The amendments relate primarily to covenants restricting the Company’s activities during a period in which interest and dividend payments have been deferred in accordance with the terms of the securities. They provide an “exchange exception” to covenants against the Company’s or its subsidiaries’ acquisition of their capital stock during a deferral period, which the Company entered in September 2009. As a result of the amendments, the Company and its subsidiaries and affiliates may issue capital stock during a deferral period in exchange for or upon conversion of outstanding Company, subsidiary or affiliate capital stock or for outstanding Company indebtedness ranking pari passu with or junior to the debentures. The amendments also eliminate a covenant against the Company’s acquisition of any of the trust preferred securities issued by the Trust or less than all of the related debentures during deferral. These and other amendments are attached as exhibits to the Company’s Current Report on Form 8-K filed with the SEC on January 27, 2011 .

In the earnings release, the Company reported that the success of the consent solicitation better positions the Company to consider certain potential capital planning strategies to improve the its regulatory capital ratios and further strengthen its overall financial position.

Bryan Cave represented First Banks in the consent solicitation and has significant experience in dealing with trust preferred securities.

Related posts:

1. Capital Treatment of Trust Preferred Securities and TARP CPP Preferred Stock
2. Will Trust Preferred Retain Tier 1 Capital Status?
3. Reminder Regarding Inclusion of Trust Preferred Securities in Tier 1 Capital

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Anyone who has been involved in a real estate transaction relating to commercial or industrial property has likely dealt with conducting “All Appropriate Inquiry” into the site, which generally includes the preparation of a Phase I Environmental Site Assessment and may include Phase II sampling work. All Appropriate Inquiry (“AAI”) is one necessary component of the “bona fide prospective purchaser” (“BFPP”) defense established under the 2002 Brownfields amendments to Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”). The BFPP defense is intended to protect property owners from liability for contamination that clearly occurred prior to their period of ownership. However, conducting AAI is not the only prerequisite to establishing a BFPP defense. The BFPP requirements beyond AAI are highlighted in Ashley II of Charleston, LLC v. PCS Nitrogen, et al., 2010 U.S. Dist. LEXIS 104772 (D.S.C. Sep. 30, 2010), one of the first cases to address in detail the BFPP defense.

In this case, Ashley purchased property that had a long history of industrial use. In conjunction with that purchase, Ashley’s environmental consultant performed Phase I and Phase II work. After the purchase, Ashley demolished many of the above-ground improvements on the property. When liability for contamination at the property was addressed, a significant battle between several potentially responsible parties arose. Ashley sought to take advantage of the BFPP defense to avoid liability. The elements of the BFPP defense are, in summary: (a) disposal of hazardous substance occurred prior to acquisition; (b) the purchaser conducted AAI; (c) the purchaser provided all required notices with respect to the discovery or release of any hazardous substance; (d) the purchaser exercises appropriate care with respect to hazardous substances found; (e) the purchaser cooperates with agencies; (f) the purchaser complies with institutional controls; (g) the purchaser complies with information requests or administrative subpoena; (h) the purchaser is not affiliated with a potentially responsible party. In the end, the court closely scrutinized each element of the test and determined that Ashley was not a BFPP.

All Appropriate Inquiry

Significantly, this is one of the first cases to address the proper conduct of AAI. The court found that although there were “inconsistencies” between the Phase I reports and the relevant ASTM standard, those inconsistencies lacked significance. The Court stated that “[w]hat is important is that Ashley acted reasonably; it hired an expert to conduct AAI and relied on that expert to perform its job properly.” Because the Court did not explain what the “inconsistencies” are, it is difficult to determine how strictly a Phase I must comply with ASTM. Interestingly, no federal agencies were involved in this case. EPA has stated that they will insist on very strict compliance with the ASTM standards in order to find that AAI was conducted. This case may (or may not) take some wind out of that sail. While strict compliance with the ASTM standards is still highly recommended, this case provides some potential relief for past transactions where the acquiring party is trying to mount a BFPP defense but the adequacy of its AAI is called into question due to the absence of strict compliance with the ASTM.

