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Introductory Note: This article was published in The Banking Law Journal in May 2002 (119 Bank Law J. 452) and focuses upon the meaning of the catch-all definition of loans with "unfavorable" features prohibited under Regulation O.


Regulation O was originally promulgated by the Board of Governors of the Federal Reserve System in 1979 to implement the lending restrictions and limitations set forth in sections 22(g) and 22(h) of the Federal Reserve Act regarding loans and other extensions of credit made to executive officers, directors, principal shareholders and other insiders (collectively referred to herein as "bank insiders").1 As a result of that legislation, four basic restrictions were imposed on loans to bank insiders: (1) individual and aggregate loan limitations; (2) a prior approval requirement; (3) a prohibition against overdrafts; and (4) a prohibition against loans with preferential terms.2

The last category also includes a blanket or catchall prohibition against loans to insiders with "unfavorable" features. The prohibition has been attacked in Federal regulatory enforcement proceedings as unduly vague and therefore unenforceable.3 This article will explore and delineate the various elements and criteria that must be satisfied before a loan to an insider can be deemed to violate the prohibition in Regulation O against loans to insiders with "unfavorable" features.

In a final agency decision and order issued by the FDIC Board of Directors in 1990, the term "unfavorable features" was specifically addressed and defined in response to a challenge that it was vague and therefore unenforceable. The final order was issued by the FDIC Board of Directors in In the Matter of R. Wayne Lowe and Jimmy A. Spivey.4 The FDIC Board in the Lowe case clearly attached the concept of added or exacerbated risk of loss or nonpayment of the loan to a determination of what constitutes an "unfavorable" feature within the meaning of the prohibition contained in Regulation O:

The Board concludes that the language is not unenforceably vague. ... In this case, the terms ["unfavorable features" ] look to whether an objective lender at the time the loan was made would have extended the credit based on the available information at the time. Bullion v. FDIC, 881 F.2d 1368,1374 (5th Cir. 1989). The terms are clearly understandable from the surrounding language in the statute and regulations. The language in the 12 U.S.C. § 375b(3) and 12 C.F.R. § 215.4(a)(2) requires that the loan at issue "not involve more than the normal risk of repayment or other unfavorable features." In context, this language plainly refers to features of the loan which either, as here, directly affect the risk of repayment or decrease the attractiveness of the loan for some other reason. The expert testimony of the FDIC examiners established why the particular features of the ... loans at issue would be considered unattractive by prudent lenders. It is easy to understand why these features, which adversely affect the risk of repayment on the loans and [the bank's] ability to collect on them if they go into default, increased the riskiness of the loans. Accordingly, the Board concludes that these terms are not unenforceably vague.5 [Footnotes omitted and emphasis added.]

On appeal, the Eleventh Circuit Court of Appeals affirmed the FDIC position regarding the meaning of "unfavorable features" and summarily rejected the argument of vagueness:

[P]etitioners argue that the "unfavorable features" prong of section 215.4(a) violates basic fairness because it is totally subjective and unenforceably vague. The FDIC correctly notes that in a case, as here, involving neither criminal sanctions nor First Amendment rights, the test for constitutional vagueness is an objective one: whether an objective lender at the time the loan was made would have extended the credit based on available information at the time.  See, Bullion, 881 F.2d at 1374-75. Given the facts surrounding [the loans in question], it is hardly surprising that an unsecured loan with out-of-state guarantors made to an entity with a negative net worth would be deemed to contain unfavorable features.  It is hard to imagine a less attractive set of terms.6  [Emphasis added.]

Accordingly, the first element of an "unfavorable" feature is that the trait or feature in question must add to or otherwise exacerbate the bank's risk regarding the repayment of the loan. Stated differently, the circumstance or trait under consideration must result in an increased level of unattractiveness to an objective and prudent lender.7

Any violation of Regulation O is premised upon conduct directed toward the consummation of a loan or other extension of credit to bank insiders with certain characteristics.  The determination of whether a particular characteristic or circumstance triggers a violation of the prohibition against loans with unfavorable features must be predicated upon the facts and circumstances in existence at the time the loan in question is approved and made, not after it has been consummated and funded.8  Accordingly, the second element of a prohibited "unfavorable" feature is that the trait must be in existence at the time the loan is made. The prohibition does not refer to features or circumstances that occur or develop after the business decision to make the loan has been made. In this same context, it is equally important to determine that the person who made the credit decision knew the circumstance or trait, or that such person, if acting objectively and reasonably, should have known about such circumstance or trait.

