On August 24, 2023, the U.S. Court of Appeals for the Second Circuit rendered its decision in Marc S. Kirschner v. JP Morgan Chase Bank, N.A., et al.¹ At issue in the case was whether promissory notes issued in connection with a $1.775B syndicated term loan constituted “securities” subject to state-law securities claims.

The plaintiff had alleged that the defendants had made multiple misrepresentations and omissions to prospective lenders in connection with the loan in violation of state “Blue Sky” laws. The defendants argued that the notes were not securities and thus, not subject to state securities laws.

To analyze the notes, the court employed the “family resemblance” test established by the United States Supreme Court in Reves v. Ernst & Young.² The test directs courts to examine a debt instrument across four factors to determine whether, on balance, the instrument has been issued in an investment context (and thus, a security) or in a consumer or commercial context (and thus, not a security). As interpreted by the Second Circuit, these factors are the:

1. Motivations of the parties engaging in the “purchase” and “sale” of the instrument;
2. Plan of distribution of the instrument;
3. Reasonable expectations of the investing public; and
4. Existence of any other risk-reducing factors that may render application of securities laws unnecessary.

Applying the factors to the notes at issue, the court reasoned that the syndicated interests bore “a strong resemblance” to commercial-purpose loans – a category of debt that the Second Circuit has recognized that is not a “security.” Accordingly, the court held that the subject notes were not “securities” for purposes of the plaintiff’s state-law securities claims.

Kirschner was closely watched for its potential to disrupt the domestic syndications market. Although the case has reaffirmed general market understanding that loan syndications are not securities, the decision is narrower than it seems. It does not establish that all syndicated loans are necessarily outside the scope of federal and state securities laws. Rather, it considers a particular loan structure through one analytical framework. Different fact patterns and other analytical frameworks may produce different outcomes.

Kirschner nevertheless offers some practical guidance for lenders to consider to help avoid securities characterization in loan syndications:

1. Lenders should generally avoid using “investment” and “securities” terminology (e.g., “investor,” “return,” “security,” “broker,” etc.) in marketing materials, commitment letters, and loan documents;
2. Credit agreements should state unambiguously that the contemplated credit facilities serve a commercial purpose;
3. Syndicate members should represent that they are sophisticated, commercial lenders and that they have conducted their own credit analysis and due diligence;
4. Customary restrictions on lender assignments should apply (e.g., minimum dollar-amount assignment thresholds, prohibitions on assignments to natural persons, administrative agent, and borrower consent requirements) to avoid the appearance of an offering to the general public; and
5. Lastly, a strong security position can reduce the risk profile of a debt instrument, making it less susceptible of characterization as a security.

Footnotes:

1. Marc S. Kirschner v. JP Morgan Chase Bank, N.A., et al., 2023 WL 5437811 (Aug. 24, 2023).

2. Reves v. Ernst & Young, 494 U.S. 56 (1990).