Debt Previously Contracted ('DPC') Investments: Equity By Accident Or Safe And Sound M&A For Lenders?

Banks have several weapons in their arsenal to prevent corporate loan defaults, including foreclosure and acting on collateral. As a potentially less draconian step, which could serve to augment rather than strain relations with the borrower, when loans become distressed (or are expected to become distressed), bank lenders and their affiliates have the authority to restructure loans to include an equity "kicker" for the lender under the authority to resolve debts previously contracted ("DPC Authority").1

Pursuant to DPC Authority, national banks may accept equity securities in lieu of (or in addition to) existing or restructured loans with a view to a subsequent sale or conversion of the equity into money to make good or reduce anticipated losses. Such transactions are not considered dealing in securities, but as compromises in good faith to resolve a debt.2 Typically, the lender would reduce either or both of the loan payment stream and/or principal balance to amounts that the borrower can demonstrate are serviceable, and then make up the difference in value with equity valued at the then-current fair market value of the borrower entity. This way, the borrower can continue to service the loan, the lender can remove the debt from its default status, and both borrower and lender will enjoy upside if the restructured debt provides the borrower with a path to growth and financial stability. Under this structure, the interests of the lender and borrower are aligned for the success of the borrower. As described in greater detail below, under DPC Authority, lenders are permitted to provide substantial assistance to borrowers to manage and operate the business back to health and profitability.

DPC Authority

A national bank's authority to take property under DPC Authority emanates from two sources. First, banks have express statutory authority to take real property in satisfaction of DPC.3 Second, the powers incidental to carrying on the business of banking include the power to acquire and manage personal property taken in satisfaction of DPC.4 Under these combined statutory authorities, a bank may acquire DPC securities and, in good faith, hold, manage, and ready those assets for sale as would any other prudent owner.5

DPC Authority is premised on the bank's good faith business judgment and is implied whenever a bank is faced with a loss. It is not necessary that the borrower be in default.6 Likewise, the property taken in satisfaction of DPC need not be the borrower's original collateral. The Office of the Comptroller of the Currency (the "OCC") and the federal courts have recognized that banks may acquire and hold various types of real and personal DPC property - including equity securities - not given as collateral for the original loan.7

Banks may also engage in activities that, absent underlying DPC Authority, are generally beyond the implied powers of a national bank. For example, banks have been permitted to operate chemical production facilities, complete the...