BEFORE THE DEPARTMENT OF REVENUE
OF THE STATE OF MONTANA
TO: All Concerned Persons
1. On October 14, 2010, the department published MAR Notice No. 42-2-851 regarding the proposed adoption and amendment of the above-stated rules at page 2303 of the 2010 Montana Administrative Register, issue no. 19.
2. A public hearing was held on November 8, 2010, to consider the proposed adoption and amendment. No one appeared at the hearing to testify. Written comments received during the comment period following the hearing are summarized as follows, along with the responses of the department:
COMMENT NO. 1: The law firm of Crowley Fleck provided written comments on behalf of the Montana Bankers Association (MBA), expressing concern with the rules limiting the lenders' ability to loan money within their existing guidelines. They comment that the proposed regulation cannot limit the statute and that 16-4-801(4), MCA, contains no limitations that suggest the proposed edits to ARM 42.12.212(6) are appropriate. They specifically question the authority in ARM 42.12.212(6)(a), to restrict banks, and ask "why can't a bank lend with a guaranty from an outsider; i.e., spouse, family member, to assure its repayment?"
RESPONSE NO. 1: The department appreciates the MBA providing comments for this rulemaking action. The intention of these rules is certainly not to place a burden on lending institutions. The department has revised the proposed rules in an effort to remove language which inadvertently may have appeared to place an obligation on the lender. The rule seeks to reconcile the newly amended law with the existing law on ownership, 16-4-801(4), MCA, not to limit the statute. As per the new language in ARM 42.12.212(6)(c), an institutional lender would continue to be able to lend with a guaranty from an outsider, such as a spouse or family member, to assure repayment of the loan.
The department seeks only to make it clear, particularly to license holders, that allowing an outsider to make a payment on their loan could, whether intentionally or unintentionally, create an "ownership interest" in their license, as defined by ARM 42.12.106(14); and if by definition it does create an ownership interest, the guarantor would need to first apply and qualify for liquor license ownership before making a direct payment on the loan. In order for a licensee to remain in compliance and prevent the occurrence of an undisclosed ownership, ARM 42.12.212(6) demonstrates the required steps for licensees and their guarantors if the guarantor is called on from the lender for payment on a loan.
It is also important to note that amendments made to 16-4-801(4), MCA, by the 2009 Legislature, did not change the qualification requirements for an individual having an ownership interest in a liquor license. The statute continues to require that each person having an interest in a liquor license, including those who make payment(s) as a guarantor on a loan secured by such license, meet all statutory qualifications to hold a liquor license prior to doing so.
Relative to lenders, 16-4-801(4), MCA, states: "[a] regulated lender, as defined in 31-1-111, may obtain a security interest in a liquor license in order to secure a loan or a guaranty of a loan. This section does not prohibit or limit the ability of a regulated lender to use loan and security documentation consistent with that used by the regulated lender generally, and the documentation does not constitute control of the operation of the business or the licensee operating the business that is subject to the security interest."
COMMENT NO. 2: The MBA further commented on ARM 42.12.212(6)(b) questioning how a bank would monitor where funds come from and, does this mean that if the funds come from a "bad" source, the bank is supposed to refuse a payment.
RESPONSE NO. 2: The department understands the MBA's concern with this section and has modified the language in ARM 42.12.212(6) in response to their concern. The rule does not require an institutional lender to refuse a payment. Rather, it outlines certain responsibilities of the licensee.
As noted in our response to the previous comment, in order for a licensee to remain in compliance and prevent the occurrence of an undisclosed ownership, ARM 42.12.212(6) demonstrates the required steps for licensees and their guarantors if the guarantor is called on from the lending institution for payment on a loan. As defined in ARM 42.12.106(14) a payment by a guarantor, or anyone, of a licensee's loan obligations (except via a loan made by the guarantor directly to the licensee) results in the guarantor sharing in the financial risks of the business, which constitutes an "ownership interest."
COMMENT NO. 3: The MBA also expressed concern that the reference to ARM 42.12.212(6)(c) appears to make the bank the enforcer, i.e., the bank is having to refuse payment under the guaranty unless the guarantor makes an application to the department. The MBA commented that they are unsure how this section would work in the real world when a bank makes a demand and the guarantor wants to bring the loan current.
RESPONSE NO. 3: The department appreciates this and all of the MBA's comments on these rules, and has modified the wording of ARM 42.12.212(6) accordingly to make it clearer that these are the responsibilities of the licensee, not the institutional lender.
COMMENT NO. 4: The MBA commented in regard to the proposed language in ARM 42.12.212(6)(d) that a bank has no way to force a guarantor to deal in a certain way with the Internal Revenue Service, and recommends that this part not be included in (6), which only deals with institutional lenders. The MBA further comments that it should be a requirement of the licensee/guarantor, and not the bank.