The most common examples of insider loans that violate the prohibition against "unfavorable" features are: (1) an extension or renewal of a loan to an insider after its adverse classification by a regulatory agency,9 (2) an insider loan made in violation of law10 or the lending bank's loan policies,11 (3) a loan to an insider with out-of-territory characteristics,12 and (4) insider loans with special or extraordinary terms or conditions.13

The occurrence of an event or circumstance that post-dates the consummation of the loan transaction may be indicative (or even determinative) of whether a particular loan transaction is subject to the requirements and prohibitions of Regulation O, but such events themselves cannot be cited as the basis for a violation of that regulation. The best illustration of this principle is an insider's receipt of the proceeds of a loan that was made to another person.  The occurrence of such an event may determine the applicability of Regulation O to the loan, but it is not a violation of Regulation O for an insider to receive such loan proceeds.14

In a recent case15 involving an alleged violation of the prohibition in Regulation O against insider loans with unfavorable features, the FDIC charged that the failure of the insider to make certain disclosures to the lending bank's board of directors constituted an "unfavorable" feature in violation of Regulation O even though such disclosures could have been made only after the loan had been made by the bank.  Such trait, however, failed the two-pronged test outlined above. It did not (and could not) exist at the time the final credit decision to make the loan was made by the responsible loan officer, and it did not increase the risk of nonpayment of the loan or otherwise diminish its attractiveness to a prudent lender.

As a minimum, therefore, the prohibition against insider loans with unfavorable features in Regulation O involves two separate elements, namely, a feature or circumstance of the loan transaction that (1) exists at the time the credit decision is made to make the loan, and (2) results (or has the capacity to result) in an undue increase in the risk of nonpayment by the borrower or loss to the bank, or an undue diminished attractiveness to an objective and discerning lender.

It should be noted that Regulation O itself does not contain any specific requirement or prohibition regarding events or circumstances that precede an insider loan transaction subject to the regulation.  Accordingly, an allegation that an insider's act of "permitting" or "allowing" a disputed loan transaction (which, by definition, necessarily involves conduct that precedes the consummation of such loan) constitutes an "unfavorable" feature is erroneous.  In addition to failing the two-pronged test outlined above, such an event or circumstance is not proscribed by Regulation O.16

Nevertheless, it is clear from the statutory provisions of the Federal Deposit Insurance Act ("FDIA") regarding the imposition of sanctions for violations of Regulation O that conduct pertaining to the consummation of a loan transaction is actionable even though such conduct occurred prior to the consummation of the disputed loan itself. Section 3(v) of the FDIA17 specifically defines the term "violation" to include "counseling," "participating in," and "aiding or abetting" a violation of law.  Thus, a person who provides counsel or who actively promotes a proposed insider loan that violates Regulation O, or who engages in conduct that otherwise aids or abets a violation of Regulation O by another will also be deemed to have committed a violation of Regulation O even though such actions and events occurred prior to the actual consummation of the disputed loan transaction.

The only remaining question is whether an allegation that an insider "permitted" or "allowed" a disputed insider loan to be made by the bank (which, for the sake of discussion, violated Regulation O) is the legal equivalent of a charge that such insider "counseled," "participated in," or "aided or abetted" the violation of Regulation O, as such terms are used in section 3(v) of the FDIA.18 In answering this question, it is easy to distinguish between "counseling," "participating in," and "aiding or abetting" on the one hand as involving affirmative acts while the charge of "permitting" or "allowing" pertains to passive conduct or a failure to act.  In this regard, the FDIC and other Federal bank regulatory agencies will cite the dichotomy between affirmative acts of misconduct (counseling or aiding a violation of law) and passive action in failing to act (failing to prevent a violation of law) in support of their position.  The banking agencies will argue that Congress intended an expansive interpretation of the term "violation" in section 3(v) of the FDIA that would encompass both passive and active conduct.

This is precisely what occurred in the Garrett case mentioned earlier.19  In support of its position in Garrett, the FDIC argued that Congress authorized the assessment of civil money penalties both for affirmative acts of misconduct as well as for passive failures to act, pointing out that such penalties can be assessed for failing to take actions required by final cease and desist orders issued under section 8(b) of FDIA.20  Such argument, of course, confuses the issue by mixing apples with oranges.  The question under discussion is whether a violation of Regulation O can be predicated upon an alleged failure to act, not whether a violation of a cease and desist order can be predicated upon such failure.  A violation of Regulation O is not the same as a violation of a cease and desist order and vice versa.21


The blanket prohibition in Regulation O against loans to bank insiders with "unfavorable" features is not unconstitutionally vague and unenforceable. On the contrary, the prohibition is real and is subject to all of the various enforcement sanctions in the arsenal of the Federal bank regulatory agencies, including cease and desist orders, civil money penalty orders, and even removal and prohibition orders under certain circumstances.  Accordingly, it is important for persons who are exposed to the imposition of such sanctions to have an accurate understanding of exactly what elements constitute a violation of that prohibition.

