[Federal Register Volume 71, Number 199 (Monday, October 16, 2006)]
[Proposed Rules]
[Pages 60678-60681]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-17170]


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FARM CREDIT ADMINISTRATION

12 CFR Part 613

RIN 3052-AC33


Eligibility and Scope of Financing; Processing and Marketing

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA or Agency) proposes to 
amend its regulation governing financing of processing and marketing 
operations by Farm Credit System (Farm Credit, FCS, or System) 
institutions under titles I and II of the Farm Credit Act of 1971, as 
amended (Act). Specifically, this proposal would revise the criteria 
used to determine eligibility of legal entities for financing as 
processing and marketing operations. FCA further proposes a non-
substantive technical correction to its regulation defining the term 
``person.''

DATES: Comments should be received on or before December 15, 2006.

ADDRESSES: We offer a variety of methods to receive your comments. For 
accuracy and efficiency reasons, commenters are encouraged to submit 
comments by e-mail or through the Agency's Web site or the Federal 
eRulemaking Portal. As faxes are difficult for us to process and 
achieve compliance with section 508 of the Rehabilitation Act, please 
consider another means to submit your comment if possible. Regardless 
of the method you use, please do not submit your comment multiple times 
via different methods. You may submit comments by any of the following 
methods:
     E-mail: Send us an e-mail [email protected]. Agency Web 
site: http://www.fca.gov. Select ``Legal Info,'' then ``Pending 
Regulations and Notices.''
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail: Gary K. Van Meter, Deputy Director, Office of 
Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive, 
McLean, VA 22102-5090.
     Fax: (703) 883-4477. Posting and processing of faxes may 
be delayed. Please consider another means to comment, if possible.
    You may review copies of comments we received at our office in 
McLean, Virginia, or from our Web site at http://www.fca.gov. Once you 
are in the Web site, select ``Legal Info,'' and then select ``Public 
Comments.'' We will show your comments as submitted, but for technical 
reasons we may omit items such as logos and special characters. 
Identifying information that you provide, such as phone numbers and 
addresses, will be publicly available. However, we will attempt to 
remove e-mail addresses to help reduce Internet spam.

FOR FURTHER INFORMATION CONTACT:

Barry Mardock, Associate Director, Office of Regulatory Policy, Farm 
Credit Administration, 1501 Farm Credit Drive, McLean, VA, (703) 883-
4456, TTY (703) 883-4434;
     or
Michael A. Anderson, Policy Analyst, Office of Regulatory Policy, Farm 
Credit Administration, Denver, CO, (303) 696-9737, TTY (303) 696-9259;
     or
Howard I. Rubin, Senior Counsel, Office of General Counsel, Farm Credit 
Administration, McLean, VA 22102-5090, (703) 883-4029, TTY (703) 883-
4020.

SUPPLEMENTARY INFORMATION:

I. Background

    Sections 1.11(a)(1) and 2.4(a)(1) of the Act authorize Farm Credit 
Banks and associations to finance the processing and marketing 
operations of bona fide farmers, ranchers, and aquatic producers or 
harvesters that are ``directly related'' to the operations of the 
borrower, provided that the operations of the borrower supply some 
portion of the raw materials used in the processing or marketing 
operation (throughput).\1\ Current Sec.  613.3010(a)(1) provides that a 
borrower is eligible for financing for a processing or marketing 
operation only if the borrower is eligible to borrow from the System or 
is a legal entity in which eligible borrowers own more than 50 percent 
of the voting stock or equity.
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    \1\ 12 U.S.C. 2019(a)(1), 2075(a)(1). Each Farm Credit Bank has 
transferred its title I authority to make long-term real estate 
mortgage loans to Federal land bank associations pursuant to section 
7.6 of the Act (12 U.S.C. 2279b).
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    We believe that our current rule, focusing solely on the percentage 
of eligible borrower ownership in a legal entity, is unnecessarily 
narrow. Therefore, FCA proposes to add additional specific criteria for 
determining what legal entities are eligible for financing for 
processing and marketing operations in accordance with the provisions 
in Sec. Sec.  1.11(a) and 2.4(a) of the Act. While potentially 
expanding the pool of eligible legal entities, we believe that the 
additional criteria properly ensure that there is a sufficiently strong 
economic link--or identity of interests--between eligible borrowers and 
the processing or marketing entity so that the financing can be 
considered made and ``directly related'' to eligible borrowers and 
their operations.