RESPONSE NO. 4: The department has amended the rule to address this and other concerns expressed by the MBA, in an effort to remove language which appeared to place an obligation on the lender. As mentioned in the previous responses, ARM 42.12.212(6) demonstrates the required steps for a licensee to remain in compliance and prevent the occurrence of an undisclosed ownership by their guarantor if the guarantor is called on from the lending institution for payment on a loan. Additional detail concerning licensee reporting requirements, relative to ARM 42.12.212(6)(d), is provided in the response to comment number 10.
COMMENT NO. 5: The MBA also commented that ARM 42.12.212(6)(f) does not appear to be accurately placed in the rule, because (6) deals with guaranties with institutional lenders, while (f) is talking about loans to certain licensees; thus, MBA is confused as to if it is supposed to tie to the banks' guarantors.
RESPONSE NO. 5: The department agrees with the MBA and in order to improve the clarity of ARM 42.12.212, the department has moved section (6)(f) to a new section (8) in the rule.
COMMENT NO. 6: The department also received written comments from James M. Kaze, an attorney with the law firm of Bocsh, Kuhr, Dugdale, Martin and Kaze. Mr. Kaze commented on ARM 42.12.209(2), asking, "what if the potential buyer is NOT buying an interest in the license itself, but instead is buying an interest in the entity that holds the license? Will that transaction no longer be covered?"
RESPONSE NO. 6: The department appreciates Mr. Kaze's comments on these rulemaking actions. The proposed amendment to this rule does not change the current statutory requirements for qualification. The intent of the rule is to make it clear that ownership of a licensed entity is not limited to those holding "shares of stock." Any holder of an ownership interest of 10 percent or more in a liquor license, whether that interest is directly in the license itself or in the entity that holds the license, must first qualify with the department under the provisions of 16-4-401, MCA. In both the current rules and the proposed rules, each person having such an interest in a license must first qualify to hold a liquor license, as described by this statute.
COMMENT NO. 7: Mr. Kaze also commented on ARM 42.12.212(3)(b) stating "loans do not secure the license; the reverse is true." He suggests striking the word "securing" and replacing it with "secured by."
RESPONSE NO. 7: The department agrees with Mr. Kaze and has changed "securing" to "secured by" in this section.
COMMENT NO. 8: Mr. Kaze further commented that ARM 42.12.212(3)(c) "does not make sense as originally written" and proposed rephrasing it by striking the word "exercised" and adding in its place the phrase "resulting in the lender acquiring the license by reason of the default."
RESPONSE NO. 8: The department appreciates this suggestion and has stricken the word "exercised" from section (3)(c). The department believes this makes the provision clear.
COMMENT NO. 9: Mr. Kaze also commented that ARM 42.12.212(4) should be revised by changing "on" to "in" and by adding the phrase "institutional loans with security interests in" after "In securing."
RESPONSE NO. 9: The department agrees with Mr. Kaze and has revised the language to section (4) as he recommended.
COMMENT NO. 10: Mr. Kaze further commented on ARM 42.12.212(6)(d), writing, "I am not aware of any such annual election requirement under the Internal Revenue Code. In addition, this is an unclear statement of effect of the lender requiring payment from a guarantor in the event of a default by the borrower. If treated as anything other than a loan to the licensee, doesn't the fact that its treated as an equity contribution in an entity licensee create a potential license transfer requirement if it is greater than a 10 percent interest?"
RESPONSE NO. 10: Yes, Mr. Kaze is correct that a payment on behalf of the licensee by an owner/guarantor could mean an increased ownership interest, which would require the filing of either a Form 37 or a full application, depending on the specific circumstances. The Internal Revenue Code governs tax treatment of such payments for the guarantor and the licensee. Based on Mr. Kaze's comment, the department has amended this provision to address these concerns.
This proposed addition to the rule is based, in part, on current ARM 23.16.122, which describes how the Department of Justice evaluates loans related to alcoholic beverage and gambling licenses. The rule is based on definitions of "gains" and "losses" contained in Generally Accepted Accounting Principles (GAAP) 22.200, in conjunction with the definitions of "ownership interest" and "undisclosed ownership interested" contained in ARM 42.12.106.
3. Based on the comments received, the department amends ARM 42.12.212 as follows, stricken matter interlined, new matter underlined:
42.12.212 LOAN STANDARDS (1) and (2) remain as proposed.
(3) The department will require any noninstitutional lender to complete documents authorizing examination and release of information, a personal history statement, and fingerprint cards on forms provided by the department, as well as any contract, purchase agreement, or other documents from the lender deemed necessary to assess the suitability of an applicant's source of funding as required in 16-4-401, MCA.
