© 2007 Wilmington Trust Corporation. Affiliates in California, Connecticut, Delaware, Florida, Georgia, Maryland, Massachusetts, Minnesota, Nevada, New Jersey, New York, Pennsylvania, South Carolina, Vermont, Cayman Islands, Channel Islands, Dublin, Frankfurt, London, and Luxembourg.
For more than 100 years, the Wilmington Trust corporate family has been
privileged to work with, and support, individuals and organizations committed to
providing quality of life and opportunities to all members of our communities.
In our second century of serving clients, our commitment to improving
the lives of our neighbors remains steadfast.
We are proud to support the
Delaware Bankers Association.
D
elaware
B
anker
Contents
View from the Chair ... 4
President’s Report ... 7
What’s New at the DBA ... 8
Cover Story: Captive Insurance ...10
Q&A with Richard F. Klumpp, JD, CPA ...14
Still Opening Doors After 75 Years ... 17
Our New Place in Cyberspace ... 20
A Matter of Trust ... 22
DBA Calendar of Events / Seminar Schedule ... 24
Real Estate Law Update ... 26
Fall 2007
Vol. 3, Issue 4 The Quarterly Publication of the Delaware Bankers Association SUBMISSIONS Delaware Banker welcomes news items from members of the Delaware Bankers Association. The Editors reserve the right to refuse any advertising or editorial copy deemed unsuitable for publication. The Editors reserve the right to set the publication date in accordance with the Association’s needs. Direct submissions to Susan Highfield at (302) 733-7452 or susan.highfield@debankers.com, or Greg Koseluk at (302) 733-7453 or greg.koseluk@debankers.com SUBSCRIPTIONS Delaware Banker is available free of charge to all officers, executives, management, and key personnel of DBA members. Paid subscriptions to Delaware Banker are available to all others at a rate of $20 per year. To be placed on the subscriber list, please email Susan Highfield at susan.highfield@debankers.com. ADVERTISING Advertising inquiries should be directed to Greg Koseluk at (302) 733-7453 or greg.koseluk@debankers.com. Rates will be furnished upon request. BOARD OF DIRECTORS CHAIRMAN Keith W. Schuck President Chase Bank USA, N.A. Clinton W. Walker Managing Director Barclays Bank Delaware President, CEO & Treasurer David G. Bakerian DIRECTORSThe Delaware Bankers Association
P.O. Box 781 Dover, DE 19903-0781 (302) 678-8600 Fax: (302) 678-5511 www.debankers.com Robert V. A. Harra, Jr. President Wilmington Trust Company W. Edwin Kee Director/Chairman The Felton Bank James J. Kelly Chief Operating Officer ING DIRECT Edward A. Reznick President & CEO Deutsche Bank Trust Co. Delaware Geoffrey M Rogers Managing Director The Glenmeade Trust Co., N.A. Richard K. Struthers Operations Executive Bank of America Card Services Mark A. Turner President & CEO WSFS Bank Richelle A. Vible President & CEO Citizens Bank (DE) PAST CHAIRMAN Connie Bond Stuart President PNC Bank, Delaware CHAIRMAN-ELECT Mark E. Huntley Chairman Delaware National Bank Editorial Disclaimer: The opinions expressed in articles by authors other than the Association staff and officers are the responsibility of the authors only and not neces-sarily those of the Delaware Bankers Association. Questions and comments should be addressed to the Editors. No part of this publication may be reproduced without the written permission of the Editors. Copyright 2005 by the Delaware Bankers Association. All Rights Reserved. Delaware Banker seeks to provide banking updates and other news of in-terest to the members of the Delaware Bankers Association. With the ex-ception of official announcements, the Delaware Bankers Association dis-claims responsibility for opinion and statements contained in Delaware Banker, and does not endorse any product or service. Delaware Banker is designed to provide accurate information on the subject matter covered. It is presented with the understanding the publisher is not engaged in ren-dering legal, accounting, or other professional services or advice. Delaware Banker - Fall 2007 3P. 17
View from the Chair
C
ommittees. The very mention of theword may send some of you running for cover. Committees, as any one who has ever served on one can attest, often get a bad rap. Sometimes that bad reputation is deserved, but mostly it is overstated, much like mother-in-law jokes. Milton Berle, speaking of jokesters, once said: “a committee is a group that keeps minutes and loses hours.” And while we could probably form a focus group to swap horror stories on committees (a sort of anti-committee committee), I’m not here to bury committees, but to praise them...at least the committees of the Delaware Bankers Association.
Before you accuse me of being the parent who believes their child is perfect, let me tell you something about the DBA committees and what makes them different. Because of our diverse group of banks, when the DBA forms its committees it’s really like putting together an all-star team. DBA committee members are the experts in their fields, each with unique talents and strengths at their positions. The majority of the committees are made up of ten or more members who serve three-year terms. While committee membership is by invitation, attendance at most committee meetings is open to all DBA members, including Associate Members. What sort of topics do DBA committees cover? Here’s a brief rundown of each.
Education Committee:
The DBA’s Education Committee oversees a full range of educational opportunities for all of the Association’s Members and the Community. Association members are given educational opportunities through on-line
by
Keith W. Schuck
President
Chase Bank USA, N.A.
Chairman
Delaware Bankers Association
“DBA committee
members are the
experts in their
fields, each with
unique talents
and strengths at
their positions.”
and correspondence courses, web seminars, various banker schools, and college degree programs. The Committee also oversees the DBA’s financial education programs to the community including: Teach Children to Save Day; the Keys to Financial Success high school elective course; the ADVANCE Scholarship program; and, The Great Investo series of radio public service announcements. Attendance at Education Committee meetings is limited to members and invited guests.
Government Affairs Committee: The mission of the Government Affairs Committee is to monitor, review and analyze state and federal legislation and regulatory actions affecting our members and to make appropriate position recommendations to the Board. The committee is comprised of the DBA Executive Committee members, and in-house bank counsel who concentrate on legislation.
(RCC) meets to: exchange and interpret regulatory information; actively participate in the regulatory rulemaking process; and, provide education and informational sharing opportunities. The RCC is open to all DBA members, and has four subcommittees:
The Rulemaking Subcommittee reviews proposed
regulations and may make comment to the appropriate regulatory agency.
The Regulatory Subcommittee reviews new regulations
and makes recommendations for implementation.
The Education Subcommittee reviews and recommends
compliance related educational programs helpful to the Compliance group.
The State Legislation Subcommittee monitors proposed
and new banking legislation in other states to determine its impact on Delaware banks that do business in those states.
Trust Committee:
The DBA’s newest committee, open to all members, promotes Delaware’s trust industry while exchanging and interpreting information on both personal and corporate
trust related issues. There are two subcommittees of the Trust Committee:
Trust Education Subcommittee which oversees various
trust related educational opportunities. This subcommittee also is responsible for the highly successful annual Delaware Trust Conference.
