SEC Division of Investment Management staff letter: Plymouth Commercial Mortgage Fund

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tt~"d ~1 ;'~ .( ';~' ! ~1~~:';': É55ta)liYc) -r ~2~) J-l.o.....:..i~ . D~C - 3 l0-:' 1- ..J.. .' '~'.' ~.1 ....1 ". .., -:t. l d ;::~~~ i::J.:' (~,,;,,~ i~~:,..: ~ i:~rJ1.;t~3 a1 ...-.- U" :1, ;., . '.l "1 ..., I '.~ ,_ .:' ;:;'__Y'N".. ,n__J ~,' .::,::h,?~ -,,'~"-:~""';- J i.. 3 -c¡" .. Our Ref No. 96-475-CC ~.~;--=.. ... . ," . ", ".d'.'H ,.....m..'__ -ilymouth Commercia Mortgage REPONSE OF 'I OFFICE OF CIDEF COUNSEL Fund DIVSION OF INESTM MANAGEMEN File No, 132-3 Your letter of September 10, 1996 reuests assurace that we would not recmmend enforcement action to the Commission if Plymouth Commercial. Mortgage Fund ("Plymouth"), afer electing to operate as a business development company ("BDC") under
Section 54 of the Investment Company Act of 1940 (the "1940 Act"), (i) trets cert debt

securities describe below as eligible securities under Section 55(a)(3)(C) of the 1940 Act

and (ll) trets its offer to provide cert assistace, also describe below, as "signcat

manageri assistace" for purpses of Section 2

(a) (47) of the 1940 Act.
Facts
Plymouth wil be initialy capita by an exchange offer made to security holders of

SWF 1995 Limited Parnership ("SWF-1995"), a Texas liited'parnership in the business of purchasing packages of distressed10ans, and wil succee to SWF-1995's business. You state that Plymouth wil then fie a registration statement on Form 10 under the Securities Exchange Act of 1934 ("Exchange Act"), and a notifcation of election on Form N-54A to be regulated as a BDC. Plymouth wil purchase from governental and non-governenta institutions packages of notes evidencing impaied loans to smal business borrowers.,l You state that the qualty of loans withi these packages var signicantly, and that Plymouth ca purchase loan packages at a substatial discount. Thus, Plymouth can offer debtors signicat

forgiveness as an incentive to. restructure the existing loan and to issue a new note. Afer

purchasing a loan package, depending on the qualty of the loan, Plymouth wil either: (1)

negotiate with the borrower to restructure the existing note, resultig in the issuance of a new note, from th~ borrower to Plymouth that wil reflect forgiveness of some pricipal and interest ("Workout Option 1")2; (2) offer the borrower forgiveness suffcient to alow the borrower to obtan a new loan from an unaffilated third pary, resulting in the borrwer

issuing a new note to the unaffilated thid pary ("Workout Option 2"); or (3) immediately

forecl9se on the note or sell it to a thid pary ("Option 3"). .

lYou define the "impaied loans" to be purchased by Plymouth as those on which the

borrower is "unable to meet its obligations as they (come) due without material assistace

other than conventional lending or financing arrngements. "

2you represent that Plymouth intends to hold these new notes for a period of six to

twelve months. During this time period, you state that the portfolio company wil have the

qpportunity to develop a timely payment history suffcient to allow it to refinance the loan with a conventional lender or to allow Plymouth to sell the note to a third-pary lender.

• 2:
  You represent that afer purchasing a package of impai loans, Plymouth wil contact the issuers of the notes it categoris as either Workout Option 1 or Workout Option 2 assets (collectively, "qualying assets"), and wil make a written offer to provide, and if accepted wil provide, the following guidace and assistace in the following maner:
  (1) Applying stadad financia analysis to review the borrwer's

currnt financial statements, suggestig modcations in

financial practices and accountig trtment where approprite,

and otherwise makg detaed remmendations to improve the borrwer's cash flow and profitabilty and to enhance the lieliood of the borrwer's reiving a favorable respnse to .a request for refinancing from a thid-pary lender; (2) providing comprehensive assistace to the borrwer in its

prepartion of a thid-pary loan reuest including, but not liited to, examination of borrowing nees and Capacity and

assistace with the draing of application forms and supporting

schedules;
(3) introducing the borrwer to prospetive thid-pary lenders as

well as to law firms, accountats, and othèr professionals for

assistance with genera business matters (such introductions to occur, depending upon thé circumstaces, either in person, by telephone or written corrspndence); and (4) inorming the borrower about varous loan and other progras

sponsored by the U.S. Smal Business Adminstration, and assisting the borrower in identifying prospetive thid-pary lenders paricipatig in the genera business loan progra authoried by Section 7(a) of the Smal Business Act or the development company loan progra authori by Sections 503

through 505 of the Smal Business Investment Act of 1958.