(a) A loan agreement may not restrict the movement or transfer of a license.
(b) Cross collateralization language is unenforceable as it relates to loans
securing secured by the liquor license as collateral.
(c) In the event of default, the lender's rights are protected under 16-4-801, MCA. Upon default
exercised, the license must be placed on nonuse status pending transfer to a qualified purchaser or temporary operating authority. The lender is prohibited from leasing the collateral.
(4) Institutional lenders may secure loans made to a license applicant or licensee with security interests
on in assets belonging to the license applicant or licensee. In securing institutional loans with security interests in the assets of a license applicant or licensee, an institutional lender may limit the movement of the assets, including a liquor license.
(5) remains as proposed.
An institutional lender may require payment from loan guarantors without initially exhausting all remedies against the borrower under the following conditions A guarantor may make a payment on an institutional loan secured by a license, regardless of whether the institutional lender has exhausted its remedies against the licensee, and such payment will not cause an undisclosed ownership violation for the licensee, only if the following are applicable:
(a) the guarantor must be an owner of applicant/licensee, i.e., partner, shareholder, member;
(b) the payment is made with the owner/guarantor's own funds or funds borrowed from an institutional source or department-approved noninstitutional source;
(c) if the guarantor is not an owner, payment may only be made as a loan to the owners or licensed borrower/entity. Funds used to loan the money for the payment under the guarantee, must be the guarantor's own funds or funds borrowed from an institutional source. The guarantor must first be found by the department to be suitable as a source of credit as part of the application or loan approval process by submitting to the department a personal history
statements statement and a complete set of fingerprint cards;
as required by the Internal Revenue Code, a licensee having a loan secured by its license, and for which a loan guarantor has made payments on such loan on behalf of the licensee, must annually notify the department within 30 days of the guarantor's payment or on the date on which the licensee's renewal application is due, whichever occurs first, elect to treat whether the payments made under a loan guarantee agreement have been elected to be treated as loans, as paid in capital, or as other equity contributions; and
(e) if the guarantor elects to treat the payments as loans to the licensee, the licensee must follow requirements for disclosing noninstitutional lenders
(f) prior department approval is not required on loans to a licensed entity by an approved (licensed) owner of the entity (shareholder, member, partner) under the following conditions:
(i) the loan is used to meet an obligation of the licensed entity that cannot be met with its existing operating accounts and reserves;
(ii) the funds loaned to the licensed entity must be those of the owner or funds borrowed from an institutional source;
(iii) the loan must be memorialized by an agreement between the licensed entity and owner. The loan agreement must meet the department's evaluation standards;
(iv) the borrower's and lender's financial records must accurately reflect the transaction; and
(v) failure to maintain adequate records of the transaction or source of funds loaned will be considered a violation of this rule.
(7) remains as proposed.
(8) Prior department approval is not required on loans to a licensed entity by an approved (licensed) owner of the entity (shareholder, member, partner) under the following conditions:
(a) the loan is used to meet an obligation of the licensed entity that cannot be met with its existing operating accounts and reserves;
(b) the funds loaned to the licensed entity must be those of the owner or funds borrowed from an institutional source;
(c) the loan must be memorialized by an agreement between the licensed entity and owner. The loan agreement must meet the department's evaluation standards;
(d) the borrower's and lender's financial records must accurately reflect the transaction; and
(e) failure to maintain adequate records of the transaction or source of funds loaned will be considered a violation of this rule.
AUTH: 16-1-303, MCA
IMP: 16-4-401, 16-4-402, 16-4-404, 16-4-801, MCA
4. Therefore, the department adopts New Rule I (ARM 42.12.213) and amends ARM 42.12.206, 42.12.208, 42.12.209, and 42.12.210 as proposed, and amends ARM 42.12.212 as shown above.
5. An electronic copy of this notice is available on the department's web site at www.revenue.mt.gov. Locate "Legal Resources" in the left hand column, select the "Rules" link and view the options under the "Notice of Proposed Rulemaking" heading. The department strives to make the electronic copy of this notice conform to the official version of the notice, as printed in the Montana Administrative Register, but advises all concerned persons that in the event of a discrepancy between the official printed text of the notice and the electronic version of the notice, only the official printed text will be considered. In addition, although the department strives to keep its web site accessible at all times, concerned persons should be aware that the web site may be unavailable during some periods, due to system maintenance or technical problems.
/s/ Cleo Anderson /s/ Dan R. Bucks
CLEO ANDERSON DAN R. BUCKS
Rule Reviewer Director of Revenue
Certified to Secretary of State January 31, 2011