Monday, November 17, 2008
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The public company Securities Purchase Agreement (the “Agreement”) provides the standard terms for the TARP Capital investment for public companies.  We address some of the most important sections of the Agreement, especially those that we believe are of particular interest to community banks or that significantly clarify the term sheet.

Recitals

The recitals to the Agreement contain two provisions that not only highlight the intent of the TARP Capital Program but also make clear what the Treasury expects from a company that receives TARP Capital.

WHEREAS, the Company agrees to expand the flow of credit to U.S. consumers and businesses on competitive terms to promote the sustained growth and vitality of the U.S. economy;

WHEREAS, the Company agrees to work diligently, under existing programs, to modify the terms of residential mortgages as appropriate to strengthen the health of the U.S. housing market;

The recitals do not form binding obligations on participating companies, and these provisions are not repeated in the binding terms contained later in the Agreement.  Moreover, subsequent guidance from the Treasury and the federal banking regulators makes clear that all banks are expected to undertake these actions, not just those that receive TARP Capital.

Article I – Purchase; Closing

Section 1.2(d) provides the closing conditions for the completion of the TARP Capital investment.

Section 1.2(d)(iv) clarifies that, by the time of closing, the company shall have modified its compensation, bonus, incentive and other benefit plans, arrangements and agreements as may be necessary to comply with the executive compensation limits that accompany participation in the TARP Capital program.  Compliance includes obtaining written consents from the affected Senior Executive Officers to the extent necessary to make such modifications legally enforceable.  For a summary, please see our Client Alert on the TARP Capital executive compensation rules.

Section 1.2(d)(v) provides that the Senior Executive Officers have to execute a waiver releasing the government from any claims related to the modifications to their employment agreements as a result of participation in the TARP Capital program.  The form of waiver is attached as Annex B to the Agreement.

Section 1.2(d)(vi) provides for a legal opinion in substantially the form attached as Annex C.  We understand that the Treasury is insisting that the legal opinion opine on the enforceability of the Agreement under New York law.

Article II – Representations and Warranties

When reviewing the representations contained in the Agreement, it is important to keep in mind two definitions provided in Section 2.1.

“‘Company Material Adverse Effect’ means a material adverse effect on (i) the business, results of operation or financial condition of the Company and its consolidated subsidiaries taken as a whole; … or (ii) the ability of the Company to consummate the Purchase and the other transactions contemplated by this Agreement and the Warrant and perform its obligations hereunder or thereunder on a timely basis.”

“‘Previously Disclosed’ means information set forth or incorporated in the Company’s Annual Report on Form 10-K” … or subsequent reports filed with or furnished to the SEC.

Section 2.2 should be read closely by every company looking to participate in the TARP Capital program as this Section provides the representations that must be made to the Treasury.  Unless the Agreement explicitly provides a disclosure schedule for a particular item or any exception was previously disclosed in SEC filings, exceptions to any representation and warranty will likely need to be disclosed in a Current Report on Form 8-K prior to execution of the TARP Capital agreements.

Article III – Covenants

Section 3.2 provides that the company and government will each be responsible for their respective costs and expenses related to the investment.

Section 3.3 provides that the company must, as of the Closing Date or immediately following shareholder approval, if required, fully reserve, free of preemptive or similar rights, a sufficient number of authorized and unissued warrant shares to permit exercise.  As soon as reasonably practicable following the Closing, the company shall cause such shares to be listed on the same securities exchange on which the company’s other shares are traded.  If requested by the government, the company shall promptly use its reasonable best efforts to also cause the preferred shares to be listed on the same securities exchange.

Article IV – Additional Agreements

Section 4.4 provides that, subject to applicable securities laws, the Treasury Department can transfer, sell, assign, or otherwise dispose of the preferred stock, warrants, or common stock underlying the warrants at any time, provided that the Treasury may not dispose of half of the initial warrant shares until December 31, 2009.  This limitation protects the ability of the company to cut in half the number of warrants issued by completing a Qualified Equity Offering prior to December 31, 2009.  The Agreement clarifies that a Qualified Equity Offering must be an offering for cash by the company of common or perpetual preferred stock, and not any other form of Tier 1 capital.  The Qualified Equity Offering (1) must be completed after the Closing Date and (2) cannot have been made pursuant to agreements or arrangements entered into, or pursuant to financing plans that were publicly announced, on or before October 13, 2008.

Section 4.5 provides the Treasury with registration rights for all “Registrable Securities,” which include the preferred stock, the warrant, and the common shares underlying the warrants.  Securities cease to be “Registrable Securities” if any of the following occur: (1) they are sold pursuant to an effective registration statement; (2) they may be sold under Rule 144 without limitation as to volume or manner of sale; (3) they cease to be outstanding; and (4) if sold in a private placement in which the registration rights are not assigned.  In the event that Rule 144 is the cause for the securities to no longer be Registrable Securities, certain provisions of the Registration Rights section remain operative so long as the Treasury holds the securities, effectively continuing to obligate the company to assist the Treasury in disposing of the securities.