Analysis
To qualfy as a BDC, an investment company must: (1) be a closed-end company organed under the laws of a state; (2) operate for the purpse of investing in securities descñbe in pargraphs (1) through 0) of Section 55(a) of the 1940 Ace; (3) invest at least 3Qualying assets describe in Section 55(a)(1)(A) and (2) are generay securities issued by "eligible portfolio companies" purchased from any source; additiorialy, Section 55(a)(I) provides that the purchase trasaction may not involve a pnblic offerig, Eligible portfolio com,panes are: (I) companies organed under the laws of a state; (2) neither investment

• 3
  70% of its assets in securities describe in pargrphs (1) through (6) of Section 55(a) ("70% test")4;(4) make avaible "signicat managerial assistace" to the portolio companes whose securities ar treated as satisfying the 70 % test; and (5) fie a notice of election to be regulated as a BDC with the Commission. You reresent that Plymouth wil meet al of these statutory reuirments. You reuest assurace only as to whether the sta would consider Plymouth's intia purchase of distressed loans at auction to be trasactions "incident" to the later issuace of a new note by the issuer, and whether the staf would consider Plymouth's proposed offer of assistace to lbe"signcat managerial assistace" for purpses of Section 2(a)(47)(A).

1. Oualying Assets under Section 55
   (3) (C)
   , , (a)
   Section 55(a)(3)(C) imposes restrictions on the source from which, and the maner in
   which, a BDC may acquire cert qualying assets. Speifcay, the securities must be issued by a company that, among other thigs, prior to the purchase of the securities by the BDC, was unable to meet its obligations without material assistace other than conventional financing ("issuer reuirments"). In addition, the BDC must purchase these securities in a non-public offerig from any of the issuer, a person ~ho is, or was withi the preeding companes (other than a smal business investment company ("SBIC") licensed by the Smal Business Adminstration that is a wholly-owned subsidiar. of a BDC) nor companes excluded from the defintion of an investment company by Section 3(c) of the 1940 Act; and (3) companes that either have no class of marginable securities, companes that are contrlled by a business development company, or cert smal portolio companes.

Section 2(a)(46)(A)-(C). If a company that otherwise would be deemed to be an eligible
portolio company has issued a class of marginable securities, Section 55(a)(I)(B) designates such securities as qualying assets, provided that immediately prior to the purchase, the BDC owns at least 50 % of certin securities of the issuer and is one of the 20 lagest holders of record of the company's voting securities. Section 55(a)(3) qualying assets ar securities issued by financialy distressed businesses that ar organ under the laws of a state and are neither an investment company (other than a SBIC) nor a company exceted from the defintion of an investment company by Section 3(c) of the 1940 Act, and that are purchased in trsactions not involving a public offerig. .

4See n.3, supra (description of qualying assets set forth in Section 55(a)(1)-(3)). Qualying assets describe in Section 55(a)(4)-(6) ar: (1) securities issued by an eligible portfolio company purchased from any person, if there is no redy market for the securities and the BDC, immediately prior to the purchase, owns at least 60% of the outstanding equity securities of the issuer; (2) securities received in exchange for or relating to qualying assets described in Section 55(a)(l)-(4), or pursuant to the exercise of options, warts or rights relating to securities described in Section 55(a)(I)-(4); and (3) cash, cash items, government securities or high grade debt investments maturig in one yea or less from the time of investment.

• 4
  thieen months, an afilated person of the issuer or from any person in "trasactions incident thereto." In designating seurities issued by a financialy distressed business as a qualing asset under Section 55(c)(3)(C), Congress intended to encourage BDCs to provide financial and manageri assistace to a company "before it~ circumstaces ar so di that it must seek protection through formal banptcy proings. "5 The liitations on the sources

from which BDCs may acquir these assets ar intended to ensure that the financiay distrssed companes obta the financial and manageri assistace that Congress 6 envisioned. You represent that the issuers of notes that Plymouth intends to trt as qualing

assets. for purpses of the 70 % test wil meet the issuer reuirments set forth in Sections. 2(a)(46) and 55 (a) (3) (C) of the 1940 Act. With respt to Workout Options 1 and 2, you maita that Plymouth's intial purchase of the existing note should be deemed a trasaction incident to the subsequent issuance of the new note by the company to Plymouth or to an unaffilated. thid pary. 7
2. Signicat Managerial Assistace

