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| ## Comptroller of the Currency                                        |
|                                                                       |
| > Administrator of National Banks                                     |
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Washington, DC 20219

**Interpretive Letter #1052**

**March 2006**

**12 USC 84**

**12 CFR 32**

November 30, 2005

Subject: Applicability of Lending Limit to Credit Programs of **\[ \]**
National Bank, **\[ *City, State* \]**

Dear **\[ \]**:

We are writing in response to your request for an opinion as to the
application of the lending limit, 12 U.S.C. § 84 and 12 C.F.R. part 32,
to three credit programs contemplated by **\[ \]** National Bank, **\[
*City, State* \]** (Bank). The programs are independent of each other
but all involve the Bank making loans, or making or buying leases,[^1]
to "captive" independent contractors. Based on the information provided
by you and by the Bank, it is our opinion that all the programs result
in loan combinations under the lending limit. In addition, Proposal Two
(described below) results in partial attribution of leases to the seller
under the third-party paper rule in light of the repurchase obligation
of the seller.

#### Facts

*Proposal One -* **\[ \]** *(Bakery)*

The Bank proposes to enter into 48-60 month equipment leases with
delivery truck drivers to finance the drivers' acquisition of handheld
computers that the drivers would use to track inventory. The drivers own
their own trucks and act as "captive" independent contractors for Bakery
in that they have no other source of income save for their income from
Bakery. Bakery produces snacks that the drivers deliver to a variety of
customers who owe their payment to Bakery. The Bank purchases the
computers from a provider of supply chain information products, services
and systems, and leases them to the Bakery drivers. Each computer lease
would be in the amount of \$4,000 to \$5,000. The Bank anticipates total
volume of \$8,000,000 to \$10,000,000 by the end of 2005.

*Proposal Two -* **\[ \]** *(Truck Leasing)*

Truck Leasing builds trucks and leases them to independent contractor
drivers of customers of Truck Leasing such as a nationwide ground
delivery service or a bakery. Any one driver works only for one such
customer of Truck Leasing. The Bank proposes to purchase such truck
leases. Each lease represents a debt of \$40,000 to \$50,000 per driver.
The Bank anticipates total volume of \$10,000,000. The trucks are
manufactured to specifications supplied by Truck Leasing's customer.
There will be lessee drivers who will not able to satisfy the Bank's
underwriting standards since they will have been in business less than
two years. In addition, the drivers will not have sufficient sources of
income, other than their income from the program sponsor, *e.g.*, the
nationwide ground delivery service, to fully support the leases and
their other obligations. As a result, Truck Leasing has agreed to a
limited recourse arrangement in which upon any default it will pay to
the Bank the lesser of (i) the outstanding balance of the lease (less
any recovery) and (ii) an amount equal to 10 percent of the purchase
price of all the leases less any prior recourse payments to the Bank. A
cash reserve of 2 percent or 2.5 percent of the purchase price of the
lease is held by the Bank to secure the limited recourse obligation of
Truck Leasing.

####### *Proposal Three --* **\[ \]** *(Tools Company)*

The Bank proposes to make two secured loans to a number of delivery
truck drivers who act as independent contractor distributors for Tools
Company, a manufacturer of tools. The first loan finances the
distributors' acquisition of a delivery truck, and the second loan
finances the distributor's start-up costs including, sales aides,
initial inventory and working capital. The distributors purchase or
lease the truck from one of a number of vendors specified by Tools
Company or from Tools Company itself in bona fide transactions. In
addition, they purchase the inventory from Tools Company, also in bona
fide transactions. The truck and start-up loans total approximately
\$130,000 for each distributor. The Bank anticipates a total annual
volume of \$15,000,000. The distributors own the inventory and deliver
tools to mechanics. In most cases, the distributors extend credit
directly to the mechanics in small amounts for a short term. In other
cases, the mechanics make payment to the distributors in cash or by way
of a credit card program set up by Tools Company and another financial
institution.

