On April 13, 2009, the Treasury Department published the standard agreements for Subchapter S institutions to participate in the TARP Capital Purchase Program.  As previously discussed, the TARP Capital Purchase Program for Sub S institutions consists of a subordinated debt instrument paying interest at a rate of 7.7% per annum until the fifth anniversary, and then at 13.8% per annum, plus an immediately exercised warrant for additional subordinated debt equal to 5% of the investment, paying interest at a rate of 13.8% per annum.  The investment has a 30 year term, and, like trust preferred securities, interest can be deferred for up to 20 consecutive quarterly periods.

Like the documents for public and private participants, the standard documents consist primarily of a letter agreement that incorporates the standard terms contained in a securities purchase agreement, as well as documents defining the investment instruments.

For some reason, the Securities Purchase Agreement defines the subordinated debt instrument to be the “Senior Notes,” presumably to be comparable to the “Senior Preferred” issued under the TARP Capital Purchase Program for public and private institutions.  However, these “Senior Notes” are subordinated to virtually all other indebtedness, whether outstanding at the time of the investment or subsequently incurred.  The TARP subordinated debt instruments are senior to any subordinated debt issued in connection with trust preferred securities.

The standard agreements for Subchapter S institutions recognize the need for Sub S entities to make tax distributions to their shareholders.  The Treasury’s consent is not required for the payment to shareholders of any “Allowable Tax Distribution.”  The term “Allowable Tax Distribution” is defined as:

dividends which are distributed to the shareholders of the Company to cover Federal and State income tax liabilities of each such shareholder emanating from the Company and Company Subsidiaries, attributed to such liabilities arising in a designated calendar year and paid no later than April 15 following the end of such year, and that are no greater in amount than the product of (a) the taxable income (as such term is used in Section 1363(b) of the Code, but including all items of income, gain, loss and deduction required to be separately stated under Section 1366(a)(1)(A) of the Code) of the Company for such year, times (b) the total of (1) the highest marginal personal federal income tax rate (the “Federal Rate”) in effect on December 31 of such year plus (2) the highest marginal personal State income tax rate (the “State Rate”) of any shareholder of the Company in effect on such December 31.

Consistent with other private participants, in addition to the Allowable Tax Distribution, Sub S participants will be permitted to make additional dividends (other than the allowable tax distributions) consistent with past practice for the first three years, slightly higher additional dividends for the next seven years, and then no additional dividends (other than the allowable tax distributions) until the TARP investment is redeemed.

The Sub S documents contain a new concept recognizing the potential need to amend the institution’s articles of incorporation to permit the Treasury to elect two directors in the event that interest is not paid on the TARP investment for six quarters.  If an amendment is required, the Treasury is permitting the investment to close, but requiring that the institution “take all corporate action necessary” to so amend the articles at the earlier of: (a) the next scheduled meeting of shareholders; or (b) 13 months after the investment.  The concept of permitting the Treasury to elect two directors has not changed from the prior standard documents, but the explicit provision permitting subsequent amendment of the articles is a new addition.

The Sub S documents also contain a completely new covenant.  Section 3.6 requires, for so long as the TARP investment is outstanding, that the company and its subsidiaries shall maintain such capital as may be necessary to meet the minimum capital requirements of the Appropriate Federal Banking Agency, as in effect from time to time.  The documents, do not, however, specify which minimum capital requirements should apply; presumably “adequate capitalization” meets the “minimum capital requirements.”