Section 2
(a) (47) (A). of the 1940 Act, in pertinent par, defines the phrse "makg avaiable signicat managerial assistace" as "any argement whereby a business

development company .'. . offers to provide, and, if accted, does so provide, signicat guidace and counsel concerng the management, operations, or business objectives and policies of a portfolio company." In enactig Section 2(a)(47), Congrss regn that "the nature and amount of managerial assistace made avaible by a business development company wil var according to the parcular nees of each portolio company . . . . "8 SSmal Business Investment Incentive Act of 1980, H.R. Rep. No. 1341, 96th Cong., 2d

Sess. (1980), reprited in 5 U.S. Code Congo & Ad. News 4800, 4824 (1980) ("House Rert No. 1341").

6See House Reprt No. 1341 at p. 4805. The fact that Congress rently expanded the permissible sources for acquirg the assets describe in Section 55(a)(I)' has no effect on the continued viabilty of the source liitations imposed, and not reed, by Congress in
Section 55(a)(3). H.R. 3005, The National Securities Markets Improvement Act of 1996,
104th Cong., 2dSess., § 505 (1996).
7you acknowledge that loans falg into Option 3 may not be qualymg assets withi the

meag of Section 55(a)(3), and do not request the stas view on this issue. 8House Report No. 1341 at p. 4815.

• 5
  You represent that Plymouth's offer of managerial assistace wil involve guidace

and counsel concerng the restructurig of the financiay distressed companes' obligations, including assisting with loan applications, educating the borrower about smal business loan programs, and introducing the borrwer to other lenders. You maita that this offer constitutes "signicat managerial assistace" for purpses of Section 2(a)(47)(A).

We would not remmend enforcement action to the Commission if Plymouth trets as qualying assets under Section 55(a)(3)(C) those notes that it purchases intiy from governenta or non-governenta institutions, provided that it manages the notes in the maner descnbe in Workout Option 1 or 29, or if Plymouth trets its proposed offer of assistace as "signicat managerial assistace" withi the meag of Section 2(a)(47)(A) of the 1940 Act. The stas position is based upon the facts and reresentations contaed in your letter. Any diferent facts or reresentations might reuire a diferent conclusion.

G-m
Eileen M. Smiley

Senior Counsel

9y ou have not requested, and we do not express, our views regarding whether any of the notes, if purchased individualy, also would be qualying assets withi the meag of
Section 55(a)(3).

Sutherland, Asbill & Brennan
TEL: 12021 383-0100 1275 PENNSYLVANIA AVENUE. N, W.
ATIA
AUSTIN
FAX: 12021 637-3593 WASHINGTON. D.C. 20004- 2404 NEW YORK WASInNGTON STEVEN B, BOEHM DIRECT LINE: (202) 383-0176 September 10, 1996

1940 Act/sections 2 (a) (48) (B), 55 (a) (3) By Messenger John V. O'Hanlon, Esq.

Assistant Chief Counsel

Division of Investment Management

Room 10097, Mail stop 10-6

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549

Re: Pi ymouth Commercial Mortqaqe Fund

Dear Mr. 0' Hanlon:
We are writing on behalf of Plymouth Commercial'

Mortgage Fund ("Plymouth"), to request the Staff of the Division

of Investment Management (I'Division" or "Staff") to advise us that it will not recommend that the Securities and Exchange

Commission ("Commission") take any enforcement action if:

Plymouth elects to be regulated as a business development company subj ect to the provisions of sections 55 through 65 of the Investment Company Act of 1940, as amended (the "1940 Act")11¡

for purposes of compliance with section 55 (a) thereof, treats

certain debt securities (described below), held and to be held in

its investment portfolio, as being assets of the type described

in paragraph (3) of that section; and, with respect to the

issuers of these debt securities, offers to provide and, if

accepted, does so provide, certain guidance and counsel on

restructuring their existing debt and related financial matters.

Specifically, Plymouth seeks your concurrence that: (1)

its purchases from governmental or non-governmental institutions

(through either competitive or negotiated bids) of groups of ' notes evidencing impaired loans to small business borrowers would

be deemed to be transactions incident to the subsequent purchases

directly from the issuer, by Plymouth or an unaffiliated third-

party investor, of other securities also of the type described in

section 55(a) (3) of the 1940 Act; and (2) Plymouth's offer to

provide, and, if accepted, actual proyision of, certain guidance

11 15 U.S.C. §§ 80a-l to -64.

