New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

George E. Pataki
Governor

Gregory V. Serio
Superintendent

The Office of General Counsel issued the following opinion on October 20, 2004, representing the position of the New York State Insurance Department.

RE: CAPCO

Questions Presented:

1) Is the payment of a commitment fee by AB Capital, the ultimate parent of XYZ II, to investors in XYZ II permissible?

2) May XYZ II use its non-certified capital to purchase the payment undertaking agreement if the cost of such agreement and insurance exceeds 35% of certified capital?

3) May AB Capital (or another party contributing non-certified capital to XYZ II) contribute additional equity capital to XYZ II to pay any closing costs that exceed 5%?

4) Does the structure of XYZ II’s offering comply with the CAPCO statute’s limitations regarding payment undertaking agreements?

5) Does the structure of XYZ II’s offering comply with the CAPCO statute’s prohibition against insurance company management of a CAPCO?

Conclusions:

1) Yes, the payment of a commitment fee by AB Capital, the ultimate parent of XYZ II, to investors in XYZ II is not prohibited by the CAPCO statute.

2) Yes, XYZ II may use its non-certified capital to purchase the payment undertaking agreement if the cost of such agreement and insurance exceeds 35% of certified capital.

3) Yes, AB Capital (or another party contributing non-certified capital to XYZ II) may contribute additional equity capital XYZ II to pay any closing costs that exceed 5%.

4) Yes, the structure of XYZ II’s offering complies with the CAPCO statute’s limitations regarding payment undertaking agreements.

5) Yes, the structure of XYZ II’s offering complies with the CAPCO statute’s prohibition against insurance company management of a CAPCO.

Facts:

XYZ II has applied to the Department for certification as a certified capital company for CAPCO Program 4. XYZ II is an indirect subsidiary of AB Capital. AB Capital is the parent company of six other CAPCO program participants that participated in CAPCO Program 3. In each of these programs, ABC Capital has raised certified capital from certified investors utilizing a substantially similar debt offering, transaction structure and documentation, modified to conform as needed to the Program’s applicable statutes and regulations. The following representations were made regarding the proposed operation of XYZ II as part of CAPCO Program 4.

Limitation of Payment Undertaking Expenditures

XYZ II’s note will repay certified investors with both a stream of premium tax credits earned through the CAPCO program, and a stream of cash payments. Together, these streams satisfy the CAPCO’s obligations under the note in full. XYZ II intends to purchase a payment undertaking agreement that will make the stream of cash payments under the notes to XYZ II’s certified investors. Market pressures will dictate the yield that XYZ II offers on the notes and, thus, the amount of the cash payment stream.

XYZ II may offer a form of non-certified capital compensation to investors in the form of a "commitment fee" to be paid by AB Capital, the ultimate parent company of XYZ II. This commitment fee would be paid directly to investors by AB Capital out of AB Capital’s existing working capital and will not utilize any certified capital or any funds raised by XYZ II, nor would it become a part of the payment undertaking agreement.

Structure of the XYZ II Offering

With respect to the structure of the transaction, XYZ II anticipates that INSURER A will be a certified investor of XYZ II. Although INSURER A itself will not provide a payment undertaking agreement nor any form of guaranty or insurance policy, affiliates of INSURER A will do so as follows:

Only the affiliates of this one certified investor – INSURER A – will provide these instruments. No other certified investor or any affiliate of any other certified investor in XYZ II will provide any form of payment undertaking agreement, insurance policy or guarantee.

Insurance Company Management Restrictions

In XYZ II’s offering structure, the only input by an insurance company subject to taxation under Article 33 of the N.Y. Tax Law is the input from National Company, as XYZ II’s insurer. As a condition to issuance of the insurance policy, National Company and Finance LLC (counter-party to the payment undertaking arrangement) require documentation to ensure that all certified capital that gets invested will be invested in qualified investments, as permitted by the statute. Neither entity will have any authority or discretion over the making of qualified investments. Furthermore, neither company will express any opinion regarding the making of qualified investments. Finally, neither company has any restrictions governing the types of qualified investments that XYZ II may make, provided that such investments are in fact qualified investments.

An independent trustee, Bank Inc. makes the singular determination as to whether the proposed investment constitutes a qualified investment. The funding process is as follows:

This documentation is intended to ensure that Finance LLC’s role is limited to contractual obligations that permit an insurance company (or in this case, an affiliate) to monitor "compliance with section eleven" or to "disallow any investments that have not been approved by the superintendent." XYZ II’s contractual obligations essentially mirror this language.

