Does a subordinated bank loan count against a Texas pawnshop's net assets when it applies for a license?

Plain-English summary

To get a Texas pawnshop license, an applicant had to show "net assets of at least $150,000 readily available" for running each shop. The Texas Pawnshop Act defined "net assets" as the book value of current assets minus "applicable liabilities," and it spelled out that applicable liabilities include debts that are unsecured or secured by current assets. The Chair of the House Investments and Banking Committee asked the Attorney General how that definition treats a debt covered by a subordination agreement: if a pawnshop borrows from a bank and gives the bank a lien on all its assets, but the bank then signs an agreement subordinating its claim so the shop can meet the $150,000 floor, does that loan still count as a liability that pulls the shop below the line?

The office walked through the statute's purpose. The 1981 amendments that added the definition were meant, the legislative history showed, to capture assets a pawnbroker could "liquidate quickly to make available to a consumer." The act lists easily liquidated items (cash, deposits, inventory, customer loans) as current assets, excludes hard-to-liquidate items (real estate, fixtures, stocks and bonds), and treats debts secured by current assets as applicable liabilities because such debts get in the way of quick liquidation.

A subordination agreement, the office explained, is a contractual reshuffling of lien priority: parties can change the usual first-in-time ordering by contract, and a court reads the agreement by its terms and the parties' intent (citing the Texas Supreme Court's ITT Diversified Credit Corp. decision and a Houston court of appeals decision applying it). On the facts described, where the bank gives up both its security priority and any unsecured-creditor claim to the first $150,000 of the shop's current assets, that $150,000 stays available for the pawnshop business and for general creditors. So a debt subordinated that way would not be an "applicable liability" subtracted in the net-asset calculation, and the shop in the hypothetical (current assets of $160,000, a single $100,000 subordinated bank debt) would qualify.

The office attached an important limit. It does not construe particular contracts or resolve fact questions in the opinion process. So while it could say how a subordination agreement of the type described generally works under the statute, it could not decide whether any specific agreement actually strips the debt of its secured or unsecured character. That turns on the agreement's own terms and the facts of the case.

Currency note

This opinion was issued in 1995. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The Texas Pawnshop Act the opinion construed (then in title 79, chapter 51 of the civil statutes, the article 5069 series) has since been recodified into the Finance Code, where pawnshop regulation and the net-asset eligibility rules now live, and the figures and definitions may have been revised. Read this page for how the office analyzed subordinated debt under the 1995 statute, and check the current Finance Code and the Office of Consumer Credit Commissioner's rules before relying on any threshold or definition mentioned here.

What the opinion meant for those who asked

For the requesting committee: The opinion answered that a debt subordinated in the way described generally was not an applicable liability under the net-asset definition, while flagging that the office could not interpret any particular subordination contract or decide the underlying facts.

For pawnshops and license applicants: Under the opinion, structuring a bank loan with a genuine subordination of the lender's priority and unsecured-creditor rights to the first $150,000 of current assets could keep that debt from being subtracted in the net-asset calculation, but whether a given agreement did so depended on its terms.

For the Office of Consumer Credit Commissioner: The opinion read the statute and the agency's own rule (7 T.A.C. § 85.2(a)(2)(A)) together, treating current assets that remain available to the business and to general creditors as counting toward the net-asset requirement, with the secured-or-unsecured status of a specific debt left to the facts.

Common questions

Did a bank loan automatically disqualify a pawnshop on net assets?
Not necessarily. The opinion said a debt subordinated so the bank gives up its priority and unsecured-creditor claim to the first $150,000 of current assets generally would not be an applicable liability subtracted in the net-asset calculation.

What is a subordination agreement here?
It is a contract in which a lender that would otherwise be secured by, or have a general-creditor claim against, the pawnshop's current assets agrees to let that claim fall behind the shop's $150,000 net-asset requirement and the rights of general creditors.

Why did the $150,000 figure matter so much?
Because the act required an applicant to have at least $150,000 in net assets readily available, and the office read the law to focus on assets a pawnbroker could liquidate quickly for consumers; a subordination that keeps that $150,000 available does not impair quick liquidation.

Could the AG say a particular subordination agreement worked?
No. The opinion stressed that the office does not construe specific contracts or resolve fact questions, so whether a given agreement actually removed a debt from the calculation depended on its terms and the facts.