John V. O'Hanlon, Esq.

and counsel concerning the current and al ternati ve future company constitutes "making

available significant managerial assistance" within the meaning

of section 2 (a) (47) of the 1940 Act.

financial structures of a portfolio

PLYMOUTH, SWF-95 AND SWFI

Plymouth was organized on August 23, 1996, as a

Delaware business trust. Plymouth intends to succeed to the

Partnership ("SWF-95") following

certain transactions described below. Thereafter, Plymouth will

elect to be regulated as a business development company ("BDC")

under the 1940 Act.

business of SWF 1995 Limited

SWF-95 was organized in 1995 as a Texas limited partnership. Since its inception, it has invested almost exclusively in impaired loans (as described below). As of July 31, 1996, it had total assets of approximately $3.2 million.

SWF-95 was organized by SouthWest Federated, Inc.

("SWFI"), a Texas corporation that was founded in 1989. SWFI

purchases groups of notes evidencing loans typically containing

from 3 to 20 loans ("loan packages"), and in. some instances

individual loans, for its own account and for the account of

loan packages frequently have

been, and are expected to be, purchased through auctions which

attract buyers nationwide and in which SWFI has been and

continues to be a regular participant. Sellers of the types of

loans acquired by SWF-95 have included entities such as the

Resolution Trust Corporation, the Federal Deposit Insurance

Corporation, and various non-governmental institutions, including

banks and thrift institutions. SWFI manages portfolios of

impaired loans for certain private limited partnerships and other

entities, including SWF-95 (collectively, "related entities").

For its management services, SWFI typically receives a percentage

of collections as a management fee, and a portion of the cash

flow distributions after a specified rate of return has been

reached. SWFI holds a 14.4% equity interest in SWF-95 and is its

certain related entities. The

general partner.
Since its inception, SWFI has raised approximately $14

million ln equity and has utilized approximately $5 million in

debt for purpos~s of investing in impaired loans for its own

account and for its related entities . with this base of capital,

SWFI has purchased approximately $175 million (outstanding

principal amount) of various types of impaired loans. Generally,

a loan is considered "impaired" when "based on current

informatipn and events, it is probable that a creditor will be

unable to collect all amounts due according to the contractual

John V. O'Hanlon, Esq.

terms of the loan agreement. ",fl Impaired loans purchased by SWF￾95 generally are those on which the borrower ,is "unable to meet

its obligations as they (come) due without material assistance

other than conventional lending or financing arrangements" within

the meaning of Section 55(a) (3) (e) of the 1940 Act. They include: commercial real estate mortgages; loans secured by

business inventories, accounts receivable, and equipment;

consumercredi ts; and unsecured loans. The difference between

the amount invested and the face amount of each' of the impaired

loans in its portfolio reflects the deep discounts at which

distressed debt, like these loans, tends to be priced. Since

inception, SWF-95 has acquired loans for an average purchase

price of $0.40 per dollar of outstanding principal amount.

In purchasing impaired loans, SWFI generally seeks

outstanding debt obligations of small companies that can be

converted into fully performing instruments through forgiveness

of some principal and restructuring the terms of the note. SWFI

will seek foreclosure only as a last resort. In selecting loans

for purchase, SWFI emphasizes thorough due diligence

investigation and analysis prior to making bids, and, to date,

has been able to generate consistently high returns because of

its experience and policy that emphasizes working with the

borrower to assist in its restructuring or repaying the

obligation. SWFI' s participation in the market for impaired

loans effectively benefits borrowers who are thereby able to

retain ownership and use of their collateral without seeking

protective measures such as bankruptcy and may also be able to

enhance their ability to service their other obligations.

As noted above, SWFI currently purchases outstanding

notes for its own account and for the accounts of the related

enti ties. On August 2, 1996, SWFI organized a new interim

private investment fund that invests in the same type~ of assets

(i.e., impaired loans) in which SWFI and the related entities

currently invest. SWFI is expected to continue making purchases

for this fund until the initial funding of Plymouth (described below) is completed. In no event, however, will the interim fund continue to 'purchase loans past December 31, 1996. Thereafter,

it is expected that SWFI will not purchase loans of the type in

which Plymouth intends to invest for any entity besides Plymouth

for a period of two years.

,fl Fin. Acct. Stds. Bd., Statement of Financial Accounting

standards No. 114, Accounting by Creditors for Impairment of a Loan

'118 (May 1993).

John V. 0' Hanlon, Esq.

