October 19, 2014

Bank Holding Companies, It Is Time To Update Your Tax Sharing Agreements

It is time to update tax allocation agreements between bank holding companies and affiliated entities, say the federal regulators.  According to guidance issued this summer, examiners will be looking for updated tax allocation agreements beginning this fall. 
photo by Phillip via on flickr/Foter
Bank holding companies usually own all of the outstanding stock of their depository institutions, which means that the holding companies and their banks are deemed to be "affiliated groups" within the meaning of Section 1504 of the Internal Revenue Code. Accordingly, they often choose to file consolidated federal income tax returns, and in some states, they are required to file consolidated state income tax returns. To address the allocation of the tax liability and the timing of contributions, bank holding companies and their banks are required* to enter into tax allocation agreements.

In 1998, the federal financial institution regulatory agencies jointly issued an Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure ("Interagency Statement") to provide guidance to insured depository institutions and their holding companies and other affiliates regarding the payment of taxes on a consolidated basis. 

In 2014, an addendum to the Interagency Statement became effective.  The addendum was intended to clarify the agencies' existing positions and to add new requirements in light of the FDIC's recent disputes with holding companies of failed banks for which it acted as receiver.  According to the amended guidance, a tax allocation agreement should explicitly address the following issues:
  • Calculation of Tax Allocation.  A subsidiary depository institution must compute its income taxes (both current and deferred) on a separate entity basis, regardless of whether the actual returns will be consolidated.  This is done both for purposes of preparing regulatory reports and to ensure the insured depository institution does not pay more than its own share of the tax liability. Certain adjustments that arise in a consolidated return, such as the application of graduated tax rates, may be made to the separate entity calculation as long as they are done consistently and fairly.
  • Current Taxes Only.  A bank should not pay its deferred tax liabilities or to its holding company, because the deferred tax account is not a tax liability required to be paid in the current reporting period. The regulators frown on this.
  • Timing of Payments to the Holding Company.  Tax payments from a bank to a holding company should never exceed the amount the bank's current tax expense calculated on a separate entity basis, nor should they be made before the bank would have been obligated to pay as a separate entity. The regulators consider any advance payments to be extensions of credit from the bank to the holding company (which are restricted by the Federal Reserve Act and regulations).
  • Tax Refunds from the Holding Company.  A bank incurring a loss for tax purposes should record a current income tax benefit and receive a refund--within a reasonable timeframe--from its holding company in an amount no less than the amount the bank would have been entitled to receive as a separate entity.  If the refund is not passed along to the bank within a reasonable period, regulators may consider it either an extension of credit or a dividend.  If, however, on a separate entity basis, the bank would not be entitled to a current refund because it has no carryback benefits available, its holding company can still use the bank's tax loss to reduce the consolidated group's current tax liability. In this situation, the holding company may reimburse the bank for the use of the tax loss.
  • Agency Relationship.  Because of recent litigation by the FDIC-R over tax assets, regulators emphasize that one of the most important provisions in a tax allocation agreement is the clear statement of an agency relationship between the bank and holding company.  The agreement should clearly state that a holding company that receives a tax refund from a taxing authority holds the funds as an agent for the subsidiary(ies). 
  • Board Approval.  All tax sharing agreements should be approved by the boards of directors of each holding company and insured depository institution in the consolidated group.
The agencies' addendum states that the agencies expect tax sharing agreements to be updated by October 31, 2014 (although it is not a true deadline).  Therefore, bank holding companies should update their tax sharing agreements and obtain board approvals promptly, if they have not already done so.

October 8, 2014

To Register Your Arbitration Clauses with AAA or Not to Register? That Is the Question!

art by Todd Berman / flickr
Does your organization have consumer contracts that include an arbitration clause?  Does the clause reference the American Arbitration Association?

You may already know that the American Arbitration Association ("AAA") recently announced that it would require registration of all consumer arbitration clauses incorporating its rules, apparently in response to pressure from the Consumer Financial Protection Bureau, which recently conducted a study of consumer arbitration clauses.  The requirement became effective in September.

Consumer Contracts

The AAA's new registration requirement applies to any arbitration clause in a consumer contract that invokes the AAA’s Consumer Rules or refers to the AAA. The rule change does not affect commercial contracts. As always, the distinction between consumer and commercial is a test of fact, regardless of the language of the document. If a consumer signs a document that purports to be an agreement for use with commercial customers and references the commercial arbitration rules, the consumer may nonetheless invoke the AAA Consumer Rules when bringing a claim.

Public Information

Registered arbitration provisions become publicly-accessible information. According to the AAA, “[b]y accessing the Registry, parties will be able to search businesses by name to determine if the AAA has reviewed their consumer arbitration clause and will administer their consumer arbitrations.” Moreover, according to the AAA, “the Registry will include online access to the arbitration clause reviewed by the AAA and may also include other documents related to the arbitration clause.” 

The Registry is available on the AAA website, and a password is not required to search it and view clauses that have been submitted.
As of the date of this post, only a small number of arbitration provisions appear to be registered, and some clauses are not visible.  It is unclear to me whether this is simply because the website is new and still being populated.

Effect of Registration

Rule 12 of the amended Consumer Rules states that beginning on September 1st, a business that “provides for or intends to provide for” AAA administration in a consumer contract “should notify the AAA of the existence of such a consumer contract or of its intention to do so at least 30 days before the planned effective date of the contract” and provide a copy of the arbitration clause to the AAA.  Rule 12 further states that the AAA will review the clause for material compliance with the Due Process Protocol and the amended Consumer Rules (including consumer fee limits). The Rule and the AAA website call for registration of existing clauses rather than just newly-adopted clauses.  (See, for example, Rule 55(viii).) The AAA may determine that additional, related provisions or documents are necessary in order to properly evaluate the clause, and may request them and post them on the Registry.