There are two elements to an insider loan with an "unfavorable" feature prohibited by Regulation O.  Both elements must be shown to prove a violation of the prohibition.  First, it must be shown that the feature or trait in question existed at the time the credit decision on the loan was made, and that the person who made the loan knew (or should have known) of such circumstance or feature.  Second, it must be shown that the trait or feature in question added undue risk of nonpayment of the loan or loss by the bank, or that such circumstance otherwise contributed to a determination by an objective lender that the loan was less attractive as a prudent use of the bank's funds.




1. The original legislation was enacted as Public Law 95-630 and was known as the Financial Institutions Regulatory and Interest Rate Control Act of 1978.  In implementation of the new law, Regulation O (12 C.F.R. Part 215) was promulgated by the Board of Governors of the Federal Reserve System in consultation with the other Federal banking agencies on November 28, 1979, and became effective on December 31, 1979 (44 Fed. Reg. 67978).  Although the designation "bank insider" is not used in either the statute or Regulation O, this article will refer to all persons subject to the prohibitions and limitations in Regulation O by such term for purposes of convenience.  Further, this article will not discuss the issue of whether a particular loan transaction is subject to Regulation O.  The applicability of the regulation is assumed.

2. Although listed in a slightly different sequence, all four limitations are set forth in section 215.4 of Regulation O, 12 C.F.R. § 215.4.

3. In this same context (and not surprisingly), there are also recorded instances where trained bank examiners have expressed the belief that because of the open-ended nature of the term "unfavorable," the final determination of what constitutes a violation of the prohibition is a matter reserved to the "expertise" and sound discretion of the banking agencies.  In effect, a violation of the prohibition occurs whenever the agency says so.  Fortunately, that is not the law.

4. FDIC Docket No. 89-21k, FDIC Enf. Dec. ¶5153 (1990).

5. Id. at A-1537-38.

6. R. Wayne Lowe v. FDIC, 958 F.2d 1526, 1533-34, at fn. 30 (11th Cir. 1992).

7. Both the FDIC Board and the Eleventh Circuit used the term “unattractive” to describe the intended meaning of an "unfavorable" feature.  In reality, of course, the concepts of an increased risk of nonpayment of a loan and an added "unattractiveness" of a loan to a prudent lender are one and the same.  The only reason the loan is less attractive to a prudent lender is because of the increased risk of nonpayment reflected by the feature or trait in question.

8. The Fifth Circuit Court of Appeals made this clear over a decade ago in Bullion v. FDIC, 881 F.2d 1368 (5th Cir. 1989): "The [FDIC] Board's analysis for finding more than the normal risk of repayment or other unfavorable features looks to whether an objective lender at the time the loan was made would have extended the credit based upon the available information at that time."  [Id., at 1374; emphasis added]  As if to emphasize the point, the Court later reinforced its determination: "[W]e find that the [FDIC] Board properly limited its conclusion to the evidence which established the situation at the time the loan was approved.")  [Id., at 1376; footnote omitted and emphasis added]

9. The critical factual circumstance in this situation is whether any type of remedial action was taken after the adverse classification but before (or preferably, as a condition of) the renewal or extension.  If remedial action was taken prior to the renewal or extension and if such action was reasonably designed to eliminate the adverse classification, a violation of the prohibition against loans with unfavorable features will not occur even though the remedial action proved to be ineffective and the loan was reclassified adversely at a later examination.

10. The reference here is not to Regulation O, but a violation of some other applicable law that exposes the lending bank to a risk of loss.  For example, the added risk of loss that would result from a mortgage loan to an insider made in violation of a legal requirement pertaining to the borrower's right of rescission.

11. If the loan is also adversely classified and the reason for the classification is directly related to the failure to follow the bank's loan policy, it is almost certain that such loan will be scheduled as a violation of the "unfavorable" features prohibition in Regulation O.  In this regard, however, it is important to recognize that all adversely classified loans to insiders do not automatically qualify as violations of the "unfavorable" features prohibition.  There must be a showing that a prudent lender would recognize the circumstance or feature at the time the loan was made as an adverse circumstance that added significant risk or unattractiveness to the loan.  The key determination, therefore, is how an objective lender would interpret all of the known circumstances and features of the loan at the time the credit decision is made.  The fact that bank examiners may reach a different conclusion at a later date based upon facts or circumstances that occurred after the loan decision is irrelevant unless such subsequent developments were reasonably foreseeable by an objective and prudent lender.