Trust Legislation Subcommittee which helps monitor
trust related Delaware legislation.
As you can see, the DBA’s committees provide invaluable opportunities for gathering and exchanging information on topics vital to our industry. I want to thank all those who serve to make our committees a success. I also encourage all the members of the DBA to take advantage of the resources available through the various committees. You can find information on committee activities in each issue of Delaware Banker in the “What’s New at the DBA” feature on page 8, and in the “Calendar of Events” on page 24. You will also find more committee information by clicking on the “Committee” tab on the DBA’s website (www.debankers.com).
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President’s Report
by
David G. Bakerian
President, CEO & Treasurer
Delaware Bankers Association
“
We may need to
call upon you to
help us explain to
our elected officials
that the banks are
responsible
busi-ness people...”
A
lthough the main focus of the Delaware Bankers Association is what’s going on in the First State, we do not operate in a vacuum. There are 50 other state bankers associations (Puerto Rico has one, too) that we communicate with on a regular basis. The American Bankers Association coordinates a monthly conference call amongst the states to discuss federal issues which impact us all. In addition, the ABA hosts a weekly state issues call which pinpoints specific state legislation that may be of concern. Among the recent hot topics that other associations are dealing with, stand outs include: file freezes; security breaches; and, identity theft. Fortunately, we have already dealt with each of these here in Delaware. Other issues our counterparts are grappling with include: credit card marketing bans; credit card disclosures; and, interchange fees. They also have bills mandating financial literacy, prohibiting outsourcing, and severely regulating ATM operations. We keep a close eye on these bills as they move about the country and the region. Here at home, we will be facing a variety of bills linked to the foreclosure issue when the legislature reconvenes in January of 2008. We already have a bill dealing with foreclosure consultants, and we anticipate others focusing on loan originators and the mortgage broker business. Although the intent of these bills is to curb fraud in the mortgage lending business, banks tend to get swept into the legislation. We need to insure that banks are separated from other lenders on thisissue. We are also facing legislation geared toward tax refund anticipation loans, payday lenders, and gift cards. Again, the bills are so broadly written, either unintentionally, or on purpose, that our industry invariably get thrown into the mix. It is one of the primary functions of the DBA to make sure that the legislators in Dover understand the banks’ role in the wider financial services field.
We may need to call upon you to help us explain to our elected officials that the banks are responsible business people, and that we shouldn’t be grouped in with those who are simply preying on consumers for a quick return. We will also be in contact with our counterparts in the other state banking associations to find out how they are dealing with similar legislative trends.
Our alliance with regional bankers associations such as those in New York, Maryland, New Jersey, and Pennsylvania, coupled with the other states and the American Bankers Association, provides us with a comprehensive communication network geared toward supplying a seamless stream of information on how to best serve the banking industry here in Delaware. We hope you are benefiting from the alliance, and, as always, we welcome your input and participation in the process.
Thanks,
What’s New at the DBA
by
Susan J. Highfield, Esq.
VP, Membership, Education
& Adminstration
Delaware Bankers Association
“The DBA continues
to offer excellent
opportunities for all
Delaware bankers
to expand their
personal growth and
development through
its many committees
and educational
programs.”
Secretary of State Rick J. Geisenberger,
and Delaware Bank Commissioner
Robert Glen. Over 50 other trust
professionals from various states and Europe as well as Delaware will present on why Delaware continues to lead the nation in trust activity. Sponsorship opportunities are still available. Go to our website at www.debankers.com and click on the Trust Conference link for more information, a complete agenda, and registration form.
DBA EVENTS DBA Fall Outing
On the Friday after Labor Day almost 200 bankers traded their business clothes for golf attire to enjoy their favorite day of fun in the sun with golf during the day and dinner and dancing in the evening at the DBA Fall Outing at the Rehoboth Beach Country Club. The DBA extends its thanks to the many sponsors who contributed to help make this day even better!
Professional Development Luncheon
In October Robert H. Sitkoff, Professor of Law, John L. Gray Professor of Law at Harvard Law School presented “Lawyers, Banks and Money: An Empirical Analysis of Perpetual Trusts, Asset Protection Trusts, and the Prudent Investor Rule.” Professor Sitkoff presented some startling statistics that reflect the impact of these changes on trust assets around the country and particularly in Delaware.
DBA SCHOOLS
The three-day DBA Regulatory
Compliance School was again held at the
Bellmore Inn in Rehoboth Beach. This program provided up-to-date information on federal compliance regulations affecting the financial services industry to keep compliance professionals current on all the important changes in the regulations. MEMBERSHIP UPDATE
The DBA welcomes the following new members:
Financial Institution Member
CHARLES SCHWAB BANK Thomas M. Forrest, CPA
President, Personal Trust Services Div. 500 Delaware Avenue, Suite 730 Wilmington, DE 19801
Phone: 302-622-3616 Thomas.forrest@schwab.com
Charles Schwab Bank, working through independent registered investment advisors, will offer personal trust administration services pending regulatory approval. Associate Member
ING Financial Partners Michael Imperiale
Investment Adviser Representative 3512 Silverside Road
Suite 9, The Commons Wilmington, DE 19810 Phone: 302-353-4722 mimperiale@ingfp.com www.ingdelaware.com
ING Financial Partners offer sound advice from financial professionals to establish a firm foundation for individual investors to assess their personal investment objectives – whether to prepare for retirement, save for a college education, or start a new business. ING Financial Partners, Inc., is an ING company.
2007 DELAWARE TRUST CONFERENCE
Space at this year ’s Delaware Trust Conference (Wednesday, November 28 to Friday, November 30) at the Hotel du Pont in Wilmington, is filling quickly. Last year’s event was sold out. Like last year, the conference, which will focus on the unique aspects of Delaware trusts, is open to trust professionals from all over the country. Guest speakers include Governor
Ruth Ann Minner, Delaware Supreme Court Justice Myron Steele, Assistant
For the first time the DBA offered the week-long Cannon
Personal Trust I School here in Delaware at Wesley College
in New Castle with 20 personal trust professionals in attendance. Cannon’s Fran DeMaris and Larry Divers taught the school. This is the first in the three-part Cannon Personal Trust series with Personal Trust II being offered by the DBA the week of March 3-7, 2008 with Personal
Trust III and Personal Trust I being offered the week of
October 6th to 10th. We are making arrangements for Cannon
Corporate Trust I to also be offered next October so that
trust professionals, personal and corporate, can gather and learn together at a convenient location in Delaware.
