2nd Circuit rules JP Morgan’s syndicated loan is not a security

Kirschner v. JP Morgan Chase Bank
Date: Aug. 24, 2023

Issue: Whether a syndicated bank loan qualifies as a security and thus is subject to securities laws.

Case Summary: In a 3-0 decision, a Second Circuit panel ruled syndicated term loans are not securities under state blue sky or U.S. federal securities laws.

Millennium Health LLC, a urine drug testing company, received a $1.775 billion syndicated loan from multiple banks for financial assistance. Millennium received the loan, then dispersed it to roughly 70 institutional investors. Millennium functioned as arrangers for syndicated credit facilities. Shortly after receiving the loan, Millennium lost a lawsuit regarding alleged kickbacks. Millennium also settled with the U.S. Department of Justice regarding possible violations of the False Claims Act. Millennium later filed for bankruptcy.

Marc S. Kirschner, a bankruptcy trustee, sued on behalf of hedge funds, mutual funds and other institutional entities that purchased notes in the syndicated loan. Kirschner argued the banks should have warned the note holders of the enforcement risks which would soon bankrupt Millennium. Kirschner also argued syndicated loans were securities and alleged the banks violated state securities laws of certain states, also known as blue sky laws. According to Kirschner, misstatements and omissions relating to the government investigation and civil lawsuit in the marketing materials for the loans violated securities laws. Defendants moved to dismiss, arguing the loan was not a security and therefore was not regulated by the state security laws. In 2020, the district court ruled that syndicated term loans were not securities under blue sky laws.

On appeal, the Second Circuit affirmed, concluding the court properly dismissed claims brought against defendants for alleged material misstatements and omissions for the loans, because plaintiff failed to plead facts plausibly suggesting that syndicated loans are securities. In reaching its decision, the Second Circuit applied the four-factor Reeves test articulated by the U.S. Supreme Court in 1990—the motivations that would prompt a reasonable seller and buyer to enter into the “transaction”; the plan of distribution of the instrument; the reasonable expectations of the investing public; and whether some factor such as the existence of another regulator scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.

The panel determined the first Reeves factor—the motivation of the seller and buyer of the debt instrument—weighed in favor of finding the term loan was a security. According to the panel, the lenders expected to profit from the term loan because they were entitled to receive quarterly interest payments over the course of seven years, indicating an investment motive. At the same time, the company’s motivations were not investment-focused because it planned to repay its outstanding credit facility instead of growing the business. On balance, the Second Circuit concluded this factor weighed in favor of finding that the complaint plausibly alleged that the term loan was a security.

The panel determined the second Reeves factor—plan of distribution of the debt instrument—weighed against finding the term loans were securities. The court explained when a note is made available to a large portion of the public, it is more likely to be a security. Here, though, the court explained the notes were offered only to sophisticated institutional entities and they received a Confidential Information Memorandum. The notes were unavailable to the general public and, thus, this factor persuaded the court against the term loans being securities.

The panel determined the third Reeves factor—reasonable expectations of the investing public—weighed against finding the term loans were securities. In the panel’s view, the lenders were sophisticated and experienced institutional entities with ample notice that the term loans were not securities. The panel reasoned the lenders had to certify they were experienced in extending credit to entities like Millennium Health and that they had conducted their own diligence. For these reasons, the court concluded the lenders could not reasonably have perceived the loans to be securities.

The panel determined the Fourth Reeves factor—whether there is another regulatory scheme that reduces the investment risks associated with the instrument—weighed against finding the loan terms were securities. According to the panel, the complaint plausibly suggested the term loans were securities because both were secured by collateral and federal banking regulators have issued policy guidance addressing syndicated loans. Because the term loans were secured by first-priority liens on substantially all the company’s assets, the panel reasoned the risk associated with purchasing the term loans was reduced.

Bottom Line: The Second Circuit’s decision reaffirms the longstanding view that syndicated loans are not securities under securities laws.

Documents: Opinion