For arbitration clauses submitted to the AAA during 2014, the registration fee is $650, which will maintain the clause on the Registry through 2015. An annual fee of $500 is imposed thereafter.

Each arbitration provision used will require a separate registration and registration fee. The AAA's Rule states that "[a]ny different arbitration agreements submitted by the same business or its subsidiaries must be submitted for review and are subject to the current review fee." Therefore, it might make sense to use only one clause, or some other limited number of standard clauses, throughout your organization.

Effect of Not Registering

If a business has not registered its consumer clause prior to the filing of a consumer case, the AAA will require that the business register its clause at that time, and will "conduct an expedited review.” The expedited review costs an additional $250. The primary risk associated with not registering the clause in advance is the chance that the AAA will determine that it does not comply with the AAA Due Process Protocols or fee limitations, and therefore decline to arbitrate.

Updating Requirement

If an arbitration provision is updated or revised, it will require a subsequent registration with the AAA.
Rule 55 purports to require re-registration and an additional $500 fee for "[a]ny subsequent changes, additions, deletions, or amendments." Despite the strict language of the Rule, it is unclear to me whether the AAA would take the position that a minor, non-substantive change would trigger the re-registration requirement; one would hope that a non-substantive change would not require an additional filing and $500 fee.

Conclusions and Additional Considerations

Based upon the new Rules and the analysis above, you might conclude that it is most cost-effective, and administratively useful, to standardize an arbitration clause (or a limited number of clauses) across the organization, whether or not you intend to register the clause in advance of a dispute. In making these determinations, you may want to consider the risk of the AAA rejecting the clause, the frequency with which your organization has historically been subject to arbitration demands, the benefits and burdens of standardizing an arbitration clause(s) across your organization, and (for heavily-regulated entities like banks) the risk of criticism for failing to register in advance, among other factors.

An Important Decision from the North Carolina Surpreme Court

image by Silver Season
In February, I wrote about an important case for lenders in North Carolina. The North Carolina Supreme Court has issued a highly-anticipated opinion that is important for lenders in North Carolina to understand.

Under North Carolina law, real estate can be held by married couples in a form known as "tenancy by the entireties," which means that the property cannot be reached by creditors of only one spouse. Therefore, lenders often obtain guarantees from the spouses of borrowers (or the spouses of individuals who own borrowing entities) to ensure that real estate assets (that might be necessary to satisfy a debt if the borrower or guarantor does not pay as agreed) will be availalbe as a source of repayment. Without spousal guarantees, lenders would often be unable to rely upon many real estate assets when underwriting a loan. Accordingly, the ability to obtain a guaranty of a spouse sometimes means the difference between a lender being able to make a loan and being forced to decline a loan application. 

The Equal Credit Opportunity Act ("ECOA") and its implementing regulation, Regulation B ("Reg B") were intended to prohibit gender-based discrimination in lending. Its original intent was to prevent married women who were qualified borrowers from being refused credit because they did not have their husbands' approval. (This was apparently a problem in the early 1970s!) Over time, the ECOA was amended and interpreted to generally prohibit, among other things, requiring a spousal guarantee absent a showing both that the borrowing spouse is not independently creditworthy enough for the loan and that the guaranteeing or supporting spouse was not selected only on the basis of his or her status as a spouse. Put simply, if an individual seeks a loan from a lender, the lender cannot automatically require that the borrower have his or her spouse co-sign or guarantee the loan. The ECOA provides for the assertion of a claim against the lender if the ECOA is violated.

In August of last year, a panel of the North Carolina Court of Appeals had opined that a violation of the ECOA not only gave a spouse the right to assert a claim against the lender, it also allowed the spouse to escape the guaranty entirely. (RL REGI North Carolina, LLC v. Lighthouse Cove, LLC, COA12–1279.)

The case at issue involved a lending arrangement where most of the assets were held by the owner of the borrowing entity, while the borrowing entity itself had comparatively few assets. The lender required not only the borrower's owner to provide a guarantee, but also the owner's spouse. The borrower defaulted. A forbearance agreement was entered into in which both the owner and the spouse acknowledged the validity of the debt and waived any and all claims against the lender. The borrower defaulted again later. The lender sought to recover against both the owner and the spouse pursuant to the guarantees. The spouse asserted the ECOA as a defense and both the trial court and the Court of Appeals agreed that the guarantee was unenforceable against the spouse.

The North Carolina Supreme Court then agreed to hear the appeal of the creditor. Because of the harmful precedent that would be established if the Court of Appeals' ruling was upheld, one of my colleagues and I filed an amicus curiae (friend of the court) brief on behalf of the North Carolina Bankers Association in support of the creditor, asking the Court to reverse the Court of Appeals' decision. We argued both the creditor's position (i.e., that the ECOA cannot be asserted as a defense and that, in any regard, the borrowers had waived any such claim or defense) and policy arguments supporting the creditor's position. In an unanimous opinion authored by Justice Newby, the Supreme Court reversed the Court of Appeals. The Court did not address the affirmative defense issue, instead finding that the spouse-guarantor waived any potential defense by signing an agreement containing a broad waiver clause. The Supreme Court thereby left for another day the issue of whether the ECOA can be asserted as a defense to a guarantee. You can read the full opinion here.

As a result of this decision, lenders are well-advised to seek broad waivers (such as those covering "any and all claims, defenses, or causes of action") in forbearance agreements and loan modification agreements.