THE PROPOSED TRANSACTIONS

SWFI has determined to continue its activities through

a newly formed Delaware business trust, Plymouth, which would

operate as a BDC within the meaning of Section 2 (a) (48) of the 1940 Act. Among other things, SWFI believes that use of the

highly structured BDC format would improve the future capital-

raising potential for an entity like Plymouth investing in iEpaired loans. Accordingly, pursuant to Section 54 (a) of the 1940 Act, Plymouth intends to file both a registration statement

on Form 10 under the Securities Exchange Act of 1934, as amended,

and a notification of election on Form N-54A to be regulated as a

BDC. Immediately priQr to that election, Plymouth will be

capitalized through an exchange offer made to holders of

interests in SWF-95~ through a private offering exempt from

registration under the Securities Act of 1933, as amended. The

exchange offer will represent the first stage of a two-stage

ini tial funding for Plymouth. Shortly after the exchange offer

is completed, Plymouth would offer, also through a private

placement, additional shares with the goal of attracting

approximately $10 million in additional equity. It is

anticipated that other infusions of capital would be made from

time to time and could include, among a number.. of alternatives, a

public offering of new shares by Plymouth after it deveIops a

track record, acceptable to prospective underwriters, as a BDC.

If a public offering is made, the BDC regulatory regime under the

1940 Act would permit Plymouth to offer a stock option plan and

to utilize leverage to a greater extent than if it were to

operate as a registered closed-end investment company.

DISCUSSION
Relevant Provisions and Need for Relief

70 Percent "Oualifving Assets" Requirement. Section 55 (a) of the 1940 Act makes it unlawful for a BDC to acquire any

assets (other than those described in paragraphs (1) through (7) thereof) unless, at the time the acquisition is made~ assets described in paragraphs (1) through (6) (collectively, "qualifying assets") represent at least 70 percent of the value

of its total assets other than 'assets described in paragraph (7).

Paragraphs (1) through (4) of Section 55 (a) describe qualifying assets which are either securities of an eligible

~ Currently, there are 23 holders of i imi ted partnership interests, 15 holders of subordinated notes (two of whom also hold

limited partnership interests), and the general partner, SWFI.

John V. 0 'Hanlon, Esq.

portfolio company within the meaning of Section 2 (a) (46) of the 1940 Act or securities of an issuer described in subparagraphs

(A) and (B) of Section 2(a)(46) that may not be an eligible portfolio company (i .e., failing to satisfy one of the three

alternative criteria of subparagraph (C) of Section 2 (a) (46)) . Paragraph (3) of Section 55 (a) describes:
securities purchased in transactions not

involving any public offering from an issuer

described in sections 2 (a) (46) (A) and (B) or from a person who is, or who in the preceding

13 months has been, an affiliated person of

such issuer, or from any person in ' transactions incident thereto, if such

securi ties were-~

. . . (C) issued by an issuer that, immediately

prior to the purchase of such issuer's securities

by the ( BDC) , was not in bankruptcy proceedings .

but was unable to meet its obligations as they

came due without material assistance other than

conventional lending or financial arrangements

(emphasis added).
Neither the
Commission nor its Staff appears to have

issued any interpreti ve authority clarifying the meaning of

"transactions incident thereto" in paragraph (3) above, and the

legislative history also appears to be silent in that regard.

Therefore, we seek the Staff's assurance that it would not

recommend that the Commission take enforcement action if Plymouth treats loan packages it purchases "from any person" (e. g., from governmental or non-governmental institutions) as qualifying

assets for purposes of compliance with Section 55 (a), so long as the borrower is an issuer described in Sections 2 (a) (46) (A) and (B) . "Makinq Available Significant Manaqerial Assistance" Reauirement. Section 54 (a) of the .1940 ~ct provides that" (a)ny company defined in Section 2 (a) (4S) (A) and (B) may elect to be subject to the provisions of sections 55 through 65" if certain conditions are met. Section 2 (a) (48) (A) merely requires that the prospective BDC be "organized under the laws of, and (have) its

principal place of business in, any State or States." In

addition to requiring that the prospective BDC be "operated for

the purpose of making investments in securities described in

paragraphs (1) through (3) of Section 55 (a) ," section 2 (a) (48) (B) requires that the prospective BDC

John V. 0 'Hanlon, Esq.

make (J available significant managerial assistance

with respect to the issuers of such securities,

provided that a (BDC) must make available

significant managerial assistance only with

respect to the companies which are treated by such

(BDC) as satisfying the 70 per centum of the, value

of its total assets condition of Section 55

(emphasis added).
Section 2(a) (47) defines "(m)aking available
significant managerial assistance" by a BDC as, inter alia:

(A) any arrangement whereby a (BDC), through its

directors, officers, employees, or general

partners, offers to provide, and, if accepted,

does so provide, significant guidance and counsel

concerning the management, operations, or business

objectives and policies of a portfolio company

(emphasis added).
Nei ther the Commission nor its Staff appears to have issued any interpretative authority clarifying the meaning of

"significant guidance and counsel concerning the management,

operations, or business objectives and policies" in subparagraph

(A) above. Therefore, we seek the Staff's assurance that it

would not recommend that the Commission take enforcement' action

if Plymouth, through its directors, officers, employees, or

general partners, offers to provide, and, if accepted, does so

provide, certain guidance and counsel to a portfolio company

concerning the restructuring of that company's obligations and

related financial matters.

