4000 - Advisory Opinions
Separate Corporate Identity of Subsidiary Established by Insolvent FDIC-Insured Institution in Connection with the Issuance of Mortgage Pay-Through Bonds or Preferred Stock
April 9, 1986
John C. Murphy, Jr. General Counsel
I am writing in response to your letter of March 7, 1986, on behalf of ***, regarding the position of the Federal Deposit Insurance Corporation ("FDIC") with respect to the separateness of a subsidiary established by an FDIC-insured institution in connection with the issuance by the subsidiary of mortgage pay-through bonds or preferred stock.
Your letter states that the insolvency of an FDIC-insured institution generally results in the acceleration of indebtedness secured by collateral pledged by such institution. As a result, a debtholder has a reinvestment risk associated with the insolvency of such institution. As a method of eliminating this reinvestment risk with respect to mortgage pay-through (or cash flow) bonds, it has been suggested that the insured institution create a wholly-owned subsidiary to which the insured institution would transfer, by capital contribution or otherwise, assets sufficient to satisfy *** rating criteria. The rated debt obligation would be issued by the subsidiary so that the insolvency or the appointment of a receiver with respect to the insured institution would not accelerate, and therefore not pose a reinvestment risk with respect to, such debt obligation. Indentures securing these financings would not provide for acceleration in the event of the insolvency of the insured institution. Your letter states further that inasmuch as *** rating is an assessment of compliance with the payment terms of the indenture, *** will not rate these financings without our concurrence with your view that, as a legal matter, the separateness of the subsidiary would be maintained notwithstanding the insolvency of the insured institution.
Your letter states further that the issue of the separateness of such a subsidiary also arises in connection with a proposed issuance of preferred stock by such subsidiary. If the separateness of the subsidiary were disregarded upon the insolvency of the insured institution, the preferred shareholders' rights to such assets would be subordinated to the rights of the general creditors of the insured institution.
Based on a letter from General Counsel to the Federal Home Loan Bank Board, dated March 23, 1984, *** has rated preferred stock issued by subsidiaries of depositary institutions insured by the Federal Savings and Loan Insurance Corporation. *** has declined to rate similar financings issued by subsidiaries of FDIC-insured institutions due in part to its concern that the FDIC might attempt to disregard the separateness of the subsidiary. You have therefore requested our opinion regarding the separateness of such a subsidiary.
As you are aware, the FDIC does not issue binding advisory opinions as to positions it would adopt in hypothetical situations that arise in future receiverships of insured institutions. The FDIC's actions in its capacity as receiver of a failed insured institution are determined on a case-by-case basis, in accordance with applicable law and in light of the specific factual situation. I am willing, however, to provide my views as to what a court would hold in response to a challenge by the FDIC as receiver of a failed insured institution to the separateness of a subsidiary of the institution in connection with the subsidiary's issuance of mortgage pay-through bonds or preferred stock.
The requirements for maintaining the separate corporate identity of
a wholly-owned subsidiary are discussed in detail in reported judicial
decisions. Although there are variations that reflect differences in
state law or the nature of a subsidiary's operations, there are certain
organizational elements and operating procedures that are generally
recognized as preserving the corporate separateness in the absence of
other factors such as, for example, fraudulent purpose on the part of a
parent. Your letter states that for purposes of this response regarding
finance subsidiaries I should assume the existence of the following
a) The subsidiary has established a separate office through which its business is conducted. In this connection, the insured institution might lease such office space on its premises to the subsidiary as may be necessary to the subsidiary's operations.
b) At least one of the subsidiary's directors and one of its executive officers are not employees of the insured institution.
c) The subsidiary maintains separate corporate records and books of accounts.
d) The subsidiary's funds are not commingled with those of the insured institution.
e) The board of directors of the subsidiary will hold appropriate meetings to authorize all of the subsidiary's corporate actions.
f) The subsidiary is adequately capitalized in light of its
contemplated business obligations.
The insured institution will receive an opinion from a reputable investment banking firm to the effect that:
a) The value of the subsidiary's common stock and the net proceeds from the sale of the subsidiary's obligations represent a fair and reasonably equivalent consideration for the assets transferred by the insured institution to the subsidiary.
b) The financing constitutes a practicable and reasonable
course of action designed to improve the financial position of the
insured institution without impairing the rights of its creditors (the
"Reasonable Course Opinion"). A Reasonable Course Opinion would
not, however, be provided in connection with pay-through bonds, with
respect to which the collateral pledged to secure such bonds will
generate a cash flow sufficient to provide full and timely payment of
such bonds. You state that the need for a Reasonable Course Opinion is
obviated by the fact that with respect to pay-through bonds the value
of the collateral (other than overcollateralization provided merely as
a substitute for pool insurance) will be approximately equal to the
funds received by the insured institution from the sale of the bonds.
In this connection, you enclose correspondence between the *** and the
General Counsel of the Federal Home Loan Bank Board.
The insured institution will adopt resolutions approving the
financing as being in the best interest of the insured institution and
its creditors. In such resolutions, the insured institution will
determine that the financing represents a practicable and reasonable
course of action to improve the financial position of the insured
institution without impairing the rights of its creditors.
All material facts relating to the financing will be adequately disclosed in any offering circular or prospectus distributed in connection with the offering of the subsidiary's obligations, and following such offering the insured institution will disclose all material transactions associated with the financing in appropriate communications to depositors and in public announcements. Moreover, the annual financial statements of the insured institution will disclose the results of the financing under generally accepted accounting principles. In disclosing the use of proceeds, however, the offering circular might indicate that the proceeds will be used for general corporate purposes, without more specific disclosure.
It is my opinion that, based on the facts and conclusions you have assumed, a court would not uphold an attempt by the FDIC as receiver of the insured institution to disregard the separateness of the subsidiary.