II. Need for Proposed Rule

    FCA believes its amendment to Sec.  613.3010 will permit System 
associations to more effectively meet the credit needs of eligible 
borrowers in the face of changing agricultural and economic conditions 
while remaining consistent with the Act. We recognize the increasing 
importance of value-added agriculture and aquaculture and the changing 
ownership structures in processing and marketing operations. As part of 
these changing agricultural and economic conditions, FCA seeks to 
ensure that affordable and dependable credit for businesses that add 
value to farm and aquatic products and commodities remains available 
for the benefit of agricultural and aquacultural producers (and the 
rural communities in which they operate).
    As farmers, ranchers, and producers or harvesters of aquatic 
products look for opportunities to increase farm and aquaculture income 
and diversify income sources, the importance of value-added agriculture 
and aquaculture has emerged, benefiting both producers and rural 
communities. Producers are pursuing value-added activities to gain more 
direct access to markets and a greater share of the consumers' food 
dollar. As such, farmers are increasingly relying on vertical 
integration and coordination of production, processing, and marketing 
to deliver products that meet consumer needs. These opportunities have 
stemmed from increased consumer demands regarding health, nutrition, 
and convenience; efforts by food processors to improve their 
productivity; and technological advances that enable producers to 
produce what consumers and processors desire. With the continuous 
shifting to a global economy, the international market for value-added 
products is growing.
    Ownership structures within processing and marketing operations are 
changing as substantial capital investments cannot be fully raised

[[Page 60679]]

through traditional methods. The farmer-owned sole proprietorships or 
closely held entities prevalent in the past are often no longer 
economically viable. Therefore, new forms of cooperatives, limited 
liability corporations, limited liability partnerships, and other 
ownership structures--requiring outside investment--are being used to 
address equity and debt capital needs. For example, many of the new 
ethanol plants are only partially owned by farmers; however, these 
plants are usually directly related to the farmer-owners' operations 
and provide significant benefits to the rural communities in which they 
are located.
    Moreover, even where sole proprietorships or closely held entities 
are economically viable, they are often not advisable from a legal 
liability, tax, or estate planning perspective. In fact, structuring a 
processing or marketing operation with prudent legal liability 
considerations protects borrowers' financial interests and is an 
acceptable safety and soundness practice. We believe that our rules 
shouldn't create a circumstance that forces eligible borrowers to 
reject prudent legal, business and tax advice if they wish to continue 
borrowing from their FCS lender.
    Processing and marketing agricultural businesses are projected to 
continue to evolve and grow within rural America. The entrepreneurial 
spirit of farmers, ranchers, and producers of aquatic products will 
require a reliable and flexible source of credit and financial 
services. As value-added agriculture continues to grow, agricultural 
producers are challenged by the need to attract substantial capital in 
order to improve income for their benefit and the benefit of rural 
America.
    FCA recognizes the importance of these value-added enterprises to 
producers and rural America and believes this proposed regulation will 
help ensure dependable credit for businesses that add value to farm and 
aquatic products and commodities, as well as the communities in which 
they operate. We believe that revisions to this regulation will provide 
the FCS with the additional flexibility to meet the existing and future 
credit needs of processing and marketing entities upon which farmers, 
ranchers, and producers or harvesters of aquatic products are 
increasingly dependent for economic survival.

