[Federal Register Volume 65, Number 179 (Thursday, September 14, 2000)]
[Rules and Regulations]
[Pages 55439-55443]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-23463]


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NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 709


Involuntary Liquidation of Federal Credit Unions and Adjudication 
of Creditor Claims Involving Federally-Insured Credit Unions in 
Liquidation

AGENCY: National Credit Union Administration.

ACTION: Final rule.

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SUMMARY: The National Credit Union Administration (NCUA) is issuing a 
final rule regarding the treatment by the NCUA Board (Board), as 
conservator or liquidating agent, of financial assets transferred by a 
federally-insured credit union to another party in connection with a 
securitization or in the form of a participation. The final rule 
generally provides that the Board will not, by exercise of its 
statutory power to repudiate contracts, recover, reclaim, or 
recharacterize as property of the credit union or the liquidation 
estate financial assets that were transferred by the credit union to 
another party in connection with a securitization or in the form of a 
participation. The final rule also addresses the treatment by the 
Board, as conservator or liquidating agent, of agreements entered into 
by a federally-insured credit union (FICU) to collateralize public 
funds. The rule establishes that the Board will not seek to avoid an 
otherwise legally enforceable security interest in collateral for 
public funds solely because the collateral was not acquired 
contemporaneously with the approval and execution of the security 
agreement. The Board will also not seek to avoid a security interest 
solely because the collateral was changed, increased or subject to 
substitution from time to time.

DATES: This rule is effective October 16, 2000.

FOR FURTHER INFORMATION CONTACT: Chrisanthy J. Loizos, Staff Attorney, 
Division of Operations, Office of General Counsel, National Credit 
Union Administration, 1775 Duke Street, Alexandria, Virginia 22314-
3428, or telephone: (703) 518-6540.

SUPPLEMENTARY INFORMATION: The Board issued a proposed rule on February 
24, 2000 addressing two issues concerning its authority as a 
conservator or liquidating agent to repudiate or avoid certain 
agreements. 65 FR 11250 (March 2, 2000). First, the Board examined 
whether its statutory authority to repudiate contracts under sections 
207 and 208 of the Federal Credit Union Act (the Act) would prevent a 
transfer of financial assets by a FICU during a securitization or a 
participation from satisfying the ``legal isolation'' condition. To 
address this issue, the Board proposed a new Sec. 709.10. The Board 
incorporates its analysis of Sec. 709.10 provided in the preamble of 
the proposed rule. The Board notes that its final rule is substantially 
identical to a final rule recently issued by the FDIC in which the FDIC 
addressed this same issue as to federally-insured banks. 65 FR 49189 
(Aug. 11, 2000). Second, the proposed rule also considered the Board's 
authority to avoid a legally enforceable security interest in 
collateral for public funds during a

[[Page 55440]]

conservatorship or liquidation. To address this issue, the Board 
proposed a new Sec. 709.11. The following discussion separately 
addresses the two new sections, providing background, a review of 
comments, and a description of minor changes from the proposed rule.