Anal vsis'

Section 55 fa) (3). To the extent that Plymouth

purchases impaired loans in packages and not individually (which

will usually be the case), the quality of the loans so acquired

can vary significantly. In most cases, a purchaser of impaired' loans like Plymouth performs the valuable service of permitting

the small business obligor t~ stave off foreclosure or other

precipitous action by its creditors. Having purchased the loans

at a discount (usually substantial) from the outstanding

principal balance plus accrued interest balance, Plymouth often

will be able to offer the borrower substantial forgiveness as an

incentive to restructure its loan~ Depending upon the quality of

John V. 0' Hanlon, Esg.

.the particular loan, such forgiveness of debt by Plymouth would

likely lead to one of the following two alternative scenarios:

1. Plymouth offers to take a new note. This new note

would reflect some forgiveness of principal and

interest and is issued by the borrower in exchange

for cancellation of the impaired ,note purchased by

Plymouth. Once the borrower has shown 6-12 months

of consistent and timely payments to Plymouth

according to the terms of the new note, this note

is either refinanced by the borrower with a bank

or other institution as a third-party lender or

sold outright by Plymouth to such a third-party

lender.
2. Plymouth offers forgiveness sufficient to allow

the borrower, which mayor may not accept

Plymouth's offer of guidance and counsel for this

purpose, to identify, contact, negotiate with, and

obtain a new loan from a third-party lender.

In some cases, however, a substantial forgiveness is not

sufficient because the borrower i s cash flow is otherWise so

encumbered that any lender would be forced to foreclose and sell

the collateral in order to recover at least' some of its investment in the impaired note. . Indeed, only by retaining the flexibility to commence foreclosure proceedings can Plymouth

ensure that a borrower negotiates in good faith to refinance its

impaired loan.
Plymouth acknowledges that, with respect to a loan on

which SWFI proceeds to foreclose or a loan of "bankable" quality

which SWFI proceeds to sell immediately to a new third-party

investor, SWFI' s purchase of an impaired loan for Plymouth's

account from a governmental or non-governmental institution is

not likely to be deemed to be a transaction incident to a prior

or subsequent purchase of a newly issued security directly from the borrower. However, with respect to scenario ( 1) above, Plymouth believes that the new note issued to it by the borrower

upon the restructuring of the borrower's impaired loan acquired

in a loan package would cause Plymouth's original purchase of the

impaired loan from the governmental or non-governmental

institution to be classified as a transaction incident to the

subsequent purchase of a newly issued security directly from the

borrower by Plymouth. wi th respect to scenario (2) above, Plymouth similarly believes that its original purchase of the

impaired loan from the governmental or non-governmental

institution as part of a loan package is a transaction incident

to the subsequent purchase of a newly issued security directly

John V. O'Hanlon, Esq.

from the borrower by a new third-party investor. In sum,

Plymouth believes that loans in either scenario (1) or scenario

(2) above, when acquired as part of a loan package, are assets described in section 55 (a) (3) of the 1940 Act and therefore are qualifying assets for purposes of the 70 percent requirement.~

Indeed, without Plymouth or another intermediary taking the risk

of purchasing a package of impaired loans oE varying credit

quality and likelihood of rehabilitation, it would likely not be

possible for this type of small business obligor to be matched

the capacity to hold a

newly restructured note with these credit characteristics to

with a third-party investor which has

maturity.
Section 2 (a) (48) (B). Plymouth, through its trustees,
officers, or employees, will promptly contact the borrower on

each loan that Plymouth intends to treat as a qualifying asset

for purposes of the 70 percent requirement and will make a

wri tten offer to provide, and if, accepted will so provide,

significant guidance and counsel to the borrower concerning its

management and its business objectives and policies in the

following manner:

1. applying standard financial analysis. to review the

borrower's current financial statements,

suggesting modifications in financial practices

and accounting treatment where appropriate, and

otherwise making detailed recommendations to

improve the borrower's cash flow and profitability

and to enhance the likelihood of the borrower's

receiving a favorable response to a request for

refinancing from a third-party lender;

2. providing comprehensive assistance to the borrower

in its preparation of a third-party loan request

including, but not limited to, examination of

borrowing needs and capacity and assistance with

the drafting of application forms and supporting

schedules;
3.. introducing the borrower to prospective third-

party lenders as well as to' law firms, accountants, and other professionals for

assistance with general business matters (such

intr~ductions to occur, depending upon the

~I This letter is not seeking the Staff's views with respect to

the status under section 55 (a) (3) of loans púrchased individually by Plymouth.