Background and statutory framework

The Texas Pawnshop Act (V.T.C.S. tit. 79, ch. 51) required a license from the Consumer Credit Commission to operate as a pawnbroker (V.T.C.S. art. 5069-51.03(a)), with a separate license for each place of business (art. 5069-51.06(a)). Article 5069-51.03A(a)(2) conditioned eligibility on "net assets of at least $150,000 readily available for use in conducting the business of each licensed pawnshop." Article 5069-51.02(g) defined "net assets" as the book value of current assets less applicable liabilities, listed which items count as current assets (cash, bank deposits, merchandise inventory, customer loans) and which do not (fixed assets, securities, prepaid expenses and general intangibles), and provided that applicable liabilities include notes or other payables that are unsecured or secured in whole or part by current assets, but not liabilities secured by other assets.

The Office of Consumer Credit Commissioner, acting under the rulemaking authority in article 5069-51.09(b), adopted 7 T.A.C. § 85.2(a)(2)(A), which calculated net assets as cash, deposits, inventory, and open pawn-loan receivables less unsecured debts and debts secured by those listed assets, with assets counting only if available for use in the pawnshop business. The office read the 1981 amendments (Act of April 27, 1981, 67th Leg., ch. 99, § 2, 1981 Tex. Gen. Laws 221), and the 1979 legislative history of the earlier vetoed Senate Bill 166, to show that "net assets" meant assets a pawnbroker could liquidate quickly for consumers. Applying the rule that courts read statutes to find legislative intent (Gov't Code § 312.005), and the contract-law treatment of subordination agreements as modifications of lien priority (ITT Diversified Credit Corp. v. First City Capital Corp., 737 S.W.2d 803 (Tex. 1987); Western Auto Supply Co. v. Brazosport Bank, 840 S.W.2d 157 (Tex. App.-Houston [1st Dist.] 1992, no writ)), the office concluded a properly subordinated debt would not impair the availability of the $150,000 and so would not be an applicable liability, subject to the office's standing limits against construing particular contracts or deciding fact questions.

Citations

Statutory and regulatory provisions discussed:

• Texas Pawnshop Act, V.T.C.S. tit. 79, ch. 51; art. 5069-51.01 (purpose); art. 5069-51.02(g) (definition of "net assets"); art. 5069-51.03(a) (license required); art. 5069-51.03A(a), (a)(2) (eligibility; $150,000 net assets); art. 5069-51.06(a) (separate license per location); art. 5069-51.09(b) (rulemaking authority)
• 7 T.A.C. § 85.2(a)(2)(A) (agency net-asset calculation rule)
• Gov't Code § 312.005 (statutory construction; legislative intent)

Cases discussed:

• ITT Diversified Credit Corp. v. First City Capital Corp., 737 S.W.2d 803 (Tex. 1987)
• Western Auto Supply Co. v. Brazosport Bank, 840 S.W.2d 157 (Tex. App.-Houston [1st Dist.] 1992, no writ)

Other authority:

• 67 TEX. JUR. 3D Statutes § 91, at 651-52 (1989); 50 TEX. JUR. 3D Liens § 12, at 299-300 (1986)
• Attorney General Opinions DM-192 (1992), JM-697 (1987), DM-98 (1992), H-56 (1973), M-187 (1968), O-2911 (1940)

Source

• Landing page: https://www.texasattorneygeneral.gov/opinions/dan-morales/dm-0332
• Original PDF: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1995/dm0332.pdf

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain (including footnote numbering) — the linked PDF is authoritative.

Office of the Attorney General
State of Texas

DAN MORALES
ATTORNEY GENERAL

March 10, 1995

Honorable Kenny Marchant
Chair
Committee on Investments and Banking
Texas House of Representatives
P.O. Box 2910
Austin, Texas 78768-2910

Opinion No. DM-332

Re: Whether certain subordinated debt of a pawnshop must be included in the calculation of net assets for purposes of determining eligibility for a pawnshop license under the Texas Pawnshop Act, V.T.C.S. tit. 79, ch. 51 (RQ-724)

You have asked whether certain subordinated debts constitute applicable liabilities that must be included in the calculation of net assets for purposes of the Texas Pawnshop Act (the "act"), V.T.C.S. tit. 79, ch. 51. Under the act, no person may engage in business as a pawnbroker unless the person has received a license from the Consumer Credit Commission.[1] V.T.C.S. art. 5069-51.03(a). To be eligible for a pawnshop license, an applicant must, among other things, "have net assets of at least $150,000 readily available for use in conducting the business of each licensed pawnshop."[2] Id. art. 5069-51.03A(a)(2). Pursuant to article 5069-51.02(g),

