May 26, 2020 - Late last week Judge Paul Gardephe delivered his long-awaited decision on a motion to dismiss in Kirschner v. JPMorgan Chase, a case that considers whether the origination and distribution of the Millennium Laboratories “Term Loan B” is subject to state (and, effectively, federal) securities laws.  As we’ve previously explained at length (here and here), because that term loan B is structurally no different from any other term loan B in the institutional syndicated loan market, a ruling that it is a security could have had enormous adverse implications for the entire loan market. The good news: the court dismissed the securities law claims against the banks that arranged and distributed the loan, ruling that the loans in question, a $1.75 billion term loan to Millennium Laboratories, did not constitute securities. The LSTA, joined by the Bank Policy Institute, filed an amicus brief in this case more than a year ago arguing in favor of the position adopted by the court. 

What does the decision say?  The court applied the “family resemblance” test set forth in Reves v. Ernst & Young, a 1990 Supreme Court Decision and the seminal case on this issue of whether or not an instrument is a security. Reves requires courts to begin with a presumption that a note is a security, which 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 identified in Reves, including “notes evidencing loans by commercial banks”.  The four factors of the family resemblance test are: (1) “the motivations that would prompt a reasonable seller and buyer to enter into [the transaction]”; (2) “the plan of distribution of the instrument”; (3) ‘the reasonable expectations of the investing public”; and (4) “the existence of another regulatory scheme [to reduce] the risk of the instrument, thereby rendering application of the Securities Act unnecessary.”  In applying the “motivations’ test, the court determined that, in this case, the borrower’s and lenders’ motivations were mixed and concluded that this factor does not weigh heavily in either direction.  Next, the court applied the plan of distribution test, holding that the plan of distribution in Millennium, which excluded private individuals, was limited to sophisticated institutions and required consent, was “relatively narrow” and not the type that was typical of a security.  Notably, the court held that even though hundreds of investment managers were solicited to participate in the loan, “this constitutes a relatively small number compared to the general public.”  Applying the “reasonable expectations” test, the court found that the Credit Agreement and the Confidential Information Memorandum distributed to potential lenders would “lead a reasonable investor to believe that the notes were loans, and not securities.”  Finally, in determining whether there exists another regulatory regime that reduces the risk of the instrument, the court stated that the purpose of the bank regulatory regime is to ensure the safety and soundness of the banks, rather than the protection of note holders.  Nevertheless, it observed that in Banco Espanol, the 2^nd Circuit case that interpreted Reves and is binding precedent in the Southern District of New York, the court distinguished the entirely unregulated scenario in Reves from the market for loan participations which was subject to the policy guidelines of the OCC.  In light of Banco Espanol, the court found that the fourth Reves factor weighs in favor of a finding that the loans are not securities.  In conclusion, the court held that since one of the tests was inconclusive but the other three weighed in favor of finding the loans “analogous to the enumerated category of loans by banks for commercial purposes”, the presumption that the loans were securities was overcome under the facts of this case and the securities law claims were dismissed.

What’s next?  The plaintiffs in Kirschner have the right to appeal the dismissal of the securities claims to the 2^nd Circuit Court of Appeals which would review the courts determination that the term loans in Millennium are not securities.  Given its significance, the LSTA will continue to follow this case closely.