Analysis:

The recent amendment of the CAPCO statute, which provided for the addition of Program 4, also featured substantive changes to the law, specifically including: the imposition of a limit on payment undertaking arrangements; the imposition of a 5% cap on the use of certified capital for closing costs and expenses; the introduction of additional requirements relating to the making of qualified investments; the addition of the definition of the terms "net profits" and "start-up business;" the amendment of the definition of the term "qualified business;" the introduction of limitations on certified investors with respect to the provision of guaranties, indemnities, bonds or other payment undertakings for the benefit of a CAPCO’s certified investor; the adjustment of certain of the requirements for continuance of certification; and the introduction of the requirement for the sharing of a portion of CAPCO’s net profits with the state. The amended provisions of the CAPCO statute relevant to the inquiries are as follows:

(9) "Qualified distribution" - any distribution or payment to a certified capital company in connection with the following: (A) Reasonable costs and expenses of such equity holders incurred by such equity holders in connection with forming, syndicating, managing and operating the certified capital company, including

* * * *

(iii) with respect to program four and any subsequent program, all payments by the certified capital company in satisfaction of its indebtedness to its certified investors, provided that no more than thirty-five percent of such certified capital company's certified capital may be used to purchase U.S. treasury securities, other investment-grade securities, a guaranty, indemnity, bond, insurance policy or other payment undertaking, or any combination thereof; and provided further, that nothing in this provision shall be construed to limit a certified capital company from expending non-certified capital in satisfaction of such indebtedness; and (iv) with respect to program four and any subsequent program, the reasonable costs and expenses of forming, syndicating, or organizing the certified capital company, separate from the costs of insuring or defeasing the obligations of the certified capital company, provided, however, that such costs and expenses shall not exceed five percent of the certified capital company's certified capital…

N.Y. Tax Law § 11(a)(9)(A)(iii) & (iv), as amended by Part D, Ch.59, L.2004.

(10) A certified capital company may obtain a guaranty, indemnity, bond, insurance policy and/or other payment undertaking for the benefit of its certified investors from any entity; provided, however, that, in no case shall more than one certified investor of such certified capital company or affiliates of such certified investor be entitled to provide such guaranty, indemnity, bond, insurance policy and/or other payment undertaking in favor of the certified investors of the certified capital company and its affiliates in this state.

N.Y. Tax Law § 11(b)(10), as amended by Part D, Ch.59, L.2004.

(7) No credit shall be allowed in any tax year in which the taxpayer shall, individually or with or through one or more affiliates, be a managing general partner of or underwrite or control the direction of investments of a certified capital company for which the credit was allowed under paragraph one of this subdivision. This provision shall not preclude a certified investor, insurance company or any other party from exercising its legal rights and remedies (which may include interim management of a certified capital company) in the event that a certified capital company is in default of its statutory obligations or its contractual obligations to such certified investor, insurance company or other party or from monitoring the certified capital company to ensure its compliance with section eleven of this chapter or disallowing any investments that have not been approved by the superintendent pursuant to subparagraph (D) of paragraph one of subdivision (c) of such section eleven. For purposes of this paragraph, affiliate shall mean a business entity in which the taxpayer holds at least a ten percent beneficial interest.

N.Y. Tax Law § 1511(k)(7), as amended by Part D, Ch.59, L.2004.

The inquiry seeks confirmation that XYZ II’s operations are, as described above, in compliance with the CAPCO statute as amended. The specific concerns are addressed below.

1. Commitment Fee

Nothing in the CAPCO statute prohibits the payment of a commitment fee out of non-certified capital by the ultimate parent company of XYZ II. Accordingly, such a fee may be offered to potential investors in XYZ II to entice them to invest in the XYZ II fund.

2. Contributions of Capital to Payment Undertaking Agreement

It was noted that XYZ II may have to offer a yield on its notes that requires a payment undertaking agreement that (together with insurance policy costs) will exceed 35% of certified capital. The exception language was cited from N.Y. Ins. Law § 11(a)(9)(iii) ("nothing in this provision shall be construed to limit a certified capital company from expending non-certified capital in satisfaction of such indebtedness") in support of the position that XYZ II may utilize non-certified capital contributed by AB Capital toward the purchase of the payment undertaking agreement in the event that the cost of the payment undertaking agreement and insurance policy exceeds 35% of certified capital. This is a logical interpretation of the statute, and not inconsistent with the apparent legislative aim of the 35% limit, i.e., ensuring that certified capital is used chiefly for the making of qualified investments as opposed to the repayment of the CAPCO’s investors.

3. Payment of Expenses

The propriety of using non-certified capital toward the payment of costs and expenses that exceed 5% was also inquired about. This would be acceptable in that, as in Item 2 above, it is consistent with the aim of limiting the expenditure of certified capital for non-qualified investment purposes.

4. Offering Structure – Payment Undertaking Agreements

As noted above, N.Y. Ins. Law § 11(b)(10) permits one certified investor or affiliates of the certified investor to provide a payment undertaking agreement, guaranty and/or insurance policy to a CAPCO. In the case of XYZ II, it appears from the description that only affiliates of one certified investor (INSURER A) will be providing any form of payment undertaking agreement, insurance policy or guarantee. Accordingly, the structure as described complies with the CAPCO statute.

5. Offering Structure – Management Restrictions

Section 1511(k)(7) of the New York Tax Law prohibits certified investors (insurance companies) from exercising any management control over the investments of a CAPCO. Based on the description of the transaction, it appears that Bank Inc. is the entity that determines whether proposed investments are certified investments, not National Company or Finance LLC. Furthermore, Finance LLC’s role appears limited to contractual obligations that permit the monitoring of "compliance with section eleven" or the "disallowing [of] any investments that have not been approved by the superintendent," which are activities expressly permitted under Section 1511(k)(7) as amended. Accordingly, the structure as proposed comports with the CAPCO statute.

For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.