Section 709.10

Background
    Under generally accepted accounting principles, a transfer of 
financial assets is accounted for as a sale if the transferor 
surrenders control over the assets. One of the conditions for 
determining whether the transferor has surrendered control is that the 
assets have been isolated from the transferor, in other words, put 
presumptively beyond the reach of the transferor, its creditors, a 
trustee in bankruptcy, or a receiver. This is known as the ``legal 
isolation'' condition. See Financial Accounting Standards Board's 
Statement of Financial Accounting Standards No. 125 (SFAS 125).
    When acting as a conservator or liquidating agent, the Board has 
the statutory authority to repudiate credit union contracts under 
section 207(c) of the Act. 12 U.S.C. 1787(c). In addition, no agreement 
that tends to diminish or defeat NCUA's interest, as a liquidating 
agent, in an asset acquired from a federally-insured credit union is 
enforceable against NCUA unless the requirements of section 208(a)(3) 
of the Act are met. 12 U.S.C. 1787(b)(9), 1788(a)(3). One particular 
requirement is that the agreement must have been executed 
contemporaneously with the FICU's acquisition of the asset. 12 U.S.C. 
1788(a)(3)(B).
    When a FICU is the transferor of financial assets in a 
securitization or in the form of a participation, two issues arise that 
may prevent these transferred assets from meeting the ``legal 
isolation'' condition. The first is whether NCUA, when acting as a 
conservator or a liquidating agent, might avoid the transfer of 
financial assets by the credit union and recover such assets; and the 
second is whether NCUA might challenge the enforceability of an 
agreement that transfers financial assets but fails to meet the 
contemporaneous requirement of section 208(a)(3) of the Act.
    The final rule provides that the Board will not use its authority 
to repudiate contracts under 12 U.S.C. 1787(c) to reclaim, recover, or 
recharacterize financial assets transferred by a FICU in connection 
with a securitization or in the form of a participation. Such assets 
may be accounted for as a sale, provided the transaction meets all of 
the requirements in SFAS 125. The Board's repudiation of a 
securitization or participation will not affect transferred financial 
assets but will excuse the Board from performing any continuing 
obligations imposed by the securitization or participation.
    The final rule further provides that NCUA will not attempt to avoid 
an otherwise legally enforceable securitization agreement or 
participation agreement solely because the agreement does not meet the 
contemporaneous requirement of sections 207(b)(9) and 208(a)(3) of the 
Act. The final rule applies only to securitizations or participations 
in which the transfer of financial assets meets all of the conditions 
for sale accounting treatment under generally accepted accounting 
principles, other than the ``legal isolation'' condition.
    The final rule defines ``participation'' as a transfer of an 
interest in a loan or a lease without recourse by the buyer against the 
lead. The Board wishes to clarify the term ``without recourse.'' The 
issue is whether aspects of recourse within a transaction, such as 
guaranties of quality or collectibility on the underlying obligation, 
jeopardize the transaction's characterization as a true sale or true 
participation agreement. Courts generally view a transaction as a 
participation only if the participant does not have recourse against 
the lead when a default occurs on the underlying obligation. See, e.g., 
In re Sackman Mortgage Corp., 158 B.R. 926, 931-34 (Bankr. S.D.N.Y. 
1993). However, the presence of recourse does not necessarily require 
that a transaction be characterized as a security interest instead of 
as a sale. See Major's Furniture Mart, Inc. v. Castle Credit 
Corporation, Inc., 602 F.2d 538 (3rd Cir. 1979). Courts look to the 
nature of the recourse, the allocation of risk, and the general nature 
of the transaction. Id.
    The rule is intended to cover participations that impose limited 
recourse conditions on the lead without shifting all of the risks of 
loss or obligations of ownership. Specifically, the rule will apply to 
participations in which: (a) The lead retained a limited subordinated 
interest in the obligation, against which losses are initially 
allocated; (b) the lead participated in a loan in order to avoid a 
statutory lending limit violation, with the option of reacquiring the 
transferred interest when reacquisition would not result in a lending 
limit violation; or (c) the participation agreement provided for 
repurchase or compensation in connection with customary representations 
and warranties regarding the underlying asset.
Comments
    The comment period ended April 3, 2000. Nine comments were received 
on proposed Sec. 709.10. Comments were submitted by five corporate 
credit unions, two national credit union trade associations, and two 
state credit union leagues. All nine commenters strongly supported the 
adoption of the proposed section.
    One commenter requested that the definition of ``without recourse'' 
permit corporate credit unions to establish reserve accounts for loan 
participations, if 12 CFR part 704 is amended to allow corporate credit 
unions to enter into these transactions with their members. On July 22, 
1999, the Board issued an advance notice of proposed rulemaking 
regarding amendments to part 704. 64 FR 40787 (July 28, 1999). Any 
issues related to the scope of Sec. 709.10(a)(4) for corporate credit 
union loan participations with natural person credit unions should be 
addressed during that rulemaking.
    The final rule is identical to the proposed rule except for the 
following changes. The proposed rule's definition of the term 
``participation'' included language that referred to ``the borrower's 
default'' in describing the meaning of the term ``without recourse.'' 
Since a participation may involve a lease as well as a loan, the final 
rule refers to ``a default on the underlying obligation'' instead of 
``the borrower's default.'' In addition, the definition of ``special 
purpose entity'' now conforms to the amended version of SFAS 125 by 
using the phrase ``demonstrably distinct'' instead of ``distinct 
standing at law'' within the definition.