Appropriate Care

The court did find that Ashley failed to prove that it exercised appropriate care with respect to known contamination when it did its demolition work. In doing this work, Ashley did not clean out and fill in known underground sumps and concrete pads, which failure could have exacerbated known releases and contamination. Ashley also failed to prevent debris piles from accumulating, and failed to investigate and remove the debris piles on a timely basis. Ashley also failed to maintain run off controls.

This finding highlights the need for post-closing attention to known environmental issues. The BFPP defense requires that a purchaser stop continuing releases, prevent threatened future releases and prevent or limit human, environmental and natural resource exposure to previous releases. Prior to demolition, Ashley knew that the underground sumps contained hazardous substances, were cracked, and often filled with rainwater. Ashley never conducted testing during its period of ownership to determine if the soil below the underground structures was contaminated. Accordingly, Ashley “did not prove that no disposals occurred on the Site after its acquisition of the Site.” Notice the burden imposed by the court to prove a negative; the primary issue, however, appears to be that Ashley did not even make even a limited effort with respect to the underground structures.

No Affiliation with a PRP

This final issue is important for contract drafting and negotiation purposes. Here, the court found that Ashley was affiliated with a PRP because, when Ashley purchased the property, Ashley agreed to indemnify prior owners from all environmental liability at the site, even if such liability was the result of a release that occurred prior to Ashley’s ownership. There was no apparent relationship between Ashley and the indemnitees other than this indemnity provision of the purchase agreement. Ashley then attempted to persuade EPA not to name the indemnitees as PRPs, even though they were prior owners and operators during the time of releases. The Court found that Ashley and the indemnitees were “affiliated” by operation of the indemnity, and that Ashley’s conduct “reveal[ed] just the sort of affiliation Congress intended to discourage.” We believe there is some serious question regarding the Court’s interpretation of Congressional intent. Nevertheless, this holding suggests that those negotiating the acquisition of property need to be concerned that, according to the Ashley Court, a purchaser’s indemnity of the seller for pre-closing releases to the environment could eliminate the ability of the purchaser to later mount a BFPP defense.

For more information on this case or any of the topics in this Client Alert, contact Brandon Neuschafer at (314) 259-2317 or bwneuschafer@bryancave.com, or any member of the Bryan Cave Environmental Client Service Group.

Related posts:

1. Client Alerts Update — May 5, 2009 to May 21, 2009
2. September 2009 Client Alerts
3. September 2010 Client Alerts

Discounts are available for Bryan Cave clients.  If you’re interested in attending, please contact your regular Bryan Cave contact person.

Related posts:

1. 2010 Annual Employment Law Seminar
2. FDIC and Open Bank Assistance
3. FDIC Issues Final Statement of Policy on Investor Qualifications for Failed Bank Acquisitions

The specific criteria used by the FDIC will vary from project to project based on the characteristics of the troubled institution, the time available for marketing, and other factors.  However, the FDIC has indicated the following base criteria:

Supervisory Criteria:

• Total Risk Based Capital ratio of 10% or higher
• Tier 1 Risk Based Capital ratio of 6% or higher
• Tier 1 Leverage Capital ratio of 4% or higher
• CAMELS composite rating of 1 or 2
• CAMELS Management component rating of 1 or 2
• Compliance rating of 1 or 2
• RFI/C rating of 1 or 2
• CRA rating of at least Satisfactory
• Satisfactory AML Record

Total Asset Size Criteria:

• Total asset size threshold is roughly double the core deposits of failing bank when the bidder is located in the same state
• Total asset size threshold is roughly four times the core deposits of the failing bank when the bidder is located in a contiguous state
• Total asset size threshold is roughly five times the core deposits of the failing bank when the bidder is located in other states

If you would like to further discuss the possibility of bidding on a troubled institution, please contact any of the attorneys in the Bryan Cave Financial Institution Group.