On October 24-26, a sold-out group of almost 60 bankcard professionals attended the internationally acclaimed three-day
Bank Card Management School program at the University
and Whist Club that included an intensive bank card simulation program that was both challenging and fun. For those who couldn’t attend, this same school is scheduled for April 9–11, 2008.
COMMITTEE NEWS
Education Committee
The Education Committee, chaired by Fil Sherry of Wilmington Trust, met at Wesley College in September to review its on-going plans and projects that include, but are not limited to: Teach Children to Save Day; Keys to
Financial Success; ADVANCE College Scholarship Program; The Great Investo; the wise use of credit for college
freshmen; FDIC Alliance for Economic Inclusion; First State Saves with the Delaware Money School; Meaningful Economics & Entrepreneurship (ME) Competition with CEEE; Traditional AIB enrollment; Web Seminars; College Degree Programs; DBA Schools and Conferences; and, how to increase banker awareness of these various opportunities.
Regulatory Compliance Committee (RCC)
The August 1st program on Regulation Z was continued at the October 3rd RCC meeting at the Delaware Public Archives Building in Dover with Felonise Norwood of Delaware National Bank as host. RCC Chairman Scot Stetka continued the discussion on the proposed amendments to Regulation Z with many issues raised and identified.
Trust Committee
Wilmington Trust Company hosted the Trust Committee meeting on Friday, September 14th. Thomas R. Pulsifer,
Esq.,. Partner, Morris, Nichols, Arsht and Tunnell, LLP, gave
a comprehensive overview of the Delaware Decanting Statute. In addition, Richard Nenno, Esq., Managing Director & Trust Counsel, Wilmington Trust, along with David
Bakerian of the DBA and Tom Pulsifer, gave a Delaware
trust legislative update to the trust professionals in attendance.
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10 Delaware Banker - Fall 2007
Captive
Insurance?
What is it, and
Why Should I Care?
by Michael W. Teichman, Esq.
Partner
Parkowski, Guerke & Swayze, P.A.
D
elaware became a captive insurance domicile in 1984, when Senate Bill 527 was signed into law and created a new chapter, Chapter 69, of the Delaware Insurance Code. In 2005, Delaware completely revised Chapter 69 with the intention of developing Delaware as a preferred captive domicile. Shortly thereafter, the Delaware Captive Insurance Association was created and, in 2006, the Insurance Department created a new Captive Insurance unit under the directorship of William P. White, former captive insurance program director in the District of Columbia. Capping off two years of activity, this year the General Assembly passed House Bill 214, providing for Special Purpose Financial Captives.“Wait a minute, I’m a banker. What’s captive insurance and why should I care?”
Simply put, a captive insurance company insures or reinsures the risks of its parent – it is a form of self insurance. Captive insurers are typically formed in one of the following structures:
• Pure captive: This is a captive wholly owned by a single
parent and is designed to insure only the risks of that parent and its affiliates.
• Association Captives: These are captive insurers formed by
associations of persons or organizations with similar risks. Often, association captives are regulated under the federal Risk Retention Act, which limits the amount of state regulation over such entities.
Delaware Banker - Fall 2007 11
Non-Captive Business:
The new statute preserves the unique ability of Delaware association and industrial insured captive insurers to write up to 50% of their business outside the association or industrial insured groups.2 The only limitations are that such business
be limited to entities in the same, related or similar business as the members of the industrial insured or association group and that the business be in the same or similar insurance lines as that written for group members.
Permitted lines of business:
Delaware captives are virtually unrestricted in the lines of business for which they can potentially obtain a certificate of authority, with the sole exception of workers compensation insurance.3 As for workers compensation, Delaware captives
are permitted to write so-called “excess workers compensation insurance” for parent and affiliated companies.4
Captive investments and accounting:
Delaware law previously extended great latitude to the ability of a pure or industrial insured captive to make investments of all types, and this has been retained.5 However, under the
new statute, Delaware captives of all types are expressly permitted to own the securities of, or interests in, another captive.6 This allows a parent company or industrial insured
group greater flexibility to segregate risks in multiple captives and to arrange those captives vertically in the corporate structure rather than horizontally.
Protected cells
This is one aspect of captive insurance where Delaware law clearly lagged behind that of other jurisdictions. Under the new statute, Delaware has adopted “sponsored captive” provisions much like those in place in other progressive domiciles.7 Accordingly, Delaware captives may be organized
to serve multiple members, each of which has the ability to segregate its risks in a protected cell that is insulated from the liabilities of other cells.
Special Purpose Financial Captives
This year’s legislation8 added cutting-edge provisions
allowing for the formation of “special purpose financial captive insurance companies” that are designed to reinsure (i.e., assume insurance risk from another insurer) blocks of insurance business from a parent company and securitize that risk in one or more capital markets transactions.
A thriving captive insurance industry will directly benefit the State, in terms of premium tax revenues, and will also indirectly benefit the State by fostering a service sector devoted to the needs of captives licensed in Delaware. The banking community can play a significant part in servicing the needs of captives.
Delaware’s captive insurance law provides a number of “bricks and mortar” requirements that provide opportunities for Delaware’s banking community: (continued on p. 12) • Industrial Insured Captives: Similar to Association
Captives, these are captives held by large and sophisticated organizations all of which are in the same or similar business and share like risks.
• Protected Cell Captives: Often called “rent-a-captive,”
these entities are designed to allow organizations that do not wish to expend the resources necessary to create and license their own captive to nonetheless participate in a captive but yet segregate, in a so called “protected cell,” their particular risks.
• Special Purpose Financial Captives: These entities are
typically created by large life insurers and reinsurers and are designed to allow capital markets to participate in risk through securitizations.
The captive insurance industry got its start in the 1950s and 1960s, and for years it was exclusively the province of offshore domiciles, particularly Bermuda. At one time, tax considerations were an important driver in the decision to form a captive and tax is indeed still relevant. However, other considerations have eclipsed tax as a driving rationale for the formation of a captive insurer. Nowadays, the primary motivation is often to obtain insurance coverages that are either not available through the traditional markets or too expensive. Entities participating in captive insurers may also enjoy a profit from coverages that can, in certain circumstances, be sold to non-affiliated third parties which are not participants in the captive.
Overseas domiciles, including Bermuda, Guernsey, Cayman Islands, Luxembourg, Barbados, and Ireland, have long been preferred locations to organize captives, while U.S. jurisdictions, most notably Vermont, have experienced significant growth over the last 15 years or so, in part due to changes in the tax code that have reduced the tax benefits formerly resulting from an overseas domicile.
“Okay, you have explained what captive insurance is, but you haven’t told me why I should care.”
