b)(3) (purpose and scope) and § 362.2(g) (definition of equity investment). See also
FDIC FIL54-2014 (Nov. 19, 2014) (filing and documentation procedures for state banks engaging, directly or indirectly, in activities or investments permissible for national banks).

3 12 U.S.C. § 29(Third). See also OCC Interpretive Letter No. 1123 at n.5 (Sept. 18, 2009) (noting that DPC Authority is a "necessary power" of banks "recognized since the earliest days of our country").

4 12 U.S.C. § 24(Seventh).

5 See OCC Interpretive Letter No. 1007 (Sept. 7, 2004) (national bank may negotiate with borrower to extinguish poor credit in exchange for form of property bank otherwise unable to hold).

6 A bank may exercise DPC Authority when an extension of credit is in default, is nonperforming, or the borrower establishes a history of poor performance. See id. at *3 ("When a national bank exercises its lending authority,
regardless of the legal form that the extension of credit takes, the bank should be able to use its DPC Authority when a credit event warrants.").

7 See OCC Non-Objection Letter No. 89-01 (Jan. 25, 1989) and OCC Interpretive Letter N. 892 (Sept. 13, 2000) (permitting bank to hold equity securities to hedge derivatives transaction by analogy to DPC Authority).
See also First Nat'l Bank of Charlotte v. Nat'l Exch. Bank of Baltimore, 92 U.S. 122, 127 (1875) and Atherton v. Anderson,
86 F.2d 518, 525 (6th Cir. 1936), rev'd on other grounds, 302
U.S. 643 (1937).

8 See e.g. OCC Interpretive Letter No. 12 (Dec. 7, 1977) (bank permitted to operate anhydrous ammonia plant); OCC No- Objection Letter No. 86-6 (Apr. 22. 1986) (bank permitted to continue construction on DPC property to realize full satisfaction of debt); and OCC No-Objection Letter No. 87-2 (bank permitted to develop DPC property to preserve zoning plan and avoid substantial decrease in property value).

9 These additional funds are not subject to the bank's legal lending limit. However, the advances are subject to certain restrictions. See 12 C.F.R. § 34.86(a). In addition, if the estimated sum of the additional funds plus the bank's current recorded investment exceed 10% of the bank's capital and surplus, the bank must notify its supervisory office at least 30 days prior to action. Id. at § 34.86(b).

10 See generally 12 C.F.R. Part 225 Subpart J (Merchant Banking Investments).

11 See Atherton at 525 ("[A bank] may clean [DPC property], make reasonable repairs upon it, and put it in presentable condition to attract purchasers in the same way that an individual of sound judgment and prudence would do if he desired to make a sale...."). See also OCC Conditional Approval No. 895 (March 31, 2009) (permitting bank to create multiple operating subsidiaries in connection with restructuring of DPC property) (quoting Morris v. Third Nat'l Bank, 142 F. 25, 31 (8th Cir. 1905), cert. denied, 201 U.S.
649 (1906) ("A [bank] may lawfully do many things in securing and collecting its loans, in the enforcement of its rights and conservation of its [DPC property], which it is not authorized to engage in as a primary business.").

12 See 12 U.S.C. § 29 and 12 C.F.R. § 1.7 (imposing limitations with respect to holding period, accounting treatment, and non-speculative purpose for DPC securities).

13 Investments of this type are permitted pursuant to the powers granted to banks under 12 U.S.C. § 24(Seventh) and 12 C.F.R. § 5.36(g).

14 See OCC Interpretive Letter No. 735 (July 15, 1996) (bank permitted to establish operating subsidiary through which it would become minority member of limited liability company).

15 12 C.F.R. § 5.34(e)(2)(B).

16 See generally, OCC, Comptroller's Licensing Manual, "Subsidiaries and Equity Investments," p.2 (Oct. 2017). See also 12 C.F.R. § 5.34.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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