Many of the distributors will not be able to satisfy the Bank's
underwriting standards since they will have been in business less than
two years. As a result, with respect to the truck loans, Tools Company
will establish a non-refillable net loss pool reserve available to the
Bank in an amount equal to 10 percent of the total truck loans. The Bank
has agreed to treat the amount of the net loss pool reserve as an
exposure to Tools Company that is subject to the lending limit. In
addition, with respect to the start-up loans, Tools Company will be
contractually bound to purchase any defaulted start-up loans from the
Bank for the lower amount of 90 percent of the cost of the inventory or
the Bank's charge-off balance. If the purchase obligation does not cover
the Bank's entire loss on a particular defaulted start-up loan, the
truck loan net loss pool reserve is available to cover it.

#### Legal Analysis

The purpose of the lending limit is to protect the safety and soundness
of national banks by preventing excessive loans to one person and to
promote diversification of loans and equitable access to banking
services.[^2] Generally, a national bank's total outstanding loans to
one borrower may not exceed 15 percent of the bank's capital and
surplus, plus an additional 10 percent of capital and surplus if the
amount over the 15 percent general limit is fully secured by readily
marketable collateral.[^3] A "borrower" includes a person who is named a
borrower in a loan or extension of credit and also a guarantor who is
deemed to be a borrower under the common enterprise test in 12 C.F.R.
§ 32.5.[^4] Pursuant to section 32.5, loans to one borrower will be
attributed to a guarantor when a common enterprise is deemed to exist
between the borrower and the guarantor. A common enterprise is deemed to
exist, *inter alia*, (i) when the expected source of repayment for each
loan is the same and neither borrower has another source of income from
which the loan and the borrower's other obligations can be fully
repaid;[^5] (ii) when loans are made to borrowers who are related
directly or indirectly through common control, including where one
borrower is directly or indirectly controlled by another borrower; and
substantial financial interdependence exists between or among the
borrowers;[^6] or (iii) when the OCC determines, based on an evaluation
of the facts and circumstances of particular transactions, that a common
enterprise exists.[^7]

###### Proposal One - Bakery

The common source of repayment prong of the common enterprise test
provides that loans to borrowers are combined when the expected source
of repayment for each loan is the same and none of the borrowers has
another source of income from which the loan and the borrower's other
obligations can be fully repaid. Here, the expected source of repayment
for each lease is income from Bakery and the drivers do not have other
sources of income with which to fully repay their loans and other
obligations. Thus, absent an exception, the extensions of credit to
Bakery's drivers are combinable under the common source of repayment
prong. The common source of repayment prong contains a limited exception
under which an employer is not treated as a common source of repayment
based only upon its employees' receipt of wages and salaries from the
employer (unless the standards of the common control and substantial
financial interdependence prong are met). The facts here do not meet the
terms of the exception and thus the leases must be combined.[^8]

###### Proposal Two -- Truck Leasing

The leases that the Bank purchases from Truck Leasing are combined as to
drivers of each customer of Truck Leasing under the analysis set forth
above for Proposal One. Thus, for example, all leases pertaining to
drivers for the nationwide ground delivery service are combined under
the common source of repayment prong and, separately, all leases
pertaining to the bakery drivers are similarly combined. In addition, as
noted above, Truck Leasing has a limited recourse obligation with
respect to defaulted leases. Under 12 C.F.R. § 32.2(k)(1)(iv), a bank's
purchase of third-party paper subject to an agreement that the seller
will repurchase the paper upon default or at the end of a stated period
is a loan to the seller in the amount of the paper purchased less any
reserve held by the bank as collateral security. Where the seller's
obligation to repurchase is limited, the bank's loan is measured by the
total amount of paper the seller may ultimately be obligated to
repurchase. Here the Bank has limited recourse to Truck Leasing. Thus,
10 percent of the outstanding leases, less the cash reserve, is the
amount that is treated as an extension of credit to Truck Leasing under
the third-party paper rule.