"[n]et assets" means the book value of the current assets of a person or pawnbroker less its applicable liabilities as stated in this subsection. Current assets include the investment made in cash, bank deposits, merchandise inventory, and loans due from customers excluding the pawn service charge. Current assets do not include the investments made in fixed assets of real estate, furniture, fixtures, or equipment; investments made in stocks, bonds, or other securities; or investments made in prepaid expenses or other general intangibles. Applicable liabilities include trade or other accounts payable; accrued sales, income, or other taxes; accrued expenses; and notes or other payables that are unsecured or secured in whole or part by current assets. Applicable liabilities do not include liabilities secured by assets other than current assets. Net assets must be represented by a capital investment unencumbered by any liens or other encumbrances to be subject to the claims of general creditors. . . .

The Office of the Consumer Credit Commissioner has promulgated a rule[3] explaining the method by which it calculates an applicant's or a licensee's net assets:

An applicant or licensee's net assets is the sum of cash on hand, bank deposits, the value of merchandise inventory held for sale in the pawnshop or to be held for sale in the pawnshop, and the amount of money loaned on open pawn loans receivable less any and all unsecured debts, and debts secured in whole or part by the previously listed assets. Assets must be available for use in the pawnshop business to be acceptable.

7 T.A.C. § 85.2(a)(2)(A).

You have described a hypothetical situation similar to a situation you understand to occur with increasing frequency. You establish that a pawnshop has current assets of $160,000, and with the exception of its subordinated debt, the pawnshop has no applicable liabilities. You continue by advising that the pawnshop has borrowed from and owes money to a bank in the amount of $100,000. The pawnshop has executed a security agreement and financing statement to the bank, covering all of the business's assets. Simultaneously with the execution of the security agreement and financing statement, the pawnshop and the bank executed a subordination agreement.

Under the subordination agreement, you state that the bank agrees to subordinate any lien or claim it might have to permit the pawnshop to meet the act's net asset requirement. The subordination agreement provides that any lien or claim of the bank to the assets of the pawnshop always will be subordinate to the $150,000 net asset requirement and subordinate to the right of general creditors to have first claim to the first $150,000 of net assets of the pawnshop. You indicate that subordination agreements come in various forms with various requirements, but all of the subordination agreements of which you are aware do not vary in their basic thrust: a lender who would otherwise be secured (by current assets) or a general creditor has agreed to subordinate its debt and any claim it might have against the current assets of the pawnshop to permit the pawnshop to meet the act's net asset requirement.

If the debt that is the subject of the subordination agreement is not an applicable liability for purposes of determining the pawnshop's net assets under V.T.C.S. article 5069-51.02(g), then the pawnshop has sufficient net assets to be eligible for a pawnshop license. See V.T.C.S. art. 5069-51.03A(a)(2). If, on the other hand, the debt is an applicable liability, then the net assets of the pawnshop in the hypothetical you have described are insufficient to qualify for licensure under the act. See id. You ask us to construe the definition of "net assets" provided in section 51.02(g) to determine whether a subordinated debt such as you describe is an applicable liability.

The legislature amended the act in 1981, adding the statement of purpose and the definition of net assets, among other things. See Act of April 27, 1981, 67th Leg., ch. 99, § 2, 1981 Tex. Gen. Laws 221, 221-22. The legislature had enacted a substantially similar definition of net assets in 1979, see S.B. 166, 66th Leg., R.S. (1979), but the governor vetoed the bill. In 1979 Representative Laney, house sponsor of Senate Bill 166, explained to the House Committee on Financial Institutions that the bill "tightened up" the act. Hearings on S.B. 166 Before the House Comm. on Financial Institutions, 66th Leg. (Feb. 27, 1979) (tape available from House Video/Audio Services) (statement of Representative Laney). According to a witness who spoke at the hearing, at that time the act required pawnbrokers and applicants to have net assets in the amount of $25,000, but the act did not define "net assets." Id. (statement of William R. Pakis, representing the Texas Pawn Brokers Association). An unidentified representative stated that the bill defined the term "net assets" in terms of assets that a pawnbroker might liquidate quickly to give to a consumer. Id.; see also id. (statement of unidentified representative explaining that S.B. 166 is consumer oriented).

In interpreting a statute, a court diligently must attempt to ascertain legislative intent. Gov't Code § 312.005; see 67 TEX. JUR. 3D Statutes § 91, at 651-52 (1989) (and sources cited therein). Upon examining the legislative history, we see that the legislature meant by the term "net assets" to describe assets of a pawnshop business that a pawnbroker might liquidate quickly to make available to a consumer.