Section 709.11

Background
    The Act authorizes federal credit unions and FICUs to be 
depositories of public money. 12 U.S.C. 1767, 1789a. Federal credit 
unions may receive payments, representing equity, on shares, share 
certificates and share draft accounts from nonmember units of federal, 
state, local or tribal governments and political subdivisions as 
enumerated in section 207(k)(2)(A) of the Act. 12 U.S.C. 1757(6). As a 
public depository, a federal credit union may pledge any of its assets 
to secure the payment of the public funds. 12 U.S.C. 1767(b).
    On April 30, 1993, the FDIC issued its ``Statement of Policy 
Regarding Treatment of Security Interests After Appointment of the 
Federal Deposit

[[Page 55441]]

Insurance Corporation as Conservator or Receiver'' (Statement of 
Policy) addressing the enforceability of security interests that secure 
public deposits in banks. It stated that the FDIC, when acting as 
conservator or receiver, would not seek to avoid an otherwise legally 
enforceable and perfected security interest solely because the security 
agreement granting or creating the security interest did not meet the 
``contemporaneous'' requirements of sections 11(d)(9), 11(n)(4)(I), and 
13(e) of the Federal Deposit Insurance Act. Congress enacted the tenor 
of FDIC's policy statement in section 317 of the Riegle Community 
Development and Regulatory Improvement Act of 1994. 12 U.S.C. 
1823(e)(2).
    Similarly, the Board believes it should limit its extraordinary 
authority as a conservator or liquidating agent with special provisions 
for security interests related to public funds. This will allow FICUs 
to offer governmental depositors the same protections the Federal 
Deposit Insurance Act provides for deposits in banks. The final rule 
establishes that the Board, acting as conservator or liquidating agent, 
will not seek to avoid an otherwise legally enforceable security 
interest in collateral for public funds solely because the collateral 
was not acquired contemporaneously with the approval and execution of 
the security agreement or was changed, increased or subject to 
substitution from time to time.
Comments
    The Board received two comments on proposed Sec. 709.11, one from a 
state credit union regulator and the other from an association 
representing state credit union regulators nationwide. Both commenters 
supported the adoption of this section, but suggested a variety of 
amendments to the proposal.
    The commenters requested that the phrase ``lawful 
collateralization'' be defined to mean that state and federal laws, 
rules, regulations and interpretive statements determine whether a 
security interest has been lawfully collateralized. The commenters also 
noted that the creation of an enforceable and perfected security 
interest in the collateral should not be required for a ``lawful 
collateralization.'' The commenters suggested that not all state laws 
require security interests provided in connection with public deposits 
to be perfected. The Board believes that the phrase ``lawful 
collateralization'' is self-explanatory and does not need to be defined 
in the rule. Furthermore, this phrase is consistent with 12 U.S.C. 
1823(e)(2). The Board recognizes that state laws vary regarding 
security interests and, therefore, will look to applicable local and 
federal laws and regulations to determine whether a security interest 
has been lawfully collateralized for purposes of this rule.
    The commenters requested that both sections within the Act 
addressing the Board's authority to repudiate contracts during 
conservatorships or liquidations be cited in the regulation, likewise 
with the references used in Sec. 709.10(f). The Board agrees and has 
included the statutory reference in the final rule. The commenters also 
suggested that the rule establish that any repeal or amendment of the 
rule will not apply to any collateral already provided in a 
collateralization agreement. Section 709.11 does not contain a 
provision for repeal upon 30-day notice by the Board like the provision 
in Sec. 709.10(g). The Board believes that a provision of this sort is 
unnecessary because any amendment of the rule would not apply 
retroactively.
    The commenters also requested clarification on two points. They 
stated that the rule should clearly provide that NCUA either: (1) Will 
not seek to avoid or repudiate a security agreement and the 
collateralization or security interest created thereunder; or (2) will 
not recover, reclaim or recharacterize any assets, securities or other 
collateral subject to a security agreement tied to the deposit of 
public funds. Like 12 U.S.C. 1823(e)(2), the final rule provides that 
the Board will not invalidate a governmental depositor's security 
interest in collateral used to secure public funds merely because the 
security agreement fails to meet the contemporaneous requirements of 
section 208(a)(3) of the Act. The Board maintains that this language is 
satisfactory and consistent with the treatment of public deposits 
within federally-insured banks.
    The commenters also requested that the rule expressly establish 
that it applies to increases or substitutions of collateral occurring 
after the agreement has been entered into by the governmental depositor 
and the credit union. The Board agrees and has made the clarification 
in the final rule.
    Finally, in the Statement of Policy discussed above, the FDIC 
assumed that a bank's agreement met certain criteria before the FDIC 
would determine not to avoid a security interest during a 
conservatorship or receivership. The FDIC identified the following 
conditions: (1) The agreement was undertaken in the ordinary course of 
business, not in contemplation of insolvency, and with no intent to 
hinder, delay or defraud the depository institution or its creditors; 
(2) the secured obligation represented a bona fide and arm's length 
transaction; (3) the secured party or parties were not insiders or 
affiliates of the depository institution; (4) the grant or creation of 
the security interest was for adequate consideration; and (5) the 
security agreement evidencing the security interest was in writing, 
approved by the bank's board of directors or loan committee (which 
approval is reflected in the minutes of a meeting of the board of 
directors or committee) and has been, continuously from the time of its 
execution, an official record of the depository institution. 58 FR 
16833 (March 31, 1993). For clarity, the Board has decided to 
incorporate these five assumptions directly into the final rule.

