February 11, 1999

Re: Guaranty of Loan to ESOP

Dear M ________:

This is in response to your letter of October 26, 1998, regarding the guaranty by (the “Bank”) of a loan made to the trustees (the “Trustees”) of the Bank’s employee stock ownership plan (the “ESOP” or “Plan”).

As we understand it, the circumstances are as follows:

The Bank has established an ESOP for the benefit of its employees. The agreement establishing the ESOP provides that, pursuant to the direction of a committee appointed by the Bank to administer the Plan, the Trustees of the ESOP shall invest assets of the Plan primarily in shares of the common stock of the Bank. The Trustees have made such purchases with funds borrowed by the Plan from Bank of ________ (the “Acquisition Loan”). The Bank guaranteed the Acquisition Loan.

In our view, the Bank violated Section 3359 of the Financial Code by guaranteeing the Acquisition Loan.

Section 3359 provides in pertinent part as follows:

“3359. . . .

(b) No bank shall acquire, hold, extend credit on the security of, or extend credit for the purpose of acquiring or carrying, any security of the bank or of any controlling person of the bank.

(c) . . .

(2) Any bank which extends credit in violation of this section shall be liable to the people of this state for twice the amount of the credit so extended. . . .”

A guaranty constitutes an extension of credit by the guarantor to the person whose credit is guaranteed. (See e.g., Financial Code Section 3371(d) which, by incorporating the definition of “extension of credit” in Regulation O, defines that term as including issuance of a standby letter of credit or similar arrangement. (See 12 C.F.R. § 215.3(a)(3)). It, therefore, appears that the Bank violated Financial Code Section 3359(b) by guaranteeing the Acquisition Loan, which funded an acquisition of the Bank’s securities.

Please have the Bank advise us not later than February 26, 1999, of what, if any, action it has taken to correct this matter.

We note that subdivision (d) of Section 3359 specifies certain transactions to which the prohibitions in Section 3359 do not apply. None of these exceptions apply to the present case. We are mindful that Paragraph (3) of subdivision (d) makes Section 3359 inapplicable to any acquisition by a bank of any of its shares if the acquisition is approved in advanced by Commissioner. This exclusion comes into play only in the event a bank acquires its own shares. It does not apply when a bank extends credit to others for the purpose of acquiring the bank’s shares. Accordingly, this exception would not provide a means by which the Bank could, in the future, guaranty loans to its ESOP for the purpose of acquiring the Bank’s stock.

If you have any questions, please feel free to contact me at (415) 263-8512.

Very truly yours,

Acting Commissioner of Financial Institutions


Senior Counsel


bcc: D. Abella
J. Carrig
W. Thompson

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Last updated: Jun 27, 2019 @ 3:37 pm