Section 4.5(a)(i) requires the company to file a Shelf Registration Statement as soon as practicable after the Closing Date (and no later than 30 days after the Closing Date).  This Section also requires the company to use its reasonable best efforts to cause the registration statement to be declared effective and to keep the statement effective until there are no Registrable Securities remaining.  If, however, a company is not eligible to file a registration statement on Form S-3, then the company is not obligated to file a Shelf Registration Statement “unless and until” requested to do so by the Treasury.

Section 4.5(a)(ii) provides that the company is obligated to “facilitate” an underwritten offering if the Treasury (or any subsequent holder) desires to distribute the securities using an underwritten offering.  Specific efforts to “facilitate” the offering are discussed in Section 4.5(c), which we discuss below.

Section 4.5(b) addresses the expenses of registration.  All Registration Expenses (generally, all registration fees, filing and listing fees, printing expenses, company counsel, blue sky fees and expenses, “road show” expenses, selling shareholders’ counsel, and auditor fees) are borne by the company.  Any Selling Expenses (generally, any discounts, selling commissions, and stock transfer taxes) are borne by the holders of the securities on a pro rata basis.

Section 4.5(c) provides the obligations of the company to use its reasonable best efforts, for so long as there are Registrable Securities outstanding to assist in any sales efforts, including to: (i) prepare and file prospectus supplements and amendments as necessary for any proposed offering; (ii) furnish preliminary and final prospectuses as reasonably requested; and (iii) make members of management available to participate in road shows.

Section 4.5(h) provides that the Treasury can assign its registration rights to a transferee of Registrable Securities.

Section 4.5(i) provides that, in the event of an underwritten offering of the Registrable Securities, the underwriter can require the company and its directors and executive officers not to sell for a period from 10 days before until up to 60 days after such underwritten offering.

Section 4.5(j) requires that the company use its reasonable best efforts to make Rule 144 and Rule 144A available for the transfer of the Registrable Securities to the public without registration.  This includes a commitment to make and keep public information available, and to file SEC reports in a timely manner.

Section 4.5(k) provides the pertinent definitions for the registration rights, while Section 4.5(o) provides the provisions that remain effective while the Treasury holds the shares even if Rule 144 is available.

As a practical matter, given the shortened Rule 144 timeframe, the registration rights should generally only be burdensome for the first six months of the investment.  After that time, the shares should be freely tradable under Rule 144 so long as current information is available.  After one year, the shares are freely tradable under Rule 144 regardless of whether current information is available.  The company may still be required to assist the Treasury in selling securities after expiration of the six-month period, but even those sales should be less burdensome than a full registered offering.

Section 4.6 provides that the Treasury will not exercise any voting rights with respect to shares underlying the warrants.

Section 4.8 provides the restrictions on dividends and repurchases.  These restrictions last until the earlier of (i) the third anniversary of the Closing Date or (ii) the date on which the Investor no longer holds any Preferred Shares (either because of redemption or transfer).  During this restricted period, the company cannot, without the consent of Treasury, (x) increase its quarterly dividend (from the last dividend declared prior to October 14, 2008) or (y) redeem, purchase, or acquire any shares of common stock or other equity securities of any kind of the company (including trust preferred securities), subject to a very limited exemption to offset share dilution caused by employee benefit plans.

Section 4.9 provides the company with a right to redeem any equity securities held by the Treasury once the Treasury no longer holds any Preferred Shares (either because of redemption or transfer) at the Fair Market Value of the security.  The Fair Market Value is a price determined by the company’s board of directors, acting in good faith in reliance on an opinion from a nationally recognized investment banking firm.  If the Treasury does not accept such value as the Fair Market Value, there is an appraisal procedure, paid for by the company, to determine the ultimate Fair Market Value.  When combined with the redemption rights contained in the Preferred Shares, this effectively provides any participating company assurances that it can prevent the Treasury from holding shares for longer than three years (thereby also limiting the length of time in which the executive compensation limitations will be in place).

Article V – Miscellaneous

Section 5.3 provides that the Treasury may unilaterally amend any provision in the Agreement “to the extent required to comply with any changes after the signing date in applicable federal statutes.”  As we have previously noted, we believe that if further regulation is coming, it is likely to be imposed on the entire industry and not limited to those that participate in the TARP Capital program.  The recent announcements by the Treasury and the federal banking regulators confirm this approach.

Section 5.5 provides that the laws of the State of New York control.  As noted above, this means that the legal opinion will necessarily need to provide for enforceability under New York law.

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