By amending the statute, creating a special captives unit in the Insurance Department, and creating an industry association, Delaware is looking to capitalize on its well established reputation as a center for corporate and financial services. Although the new statute retains a number of features from its earlier form, the captives statute is, in fact, entirely rewritten. The following are some of its more noteworthy features:
Flexibility as to corporate entity:
• Captive insurers licensed in Delaware must keep their books and records in this state.9
• Captive insurers licensed in Delaware must maintain a principal place of business in Delaware.10
• Captive insurers licensed in Delaware must hold at least one board meeting each year in Delaware.11
• Captive insurers licensed in Delaware must maintain “minimum capital and surplus” (between $250,000 and $1,000,000 depending upon the type of captive) on deposit with a financial institution in Delaware, either in the form of cash, irrevocable letter of credit or securities approved by the Commissioner.12
• One member of the captive’s governing body (board of directors, managing partner, statutory trust trustee, etc.), must have principal place of business in Delaware.13
As is evident, most of these requirements lend themselves to banks that have the capability of providing services and facilities for captives, in much the same way that many Delaware banks have serviced the Delaware holding company industry here.
Many captives will be formed by entities, associations or industries with no experience in the insurance field, and this provides an additional opportunity for Delaware banks that service captives to become captive insurance managers. A captive manager acts as a clearinghouse to obtain and
coordinate services that a captive will need in order to conduct its business, including actuarial, accounting, investment management, and underwriting. One Delaware bank that is already heavily invested in this activity is Wilmington Trust. Brian Flinchum, Assistant Vice President – Captive Management, describes Wilmington Trust’s captive management business: “Captive insurance is a natural extension of the bank’s current entity management services. The main difference is that you must add staffing with insurance accounting knowledge as well as individuals with an understanding of the complex alternative/captive insurance market.” Flinchum states that Wilmington Trust was attracted to this business because “the captive insurance market is experiencing high growth, and our entrance into the market offers the bank a unique position as an institutional independent manager in the captive market. Currently, only 50% of Fortune 500 companies have captives, and as you move down to the Fortune 2000 companies, the number of firms with captives shrinks to 20%, so the market is still young enough to sustain many new entrants.” When asked about the opportunities for Delaware banks in the captive management arena, Flinchum stated that “in order to justify forming a single parent captive, the prospect will need at least a $1 million in premium. Regional and national banks are therefore best suited to offer captive management services since their client bases consist of many companies with gross revenues in excess of $250 million.”
(continued from p. 11)
Captive Insurance
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In addition to servicing captives, local and regional banks may find a number of advantages in forming a captive insurer to insure their own risks. Insuring a bank’s risks in a captive, as opposed to the conventional market, will allow a bank to structure its insurance programs to cover its unique exposures, rather than rely solely on the one-size-fits-all coverages available through traditional insurers. In this regard Flinchum points out that “regional and community banks between $250 million to $10 billion in assets are good candidates to form a small property and casualty company because banks of this size may be able to take advantage of beneficial treatment under section 831(b) of the Internal Revenue Code.” With the recent enhancements in Delaware’s captive insurance laws, the creation of a dedicated captives unit in the Insurance Department, and the formation of the Delaware Captive Insurance Association, Delaware is poised to become a major player in this industry. Thus, while captive insurance might not seem an area of natural interest to bankers, if this growth occurs as is anticipated, Delaware banks will enjoy a significant opportunity to provide services to new Delaware captives. A Delaware captive may also prove to be an excellent vehicle for Delaware banks to improve and tailor their insurance and risk management programs to their unique risk management needs.
MICHAEL W. TEICHMAN is a Director in the law firm of Parkowski, Guerke & Swayze, P.A.. Mr. Teichman practices in the areas of administrative and commercial law, with a concentration in the representation of insurance and financial institutions in regulatory matters, and commercial entities in matters involving Delaware en-vironmental and land use regulation. Mr. Teichman also represents Delaware financial institutions and corporate trustees in transactional matters and in litigation relating to the reformation of trusts, and frequently serves as special Delaware counsel in the preparation of Delaware corporate opinions. He may be contacted via email at: mteichman@pgslegal.com.
Footnotes 1 18 Del. C. § 6906
2 18 Del. C. § 6903(a)(2) (for association captives); 18 Del. C. § 6903(a)(3)
(for industrial insured captives).
3 18 Del. C. § 6903(a). 4 18 Del. C. § 6903(a)(8).
5 18 Del. C. § 6910(b). Association captives, risk retention groups and
special purpose captives are still required to comply with investment requirements applicable to conventional insurers under Chapter 13 of the Delaware Insurance Code.
6 18 Del. C. § 6910(d). 7 18 Del. C. §§ 6931 – 6938.
8 House Bill 214, signed into law on July 18, 2007 9 18 Del. C. § 6923. 10 18 Del. C. § 6903(b)(3). 11 18 Del. C. § 6903(b)(2) 12 18 Del. C. § 6905(c). 13 18 Del. C. § 6906(f).
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14 Delaware Banker - Fall 2007
Delaware Banker: What is captive insurance?
Richard Klumpp: Captive insurance is a form of self-insurance in which a company establishes and licenses a subsidiary to insure some of their risks rather than go to the traditional insurance market. The parent company pays its premiums to the captive insurance company not to a traditional insurer.
DB: Does the captive company assume all the risk, or do they have to obtain reinsurance?
RK: It would depend on what the coverage is as to how the parent wants to do it. They could decide to take the first $100,000 of risk, and their captive insurance company will do the next $1,000,000, and then add a reinsurance layer on top of that. They could do the reinsurance layer themselves, and go to the outside market for the first pieces. It varies depending on how a parent sees its program. A lot of companies will have traditional insurance, say for their directors’ and officers’ coverage. That might come into effect at a $2,000,000 deductible. So they might put the deductible in the captive. Or they might keep something to pay out of pocket, say the first $500,000, and then the next $1,500,000 in the captive, and then the traditional market on top of that. There are many variations. It just depends on the management’s needs.
DB: How have the recent revisions to Delaware’s captive insurance laws made it more advantageous?
RK: The initial revision completed in 2005 simplified things. It definitely simplified the tax structure at a straight 0.2 percent on the premiums, whereas in the past the number was much higher.
Other states have a graduated scale that goes backwards, starting at a higher rate and going to a lower rate as the premium increased. Delaware law set it at 0.2 percent, which makes it easier for small captives. It doesn’t penalize them for being small, unlike some other states. Also, the Delaware revisions cleared up some regulatory issues. The capital structures were reduced to make things more in line with the other domiciles. The statute itself was the first part of a three-legged program. First, a good statute was needed. On top of that a good regulator was needed, which was when Bill White (William P. White, administrator of Delaware’s captive insurance program) came in. And finally the Delaware Captive Insurance Association became the marketing arm of the State’s captive industry. Those three pieces together are what makes Delaware so strong.
DB: How would a Delaware bank benefit from captive insurance?
