On August 24, 2023, the Second Circuit in Kirschner v. JP Morgan Chase Bank, N.A., No. 21-2726 (2d Cir. Oct. 28, 2021) affirmed a decision by the Southern District of New York (explained in our prior blog post here) that syndicated term loan notes are not securities. The Second Circuit’s affirmance avoids the potentially disruptive impacts to the syndicated loan market that we discussed in our earlier post, and instead mirrors prior Second Circuit precedent that notes bearing characteristics similar to those at issue in this case are not securities.
The transaction at issue involved a $1.775 billion term loan to Millennium Health LLC, Inc. (“Borrower”) that closed on April 16, 2014, pursuant to a credit agreement that limited the development of a secondary market for the notes by, among other terms: (1) prohibiting assignment of the notes to a natural person, (2) requiring that both Borrower and JP Morgan Chase, acting as the Administrative Agent, provide written consent to any assignment, unless the assignment was to a Lender, an affiliate of a Lender, or an Approved Fund (3) prohibiting any assignment for more than $1,000,000, unless the assignment was to a Lender, an affiliate of a Lender, or an Approved Fund or an assignment of the entire remaining amount of the assigning Lenders’ allocation.
The Circuit Court Decision
Jurisdiction Under the Edge Act
The Second Circuit first addressed Appellant’s challenge to the District Court’s jurisdiction pursuant to the Edge Act, 12 U.S.C. § 632, which provides federal authority for American banks to engage in international banking. Appellant argued that the Edge Act did not grant jurisdiction to the District Court based on Appellant’s view that the transaction was domestic and at most concerned the mere “fortuitous involvement” of the foreign lenders in an otherwise domestic transaction. Appellant, thus, argued that the transaction did not involve any “international or foreign banking.”
Reviewing de novo the District Court’s decision that it did have jurisdiction, the Second Circuit concluded that the “direct assignment of a loan to a foreign entity qualifies as ‘international or foreign banking’” for purposes of the Edge Act. Kirschner, ECF No. 216-1, at 22. The Second Circuit concluded that the assignment of loan interests to foreign lenders qualified as “international or foreign banking” and was not merely “fortuitous” because the decision to assign the Term Loan interests to foreign participants was made deliberately.
Whether the Notes Are Securities
The Second Circuit then turned to the question of whether the notes at issue here are securities. In doing so, the Court applied the “family resemblance” test first articulated by the United States Supreme Court in Reves v. Ernst & Young, 494 U.S. 56 (1990), which incorporates a presumption that every “note” qualifies as a security—but which provides a four-factor test “to uncover whether the note was issued in an investment context (and is thus a security) or in a consumer or commercial context (and is thus not a security).” Kirschner, ECF No. 216-1, at 25. As applied by both the District Court and the Second Circuit, the four factors are: “1) ‘[T]he motivations that would prompt a reasonable seller and buyer to enter into’ the transaction; 2) ‘[T]he plan of distribution of the instrument’; 3) ‘[T]he reasonable expectations of the investing public’; and 4) ’[W]hether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Acts unnecessary.” Id. (quoting Reves, 494 U.S. at 66-67).
Unlike the District Court, the Second Circuit found that the first factor weighed in favor of treating the notes as a security. All three of the other factors, however, were found to weigh against treating the notes as securities. In particular, the Second Circuit reasoned:
- On the first factor, the Second Circuit noted that Borrower’s motivations were commercial but that the lenders’ motivation was investment, as the lenders expected to receive a “valuable return” on their purchase. Although the parties’ motivations were mixed, the Second Circuit concluded that this application tilted in favor of treating the notes as securities.
- On the second factor, the Second Circuit observed that the notes were offered only to sophisticated institutional entities that had submitted a legally binding offer. Although there was a secondary market for the notes, the restrictions on any assignment rendered them unavailable to the general public. In particular, the notes (1) could not be assigned to a natural person, and (2) could not be assigned without prior written consent from both Borrower and the Administrative Agent. The Second Circuit reasoned that these restrictions prevented the notes from being sold to the general public.
- On the third factor, the Second Circuit observed that the lenders (1) were given ample notice that the notes were loans and not an investment; and (2) certified that they were sophisticated and experienced in extending credit to entities similar to Borrower and made their own appraisal as to Borrower without reliance upon any other lender. Although the court noted that there were isolated instances of references to the buyers as “investors” in the loan documents, the loan documents more consistently referred to the buyers as “lenders” rather than “investors”, and the references could not have plausibly created the reasonable expectation that the buyers were investing in securities.
- Finally, the Second Circuit held that the application of securities laws did not seem necessary because (1) the notes were secured by a perfected first priority security interest in Borrower’s collateral, and (2) the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve, and the Federal Deposit Insurance Corporation issued “specific policy guidelines” addressing syndicated term loans. The court acknowledged that although the guidance was there to minimize risks to banks, as Appellant argued, the guidance also aims to protect consumers, as the regulators themselves explained.
The Second Circuit thus affirmed the District Court decision. In a separate summary order, the Second Circuit also affirmed the District Court’s grant of dismissal with prejudice, thus closing the case absent further appellate review. Kirschner, ECF No. 217. Appeal to the Supreme Court is possible, although it remains to be seen whether the parties will file further appeals and, if so, whether the Supreme Court will grant certiorari to hear this case. We will continue to monitor the case closely for further developments.
 An “Approved Fund” also had some connection to a Lender or a Lender affiliate. The credit agreement defines “Approved Fund” as “any Person (other than a natural person or a Disqualified Lender) that is engaged in making, purchasing, holding or investing in bank loans and similar extensions of credit in the ordinary course of its business and that is administered or managed by (a) a Lender, (b) an affiliate of a Lender or (c) an entity or an affiliate of an entity that administers or manages a Lender.” Id. at 14.
 The Edge Act provides for federal court jurisdiction over cases that (1) are “of a civil nature at common law or in equity”; (2) involve at least one party that is an Edge Act bank or corporation; and (3) arise “out of transactions involving (a) international or foreign banking, (b) banking in a dependency or insular possession of the United States, or (c) out of other international or foreign financial operations.” Id. at 19 (internal quotation marks omitted). The Second Circuit further explained that Edge Act banks or Edge Act corporations are “chartered by the Federal Reserve Bank” and can “engage in offshore banking operations freed from regulatory barriers imposed by state banking commissions.” Id. at 18. The parties agreed that the first two elements were satisfied.