Regulatory Procedures

Paperwork Reduction Act

    NCUA has determined that the rule does not increase paperwork 
requirements under the Paperwork Reduction Act of 1995 and regulations 
of the Office of Management and Budget.

The Regulatory Flexibility Act

    The Regulatory Flexibility Act requires NCUA to prepare an analysis 
to describe any significant economic impact any final regulation may 
have on a substantial number of small entities (those under $1 million 
in assets). The final rule addresses the manner in which the Board will 
enforce its rights as a conservator or liquidating agent when 
evaluating financial assets transferred during a securitization or 
participation, or reviewing the collateralization of public funds. The 
final rule does not impose any reporting or recordkeeping burdens that 
are not already a function of entering into such transactions. 
Therefore, the Board certifies that this final rule will not have a 
significant economic impact on a substantial number of small credit 
unions.

Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121) provides generally for congressional review of agency 
rules. A reporting requirement is triggered in instances where NCUA 
issues a final rule as defined by Section 551 of the Administrative 
Procedures Act. 5 U.S.C. 551. The Office of Management and Budget has 
determined that this is not a major rule.

[[Page 55442]]

Executive Order 13132

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their regulatory actions on state and local 
interests. In adherence to fundamental federalism principles, NCUA, an 
independent regulatory agency as defined in 44 U.S.C. 3502(5), 
voluntarily complies with the executive order. This final rule applies 
to all federally-insured credit unions, but it will not have 
substantial direct effects on the states, on the relationship between 
the national government and the states, or on the distribution of power 
and responsibilities among the various levels of government. NCUA has 
determined that the final rule does not constitute a policy that has 
federalism implications for purposes of the executive order.

