Syndicated term loans can be a significant piece of the capital stack when financing renewable energy projects; however, a crucial pending case in the U.S. Court of Appeals for the Second Circuit could complicate the use of these types of loans going forward. The case—Kirschner v. JP Morgan Chase—will seek to answer the central question at play: are syndicated term loans subject to federal and state securities laws? The eventual ruling in this case could potentially impact any borrower or lender issuing or holding a term loan in a syndicated facility.
On July 18, 2023, the General Counsel of the Securities and Exchange Commission (SEC) notified the Court that “[d]espite diligent efforts to respond to the Court’s order and provide the Commission’s views, the staff is unfortunately not in a position to file a brief on behalf of the Commission in this matter.”
The Court had asked the SEC to submit an amicus brief addressing the SEC’s view as to whether the term loan in the Kirschner case was a security. The deadline for the SEC’s submission was originally set for April 13 but was subsequently extended three times to July 18 at the SEC’s request.
The SEC’s ultimate decision not to weigh in on this matter (even after requesting and receiving a number of extensions from the Court) gives some indication of the complexity of the issue. Despite the enormous policy implications, the case now moves forward without any insight from the federal government’s top securities regulator.
In the Kirschner case, the plaintiff has contended that term loan notes have many of the characteristics of high-yield bonds and, like those bonds, should be similarly regulated as securities.
The District Court dismissed the claims in May 2020. Among other things, District Court held that under a 1992 Second Circuit interpretation of the U.S. Supreme Court’s seminal Reves test for when notes qualify as securities, the term loan notes in question were not securities.[2]
A holding that term loans are securities likely would have a damaging impact on the loan market resulting in substantial changes to established customary practices and a net increase in overall transaction costs. For example, loan market participants would be required to comply with securities laws at the state and federal levels subjecting them to multiple sets of rules that may have very different requirements and compliance regimes.
In addition, it is likely that a final ruling by the Court that loans are subject to the securities laws would apply to both existing term loans and new term loans. Parties would be restricted from trading those term loans until they were registered or subject to an exemption from registration. In addition, loan syndication and trading activity would need to be conducted through registered broker-dealers, and market participants would need to determine if they would be required to be registered. Broker-dealers are subject to extensive regulations that could cause significant disruptions to loan transactions.
Subjecting syndicated term loans to state and federal securities laws would also materially disrupt customary practices between borrowers and other loan market participants that have developed over the years potentially eliminating a well-established financing structure for both borrowers and lenders.
Somewhat surprising, the SEC has left the market hanging. If the SEC had filed a brief stating its view that the term loans were not subject to state and federal securities laws, such view would have carried substantial weight with the Court.
At this point, a likely result is that the Court will remand the case to the District Court to develop a more extensive evidentiary record on whether the term loans in question are securities.
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