Alert August 04, 2009

OCC Issues Interpretive Letter regarding the Exchange of Real Property Acquired for Debt Previously Contracted

The OCC issued Interpretive Letter #1118 (“Letter #1118”), permitting a national bank (the “Bank”) to exchange real property acquired for a debt previously contracted (“DPC”) for an interest in an entity that would dispose of the real property.  The Bank had purchased participations secured by townhouse units in a townhouse apartment complex, and subsequently acquired an interest in the units (the “DPC Interests”) when the borrower defaulted.  The Bank and several other financial institutions with fractional interests in townhouse units at the complex decided to contribute their DPC Interests to an LLC (“LLC”) to manage and dispose of the real estate.  In this case, the Bank contended that by exchanging the DPC Interest for an interest in the LLC, which would wholly own the property interests making up the entire townhouse complex, it would be better able to recover its loan loss and to dispose of the property.  Furthermore, the LLC would operate and maintain the complex as a whole, rather than each individual bank’s bearing responsibility to operate and maintain its individual units in the townhouse complex, providing each of the banks with cost savings through efficiencies.  The OCC concluded that the Bank has authority under 12 U.S.C. §§ 24(Seventh) and 29 to engage in this exchange. 

Letter #1118 reiterates that national banks may exchange permissibly acquired DPC real property for other types of real or personal property, provided, inter alia, that the exchange is made in good faith.  OCC precedent has required that the exchange for other property must improve the ability of the Bank to recover, or otherwise limit, its loan loss. Such determinations are specific to each DPC property and the associated exchange.

The OCC provided that approval of the exchange was subject to certain conditions.   First, prior to making the exchange, the Bank’s directors must determine that the exchange is in the best interests of the Bank and would improve the ability of the Bank to recover, or otherwise limit, its loan loss. Second, prior to making the exchange, the Bank must notify its OCC Supervisory Office, in writing, of the proposed exchange and must receive written notification of supervisory non-objection, based on an evaluation of the adequacy of the Bank’s risk management and measurement systems and controls to enable the Bank to exchange for, hold, and dispose of the LLC interest in a safe and sound manner, and an evaluation of any other supervisory considerations relevant to the exchange.  Third, the Bank may not further exchange the LLC interest for an interest in any other real or personal property.  Fourth, the Bank must ensure that the LLC complies with the provisions of the OCC’s OREO regulation, 12 C.F.R. Part 34, Subpart E, including obtaining a current appraisal on the property.  Fifth, the Bank must dispose of its interest in the LLC no later than five years from the date it acquired title to the DPC Interests, unless granted an extension by the OCC.