###### Proposal Three -- Tools Company

As noted above, many of the Tools Company borrowers will not be able to
satisfy the Bank's underwriting standards since they have not been in
business for two years. As a result, Tools Company provides a net loss
pool reserve available to the Bank in an amount equal to 10 percent of
the total truck loans. In addition, Tools Company is obligated to
purchase all defaulted start-up loans from the Bank for the lower amount
of 90 percent of the cost of the inventory or the Bank's charge-off
balance. If the purchase obligation does not cover the Bank's entire
loss on a particular defaulted start-up loan, the truck loan net loss
pool reserve is available to cover it. Thus, Tools Company is a
"guarantor"[^9] on the Bank' loans to its borrowers and the guarantee
could cover all defaulted loans. Under the lending limit, a guarantor is
deemed to be a borrower, with the named borrower, if the common
enterprise test is satisfied.[^10] The guarantor rule applies to this
proposal, not the third-party paper rule discussed above, since this
proposal involves direct loans and not the purchase of paper.

With respect to the common enterprise test, Tools Company is in a common
enterprise with the named borrower because there is common control and
substantial financial interdependence between Tools Company as guarantor
and the named borrower. For the purposes of the common control with
interdependence prong, control is presumed to exist when a person
directly or indirectly has power to exercise a controlling influence
over management or policies of another person. Each of the distributors
is dependent on Tools Company, the guarantor, for critical business
functions. Tools Company exclusively determines the terms that goods and
services are provided to the distributors. For example, the distributors
are prohibited from offering products from any other manufacturer. Tools
Company decides on what products to offer for sale and their price.
Tools Company also largely determines the distributor's customers; each
distributor is provided an exclusive route or territory. Tools Company
does not allow distributors to compete for the same clients. Each
distributor has a regional and district manager that provides training
and product support. The Tools Company district manager will from time
to time accompany the distributor on sales calls to aide in direct
marketing efforts. In addition, Tools Company provides product promotion
and marketing efforts and Tools Company receives all payments on credit
card orders and forwards payments to the distributors. It is therefore
clear that Tools Company has power to exercise a controlling influence
over the management and policies of the distributors.[^11] With respect
to interdependence, the distributors are required to sell Tools Company
products exclusively and so all of their expenditures are to the
guarantor, Tools Company. Substantial financial interdependence is
deemed to exist when 50 percent or more of one borrower's gross
expenditures are derived from transactions with the other borrower, here
the guarantor Tools Company.[^12] Thus, the loans to the distributors
must be attributed to Tools Company and combined under the common
control with interdependence prong of the common enterprise test.[^13]

#### 

#### Safety and Soundness

Independently from the applicability of the lending limit, loans made by
national banks must be consistent with safe and sound banking practices.
A bank management's creation of excessive credit concentrations within a
loan portfolio is an unsafe and unsound banking practice. If the
individual transactions under the proposals were not subject to
aggregate limitations, Bank management would be able to create a
commercial loan portfolio with a risk profile that is highly dependent
on the financial condition of a handful of corporations. If a program
sponsor were to experience financial deterioration and cease operations,
a significant portion of the associated borrowers would likely default
simultaneously given the financial interdependence between the program
sponsors and the individual borrowers. Given the Bank's capital base and
Bank management's projected volume of loans and leases for the programs,
such a situation could threaten the viability of the institution.

#### Conclusion

Based on the application of the lending limit, and consistent also with
safe and sound banking practices, extensions of credit are combined as
to Bakery (Proposal One), each customer of Truck Leasing (Proposal Two)
and Tools Company (Proposal Three), and 10 percent of the outstanding
leases in Proposal Two, less the cash reserve, is the amount that is
treated as an extension of credit to Truck Leasing.