Related posts:

1. Additional Guidance on Troubled Bank Eligibility
2. Stress Test Results and Loss Projections
3. FDIC Expands Bidder List for Troubled Institutions

Increase in the Net Operating Loss Carryback Period

Original provisions coming out of the tax writing committees of the House and Senate included a provision extending the period in which 2008 and 2009 NOLs could be carried back from two (2) to up to five (5) years.  The provision also eliminated the 90% limitation on the use of AMT NOLs that were carried back from 2008 or 2009.  The limitations in the original provisions were that the expanded carryback period did not apply (i) if the bank or other financial institution received any money under the Troubled Assets Relief Program (TARP) (ii) to Fannie Mae, Freddie Mac, or (iii) any corporation that is a member of the same affiliated group for income tax purposes as a bank or other financial institution that received TARP funds.

The Act retains the expanded carryback period for NOLs, but only for those generated in 2008 (or, at the election of the taxpayer, taxable years beginning in 2008).  Further, only taxapayers that are “eligible small businesses” may take advantage of the expanded carryback period.  An “eligible small business” that elects may carryback a 2008 NOL for up to five (5) years.  An eligible small business is a taxpayer having less than $15,000,000 in average annual gross receipts for the three (3) years prior to the year in which the NOL occurs.  Thus, the usefulness to most financial institutions of the expanded NOL carryback provisions appears to have been severely limited by the change in eligibility requirements.

Repeal of IRS Notice 2008-83

The Act retains the provisions repealing IRS Notice 2008-83 originally included in the House bill and subsequently added to the Senate bill.  An explanation of these provisions is set forth below.

The tax law currently limits the use of NOL carryovers if the corporation possessing the NOLs experiences an ownership change with respect to its stock (i.e., a more than 50% shift in the ownership of its stock) measured over a three (3) year period.  The limitations also can apply to built-in losses (i.e., losses that economically accrue with respect to a corporation’s assets prior to an ownership change) that exceed a threshold amount and that are recognized for tax purposes after the ownership change occurs.  The IRS issued Notice 2008-83 on October 1, 2008, in which it provided that losses recognized by a bank on loans or bad debts that accrued economically prior to an ownership change with respect to a bank’s stock were excepted from the NOL limitations applicable to built-in losses.  A number of questions were raised subsequent to the issuance of Notice 2008-83 as to whether (i) Treasury had the authority to issue regulations applicable to particular industries or classes of taxpayers, (ii) such notice was consistent with the provisions of the tax law, and (iii) Treasury complied with appropriate internal procedures in connection with the issuance of the notice.  The Act effectively repeals Notice 2008-83 for all ownership changes occurring after January 16, 2009, but the notice will be deemed to have the force and effect of law for (1) all ownership changes occurring on or before such date, and (2) all ownership changes occurring after such date if such change occurs with respect to a transaction that (i) is pursuant to a written binding contract entered into on or before such date, or (ii) was described in a public announcement or in a filing with the Securities and Exchange Commission on or before such date.

TARP Bailout Will Not Trigger NOL limitation Rules

As explained above under IRS Notice 2008-83, an ownership change with respect to a financial institution’s stock will result in the imposition of limitations on the subsequent use of NOLs and built-in losses that arise prior to the ownership change.  The Act provides that any ownership change that occurs as a result of a restructuring plan required under a loan agreement or a commitment for a line of credit entered into with the Treasury Department under the Emergency Economic Stabilization Act of 2008 is not subject to the limitations on the subsequent use of NOLs and built-in losses that arise prior to the ownership change.

Other Provisions

Other provisions of the Act likely to be of interest to banks and other financial institutions include:

Extension of 1^st Year Bonus Depreciation – For most new depreciable assets (other than buildings) placed in service during 2008, The Economic Stimulus Act passed in early 2008 permitted 50% of the cost to be expensed immediately, with the balance recovered under the regular depreciation rules.  This special first-year deduction applied both for regular tax and alternative minimum tax purposes.  These bonus depreciation rules were to apply only for 2008.  The Act extends these rules through 2009.