RK: The banks in Delaware could benefit in a couple of different ways, first from the service provider side. Captives need bank accounts, custodial accounts, there are wire transfers that go in and out that need to be done through a bank. There are trust services. The way a lot of captives are structured the capitalization piece requires what’s called a Reg 114 Trust, and a bank could serve as the trustee in that regard. So there are a lot of ways for banks to sell services to captives. At the same time, banks can take advantage of a captive to insure their risks. There’s a structure under the IRS code that allows an entity to set up an insurance company with up to $1.2 million in premiums to gain certain tax advantages. We at Wilmington Trust have helped other banks set up those types of structures. And in general, banks can take advantage of the basic benefit of a captive: instead of paying a premium to an insurance company, you’re paying it to yourself. If you don’t have any claims, you’re getting the benefit of that Richard Klumpp is responsible for managing all administrative and business operations for
Wilmington Trust SP Services, Inc. and its subsidiaries. These companies provide a wide array of nexus services to a variety of special purpose vehicles involved in either securitizations, structured finance transactions, corporate reorganizations, risk management, or financial planning strategies that take place domestically and in the Caribbean. Rich serves as director and officer for many high profile client companies. Rich joined Wilmington Trust SP Services in 1996 and spent four years leading Wilmington Trust’s Las Vegas, Nevada office prior to his current position. He holds a Juris Doctor from Widener University School of Law and earned a bachelor’s degree in Accounting, with a minor in Economics, from the University of Delaware. He received his Certified Public Accountant certificate in Delaware. Rich serves as a board member and president of the Delaware Captive Insurance Association and as a board member and treasurer of Ingleside Homes, Inc., a local non-profit organization that provides various care levels of retirement living to senior citizens. He is a member of the American Institute of CPAs, the Delaware Society of CPAs, the American Bar Association JD Division, and is an associate member of the Nevada Society of CPAs.
With: Richard F. Klumpp, JD, CPA
President, CEO, and Division Manager, Wilmington Trust SP Services, Inc.
President, Delaware Captive Insurance Association
premium dollar, investing it, rather than the insurance company benefiting.
DB: What are the risks for Delaware banks?
RK: The risks to Delaware banks are similar to what any bank would face. The risk is that you actually have a large claim and don’t experience the benefits of the captive for that insurance period.
DB: How would a bank go about forming a captive insurance company?
RK: There are a lot of risk consultants, or captive managers who help with feasibility studies. The first step would be conducting a feasibility study to determine: “will this work for me,” “what kinds of coverages do I want to insure,” “where should I establish this capitve,” and making sure that the pro forma financial statements as expected. After that step you would then go to formation, which would be submitting an application with the Department of Insurance. At the end of that process you’d receive your certificate of authority to do business, and start to write the premium.
DB: How stringent are the regulations on captive insurance, as opposed to those for banking?
RK: Captive insurance regulations are less complicated as compared with what most banks have to go through. You first meet with the regulators who validate the captive’s business plan
and make an assessment of it’s financial soundness. They make sure that what you’re doing is insurance. After that and the initial licensing, you probably wouldn’t meet with the regulators until the next year when its time to file the annual statements. There’s a biannual audit of the captive that you would go through with the regulators. That’s generally a one-person, desk audit situation.
DB: And that’s state regulation?
RK: Yes, the State Department of Insurance. And when setting up a captive, that’s something that people look at – how the Department of Insurance is set up in Delaware. Many states will regulate captives as a commercial insurance company, which is a completely different set of rules and expectations. Delaware definitely views those two as separate and distinct, and the captive insurance business is regulated by a separate arm of the Department of Insurance. The regulatory process for a captive is less complicated than for a commercial insurance company.
DB: Does setting up a captive insurance company allow easier entry into the re-insurance market, and what sort of savings does this provide?
RK: Yes, you can go to reinsurance markets directly through a captive which is something you can’t do as a non-insurance company. Just having that direct ability saves you money. You also can determine how much reinsurance you want and can shop
continued on p. 16
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the premium. So you can go out to the different reinsurance intermediaries and they will help guide you to the various reinsurance companies, and help negotiate the rates.
DB: Can captive insurance companies accept third-party business, or are they bound exclusively to their parent?
RK: A captive can write third-party business. There are a lot of captives set up in different industries – auto dealers, for instance, do a lot of their warranty work through captives, and that’s a third-party to the end buyer of the car. That extended warranty that a car buyer will purchase is done through a captive. One reason for a bank to set up a captive would be for Private Mortage Insurance (PMI). Instead of using a traditional carrier they could write the mortgage insurance through its captive. Workers compensation is another example of third-party business through a captive.
DB: What cash flow benefits and actual reduction of insurance costs are available through captive insurance?
RK: Your premiums are based on your loss history, versus the market’s loss history. If you have a good loss history then you’ll have lower premiums. So it will reduce your insurance costs from that perspective. From the cash flow perspective, you’re paying
yourself the premium. If you don’t have claims, that money stays within your consolidated group. The investment income is credited to you, versus paying that premium to the insurance company and never seeing it again.
DB: How can captive insurance programs improve risk management?
RK: Since you’re insuring yourself, and you benefit from that low claims history for not having claims, we actually see companies whose risk management is enhanced. They’ll spend more time and effort to ensure there are no claims, rather than taking the attitude that: “I have to pay the insurance company the money anyway. I’ll never see it again.” With captive insurance you are the insurance company. The fewer claims you have, the more money that stays within your group.
DB: What are the tax advantages of captive insurance?
RK: In a number of instances you can get immediate deductibility of the premium you pay. In cases where you self-insure you wouldn’t get a tax deduction until the claims actually occurred. And then the 831(b) captive gives you the opportunity to insure up to $1.2 million in premium and get a federal tax deduction for that.
continued from p. 15
DB
P
ARKOWSKI,
G
UERKE
&
S
WAYZE,
P.A.
PGS
PGS
A T T O R N E Y S A T L A WDover - (302) 678-3262 Wilmington - (302) 654-3300 email: pgs@pgslegal .com www.pgslegal.com
Building Bridges between the
Financial Services Industry
and Government
A business-focused law firm
with emphasis in the areas of...
FHLB of Pittsburgh
Delaware Banker - Fall 2007 17
I
t was 1932, and The Great Depression was taking a heavytoll. More than a quarter of Americans were out of work. A quarter million homebuyers lost their mortgages. Nine million banking customers saw their savings accounts go up in smoke. And thousands of banks collapsed.
Reacting, President Herbert Hoover first pushed for establishment of the Reconstruction Finance Corporation to shore up commercial credit at local financial institutions suffering a crisis of public confidence, and to bolster liquidity for railroads, agriculture, local government and other types of community infrastructure.