The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    The NCUA has determined that this rule will not affect family well-
being within the meaning of section 654 of the Treasury and General 
Government Appropriations Act, 1999, Pub. L. 105-277, 112 Stat. 2681 
(1998).

Agency Regulatory Goal

    NCUA's goal is to promulgate clear and understandable regulations 
that impose a minimal regulatory burden. We requested comments on 
whether the proposed rules were understandable and minimally intrusive 
if implemented as proposed. We received no specific comment on this 
issue.

List of Subjects in 12 CFR Part 709

    Credit unions, Liquidations.


    By the National Credit Union Administration Board on September 
7, 2000.
Becky Baker,
Secretary of the Board.

    For the reasons set out in the preamble, the NCUA amends 12 CFR 
part 709 as follows:

PART 709--INVOLUNTARY LIQUIDATION OF FEDERAL CREDIT UNIONS AND 
ADJUDICATION OF CREDITOR CLAIMS INVOLVING FEDERALLY-INSURED CREDIT 
UNIONS IN LIQUIDATION

    1. The authority citation for part 709 is revised to read as 
follows:

    Authority: 12 U.S.C. 1757, 1766, 1767, 1786(h), 1787, 1788, 
1789, 1789a.

    2. Amend Sec. 709.0 by revising the first sentence to read as 
follows:


Sec. 709.0  Scope.

    The rules and procedures set forth in this part apply to charter 
revocations of federal credit unions under 12 U.S.C. 1787(a)(1)(A), 
(B), the involuntary liquidation and adjudication of creditor claims in 
all cases involving federally-insured credit unions, the treatment by 
the Board as conservator or liquidating agent of financial assets 
transferred in connection with a securitization or participation, and 
the treatment by the Board as conservator or liquidating agent of 
public funds held by a federally-insured credit union. * * *

    3. Add Sec. 709.10 to part 709 to read as follows:


Sec. 709.10  Treatment by conservator or liquidating agent of financial 
assets transferred in connection with a securitization or 
participation.

