Recently, the U.S. District Court in the Southern District of New York held in Kirschner v. J.P. Morgan that a syndicated term loan was not a “security” under several state securities (or Blue Sky) laws. While the ruling did not interpret federal law, it supports the position that syndicated term loans should not be considered securities under either the Securities Act of 1933 or the Securities Exchange Act of 1934.
Non-security status is critical to the existing syndicated loan market, which provides hundreds of billions worth of debt capital to companies in the U.S. every year. In some respects, the high yield debt securities market and the syndicated loan market (in particular, the Term Loan B market) have converged over many years. Institutional investors invest in both bank loans and high yield bonds, and the terms and conditions of the two debt products have gotten more similar over time, with covenant-lite loans and other features causing loans and high yield bonds to look very similar. High yield bond offerings include registered public offerings and public-style Rule 144A offerings, both of which typically involve procedures designed to protect against securities law liabilities; syndicated loans are typically marketed without comparable securities law protective procedures.
Kirschner was an action by the trustee, acting on behalf of institutional investors in a $1.775 billion syndicated loan transaction arranged by several banks. The trustee claimed violations of various Blue Sky laws, alleging that the loan documents, which included promissory notes, were securities.
The defendants moved to dismiss, and the LSTA (Loan Syndications and Trading Association) and the Bank Policy Institute filed an amicus brief urging the court to rule that the loans were not securities. On May 22, 2020, the District Court dismissed the Blue Sky law claims against the banks responsible for arranging and distributing the syndicated loans, ruling that the loans in question were not securities.
The court applied the family resemblance test, which the U.S. Supreme Court used in Reves v. Ernst & Young under federal law to determine whether the promissory notes qualified as securities. The test requires courts to begin with a presumption that a note is a security. The presumption may only be rebutted by a showing that the note bears a strong “family resemblance” to one of an enumerated category of non-security instruments set out in Reves. The enumerated category applied by the court in Kirschner was “notes evidencing loans by commercial banks.”
The family resemblance test consists of four factors:
- The motivations prompting a reasonable seller and buyer to enter the transaction
- The plan of distribution of the instrument
- The reasonable expectations of the investing public
- The existence of another regulatory scheme to reduce the risk of the instrument, thereby rendering application of securities laws unnecessary.
The court found that the first factor – motivations – did not weigh heavily in either party’s favor. For the second factor – plan of distribution – the syndication excluded private individuals, was limited to sophisticated institutions and required consent to transfer, and therefore was relatively narrow and not the type that is typical for a public securities offering. The third factor – reasonable expectations – was established by the Credit Agreement and its related Confidential Information Memorandum and would lead a reasonable investor to believe the notes were loans and not securities. Finally, the court found that the fourth factor – existence of other regulatory schemes and agencies – such as the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve Board, rendered application of state Blue Sky laws unnecessary. That conclusion was bolstered by the Second Circuit U.S. Court of Appeals decision in Banco Espanol.
The plaintiff in Kirschner can appeal the decision, and a judgment at the District Court level is not controlling on other courts. However, the court’s determination that securities laws are inapplicable to the loan at issue is helpful in relieving concerns that the syndicated loan market could be disrupted by a contrary decision.
Syndicated loans play an important role in the U.S. economy, and the assumption that syndicated loans are not “securities” is important to the syndicated loan market. By avoiding the need to register loans with the SEC and limiting securities law antifraud liability, syndicated loans can provide borrowers greater flexibility in accessing sources of debt capital. The LSTA’s Elliot Ganz called the ruling “a victory for the flow of capital to American businesses.”
If you have questions or concerns about navigating the syndicated loan market or other securities related issues, your regular Locke Lord contact and any of the authors can offer guidance and discuss these matters with you.
 Kirschner v. JP Morgan Chase Bank, N.A., No. 17 Civ. 6334 (S.D.N.Y. May 22, 2020).
 Reves v. Ernst & Young, 494 U.S. 56 (1990).
 Banco Espanol de Credito v. Security Pacific National Bank, 973 F.2d 51 (2d Cir. 1992).