On August 24, 2023, the Second Circuit Court of Appeals determined in the highly anticipated case, Kirschner v. JP Morgan Chase Bank N.A., et al., that syndicated term loans are not securities. The Court upheld the district court’s decision and affirmed the market’s long-standing expectation that syndicated term loans are not securities.

Why Does It Matter?

When it comes to their most basic mechanics, bonds and loans are essentially the same – one party gives money to another party with the expectation that the receiving party will pay it back at some agreed time with interest. Now, that is of course an extreme oversimplification, as bonds and loans differ greatly from one another – one significant difference being that bonds have generally been considered to be securities whereas loans have not – but why does that matter? Among many other reasons, being a loan versus being a security subjects the parties involved in the transactions to different rules and regulations. So, when a case came forward that opened the door to a finding that a loan is a security, thereby potentially subjecting the parties involved in loan transactions to securities laws, people paid attention.

What Happened?

We won’t go too far into the weeds on the case itself, but suffice it to say, the Court’s decision hinged on whether the term loans at issue were securities. To make that determination, the Court applied the following four-factor test laid out by the United States Supreme Court in Reves v. Ernst & Young:

1. Motivations of the Seller and Buyer. Simply put, the Court found that the lender’s motivation for entering the transaction was for investment purposes (suggesting more of a securities vibe) whereas the borrower’s motivation was for commercial purposes (suggesting less of a securities vibe). In the end, the Court leaned more heavily on the lender’s motivation on this first factor, but as we note below, it was not enough to outweigh the Court’s findings on the remaining three factors.

2. The plan of distribution of the debt instrument. Because the term loans were only offered to sophisticated institutional entities with restrictions on transfer that rendered the term loans unavailable to the general public, as opposed to offering and selling the term loans to a broad segment of the public, the Court weighed this factor in favor of the term loans not being securities.

3. The reasonable expectations of the investing public. The Court concluded that the lenders involved in this loan transaction received sufficient notice regarding the details of the term loans and had certified that they were sophisticated and experienced in this type of lending transaction and had done their own due diligence into the borrower. The applicable instruments also referred to the buyers as “lenders” more frequently than as “investors,” tipping the analysis in favor of a finding that the term loans were not securities.

4. Whether another regulatory scheme exists that reduces the investment risk of the instrument, making securities regulation unnecessary. Because the term loans were secured by collateral and subject to federal banking regulators who have issued guidance regarding syndicated term loans, the Court found that there was another regulatory scheme in place that reduced the investment risk of the term loans, thereby making securities regulation unnecessary.

As a result, the Court held that while the first factor weighed in favor of a finding that the term loans were securities, the other three factors weighed in favor of a finding that the term loans were not securities, and these factors were sufficient to affirm the lower court’s finding and the market’s long-standing practice of not treating term loans as securities.

What Did We Learn?

At the end of the day, the syndicated loan market can rest easy knowing that their existing market practices generally conform to the test set forth above. Nevertheless, the Court did not determine that all syndicated term loans are not securities, so these factors should be considered in detail when entering into any new syndicated term loan transaction to help reduce the risk of inadvertently trading in securities and becoming subject to securities laws.