    (a) Definitions. (1) Beneficial interest means debt or equity (or 
mixed) interests or obligations of any type issued by a special purpose 
entity that entitle their holders to receive payments that depend 
primarily on the cash flow from financial assets owned by the special 
purpose entity.
    (2) Financial asset means cash or a contract or instrument that 
conveys to one entity a contractual right to receive cash or another 
financial instrument from another entity.
    (3) Legal isolation means that transferred financial assets have 
been put presumptively beyond the reach of the transferor, its 
creditors, a trustee in bankruptcy, or a receiver, either by a single 
transaction or a series of transactions taken as a whole.
    (4) Participation means the transfer or assignment of an undivided 
interest in all or part of a loan or a lease from a seller, known as 
the ``lead,'' to a buyer, known as the ``participant,'' without 
recourse to the lead, under an agreement between the lead and the 
participant. Without recourse means that the participation is not 
subject to any agreement that requires the lead to repurchase the 
participant's interest or to otherwise compensate the participant due 
to a default on the underlying obligation.
    (5) Securitization means the issuance by a special purpose entity 
of beneficial interests:
    (i) The most senior class of which at time of issuance is rated in 
one of the four highest categories assigned to long-term debt or in an 
equivalent short-term category (within either of which there may be 
sub-categories or gradations indicating relative standing) by one or 
more nationally recognized statistical rating organizations; or
    (ii) Which are sold in transactions by an issuer not involving any 
public offering for purposes of section 4 of the Securities Act of 
1933, as amended, or in transactions exempt from registration under 
such Act under 17 CFR 230.91 through 230.905 (Regulation S) thereunder 
(or any successor regulation).
    (6) Special purpose entity means a trust, corporation, or other 
entity demonstrably distinct from the federally-insured credit union 
that is primarily engaged in acquiring and holding (or transferring to 
another special purpose entity) financial assets, and in activities 
related or incidental thereto, in connection with the issuance by such 
special purpose entity (or by another special purpose entity that 
acquires financial assets directly or indirectly from such special 
purpose entity) of beneficial interests.
    (b) The Board, by exercise of its authority to disaffirm or 
repudiate contracts under 12 U.S.C. 1787(c), will not reclaim, recover, 
or recharacterize as property of the credit union or the liquidation 
estate any financial assets transferred to another party by a 
federally-insured credit union in connection with a securitization or 
participation, provided that a transfer meets all conditions for sale 
accounting treatment under generally accepted accounting principles, 
other than the ``legal isolation'' condition addressed by this section.
    (c) Paragraph (b) of this section will not apply unless the 
federally-insured credit union received adequate consideration for the 
transfer of financial assets at the time of the transfer, and the 
documentation effecting the transfer of financial assets reflects the 
intent of the parties to treat the transaction as a sale, and not as a 
secured borrowing, for accounting purposes.
    (d) Paragraph (b) of this section will not be construed as waiving, 
limiting, or otherwise affecting the power of the Board, as conservator 
or liquidating agent, to disaffirm or repudiate any agreement imposing 
continuing obligations or duties upon the federally-insured credit 
union in conservatorship or the liquidation estate.
    (e) Paragraph (b) of this section will not be construed as waiving, 
limiting or otherwise affecting the rights or powers of the Board to 
take any action or to exercise any power not specifically limited by 
this section, including, but not limited to, any rights, powers or 
remedies of the Board regarding transfers taken in contemplation of the 
credit union's insolvency or with the intent to hinder, delay, or 
defraud the

[[Page 55443]]

credit union or the creditors of such credit union, or that is a 
fraudulent transfer under applicable law.
    (f) The Board will not seek to avoid an otherwise legally 
enforceable securitization agreement or participation agreement 
executed by a federally-insured credit union solely because such 
agreement does not meet the ``contemporaneous'' requirement of sections 
207(b)(9) and 208(a)(3) of the Federal Credit Union Act.
    (g) This section may be repealed by the NCUA upon 30 days notice 
and opportunity for comment provided in the Federal Register, but any 
such repeal or amendment will not apply to any transfers of financial 
assets made in connection with a securitization or participation that 
was in effect before such repeal or modification. For purposes of this 
paragraph, a securitization would be in effect on the earliest date 
that the most senior level of beneficial interests is issued, and a 
participation would be in effect on the date that the parties executed 
the participation agreement.

    4. Add Sec. 709.11 to part 709 to read as follows:


Sec. 709.11  Treatment by conservator or liquidating agent of 
collateralized public funds.

    An agreement to provide for the lawful collateralization of funds 
of a federal, state, or local governmental entity or of any depositor 
or member referred to in section 207(k)(2)(A) of the Act will not be 
deemed to be invalid under sections 207(b)(9) and 208(a)(3) of the Act 
solely because such agreement was not executed contemporaneously with 
the acquisition of collateral or with any changes, increases, or 
substitutions in the collateral made in accordance with such agreement, 
provided the following conditions are met:
    (a) The agreement was undertaken in the ordinary course of 
business, not in contemplation of insolvency, and with no intent to 
hinder, delay or defraud the credit union or its creditors;
    (b) The secured obligation represents a bona fide and arm's length 
transaction;
    (c) The secured party or parties are not insiders or affiliates of 
the credit union;
    (d) The grant or creation of the security interest was for adequate 
consideration; and,
    (e) The security agreement evidencing the security interest is in 
writing, was approved by the credit union's board of directors, and has 
been continuously an official record of the credit union from the time 
of its execution.

[FR Doc. 00-23463 Filed 9-13-00; 8:45 am]
BILLING CODE 7535-01-P