The Second Circuit Agrees: Loans are Not Securities

In a highly anticipated decision, the United States Court of Appeals for the Second Circuit affirmed the District Court’s decision in Kirschner v. JP Morgan Chase Bank that the syndicated loan at issue in the case was not a security and therefore not subject to state and federal securities laws. The August 24 ruling is being viewed as a victory by the loan market; any decision to the contrary would have subjected borrowers and lenders to a more complex and stringent regulatory framework, disrupting decades of market practice. 

Background

The Kirschner case arose from a $1.775 billion loan made in 2014 by several lending banks to a private lab testing company, Millennium Laboratories LLC. After Millennium filed for bankruptcy in November 2015, bankruptcy trustee, Marc Kirschner, sued the banks that arranged the loans asserting, among other things, violations of state securities laws.

In May 2020, the United States District Court for the Southern District of New York granted the defendants’ motion to dismiss the trustee’s claims finding that the loans did not qualify as securities. In reaching this decision, the District Court applied the four-factor “family resemblance test” previously adopted by the Supreme Court in 1990 in Reves v. Ernst & Young.

The Appeal 

The trustee filed an appeal seeking to overturn the District Court’s ruling. After oral arguments in March 2023, the Loan Syndications and Trading Association (LSTA), together with the Bank Policy Institute, filed an amicus brief in support of the position that syndicated term loans are not securities. The Second Circuit subsequently invited the Securities Exchange Commission to share its views on the issue. The SEC declined.

In its decision, the Second Circuit agreed with the District Court and, applying the Reves test, determined that the loans are distinguishable from other instructions that qualify as securities.

Implications

The Second Circuit’s ruling comes as a relief to a loan market that faced increased compliance costs, new constraints on borrowers and lenders, and burdensome disclosure requirements had the decision gone the other way. Notwithstanding this “win,” it is important to note that the Reves test is fact-specific and it is possible that the question of whether loans are securities is raised again under different circumstances. For now, though, loan market participants can comfortably rely on the existing framework without fear of imminent disruption.

The case is Kirschner v. JPMorgan Chase Bank, 21-2726, Second US Circuit Court of Appeals (Manhattan).