Parallel to enactment of the RFC, Hoover began pressing Congress for action to reduce home loan foreclosures and support the reemergence of widespread homeownership. When Congress passed The Federal Home Loan Bank Act and chartered a network of region-responsive FHLBanks, it breathed new life into savings and loan associations and mutual savings banks, setting the stage for a constant stream of low-cost funding for mortgage lending.
Providing ready, low-cost liquidity to our owner-member financial institutions in all economic cycles was, and is, the FHLBanks’ core mission. From the time we opened our doors in the fall of 1932 to 1989, when Congress enacted the Financial Institutions Reform, Recovery, and Enforcement
The Federal Home Loan Bank of Pittsburgh
Continues to Serve Homebuyers
and Members
Act (FIRREA), FHLBank Pittsburgh and its eleven sister banks around the country supported a residential lending industry that served Americans through wartime, a postwar building boom, the Baby Boom and into the Internet Era. With enactment of FIRREA, Congress expanded the FHLBanks’ historic mission of ensuring funds for homeownership to include affordable housing and – of equal importance – allowed commercial banks to become FHLBank members. For FHLBank Pittsburgh, FIRREA signaled a new found ability to serve virtually every local lender across our footprint of Delaware, Pennsylvania and West Virginia, enabling us to progress from a $5 billion institution to one more than 16 times that size today. Post-FIRREA, a very large percentage of the banks eligible to belong to our cooperative decided to do so.
As the Clinton Era drew to a close, Congress again expanded the mission of the FHLBanks, giving us the green light to help community lenders make small business loans bankable. Today, with more than 8,100 owner-members nationwide and $641 billion in low-cost loans (advances) at year-end 2006, the nation’s FHLBanks provide financing that helps millions of homebuyers, small businesses and families realize their big dreams.
Still Opening
Doors After
75 Years
by John R. Price
President & CEO
Federal Home Loan Bank of Pittsburgh
18 Delaware Banker - Fall 2007
(continued from p. 17)
FHLB of Pittsburgh
is the equivalent of the largest stand-alone housing foundation in the country.
Special Announcement
I am also pleased to use this opportunity to announce that FHLBank Pittsburgh will launch a new program in 2008 aimed at fostering sustainable economic development in a variety of Delaware’s neighborhoods and counties. This new initiative, Blueprint Communities, will provide selected revitalization teams representing the public, private and nonprofit worlds with comprehensive training in leadership, capacity building and strategic planning – underwritten by FHLBank, and setting the stage for these communities to get their “second wind” and qualify for additional funding and technical assistance through program partners. Blueprint
Communities has proved adept at crystallizing revitalization
plans in 32 communities in Pennsylvania and West Virginia. Now it is Delaware’s turn. We stand ready to execute a first-rate economic development program on behalf of our Delaware members and the neighbors they serve.
From bust to boom and from recession to downtown renaissance, the FHLBanks of America have demonstrated remarkable adaptability and resilience. By doing the work that Congress chartered us to do 75 years ago and building upon that important mission in new and exciting ways, we continue to play a unique role in meeting the needs of local lenders. It’s a partnership that works, and one that works wonders for communities, too.
Let’s make our next 75 years together just as special.
“Mortgage Partnership Finance®” is a registered trademark of the Federal Home Loan Bank of Chicago.
John Price is president and chief executive officer of the Federal Home Loan Bank of Pittsburgh. Mr. Price graduated from Grinnell College in Iowa, was named a Rhodes Scholar, earned advanced degrees in development economics and diplomatic history at Oxford University and received his law degree from Harvard Law School.
During the first Nixon Administration, he served as special assistant to the President for urban affairs, working on welfare, health insurance and urban development.
He then spent 29 years at what is now JP Morgan Chase in New York. Immediately prior to joining FHLBank, Mr. Price was senior advisor to the Institute of International Finance in Washington, DC, a global organization with some 340 banks and Central Banks as members.
What’s Next?
As FHLBank Pittsburgh and the entire System celebrate our 75th Anniversary, we can look back on the past with
satisfaction. For example, in the First State, we have provided more than $9.1 billion in low-cost liquidity to our local members, have extended more than 1,000 grants totaling approximately $4.6 million to lower-income first-time homebuyers, and contributed more than $6.6 million in Affordable Housing Program grants to help fund 1,073 units of low- and moderate-income housing encompassing 40 projects – all in Delaware.
More important, however, is the need to fix our eyes firmly on the future. For the fact is, just as the role of the FHLBanks has changed, so has competition across the banking industry. These days, success in the marketplace not only requires intricate knowledge of customers but a variety of customer retention tools, access to flexible funding options and an even stronger commitment to the community.
How can FHLBank best help its Delaware members succeed in this challenging environment?
This year, as we celebrate our founding, FHLBank Pittsburgh is taking the following actions in the First State to add even more value for our members. We are:
• Restructuring the pricing on our advances to make them even more market-competitive;
• Expanding the collateral that we accept for advances; • Introducing Modicus®, our free software to provide members with additional flexibility in analyzing various advance funding strategies – helping them to better manage their risk, make more effective funding decisions, and engage in more informed use of our credit products; • Gaining near-universal acceptance of a wide range of online transactions through our expanded members-only Web site, Bank4Banks®.com;
• Continuing to offer a secondary mortgage market alternative via our Mortgage Partnership Finance® Program;
• Extending $7 million this year through our very popular Banking On Business Program, providing much-needed capital for small business startups or expansion; and, • Putting forth a record amount of grants as part of the System’s Affordable Housing Program, an initiative that
In Wilmington, Financial Partnerships Build Better Neighborhoods
To see what some of the First State’s neighborhoods might look like in the future as a result of their participation in the new Blueprint Communities initiative (see main article), one only needs to review the success of revitalization efforts in Wilmington’s West End.
Working with Cornerstone West – a community development corporation established in 1999 in concert with West End Neighborhood House, St. Francis Hospital and other community leaders – FHLBank and local members embraced Cornerstone’s mission of revitalizing the West End by targeting substandard housing, blight and low rates of homeownership. By addressing these interrelated issues, Cornerstone and its partners created a quiet but very visible renaissance in community stability.
One neighborhood – Hilltop – is a microcosm of Cornerstone’s work. Over the past five years, Cornerstone and its financial partners – FHLBank, Artisans’ Bank, Citizens Bank, Citicorp Trust Bank and Wilmington Trust – have helped fund the rehabilitation or construction of dozens of affordable housing units, part of more than 80 units of affordable housing that Cornerstone has spearheaded. Eyesores were demolished, vacant lots brought to life, population density reduced and first-time, low-income homeownership opportunities created.