III. Section-by-Section Analysis

    The two criteria contained in existing Sec.  613.3010(a)(1) and 
(a)(2) are retained in paragraphs (a)(1) and (a)(2), with paragraph 
(a)(2) making clear that it only applies to a legal entity that does 
not qualify for financing under paragraph (a)(1) as a bona fide farmer, 
rancher, or producer or harvester of aquatic products. However, as 
discussed above, we believe that a limitation based solely on the 
percentage of voting stock held by eligible borrowers--representing 
pure numerical voting ``control'' of the entity--is an unnecessarily 
narrow way of looking through a legal entity to determine whether a 
loan can be viewed as made to an eligible borrower or ``directly 
related to'' an eligible borrower's operation. Therefore, the proposal 
would add new paragraph (a)(3) to provide alternative ways of 
determining actual eligible borrower ``control'' over a legal entity 
where the eligible borrower owns 50 percent or less of the voting stock 
or equity, new paragraph (a)(4) to provide eligibility for legal 
entities where eligible borrowers have a significant equity stake and 
provide a substantial amount of the throughput, and new paragraph 
(a)(5) to provide financing for legal entities that are a direct 
extension or outgrowth of an eligible borrower's production operation, 
regardless of the amount of eligible borrower ownership of the legal 
entity. A legal entity will need to meet one of these criteria in order 
to borrow from an FCS association.

A. Section 613.3010(a)(3)--Majority Voting, Management, or Actual 
Control

    Under proposed Sec.  613.3010(a)(3), if eligible borrowers own 50 
percent or less of the voting stock or equity and one or more of those 
eligible borrowers/owners regularly produce some portion of the 
throughput used in the processing or marketing operation, then one of 
the following criteria must be met:
1. Majority Voting Control
    Proposed Sec.  613.3010(a)(3)(i) provides that a legal entity is 
eligible for financing under this paragraph if eligible borrowers under 
Sec.  613.3000(b) own 50 percent or less of the voting stock or equity, 
regularly produce some portion of the throughput used in the processing 
or marketing operation and ``exercise majority voting control over the 
entity.'' An example of this is a corporation with separate classes of 
voting stock, where the eligible farmer-owned class of stock exercises 
actual majority voting control regardless of their overall percentage 
ownership of stock. Another example would be where holders of a 
majority of voting stock agree, by contract or otherwise, to allow 
eligible farmer-owners to exercise voting control. This provision would 
also encompass a legal entity in which eligible borrowers have the 
voting power to elect at least 40 percent of the entity's board of 
directors (or general partners of a limited partnership, or managing 
members of a limited liability company) and non-eligible investors can 
elect no more than 40 percent, with the remainder to be elected through 
mutual agreement.
2. Management Control
    Proposed Sec.  613.3010(a)(3)(ii) would authorize financing for a 
legal entity in which eligible borrowers under Sec.  613.3000(b) own 50 
percent or less of the voting stock or equity, regularly produce some 
portion of the throughput used in the processing or marketing operation 
and ``exercise control over management of the legal entity.'' Eligible 
borrowers could exercise control over management by ``constituting a 
majority of the directors of a corporation, general partners of a 
limited partnership, or managing members of a limited liability 
company.'' In these circumstances, eligible borrowers are exercising 
actual management direction and control over the entity, even though 
they may not own a majority of the voting stock or equity.
3. Actual Control
    Proposed Sec.  613.3010(a)(3)(iii) would authorize financing for a 
legal entity in which eligible borrowers under Sec.  613.3000(b) own 50 
percent or less of the voting stock or equity, regularly produce some 
portion of the throughput used in the processing or marketing operation 
and ``exercise the documented power and authority to directly determine 
and implement the policies, business practices, management, and 
decision-making process of the legal entity.'' This is intended to 
cover unusual circumstances where the borrower does not meet the 
specific criteria of paragraphs (a)(3)(i) or (a)(3)(ii) but where, 
through contractual agreement or otherwise, eligible borrowers have 
``documented power and authority'' over the legal entity.

B. Section 613.3010(a)(4)--Substantial Ownership Interest and Supply of 
Throughput

    Proposed Sec.  613.3010(a)(4) would authorize financing for a legal 
entity ``in which eligible borrowers under Sec.  613.3000(b) own at 
least 25 percent of the voting stock or equity and supply 20 percent or 
more of the throughput used in the processing or marketing operation.'' 
Under this provision, eligible borrower-owners do not need to exercise 
voting control over the entity

[[Page 60680]]

because the substantial ownership requirement coupled with the 20-
percent throughput requirement ensures that eligible borrowers have 
both a significant investment in the entity and the operation is 
``directly related to'' eligible borrowers' operations.