John V. 0' Hanlon, Esq.
September 10, i996

circumstances, either in person, by telephone or

written correspondence); and

4. informing the borrower about various loan and
   other programs sponsored by 'the U.S. Small

Business Administration, and assisting the

borrower in identifying prospective third-party

lenders participating in the general business loan

program authorized by section 7 (å) of the Small

Business Act (so-called "7 (a) loans") or the

development company loan program authorized by

. Sections 503 through 505 of the Small Business

Investment Act of 1958 (so-called "504 loans").

The above services will be made generally available on an ongoing

basis as long as Plymouth holds the borrower's loan in its

portfolio. To the extent that the borrower abuses the offered

managerial assistance by failing to negotiate in good faith to

restructure its impaired loan, by not making the contracted

payments on Plymouth's loan without good reason, or by not

otherwise using the offered assistance in good faith, Plymouth

may determine to withhold certain aspects of the managerial assistance. Plymouth believes that the managerial assistance

program outl ined. above should be deemed to constitute

l'significant guidance and counsel concerning the management,

operations, or business objectives and policies of a portfolio

company," as that phrase appears in the definition of "(m)aking

available significant managerial assistance" in section

2(a) (47) (A) of the 1940 Act. Therefore, Plymouth believes that offering to provide, and if accepted so providing, such guidance

and counsel to its small business obligors on restructuring their

existing debt and related financial' matters should be deemed to

fulfill its obligation under section 2 (a) (48) (B) of the 1940 Act

to "make available significant managerial assistance with respect

to the companies which are treated by such (BDC) as satisfying

the 70 per centum of the value of its total assets condition of

section 55" 'thereof.
Policy Considerations

The assurances sought in this letter are consistent

with the policy underlying the Small Business Investment

Incentive Act of 1980 (the "1980 Amendments" to the 1940 Act)~/,

which introduced the BDC regulatory regime as an. alternative to

~I Pub. L. No. 96-477, 94 Stat. 2275 (1980).

John V. O'Hanlon, Esq.

registration under the 1940 Act for closed-end investment

companies. That legislation had as its purpose the promotion of investments in small businesses. By' participating in the market for distressed debt of smaller companies, entities like Plymouth

frequently act as.a last resource for entrepreneurs to avoid

bankruptcy or foreclosure when faced with an untenable burden of

interest and principal payments on an outstanding loan. Indeed,

the, existence of buyers of impaired loans makes the primary sources of debt financing to small business borrowers (e.g., banks) more willing, at least to some extent, to make the loans

in the first instance and with lower levels of debt service

paýments than would otherwise be the case.

SWFI has observed three recent trends in the banking

industry that underscore the importance of the role of entities

like Plymouth. First, following the combination of two banks

through merger or other means, the acquiring bank often decides

to liquidate the impaired loans it inherits from the acquired

bank, which typically has a relatively high proportion of

impaired loans on its books (contributing, in part, to a troubled

bank's demise). Without a demand for
'impaired loans by entities

like Plymouth, foreclosure by the acquiring bank would be thê

likely re$uI t. Second, many banks have downsized their staffs

over the past few years, a pattern which among other things has

led disproportionately to the scaling back or, in the case of

many smaller- to mid-sized banks, complete elimination of their

"workout" capacity. Absent that capability, foreclosure has

become a more common result. Notably, many of the downsized

banks have shown a preference for selling impaired loans rather

than working with debtors. Third, possible revisions to risk-

based capital requirements may make bank lenders somewhat more

anxious to dispose of impaired loans.~/ Plymouth provides a

non-foreclosure option for many of these loans.

, To the extent a purchaser i ike Plymouth stands prepared

to purchase the types of notes described above at a discount and

to work with borrowers whose cash flow or asset quality has

deteriorated, small businesses cart be given increased chances of

survival which they might not otherwise have. While impaired

loans of large denominations can be rehabilitated through

pooling, securitization, or other strategies that appeal to

investment banking firms or other large institutional buyers looking for economies of scale, very few al ternati ves are available for lenders desiring to resolve smaller credits. These

W ,See Jaret Seiberg, Greenspan Hints at Revision in Capital Rul,es on Credit Risk, American Banker, May 3, 1996, at 1.

