Appeals court: Syndicated loans are not securities

JPMorgan has won a victory in closely-watched litigation over the scope of securities regulation: specifically, about the meaning of the word “securities” in such regulations or in the statutes that mandate it. The issue arose over whether a loan could be considered a security.  

On 24 August 2023, the US Court of Appeals, Second Circuit, upheld a decision by a district court in Manhattan, dismissing the lawsuit of Kirschner v Morgan. This is litigation in which a bankruptcy trustee alleged that the debt obligations of Millennium Laboratories, syndicated by JPMorgan, were subject to the stringent disclosure rules of “blue sky” securities laws.  

Judge Jose Cabranes wrote the opinion for the court. In the first footnote of this decision, Cabranes defines a “syndicated loan” broadly and in a straightforward way: it is a loan extended by a group of financial institutions to a single borrower. In this instance, the single borrower was Millennium Health, a California-based urine drug testing company.  

In March 2014, as the Cabranes decision recounts, defendants-appellees, a group of banks (ie, a syndicate) led by JPMorgan Chase Bank, agreed to extend to Millennium a $1.7 billion term loan and a $50 million revolving loan. That loan closed in April of that year. 

In November 2015, Millennium filed a voluntary petition for relief under chapter 11 in the US Bankruptcy Court for the District of Delaware. Plaintiff Kirschner, the trustee in the bankruptcy proceedings, filed a state securities lawsuit in New York state court in August 2017, on behalf of lenders that had purchased notes and had claims in the bankruptcy proceedings. It alleged breach of fiduciary duties, breach of contract, breach of post-closing contractual duties, and breach of the implied covenant of good faith and fair dealing.

These are all common claims within the context of state blue-sky securities laws, but also touch on the legal semantic point at issue.  

That case was later removed to the US district court for the Southern District of New York. As noted above, that court dismissed Kirschner’s case, and Kirschner appealed. 

The dispute has drawn significant attention, not because most authorities thought Kirschner had a strong case, but because even a small chance that syndicated loans could be redefined as securities raised the possibility of a stunning blow to the market. 

Such a ruling would raise immediate doubt as to its retrospective impact on a lot of deals that parties have already made in good faith, on which they are at present performing. It would also likely halt loan origination and borrowing in the absence of guidance as to how origination could comply with the pertinent securities laws. In the private lending space, uncertainties could cause fund redemptions at a destabilizing level. Adjacent markets such as that in CLOs could also grind to a halt.  The second circuit’s opinion banishes these threats – at least for now.  

The second circuit opinion argues that one of the traditional indicia of a security is: an instrument offered or sold to a broad segment of the public. This factor weighs against the plaintiff, because the pleaded facts do not suggest the instrument was meant to have such appeal.

There was a secondary market for the notes, but it was constrained in three important ways: with some exceptions, they could not be assigned without written consent from both Millennium and JPMorgan Chase; no assignment could total more than $1 million, unless it was to a lender, an affiliate of a lender, or an approved fund; and the notes could not be assigned to a natural person. (A “natural person” is a legalism that refers to flesh-and-blood human creatures, as distinct from the law-created personhood of corporations.) 

Another important factor: an instrument may be a security if the lenders reasonably perceived it as a security.  In this instance, though, the court said that perception would be unreasonable. One reason for this inference: the loan documents more consistently refer to the buyers as “lenders” rather than “investors”.  

Judge Cabranes, in rejecting the broadening of the word “securities,” wrote for a unanimous three-judge panel of the Second Circuit (with Judges Bianco and Perez). In principle, the plaintiff could appeal to the whole of the Second Circuit (en banc). There has been no indication yet that he will do so.