C. Section 613.3010(a)(5)--Extension or Outgrowth of Production 
Operations

    Proposed Sec.  613.3010(a)(5) would authorize financing for a legal 
entity that regularly processes or markets some portion of an eligible 
borrower's throughput and whose operations are a direct extension or 
outgrowth of that eligible borrower's operation. This is intended to 
cover entities--regardless of ownership--in which an eligible borrower 
has significant involvement, that fulfill the eligible borrower's 
business needs, and that are functionally integrated with the eligible 
borrower's production operation. Under paragraph (a)(5), the legal 
entity's financial condition is necessarily dependent upon the 
continued involvement of the eligible borrower. This mutual 
interdependency in financial performance is further indicia that the 
processing and marketing operation is part, or an ``extension or 
outgrowth,'' of the eligible borrower's production operation.
    As discussed above, many farming operations are evolving to include 
value-added processing and marketing operations. In many instances, 
value-added processing and marketing operations are formed by, and for 
the direct benefit of, eligible borrowers, their families, or other 
individuals with direct ties to an eligible borrower's production 
activities. In these instances, the processing or marketing operation 
is truly part of--or a ``direct extension or outgrowth'' of--the 
production operation. However, the ownership structures of these value-
added operations are typically crafted to meet tax and liability 
concerns--rather than FCS requirements--and consequently may not 
satisfy the requirements of our current rule. Moreover, family members 
owning and operating value-added businesses may not themselves qualify 
for financing as ``bona fide farmers.'' However, the economic reality 
is that these value-added operations are integrated with and 
inextricably linked to an eligible borrower's production activities.
    Under the Act and our rules, the processing or marketing financing 
must be a credit need of the eligible borrower. Therefore, paragraph 
(a)(5) provides that the eligible borrower must establish the necessary 
link between the processing and marketing entity and the eligible 
borrower's operation.
    The first specific element that an eligible borrower must 
demonstrate under paragraph (a)(5) is that ``the legal entity was 
created and operates with the active support and involvement of the 
eligible borrower.'' An example of this is the eligible borrower who 
assists a family member or friend in a start-up processing or marketing 
company in which the eligible borrower does not have any legal 
ownership; however, the start-up company provides an opportunity for 
the eligible borrower to manage production risk through product control 
for the benefit of that eligible borrower. The eligible borrower's 
``active'' involvement (meaning more than a token investment of money, 
time, resources, or throughput) in the creation of the legal entity and 
continued active involvement in the operation of the legal entity is 
evidence that the operation is truly an ``extension or outgrowth'' of 
the eligible borrower's production operation. Where the financing is 
for a start-up venture, the eligible borrower should be able to 
demonstrate, through a business plan or otherwise, the eligible 
borrower's intent to remain actively involved in the processing and 
marketing operation.
    The second specific element that an eligible borrower must 
demonstrate under paragraph (a)(5) is that ``the legal entity fulfills 
a business need and supports the operation of the eligible borrower 
through product branding or other value-added business activity 
directly related to the operations of the eligible borrower.'' 
Regardless of direct ownership by an eligible borrower, a processing or 
marketing operation may be so integral to the eligible borrower's 
operation and economic well-being that without it, the eligible 
borrower would not receive the same economic benefit. This processing 
or marketing operation may support the eligible borrower's business 
needs through product branding, product customization to meet specific 
contract requirements, or any other value-added activity that meets the 
needs of the user or consumer and benefits the economic well-being of 
the eligible borrower.
    The third criterion an eligible borrower must demonstrate is that 
``the legal entity and the eligible borrower coordinate to operate in a 
functionally integrated manner.'' This coordination may be evidenced by 
shared resources (such as management expertise, employees, or assets) 
or other indicia of integration. We believe that Congress intended for 
the System to provide financing to assist eligible borrowers in the 
upward vertical integration of their operations.
    The fourth requirement implements the statutory mandate that the 
eligible borrower must provide some throughput to the processing or 
marketing operation.

