July 10, 2019 - As we recently reported, the LSTA filed an amicus brief in a federal case coming out of the Millennium bankruptcy which is considering whether broadly syndicated term loans are securities for the purposes of federal and state securities laws.  The LSTA argued that they are not and explained the materially negative consequences to borrowers and lenders were a court to reach the opposite conclusion.  Recently, the banks completed the briefing in this case by filing a reply brief that reiterated their view that the term loan in that case is not a security. 

Background.  The trustee for the bankruptcy’s litigation trust sued the agent banks that underwrote a $1.75 billion dollar loan to Millennium, alleging that by fraudulently originating the loans they violated state “Blue Sky Laws” which are the state equivalent of the federal securities laws.  The banks brought a motion to dismiss on a number of grounds, including that the loan in question is not a “security” and is therefore not subject to state Blue Sky laws.  The trustee responded, arguing, first, that the term loan should be considered a security and, second, that whether or not the term loan is a security is a matter of fact that must be resolved at trial and not a legal issue that can be decided by the court in a motion to dismiss.  The LSTA’s amicus argues that broadly syndicated term loans such as the one at issue in Millennium are not securities for the reasons set out in this FAQ.  For a deeper dive, please see Reorg Research’s very helpful recently published summary of the parties’ positions in the Millennium litigation.The District Court must now decide whether to entertain oral arguments from the litigants, and, ultimately, whether or not to grant the motion to dismiss.  If it grants the motion, the plaintiff is likely to appeal but if it denies the motion the defendants would not have the right to appeal and the issue of whether or not the term loan is a security would be further litigated through discovery and possibly trial. 

Why do we care if loans are treated as securities?   The LSTA will soon be publishing an in-depth analysis of the potential changes to market practices that could result from a ruling that term loans are subject to the securities laws.  For now, it’s important to understand that if participants in the syndicated term loan market were subject to liability under the securities laws, the process of syndicating and trading loans would change dramatically, adding costs and making the process more time-consuming and cumbersome for both borrowers and lenders.  This could make the broadly syndicated term loan market a much less attractive asset class for borrowers and could push them, instead, to issue secured bonds or to look to direct loans for financing (since direct loans would not likely be considered securities).  Moreover, if syndicated term loans were considered securities, the principal source of funding for such loans—CLOs—would be jeopardized. Regulations implementing the “Volcker Rule” bar banks from acquiring or retaining “ownership interests” in “covered funds” and regulators have interpreted that provision to mean that banks may not invest in notes issued by CLOs that own securities.  A holding that syndicated term loans should be treated as securities would jeopardize many CLOs’ ability to participate in such lending and could mean that U.S. banks would immediately have to divest themselves of approximately $86 billion in interests in CLOs —25% of CLOs’ AAA notes. The LSTA will continue to closely monitor this important case.