Recently, the U.S. District Court for the Southern District of New York ruled in Kirschner v. JP Morgan[1] that a syndicated term loan was not “security” under several state securities laws (or Blue Sky). While the ruling did not interpret federal law, it supports the position that syndicated term loans should not be considered securities under the Securities Act of 1933 or the Securities Exchange Act of 1934.

Unsecured status is critical to today’s syndicated loan market, which annually provides hundreds of billions of debt capital to companies in the United States. In some ways, the high yield debt market and the syndicated loan market (particularly the B term loan market) have converged for many years. Institutional investors invest in both bank loans and high yield bonds, and the terms and conditions of the two debt products have become more similar over time, with covenant-lite loans and other features causing high yield loans and bonds look very similar. High yield bond offerings include registered public offerings and public Rule 144A style offers, which typically involve procedures designed to protect against obligations under securities law; Syndicated loans are generally marketed without comparable protection procedures in securities law.

Kirschner was an action of the trustee, acting on behalf of institutional investors in a syndicated loan transaction of $ 1.775 billion arranged by several banks. The trustee alleged violations of various laws of Blue Sky, alleging that the loan documents, which included promissory notes, were securities.

The defendants requested the dismissal, and the Loan Syndications and Trading Association (LSTA) and the Bank Policy Institute filed an amicus brief urging the court to declare the loans not securities. On May 22, 2020, the district court dismissed the Blue Sky Law claims against the banks responsible for organizing and distributing syndicated loans, ruling that the loans in question were not securities.

The court applied the family resemblance test, which the United States Supreme Court used in Dreams vs. Ernst & Young[2] under federal law to determine whether promissory notes were considered securities. The test requires courts to first assume that a note is a security. The presumption can only be rebutted by showing that the note has a strong “family resemblance” to one of the listed categories of non-financial instruments. Dreams. The enumerated category applied by the court in Kirschner was “notes attesting to commercial bank loans.”

The family resemblance test consists of four factors:

• The motivations for a reasonable seller and buyer to enter into the transaction
• The instrument’s distribution plan
• Reasonable expectations of the investing public
• The existence of another regulatory regime to reduce the risk of the instrument, thus rendering the enforcement of securities laws unnecessary.

The court ruled that the first factor – motivations – did not weigh heavily in favor of either party. For the second factor – the distribution plan – the syndication excluded individuals, was limited to sophisticated institutions and required consent to the transfer, and was therefore relatively narrow and not of the typical type of a public offering of securities. The third factor – reasonable expectations – was established by the Credit Agreement and its related Confidential Disclosure Memorandum and would lead a reasonable investor to believe that the Notes were loans and not securities. Finally, the court concluded that the fourth factor – the existence of other regimes and regulatory agencies – such as the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Federal Reserve Board, rendered the application of the rules unnecessary. state laws on blue sky. This conclusion was reinforced by the decision of the United States Second Circuit Court of Appeals in Banco Spanish[3].

The complainant in Kirschner can appeal the decision, and a judgment at the district court level does not control other courts. However, the court’s ruling that securities laws are inapplicable to the loan at issue is helpful in allaying fears that the syndicated loan market may be disrupted by a contrary ruling.

Key to take away

Syndicated loans play an important role in the US 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 anti-fraud liability under securities law, syndicated loans can offer borrowers greater flexibility in accessing sources of debt capital. Elliot Ganz of the LSTA called the move “a victory for the flow of capital to American businesses.”

[1] Kirschner v. JP Morgan Chase Bank, NA, No.17 Civ. 6334 (SDNY May 22, 2020).

[2] Reves c. Ernst & Young, 494 US 56 (1990).

[3] Banco Espanol de Credito v. Security Pacific National Bank, 973 F.2d 51 (2d Cir. 1992).