For the 55-block area known as Hilltop, the changes were both radical and welcome. The Hilltop Neighborhood Working Group, a community and government partnership endorsed by Mayor James Baker, cracked down on drug corners, filled potholes, collected trash and improved lighting, adding elements of community stability and making the neighborhood more appealing. As a result of successes in Hilltop and other West End locations, Cornerstone can point to some dramatic community improvements:
Homeownership rates have soared to 100 percent in some locations, with the current increase in overall homeownership
standing at 44 percent.
Property values and the average sales price for homes in certain developments have risen by more than 100 percent. Hundreds of homebuyers have received valuable counseling on homeownership at West End Neighborhood House. Private developers have invested another $5.5 million in targeted areas.
There is more to come - On September 24, 2007 Cornerstone West Executive Director Paul Calistro, Jr., announced that FHLBank is making another affordable housing grant in the West End, this one a $150,000 grant for much-needed owner-occupied residential rehabilitation in Hilltop, Little Italy and Cool Spring. Both elderly and disabled homeowners will benefit, and JPMorganChase is contributing another $100,000 to the effort.
“We simply cannot accomplish our mission without the support of a variety of public and private partners,” said Calistro, a member of FHLBank’s Affordable Housing Advisory Council. “Long-range planning, expert know-how and the commitment of partners who believe in creating holistic change all drive a community’s success. We believe what we have accomplished in the West End in a relatively short period is a model that other Delaware communities can follow.”
20 Delaware Banker - Fall 2007
On-Line Resources
Our New Place
in Cyberspace!
W
hile the original Delaware BankersAssociation website (www.debankers. com) may not have actually been hand chiseled on to stone tablets, at times, the staff was beginning to feel as if it had. Technologically the old site was a few steps ahead of Fred Flintstone’s newspaper, but as the years went by, it became increasingly difficult to provide members with the latest information in a timely fashion. The first DBA website was created way back in the heady dot.com days of 1998, with an updating in 2001. While these sites served their purpose at the time, the greatest difficulty was that the control of a majority of the content rested, not in the hands of the DBA, but in their internet service provider (ISP). This meant that, except for a relatively few places on the site, any time the site needed to be updated, the ISP had to do so, and at a rather hefty cost. By 2006 the DBA staff realized that they needed a new website, particularly one that they could control...a case of being “webmasters” of their own domain name, so to speak. Susan Highfield, Margaret Cregan, and Greg Koseluk of the DBA worked closely with Eric Hutts, of Associate Member HostMySite.com. Eric recommended various software packages and generally was there to answer any questions to guide the DBA through the more unfamiliar regions of cyberspace. The new site went live in September, and is now available for your inspection, and hopefully your use. Some of the website’s new feature are illustrated here.
DB
302-576-9600
Serving banking and financial institutions internationally
www.delawarecounselgroup.com
A Certified Women-Owned Business - State of Delaware
Admitted to Membership in the National Association of Minority & Women-Owned Law Firms
A Matter of Trust
by
Aaron Fox
Trust Officer
The Goldman Sachs Trust Company
of Delaware
“There is little
doubt that the trust
investing world
has significantly
changed in the last
decade...”
Alternative investment partnerships also
present state fiduciary income tax
considerations because their underlying
investments are not transparent to the
investor. Investment activity within
these vehicles may cause “source
income” to be generated in certain
jurisdictions, which those jurisdictions
will then attempt to use as the nexus to
impose fiduciary tax liability where they
otherwise would not.
There is little doubt that the trust
investing world has significantly
changed in the last decade and a prudent
trustee is now practically forced to
consider these types of investments in
most situations. However, before
jumping into these more exotic
investment vehicles, it is important to
be certain our clients understand the
implications, risks, and possible
consequences.
Aaron Fox serves as Trust Officer for the Goldman Sachs Trust Companies. Aaron joined Goldman Sachs in January 2005. Prior to joining the firm, he was a Senior Trust Officer at The Glenmede Trust Company, N.A., in Philadelphia, Pennsylvania. He also served as an Estate Settlement Officer at Glenmede and was a member of its Philanthropic Advisory Services Team. Aaron graduated with a B.A. from Rutgers University and a J.D. from The Villanova School of Law. He is a member of the Philadelphia Bar Association.
Opinions contained herein are those of the author and do not necessarily reflect the views of Goldman, Sachs & Co., The Goldman Sachs Trust Company, N.A. or any of its affiliates.
T
rust investing used to be easy. It
was simply a matter of buying a
few investment grade bonds and
sprinkling in some large-cap, blue-chip
equities. However, with the increased
popularity and accessibility of hedge
funds, private equity vehicles,
structured products, and real estate, a
Trustee is now faced with enormous
choices (and responsibilities) when it
comes to fiduciary investing.
One of the first things a trustee will be
faced with is the allocation of principal
and income derived within these
modern investment vehicles. Whereas
a dividend from a common stock or
interest from a debt security is easily
recognizable as belonging to the income
beneficiary, a partnership distribution
from a hedge fund cannot be
categorized as easily. It is common for
these distributions to include a partial
return of principal, which would not
normally be allocated to the income
beneficiary. Further, the K-1 that is
generated from these vehicles often
does not arrive until the middle of the
following year, forcing the trustee to
allocate the entire distribution to
principal until the K-1 can be reviewed.
Additionally, hedge funds and private
equity funds are usually illiquid and
often require the investor to commit to
a fixed time frame before they can be
redeemed. Because the needs of the
beneficiaries can change quickly, these
constraints may prevent the trustee from
acting expeditiously under shifting
circumstances.
The Increasingly Complex World
of Trust Investments
www.pepperlaw.com
Berwyn | Boston | Detroit | Harrisburg | New York | Orange County | Philadelphia | Pittsburgh | Princeton | Washington, D.C. | Wilmington
You Are at Risk
You’ve probably seen the headlines. Major financial institutions in Delaware and around the nation have
been sued by professional employees seeking overtime under the Fair Labor Standards Act.
Don’t be next. Our FLSA audit is designed to assist banks and other financial services employers assess legal
risks and vulnerabilities today, so that you can avoid or defeat FLSA claims tomorrow.
For more information, contact Richard P. Eckman at 302.777.6560, Christopher Lamb at 302.777.6548 or
Sean P. McDevitt at 302.777.6516, or e-mail phinfo@pepperlaw.com.
