Kevin Handly
By statute, Massachusetts banks are limited in the amount of credit they may extend to a “single borrower.” Generally speaking, under Section 6 of Chapter 167E of the Massachusetts General Laws, the total obligations of one borrower to a Massachusetts bank may not exceed 20 percent of the bank’s capital.
For a busy commercial bank, the question often comes up, what is “one borrower” for purposes of these limitations? Will a proposed new loan be aggregated with prior loans to related borrowers? If the borrower is the same legal entity, the answer is of course, “yes.” But often the facts are not so simple, and it may be necessary to dig deeper.
In applying single obligor limitations to specific fact situations, it is helpful to bear in mind their statutory purposes. One objective, clearly, is to protect banks from the heightened risks that could result from putting all of their eggs in one basket. Diversifying loans among many borrowers assures that if one borrower goes bust, the bank won’t necessarily go down with it. Another goal is to assure broad access to bank credit. In a climate of credit scarcity, a single borrower or group shouldn’t be able to monopolize a bank’s lending resources, thereby depriving other borrowers of a fair opportunity to obtain credit.
The statute itself provides that an “obligation [of] one borrower will be attributed to another … if the obligation [is] for the direct benefit of another person or [if] a common enterprise is considered to exist between the persons.” These “direct benefit” and “common enterprise” tests were first applied by the Massachusetts Division of Banks in 2001 and subsequently added to the statute in 2004. In Selected Opinion 01-094, the division repudiated its prior interpretations of the statute as “much too broad,” and stated that henceforth, an extension of credit to one borrower or guarantor would be aggregated with loans to another only “if it falls within the direct benefit or common enterprise tests.”
In so construing the Massachusetts single-borrower limitation, the division borrowed directly from 12 CFR Part 32, the regulations of the Office of the Comptroller of the Currency (OCC) interpreting the federal lending limit statute applicable to federally chartered banks. In the absence further guidance from the Division of Banks, the OCC regulations in 12 CFR Part 32 give meaning to both the direct benefit and the common enterprise tests incorporated in the amended Massachusetts single-borrower statute.
Direct Benefit And Common Enterprise Tests
With respect to the “direct benefit” test, the comptroller’s regulations provide that “a loan … to a borrower will be … attributed to [another] person when the proceeds, or assets purchased with the proceeds, are transferred to another person, other than in a bona fide arms’ length transaction where the proceeds are used to acquire property, goods or services.” Thus, a bank’s loan to a buyer will not be attributed to the seller if the purchase of goods or services is in good faith and on market terms.
With respect to the “common enterprise” test, the comptroller’s regulations provide that “a common enterprise will be deemed to exist and loans to separate borrowers will be aggregated” when the expected source of repayment for each loan is the same, or when the borrowers are related directly or indirectly through common control and substantial financial interdependence exists between them, or the comptroller determines, “based upon the facts and circumstances of the particular transaction, that a common enterprise exists.” Thus, under the common enterprise test, a loan to a subsidiary will not be combined with a loan to its parent, or a loan to one corporation with a loan to its sister corporation unless the two related entities are financially interdependent. The necessary “financial interdependence” will be found only “when 50 percent or more of one borrower’s gross receipts or gross expenditures … are derived from transactions with the other borrower.”
As these authorities make clear, the proper application of Massachusetts single-borrower limitations to related borrowers is not always obvious. A careful review of the legal and financial relations between existing and prospective borrowers may lead to surprising conclusions.
This article is not intended to be, and may not be relied upon as, legal advice, which can only be based upon a careful review of particular facts and circumstances.