Extension of Section 179 Expense Amount – The Economic Stimulus Act passed in 2008 increased the amount of eligible purchases that businesses could elect to immediately expense to $250,000 for purchases made during 2008, and also increased the level of purchases at which this benefit would begin to be phased out to $800,000.  The new legislation extends these amounts for another year.

Work Opportunity Tax Credit (WOTC) – The list of individuals that are eligible employees for the WOTC is expanded to include “unemployed veterans” (generally defined to include those who have been discharged from active duty within the past 5 years who have been receiving unemployment compensation for at least 4 weeks) and “disconnected youth” (generally defined as those between the ages of 16 and 25 who have not been in school or employed for the previous 6 months and who lack the basic skills to be employable).  Employers hiring these individuals during 2009 or 2010 may be eligible for a tax credit of $2,400 per such person hired.

Cancellation of Business Indebtedness – A corporation that satisfies its indebtedness or any other taxpayer satisfying trade or business indebtedness at a discount in 2009 or 2010, which otherwise would result in the recognition of cancellation of debt (COD) income under current law, can elect to defer taxation of the COD income and recognize the deferred COD income ratably over five (5) taxable years beginning with the year 2014.  The provisions allowing for the deferral of COD income are quite complex and they include rules (i) limiting the deduction for any original issue discount arising in connection with the issuance of a new or revised debt instrument issued (or deemed issued) in satisfaction of the indebtedness giving rise to the deferred COD income and (ii) accelerating the recognition of deferred COD income in certain cases in which subsequent events have occurred.

S Corporation Banks and Other Financial Institutions

Banks and other financial institutions that have elected to be taxed under the provisions of subchapter S also should be aware that the 10-year period in which built-in gains tax applies to a sale of assets by an S corporation that was formerly a C corporation has been shortened to seven (7) years for asset sales which occur during 2009 or 2010.

Related posts:

1. Tax Impact of Stimulus Bills for Community Banks
2. Stimulus Legislation and TARP Capital Executive Compensation Restrictions
3. Impact of Latest Tax Rules on Bank M&A Activity

Increase in the Net Operating Carryback Period

The provisions of the Senate Finance and the House Ways and Means Committees’ bills increasing the NOL carryback period to two (2) to five (5) years are essentially identical.  The increased carryback period only applies to NOLs arising in 2008 and 2009.  In addition, the 90% limitation (or the 10% haircut  required) on the use of NOL carrybacks when computing a corporation’s alternative minimum tax is suspended.  For those banks or other financial institutions with NOLs in 2008 and 2009, the bill will provide three (3) additional years (i.e., 2003, 2004, and 2005) from which they can obtain a refund of federal income taxes paid.

The bills contain a number of limitations, including that the expanded carryback period does not apply (i) if the bank or other financial institution received any money under the Troubled Assets Relief Program (TARP) (ii) to Fannie Mae or Freddie Mac, or (iii) any corporation that is a member of the same affiliated group for income tax purposes as a bank or other financial institution that received TARP funds.

IRS Notice 2008-83

The tax law currently limits the use of NOL carryovers if the corporation possessing the NOLs experiences an ownership change with respect to its stock (i.e., a more than 50% shift in the ownership of its stock) measured over a three(3) year period.  The limitations also can apply to built-in losses (i.e., losses that economically accrue with respect to a corporation’s assets prior to an ownership change) that exceed a threshold amount and that are recognized for tax purposes after the ownership change occurs.  The IRS issued Notice 2008-83 on October 1, 2008, in which it provided that losses recognized by a bank on loans or bad debts that accrued economically prior to an ownership change with respect to a bank’s stock were excepted from the NOL limitations applicable to built-in losses.  A number of questions were raised subsequent to the issuance of Notice 2008-83 as to whether (i) Treasury had the authority to issue regulations applicable to particular industries or classes of taxpayers, (ii) such notice was consistent with the provisions of the tax law, and (iii) Treasury complied with appropriate internal procedures in connection with the issuance of the notice.