DBA Calendar of Events
Get timely information over your computer with DBA Web & CD Seminars. The sessions are generally from 2:30 to 4:30 pm ET. The registration fee allows you access to one website “seat,” one site license and all hand out materials. Webinars are live and allow time throughout for questions and answers. Or purchase seminars on CD for multiple uses at your convenience. For more information, or to register, please click on the web seminars link at www.debankers.com. SEMINARS
November 2007
November 1 - Fair Credit Reporting Act
Frequently Asked Questions
November 2 - Mortgage Lending
Part 1
November 6 - Managing a Successful
Branch - Part 1
November 8 - Complying with RESPA’s
Section 8 Rules
November 9 - Mortgage Lending
Part 2
November 13 - Truth in Lending: Home
Equity Lines of Credit
November 15 - Managing a Successful
Branch - Part 2
November 16 – Commercial Loan
Documentation – Part 1
November 19 – Commercial Loan
Documentation – Part 2
November 28 – Conducting Background
Investigations 2007 December 2007
December 3 – Introduction to
Commercial Lending Part 1
December 10 – Introduction to
Commercial Lending Part 2
December 13 – Lending Compliance
Update
December 20 – RESPA – Frequently
Asked Questions
For more information on these and other programs visit www.debankers.com,
or phone the DBA at 302-733-7452, or email: debankers@debankers.com
2007
Tuesday, November 27 – Education Committee Meeting – Noon
Wednesday, November 28th – Friday November 30th – 2007 Delaware Trust Conference - Hotel du Pont, Wilmington, DE. – Join trust professionals from all over the country and Europe to Experience the Center of the Trust Universe to learn the latest updates and information about personal and corporate (statutory) trusts in Delaware. This “Delaware only” information is not available any place else in the country! Details and registration information is available at the DBA’s website (www.debankers.com). Excellent sponsorship opportunities available!
Wednesday, December 5th - Regulatory Compliance Committee Meeting – New Castle County - 10:00 – noon, Scot Stetka at Barclays Bank Delaware, host. All DBA Compliance professionals are invited to attend this open forum meeting.
2008
Wednesday, February 6th – Regulatory Compliance Committee Meeting – Sussex County. The meeting will be held from 10:00 until noon. All DBA Compliance professionals are invited to attend this open forum meeting.
Friday, February 8th - Trust Committee Meeting – New Castle County. The meeting will be held from 9:00 to 11:00. All DBA Trust professionals are invited to join their colleagues at this open forum Trust Committee meeting.
Monday, March 3rd – Friday, March 7th – Cannon Personal Trust II School in Delaware – 8:30 – 4:30 Daily. Attention Personal Trust Professionals! Now you don’t have to leave the State to go to the nationally acclaimed Cannon Trust School!! Due to the number of trust professionals in Delaware, we have made arrangements to have Cannon come here. This school is for anyone who has completed Cannon Personal Trust I. This is a great way to get the education you want and need without leaving home for a week! Daniel Smith II of Cannon will be teaching the course. Early Bird registration discounts available until December 31st!
Wednesday, March 5th – Friday, March 7th – DBA Executive Officer Visit to Washington, DC. This highly acclaimed event for top-level bank executives provides an extraordinary opportunity to meet with the key regulators at the Federal Reserve, FDIC, OCC, & OTS as well as with our industry’s representatives at the American Bankers Association in Washington, DC. In addition, we also meet with the entire Delaware Congressional Delegation. At all of the meetings DBA participants can personally ask these top Washington movers and shakers questions on issues important to our industry. This year DBA participants will be staying at The Hay Adams Hotel located at Sixteenth & H Streets, NW Washington, DC 20006. For more information call 302-678-8600.
Real Estate Law Update
the borrower’s sole member and controlled by the two guarantors. The proceeds were subsequently divided and transferred to separate accounts maintained for the benefit of the guarantors. The lender was never notified of the $2 million settlement, which the borrower’s financial statements reflected as a reduction in basis and a transfer to the borrower’s member.
The Court concluded that the zoning appeal and the $2 million settlement payment were part of the “Mortgaged Property” as broadly defined in the mortgage’s granting clauses, rejecting the borrower’s position that the transfer restriction in such granting clauses only pertained to the real estate. In so holding the Court noted that maintaining the value of all of the mortgaged property was “crucial in the context of a nonrecouse loan because the mortgaged property is the only source of repayment in most default situations.” Id. at 379-380. By transferring the mortgaged property without the lender ’s consent, borrower defaulted under the loan agreement, triggering application of the default interest rate and the “bad boy” carve-outs, resulting in liability for both the borrower and the guarantors in what would have otherwise been a nonrecourse loan.
The lesson for borrowers to take from this case is that the “carve-out” “nonrecourse” CMBS loans may more easily become recourse than they even thought they could. Unless borrowers can tighten the carve-out clauses, the “nonrecourse” advantage of conduit financing over traditional bank loans may be nonexistent in many cases.
Cheryl Santaniello is an attorney in Young Conaway’s Commercial Real Estate Banking and Land Use section. Ms. Santaniello represents both lenders and borrowers in mortgage loan transactions involving acquisition and construction financing, permanent financing and revolving credit facilities. She also represents landlords and tenants in drafting and negotiating commercial leases and represents buyers and sellers in drafting and negotiating commercial agreements of sale.
In Blue Hills Office Park LLC v. J.P. Morgan
Chase Bank, as Trustee for the Registered Holders of Credit Suissee First Boston Mortgage Securities Corp., Commercial Mortgage Pass-Through Certificates, Series 1999-C1, and CSFB 1999-C1 Royall Street, LLC, 477 F. Supp. 2d 366 (D. Mass. 2007), a
borrower’s decision to settle a zoning appeal and transfer the $2 million settlement proceeds to the sole member of the borrowing entity, without the lender’s consent or approval, triggered “bad boy” exception to the nonrecourse nature of a nonrecourse securitized commercial real estate loan, resulting in foreclosure and a $17.5 million full recourse judgment against the borrower and its individual guarantors.
In Blue Hills, the loan, as well as the guaranty of the individual guarantors, had full liability carve-outs for certain events of default, including transfer of the mortgaged property without consent and the failure of the borrower to maintain its status as a single purpose entity. “Mortgaged Property” was broadly defined in the underlying mortgage to include the real estate together with numerous other rights and privileges contained in several pages of “granting clauses”.
Borrower’s troubles began when it received notification that its sole tenant would not be renewing its lease and planned to move and purchase the building on a neighboring lot, upon the condition that its neighboring owner obtain a special permit from the zoning board to construct a parking garage. The borrower appealed the determination of the zoning board granting the special permit with the hope that its only tenant would reconsider its decision to move if it were unable to obtain the requisite zoning approvals. The borrower shortly thereafter settled the zoning appeal by receiving $2 million from the adjoining property owner in exchange for borrower’s waiver of all further rights of appeal. The borrower never notified the lender of the appeal or obtained its consent to the settlement. The $2 million in settlement proceeds was initially wired to a client account maintained by borrower’s law firm, held in the name of
A Happy Ending for Lender & Its Counsel
“Bad Boy” Carve-Outs Enforced Resulting In $17.5 Million Judgment
26 Delaware Banker - Fall 2007