In this regard, we note that article 5069-51.03A(a), which provides requisites for eligibility for a pawnshop license, includes a mandate that an applicant for a license have net assets of at least $150,000 "readily available for use in conducting the business of each licensed pawnshop." We further note that, for purposes of calculating an applicant's or licensee's net assets, the act lists as current assets items easily liquidated. See V.T.C.S. art. 5069-51.02(g). The act explicitly excludes items that may be difficult to liquidate: "investments made in fixed assets of real estate, furniture, fixtures, or equipment; investments made in stocks, bonds, or other securities; or investments made in prepaid expenses or other general intangibles." Id. Likewise, applicable liabilities include liabilities secured by current assets, which would hinder the quick liquidation of the assets. See id.

Ordinarily, different liens on the same property have priority in the time of their creation. 50 TEX. JUR. 3D Liens § 12, at 299 (1986) (and authorities cited therein). Parties may vary the common practice by contract, however. See id. at 299-300. A subordination agreement is a contractual modification of lien priorities. ITT Diversified Credit Corp. v. First City Capital Corp., 737 S.W.2d 803, 804 (Tex. 1987); Western Auto Supply Co. v. Brazosport Bank, 840 S.W.2d 157, 159 (Tex. App.-Houston [1st Dist.] 1992, no writ) (citing ITT Diversified Credit Corp.). Accordingly, such an agreement must be construed consistent with the parties' expressed intention as well as the terms of the agreement itself. ITT Diversified Credit Corp., 737 S.W.2d at 804; Western Auto Supply Corp., 840 S.W.2d at 159 (citing ITT Diversified Credit Corp.).

From your description of the subordination agreement and from the information we have found, it appears that a bank forfeits its security priority to current assets of the pawnshop in the amount of $150,000. It also would appear that the bank forfeits any rights it may have as an unsecured creditor to current assets in the amount of $150,000. If these assumptions are true, a subordination agreement would not render a pawnshop's current assets unavailable for use in the pawnshop business, see V.T.C.S. art. 5069-51.03A(a)(2); 7 T.A.C. § 85.2(a)(2)(A), nor would it hinder a pawnshop's ability quickly to liquidate its assets. Thus, debt that is subject to a subordination agreement such as you describe would not be an applicable liability for purposes of calculating a pawnshop's net assets under article 5069-51.02(g), V.T.C.S.

We do not construe contracts in the opinion process, however. Attorney General Opinions DM-192 (1992) at 10; JM-697 (1987) at 6. Additionally, we cannot resolve fact questions in the opinion process. See, e.g., Attorney General Opinions DM-98 (1992) at 3; H-56 (1973) at 3; M-187 (1968) at 3; O-2911 (1940) at 2. Thus, we are unable to determine whether, in a particular case, a debt subject to a particular subordination agreement actually is an unsecured debt or a debt secured in whole or part by a pawnshop's current assets.

SUMMARY

Assuming that under a subordination agreement, a bank forfeits its security priority as well as any rights it may have as an unsecured creditor to current assets of a pawnshop-borrower in the amount of $150,000, a subordination agreement would not render the pawnshop's current assets unavailable for use in the pawnshop business. Accordingly, debt that is subject to a lender's subordination agreement generally is not an applicable liability for the purpose of calculating the pawnshop's net assets under V.T.C.S. article 5069-51.02(g).

DAN MORALES
Attorney General of Texas

JORGE VEGA
First Assistant Attorney General

SARAH J. SHIRLEY
Chair, Opinion Committee

Prepared by Kymberly K. Oltrogge
Assistant Attorney General

[1] The purpose of the act is to (1) exercise the state's police power to ensure a sound system of making pawn loans and acquiring and disposing of tangible personal property by and through pawnshops and to prevent unlawful property transactions, particularly in stolen property, through licensing and regulating pawnbrokers and certain persons employed by or in pawnshops; (2) provide for licensing fees, investigation fees, and minimum capital requirements of licensees; (3) ensure financial responsibility to the state and the public; (4) ensure compliance with federal, state, and local laws, rules, regulations, and ordinances; and (5) assist local governments in the exercise of their police powers. V.T.C.S. art. 5069-51.01.

[2] A pawnbroker must receive a separate license for each place of business. See V.T.C.S. art. 5069-51.06(a).

[3] Article 5069-51.09(b), V.T.C.S., authorizes the Consumer Credit Commissioner to adopt regulations necessary for the enforcement of the act and consistent with the act's provisions.