The Kirschner litigation arose out of a $1.775 billion syndicated loan transaction that closed in April 2014 in which several banks assigned portions of a term loan to Millennium Laboratories LLC (“Millennium”) in a syndicated loan transaction to hundreds of mutual funds, hedge funds, and other institutional investors. JPMorgan knew U.S. officials were investigating Millennium when it arranged and sold the loan, but relied on Millennium’s statement that such investigation was not material and as a result the information was not disclosed to investors who were about to buy the debt.
Within a matter of months after closing, the lenders saw the value of their loan plunge when Millennium disclosed that that federal authorities were investigating Millennium’s billing practices. Eventually Millennium agreed to pay $256 million to resolve the investigation and went on to file for bankruptcy protection. After Millennium filed for bankruptcy in November 2015, the investors’ claims were contributed to the Millennium Lender Claim Trust (the “Trust”). The trustee for the Trust filed a complaint in August 2017 against the arrangers asserting claims under state securities law and common law and alleging that the offering materials failed to disclose Millennium’s wrongdoings and that the arrangements should be liable for a materially false presentation of Millennium’s financial condition and business practices. In June 2019, the defendants moved to dismiss the complaint, contending in part that the loan was not a security subject to state securities laws. Plaintiff opposed that motion, arguing that the loan was evidenced by a note and as a result “a security” for which the arrangers should have provided securities-type disclosures.
Although, the Securities Act of 1933 defines the term “security” to include “any note” and the loans are evidenced by notes, courts have repeatedly found as they did in Kirschner that “any note” does not include “any” note and that syndicated loans are not securities. The Court in reaching its decision relied heavily on the Second Circuit’s decision in Banco Español de Crédito (which held that “loan participations” were not securities, but loans) and the Supreme Court’s “family resemblance test” in Reves v. Ernst & Young, 494 U.S. 56 (1990), which held that while any note is presumed to be a security, such presumption may be rebutted if resemblance to an instrument commonly denominated by a note which is not a security, including loans by commercial banks for current operations, can be demonstrated by a four-factor test.
The “family resemblance test” in Reves takes into account: (i) the motivations of seller and buyer to enter into the transaction; (ii) the plan of the instrument’s distribution; (iii) the reasonable expectations of the investing public; and (iv) the existence of another regulatory scheme rendering the application of the Securities Act unnecessary. Applying the Reves test, the Court concluded that the Millennium’s notes were not securities because the notes were sold to a relatively small group of highly sophisticated investors -- not the general public. Those investors knew that the notes they purchased didn’t have “securities-like” disclosure and were sophisticated enough to understand the risks associated therewith.
Although Kirschner was decided on a case specific factual basis, the features of the loan which led the Court to find that the Millennium loan was not a security are common to syndicated loans more generally. In light of these similarities, the finding implicitly reaffirmed settled market expectations that syndicated loans are not securities and thereby providing additional comfort to market participants (which is particularly important in the current COVID-19 environment). With companies increasingly credit crunched and with liquidity needs becoming ever more urgent and information about the business and projections ever more uncertain, “securities” treatment might have substantially chilled, if not frozen, new issuances and secondary transactions in the syndicated loan market. The Kirschner decision should provide comfort to loan market participants in this time of uncertainty.
- Even though broadly syndicated loans are very similar to high-yield bonds and there has been increasing convergence in recent years on their terms, it is important to note that loan offering memorandums do not currently require the same level of financial disclosure as found in bond prospectuses. In many cases borrowers simply cannot produce the types of information required for securities-level disclosure and, even where they could, avoiding the time and cost associated with preparing such disclosures might be a reason that a company might elect to enter into a broadly-syndicated loan instead of a high-yield bond. The syndicated term loan market currently operates on the basis that the parties investing in such loans are sophisticated and do not need or expect a mandatory disclosure regime equivalent to bond disclosures. Lenders that become part of loan syndicates do so on the express understanding that they are responsible for conducting their own diligence and the standard terms and conditions for secondary loan transactions provide that while the other party may have information about the borrower that may be material to the decision to enter the transaction and that no liability attaches to either party for nondisclosure of such information, as long as the representations and warranties in the agreement itself are accurate.
Client Alert 2020-351