John V. O'Hanlon, Esq.

types of resolutions also help avoid costly litigation, which

itself could prove fatal for a small business.

Rep. Broyhill of North Carolina, the Ranking Minority

Member of the House Committee on Interstate and Foreign Commerce

reiterated the intent of Congress moments before the House voted

to concur with the Senate's amendments to H.R. 7554, which

shortly thereafter was signed into law by the President as the

1980 Amendments to the 1940 Act:

As the principal sponsor to this legislation I

want the record to reflect that its purpose is to

remove unnecessary regulatory impediments on the

ability of small businesses, growing businesses,

and financiallrl troubled businesses to raise much-

needed capitaij

(emphasis added).
Rep. Broyhill was emphasizing the expansive interpretation that

he, as the principal sponsor ofH.R. 7554, hoped would be given

to the 1980 Amendments. We seek herein the Staff's concurrence

that the proposed ~ransactions by Plymouth are consistent with

the purpose of the 1980 Amendments.

Recent initiatives also support a flexible

interpretation of the BDC provisions of the 1940 Act. The Senate

version of R.R. 3005 (S. 1815), which is currently awaiting

reconciliation with the House version by the soon-to-be-convened

Conference Committee, reflects the belief of the Senate Committee

on Banking, Housing, and Urban Affairs

that changing BDC regulation to make it easier and

less costly for BDCs to offer securities and to

invest in small businesses will make this type of

investment vehicle more attractive. S. 1815

creates a new class of portfolio companies in

which BDCs may invest without making available

"significant managerial assistance," permits BDCs

~o acquire more freèiy thè securities of portfolio

companies, and allows BDCs greater flexibility in

their capital structure.Y

11 126 Congo Rec. 28,632 (1980).
§I S. Rep. No. 293, 104th Cong., 2d Sess. 13 (1996).

John V. O'Hanlon, Esq.

Specifically, the proposed "new class of portfolio companies in

which BDCs could invest without making available significant

managerial assistance . . . would include any company that has

total assets of $4 million or less and capital and surplus of

more than $2 million. ,,2/ In addition, S. 1815 would expressly

permit BDCs to treat securities of "eligible portfolio companies"

(i.e., issuers that meet the criteria set forth in all three

subparagraphs of Section 2(a) (46) of the 1940 Act rather than

merely in subparagraphs (A) and (B) thereof) as qualifying assets

for purposes of the 70 percent requirement of Section 55 (a) even

if acquired from a person other than the issuer or a

current/former affiliated person thereof .ll/ If this becomes

law, the meaning of "transactions incident thereto" as used in

Section 55(a) (3) would no longer be determinative of the
qualifying asset status of a note evidencing an impaired loan

purchased by a BDC from a governmental or non-governmental insti tution as long as the borrower meets not only the criteria of subparagraphs (A) and (B) of Section 2 (a) (46), already a necessary condition of qualifying asset status under Section

55(a)(3), but also the criteria of subparagraph (C) of Section

2 (a) (46) so that it is an "eligible portfolio company."

The transactions described above are consistent with both the public interest as well as the policy and purposes of

the 1980 Amendments and the currently pending legislation. They

also are consistent with the protection of investors in Plymouth,

who stand to benefit from the returns earned on the investments

in impaired loans without being exposed to risks of a type not

anticipated by the 1980 Amendments.

CONCLUSION
In view of ,the foregoing, Plymouth respectfully

requests that you advise that the Staff will not recommend the

Commission to take any enforcement action if: Plymouth elects to

be regulated as a BDC subject to the provisions of Sections 55

through 65 of the 1940 Act; for purposes of compliance with

Section 55 (a) thereo~, treats certain debt securities (described

above), held and to be held in its investment portfolio, as being assets of the type described in paragraph (3) of that section; , and, with respect to the issuers of these debt securities, offers

V Id. (discussing S. 1815 § § 303-304, which propose to amend

Sections 2(a)(46)(C) and 2(a)(48)(B) of the 1940 Act).

10/ See S. 1815, 104th Cong., 2d Sess. § 305 (1996) (proposing to amend Section 55 (a) (1) (A) of the 1940 Act).

John V. O'Hanlon, Esq.

to provide and, if accepted, does so provide, certain guidance

and counsel on restructuring their existing debt and related

financial matters.

---

If yöu have any questions or require any additional

information, please call the undersigned at (202) 383-0176, or

David L. Abrams at (202) 383-0181.

cc: Jack W. Murphy /SEC ¡
John C. Mosher/SWFI
David L. Abrams/SA&B