The House Ways and Means Committee economic stimulus tax bill contains provisions effectively repealing Notice 2008-83 for all ownership changes occurring after January 16, 2009, but the notice will be deemed to have the force and effect of law for (1) all ownership changes occurring on or before such date, and (2) all ownership changes occurring after such date if such change occurs with respect to a transaction that (i) is pursuant to a written binding contract entered into on or before such date, or (ii) was described in a public announcement or in a filing with the Securities and Exchange Commission on or before such date.  The Senate Finance Committee economic stimulus tax bill does not contain any provisions limiting the impact of IRS Notice 2008-83.

January 27, 2009 Update: On January 27, 2009, the Senate Finance Committee approved its version of the bill on January 27, 2009, which included an amendment virtually identical to the House bill that closes down the built-in loss benefit that the Treasury granted in IRS Notice 2008-83.  Thus, now both versions (House and Senate) of the bill are in sync on these two issues.

Related posts:

1. Impact of Latest Tax Rules on Bank M&A Activity
2. TARP Capital and Community Banks
3. Impact of Wall Street Deleveraging

“It is something that we plan on doing in the future where it’s appropriate,” says Herb Held, assistant director in the FDIC’s division of resolutions and receiverships. “I think it’s a good deal for everybody: the FDIC, the acquiring bank and the borrowers. It keeps the assets where they were.”

This leaves open the question of whether the FDIC will begin using a loss-sharing approach to facilitate open bank transactions.  Some advisers believes that the FDIC will use this approach to effectively entice sound financial institutions to purchase struggling banks, or those which may be in imminent danger of failing.  While there is no existing precedent during this period of economic turmoil, open bank assistance was a well regarded and oft used solution in earlier troubled times.  Where FDIC does provide stop loss or other support, it comes ahead of shareholders in the troubled institution, so it does not help shareholders in most instances; however, it does prevent the extra disruption of a failure.  Traditionally, FDIC officials informally estimated the additional loss upon a failure was at least 15% higher than the loss where the troubled bank is acquired by a healthy bank in an open bank transaction.  As a result, properly structured stop loss or other assistance programs should save the deposit insurance fund real dollars.

For now, the FDIC appears tied to the position that it can only offer loss-sharing following receivership and a full auction of the troubled or failing institution in order to comply with its legal obligation to provide the least-costly solution.  If a tangible proposal for a loss sharing were presented to a regional FDIC office, such a proposal would be have to be structured to assure “least costly” status and would be forwarded to DC for review.

Accordingly, we recommend that neither acquiring banks, nor troubled institutions looking to be acquired, put too many eggs in the basket hoping for FDIC loss-sharing assistance.

Related posts:

1. FDIC Expands Bidder List for Troubled Institutions
2. Additional Guidance on Troubled Bank Eligibility
3. Impact of Latest Tax Rules on Bank M&A Activity

Generally, a corporation that has a taxable loss (i.e., tax deductions in excess of taxable income and gains) for federal income tax purposes during a taxable year generally may carry that loss back to each of the two (2) preceding years (to recoup federal income taxes paid in those years) and then forward to each of the following twenty (20) taxable years.  There are special rules, however, that limit the use of a tax loss (commonly referred to as a net operating loss or “NOL”) carryforward that arose prior to the time when the corporation underwent an ownership change with respect to its stock.

If an ownership change has occurred, generally the annual amount of taxable income that can be “sheltered” (i.e., the amount of NOL deduction that can be claimed with respect to) by an NOL that arose prior to the ownership change (the “annual NOL limitation”) is limited to the fair market value of the corporation’s stock (determined immediately before the ownership change) times the federal long-term tax-exempt rate (which, for the month of October 2008, was 4.65%).