IV. Technical Correction

    We are also proposing to correct an omission that inadvertently 
occurred during the January 30, 1997, regulatory amendments \2\ by 
adding the words ``a legal entity or'' to the Sec.  613.3000(a)(3) 
definition of ``[p]erson''. This does not provide any additional 
authority and is in accord with our stated intent published in the 1997 
Federal Register final rule preamble.
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    \2\ See 62 FR 4441 (Jan. 30, 1997).
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V. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.), the FCA hereby certifies that the proposed rule 
will not have a significant economic impact on a substantial number of 
small entities. Each of the banks in the System, considered together 
with its affiliated associations, has assets and annual income in 
excess of the amounts that would qualify them as small entities. 
Therefore, System institutions are not ``small entities'' as defined in 
the Regulatory Flexibility Act.

List of Subjects in 12 CFR Part 613

    Agriculture, Banks, banking, Credit, Rural areas.

    For the reasons stated in the preamble, part 613 of chapter VI, 
title 12 of the Code of Federal Regulations are proposed to be amended 
to read as follows:

PART 613--ELIGIBILITY AND SCOPE OF FINANCING

    1. The authority citation for part 613 continues to read as 
follows:

    Authority: Secs. 1.5, 1.7, 1.9, 1.10, 1.11, 2.2, 2.4, 2.12, 3.1, 
3.7, 3.8, 3.22, 4.18A, 4.25, 4.26, 4.27, 5.9, 5.17 of the Farm 
Credit Act (12 U.S.C. 2013, 2015, 2017, 2018, 2019, 2073, 2075, 
2093, 2122, 2128, 2129, 2143, 2206a, 2211, 2212, 2213, 2243, 2252).

Subpart A--Financing Under Titles I and II of the Farm Credit Act


Sec.  613.3000  [Amended]

    2. Amend Sec.  613.3000(a)(3) by adding the words ``a legal entity 
or'' before the words ``an individual''.
    3. Revise Sec.  613.3010(a) to read as follows:

[[Page 60681]]

Sec.  613.3010  Financing for processing or marketing operations.

    (a) Eligible borrowers. A borrower is eligible for financing for a 
processing or marketing operation under titles I and II of the Act only 
if the borrower:
    (1) Is a bona fide farmer, rancher, or producer or harvester of 
aquatic products who regularly produces some portion of the throughput 
used in the processing or marketing operation; or
    (2) Is a legal entity not eligible under paragraph (a)(1) of this 
section in which eligible borrowers under Sec.  613.3000(b) own more 
than 50 percent of the voting stock or equity and regularly produce 
some portion of the throughput used in the processing or marketing 
operation; or
    (3) Is a legal entity not eligible under paragraph (a)(1) of this 
section in which eligible borrowers under Sec.  613.3000(b) own 50 
percent or less of the voting stock or equity, regularly produce some 
portion of the throughput used in the processing or marketing operation 
and:
    (i) Exercise majority voting control over the legal entity; or
    (ii) Exercise control over management of the legal entity, such as 
constituting a majority of the directors of a corporation, general 
partners of a limited partnership, or managing members of a limited 
liability company; or
    (iii) Exercise the documented power and authority to directly 
determine and implement the policies, business practices, management, 
and decision-making process of the legal entity; or
    (4) Is a legal entity not eligible under paragraph (a)(1) of this 
section in which eligible borrowers under Sec.  613.3000(b) own at 
least 25 percent of the voting stock or equity and supply 20 percent or 
more of the throughput used in the processing or marketing operation; 
or
    (5) Is a legal entity not eligible under paragraph (a)(1) of this 
section that is a direct extension or outgrowth of an eligible 
borrower's operation. To obtain financing for a legal entity under this 
paragraph, the eligible borrower must establish that:
    (i) The legal entity was created and operates with the eligible 
borrower's active support and involvement,
    (ii) The legal entity fulfills a business need and supports the 
operation of the eligible borrower through product branding or other 
value-added business activity directly related to the operations of the 
eligible borrower,
    (iii) The legal entity and the eligible borrower coordinate to 
operate in a functionally integrated manner, and
    (iv) The legal entity regularly processes or markets some portion 
of the eligible borrower's throughput.
* * * * *

    Dated: October 11, 2006.
Roland E. Smith,
Secretary, Farm Credit Administration Board.
 [FR Doc. E6-17170 Filed 10-13-06; 8:45 am]
BILLING CODE 6705-01-P