12. This is particularly true where there is a discernable pattern of lending which shows that such characteristics are limited to loans to bank insiders.  The fact that such loans may have been permitted by the lending bank's loan policy and/or were reviewed and approved by the board in advance will not change a finding of a violation of the prohibition against loans to insiders with "unfavorable" features.

13. These violations usually occur as the result of special addendums or other amendments to the contractual provisions the bank normally employs for substantially similar loans made to non-insiders.  If such amendments add undue risk or otherwise make the loan less attractive to a prudent and objective lender, they can be deemed an "unfavorable" feature even though the loan may not be adversely classified upon review by an examiner with a bank regulatory agency.

14. Receipt of the proceeds of a loan by a bank insider triggers the so-called "tangible economic benefit" rule in section 215.3(f) of Regulation O, 12 C.F.R. § 215.3(f), thus making the loan transaction subject to the requirements of Regulation O.  There is nothing in Regulation O, however, which prohibits an insider from receiving or using the proceeds of a loan made to another person.  The same was true regarding a charge by the FDIC that the targeted banker in the Garrett case (see, fn. 15, infra) violated Regulation O by concealed his interest in certain loans from the bank=s board of directors.  Such an event (assuming arguendo that it occurred) post-dated the consummation of the disputed loans and could not have supported the alleged violation of Regulation O.  This was particularly true in the absence of any prerequisite in Regulation O itself requiring the insider to make any type of ex post facto disclosure or notification regarding his or her receipt of the proceeds of a loan made to another.  [It should be noted that it was agreed in the Garrett action that because of certain circumstances, the notification requirement contained in section 215.5(d) of Regulation O, 12 C.F.R. § 215.5(d), was not applicable.]

15. Unfortunately, there is no reported opinion in the case.  Prior to the conclusion of the evidentiary hearing (which up to that time had taken more than sixteen weeks and thousands of pages of sworn testimony) and prior to the issuance of a recommended decision by the presiding Administrative Law Judge, the FDIC issued a final order dismissing all of the charges, with prejudice, issued against the targeted banker.  [Such action by the FDIC was unprecedented in the history of the agency.]  The author=s familiarity with the case is predicated upon his representation of the banker in that case.  See, In the Matter of Glen Garrett, FDIC Docket No. 94-141k, FDIC Enf. Dec. ¶11,599 (1999).

16. Depending upon the circumstances, such conduct could constitute an actionable breach of fiduciary duty by the insider.  A breach of fiduciary duty, however, is not treated the same as a violation of law.  As a general rule, the Federal bank regulatory agencies prefer the imposition of enforcement sanctions for violations of law as opposed to breaches of fiduciary duty.  The standard of proof required for sanctions based upon violations of law is less demanding than the standard required for breaches of fiduciary duty.  See, e.g., the provisions for the assessment of so-called "First Tier" and "Second Tier" civil money penalties pursuant to section 8(i) of the Federal Deposit Insurance Act, 12 U.S.C. § 1818(i).   A "First Tier" civil money penalty (which has more relaxed standard of proof than that required for "Second Tier" penalty) cannot be imposed for a breach of fiduciary duty.  In order to impose a penalty for a breach of fiduciary duty, the agency will have to bear the more difficult burden of proof for "Second Tier" penalties to show either culpability or personal gain by the alleged offender.   Such elements are not required for "First Tier" penalties.  Thus, while both forms of conduct are wrong and to be avoided, a violation of law is generally considered the more serious since it exposes the banker to serious enforcement sanctions predicated upon an easy standard of proof.

17. 12 U.S.C. § 1813(v).

18. Id.

19. See, fn. 15 and accompanying text, supra.

20. 12 U.S.C. § 1818(b).

21. The FDIC argument in Garrett would have be sustainable if there were a requirement in Regulation O that imposed a specific duty to take action in the same manner as an affirmative action requirement in a cease and desist order.   The FDIC, however, was unable to point to any such requirement in Regulation O that was applicable to the disputed loans in question.  In the absence of any showing that Regulation O imposed a duty to take certain affirmative action, it was impossible for the agency to prove the alleged violation of Regulation O by merely showing that the targeted banker "permitted" or "allowed" the loan to be made.  Regulation O itself does not impose a legal duty or obligation to prevent violations of its requirements and limitations.


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Last revised: June 1, 2012.