Calculation of Fair Market Value in Connection with an Ownership Change

The rules for computing the annual NOL limitation provide that any capital contribution received by a corporation experiencing an ownership change that is part of a plan that will, as a principal purpose, avoid or increase the limitation is not taken into account in computing the fair market value of the corporation’s stock.  Further, the rules state that any capital contribution made during the two-year period ending on the ownership change date is presumed to be part of the plan unless excepted by regulations issued by the Treasury.  Thus, this rule requires that the fair market value of a corporation for purposes of computing the annual NOL limitation after an ownership change has occurred must be reduced by any amount paid to the corporation in connection with any issuance of its stock in the two-year period leading up to the ownership change, unless an exception in the Treasury Regulations is met.

IRS Notice 2008-78 provides several changes in the rules and safe harbors for determining when fair market value must be reduced by amounts paid for stock issuances occurring within two years of an ownership change.  First, the Notice states that the presumption that a stock issuance within two years of an ownership change is part of a plan to increase the value of the corporation’s stock no longer applies.  Second, the Notice provides that the fair market value of a corporation experiencing an ownership change is not reduced by the amount paid for stock issued within the two-year period prior to the ownership change unless the stock was issued as part of a plan that will, as a principal purpose, increase the annual NOL limitation.  Further, whether a stock issuance is part of such a plan is based on all the facts and circumstances.  In addition, if a stock issuance meets a published safe harbor, the amount paid for the stock will not reduce the fair market value of the corporation’s stock for purposes of computing the annual NOL limitation even if it might otherwise appear to be part of a plan to increase the limitation.  Finally, the fact that a stock issuance does not meet a safe harbor does not constitute evidence that it was part of a plan to increase the annual NOL limitation.

Treatment of Built-in Losses

The rules limiting the use of an NOL carryforward after an ownership change has occurred in some instances also can apply to limit unrealized losses that have economically accrued before the ownership change occurs, but which losses are not reported for tax purposes until after the stock ownership change.  These losses, which are referred to as “built-in losses,” treat the losses as additional NOL carryforward subject to the annual NOL limitation.

If a loss is a built-in loss, the built-in loss is, in affect, added to (stacked on top of) the NOL carryforward and the amount of deduction that may be claimed for the total of both the NOL carryforward and the built-in loss cannot exceed the corporation’s annual NOL limitation.  For example, if a corporation that has experienced a stock ownership change, for which the annual NOL limitation equals $500,000, and has $10,000,000 of pre-change NOL carryforward and has recognized $2,000,000 of built-in loss in a prior taxable year (but in a year after the ownership change has occurred), in any subsequent taxable year in which the corporation has taxable income, the combined amount of NOL carryforward and built-in loss that may be used to shelter taxable income in that year cannot exceed $500,000.  It should be noted that if the annual NOL limitation is not fully utilized during a taxable year after an ownership change has occurred, the unused limitation increases the next year’s annual NOL limitation.

Notice 2008-83 states that the IRS and Treasury are studying the proper treatment of certain items (namely, bad debt deductions and losses on loans) that could give rise to a built-in loss.  The Notice provides that any deduction allowed to a bank after it has experienced an ownership change with respect to its stock, which is with respect to a loss on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts), shall not be treated as a built-in loss or a deduction that is attributable or treated as if it was incurred prior to such ownership change.  Banks (as that term is defined in Section 581 of the Internal Revenue Code) may rely on the principles set forth in the Notice until additional guidance is issued by the IRS.  (Note: On November 18, 2008, the Treasury announced that its Inspector General is reviewing the Treasury’s authority to issue Notice 2008-83.)

Conclusion

The net result of these changes is that some acquisition transactions will practically pay for themselves due to the tax advantages obtained under the revised regulations.  It certainly changes the economics of some of the already announced deals such as Wells Fargo and Wachovia.  Instead of amortizing the tax losses over 25 years at $1 billion per year, Wells will get the benefit of $25 billion of Wachovia’s losses in the first year.

Related posts:

1. Tax Impact of Stimulus Bills for Community Banks
2. Summary of Tax Impact of Economic Stimulus Legislation
3. Latest Opponent to Banking Industry – Darth Vader