On May 22, Judge Gardephe granted a motion to dismiss in Kirschner v. JPMorgan Chase Bank, N.A., a case that, among other things, considered whether the origination and distribution of a syndicated bank loan is subject to securities laws of California, Massachusetts, Colorado and Illinois. In Kirschner, Millennium Laboratories LLC, after entering into a $1.775 billion syndicated loan, lost a significant litigation and reached a settlement with the U.S. Department of Justice with respect to False Claims Act violations. Shortly after Millennium filed for bankruptcy protection, the bankruptcy trustee filed a lawsuit against the banks and broker-dealers of the syndicated loan claiming, among other things, that they violated blue sky laws by making misstatements and omissions that are actionable under the California Corporate Securities Law, Massachusetts Uniform Securities Act, Colorado Securities Act and Illinois Securities Law. In deciding whether the syndicated loan constituted security, the court applied the “family resemblance” test established by the U.S. Supreme Court in Reves v. Ernst & Young and ruled that the syndicated bank loan did not constitute a security.

In Reves, the Supreme Court established a presumption that a note is a security, which presumption may be rebutted by a showing that the note bears a strong family resemblance to one of enumerated categories of nonsecurity instruments identified in Reves. The four factors of the family resemblance test are listed below.

  1. Motivations of Seller and Buyer. According to Reves, if the seller's purpose is to raise money for the general use of a business enterprise or to finance substantial investments and the buyer is interested primarily in the profit of the note, the instrument is likely to be a security. On the other hand, if the note is issued to address the seller's cash-flow difficulties or to advance some other commercial or consumer purpose, the note is not likely to be a security. In Kirschner, from the buyers' perspective, the purpose of acquiring the notes appears to have been an investment, while from defendants' perspective the seller's motivation was to pay dividends and to satisfy or refinance existing debt. The court concluded that this factor “does not weigh strongly in either direction” because the motivations were mixed.

  2. Plan of Distribution. The second Reves factor considers “the plan of distribution” for the instrument, including whether it is subject to “common trading for speculation or investment.” In Kirschner, the court cited the Second Circuit case Banco Espanol de Credito v. Sec. Pac. Nat'l Bank, where the restrictions on the notes “worked to prevent the loan participations from being sold to the general public.” The court ruled that Millennium's plan was “relatively narrow,” finding that the plan was limited to sophisticated institutions and that transfers required the consent of a lender, lender affiliate or “Approved Fund.” In addition, although the court acknowledged that “hundreds of investment managers were solicited,” it held that “this constitute[d] a relatively small number compared to the general public.”

  3. Reasonable Expectations of the Investing Public. According to Reves, the court will consider instruments to be securities on the basis of such public expectations, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not securities as used in that transaction. In Kirschner, the court, citing Banco Espanol, focused on the terminology used in the marketing materials and credit documentation for the syndicated loan, which referred to “loans” and “lenders” rather than to “investor.” The court stated that the credit agreement and the confidential information memorandum distributed to potential lenders would “lead a reasonable investor to believe that the notes constitute loans, and not securities.”

  4. Existence of Another Regulatory Scheme. The last Reves factor is “the existence of another regulatory scheme [to reduce] the risk of the instrument, thereby rendering application of the Securities Act unnecessary.” The Kirschner court cited Banco Espanol, which distinguished “the entirely unregulated scenario” at issue in Reves (involving “uncollateralized and uninsured” instruments and “no risk-reducing factor”) from the market for the sale of loan participations to “sophisticated purchasers,” which “is subject to policy guidelines from the Comptroller,” and concluded that the final Reves factor “weighs in favor of finding that the notes were not securities.”

The complaint also alleged claims for common law negligent misrepresentation, breach of fiduciary duty, breach of contract, breach of post-closing contractual duties, and breach of the implied covenant of good faith and fair dealing. The court dismissed these additional claims.

Originally published Kramer Levin, May 2020

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