We trust the foregoing is responsive to your inquiry. If you have any
questions, please contact Jonathan Fink of my staff at (202) 874-5300.

Sincerely,

signed

Eric Thompson

Director, Bank Activities & Structure

[^1]: Pursuant to 12 C.F.R. § 23.6, a lease of personal property
    authorized under 12 U.S.C. § 24 (Seventh) or 12 U.S.C. § 24 (Tenth)
    is subject to the lending limit. This letter does not address the
    permissibility of the Bank's acquisition or origination of leases
    pursuant to 12 C.F.R. part 23.

[^2]: 12 C.F.R. § 32.1(b)

[^3]: 12 U.S.C. § 84(a); 12 C.F.R. § 32.3(a).

[^4]: 12 C.F.R. § 32.2(a).

[^5]: 12 C.F.R. § 32.5(c)(1).

[^6]: 12 C.F.R. § 32.5(c)(2). Substantial financial interdependence is
    deemed to exist when 50 percent or more of one borrower's gross
    receipts or gross expenditures (on an annual basis) are derived from
    transactions with the other borrower. Gross receipts and
    expenditures include gross revenues/expenses, inter-company loans,
    dividends, capital contributions, and similar receipts or payments.

[^7]: 12 C.F.R. § 32.5(c)(4).

[^8]: Though it has no explicit geographic limitation, the
    employer/employee exception is often referred to as the "company
    town" exception since it is understood as having been originally
    intended to facilitate the location of national banks, and the
    granting of credit to employees, in such a town. A "company town" is
    a town in which residents are dependent on the economic support of a
    single firm for maintenance of retail stores, schools, hospitals,
    and housing. Without the exception, it would be difficult for a
    local bank to serve effectively the credit needs of the town's
    residents. The OCC has not expanded the employer/employee exception
    to a case that involves neither employees' wages and salaries nor
    "unique and compelling similarities" to the company town. *Cf*. OCC
    Interpretive Letter No. 979, reprinted in \[2003-2004 Transfer
    Binder\] Fed. Banking L. Rep. (CCH) 81,502 (Dec. 18, 2003).

[^9]: The term "guarantor" is not defined in the lending limit. A
    guarantor's obligation can be described as a "promise to answer for
    the payment of some debt, or the performance of some duty, in case
    of the failure of another who is liable in the first instance."
    *See* Black's Law Dictionary, 8th ed., 2004.

[^10]: 12 C.F.R. § 32.2(a).

[^11]: The case at hand is very different from proposals involving loans
    to franchisees such as automobile dealerships or restaurants in
    which the franchisor typically does not guarantee the franchisees'
    borrowing and franchisees arrange their own financing from different
    sources. Non-guarantor franchisors are generally not "borrowers" and
    thus combination of loans to different franchisees under the common
    control and financial interdependence prong would not occur.
    However, if a national bank did make a substantial number of loans
    to franchisees of the same franchisor, the OCC may view those as a
    concentration of credit.

[^12]: The OCC has noted that substantial financial interdependence can
    also exist below the 50 percent threshold depending on the presence
    of other factors. *See*, *e.g.*, Letter of William B. Glidden,
    Assistant Director, Bank Activities & Structure (unpublished) (Jan.
    24, 2001).

[^13]: With respect to the common source of repayment prong of the
    common enterprise test, if the Bank reasonably were to expect that
    the borrowers can fully repay their loans from their income and
    other resources, principally the income they generate from the sale
    of tools to the different mechanics to whom they deliver, the common
    source of repayment prong of the common enterprise test would not
    cause the loans to be attributed to Tools Company, the guarantor.
    Conversely, if the borrowers were not reasonably expected to be able
    to fully repay the loans from their income and other resources,
    Tools Company, as guarantor, would be the expected source of
    repayment of the loans and the common source of repayment prong, in
    addition to the common control with interdependence prong, would
    cause the loans to be attributed to Tools Company.