Second Circuit Rules That Syndicated Loans Are Not "Securities" Under State And Federal Law

• Published date: 11 September 2023
• Subject Matter: Corporate/Commercial Law, Securities
• Law Firm: Goodwin Procter LLP
• Author: Dylan S. Brown, Michael Goldstein, Debora Hoehne and Artem Skorostensky

On August 24, 2023, the U.S. Court of Appeals for the Second Circuit in Kirschner¹ unanimously held that notes evidencing syndicated loans² do not plausibly qualify as "securities" covered by state and federal securities laws under Reves v. Ernst & Young, 494 U.S. 56 (1990).³ The decision reaffirms the long-held understanding by market participants that commercial loans are not securities for purposes of the securities laws.

Background

In Kirschner, approximately seventy institutional investor groups, comprised of approximately 400 mutual funds, hedge funds, and other institutional investors (the "Investors"), purchased $1.775 billion in loans ("Notes") of Millennium Laboratories LLC ("Millennium") from the original lenders (the "Original Lenders").⁴

Millennium filed for bankruptcy in 2015. The chapter 11 plan approved by the Bankruptcy Court created the Millennium Lender Claim Trust (the "Trust") and authorized the Trust to pursue the Investors' claims against Original Lenders.

In August 2017, Marc S. Kirschner (the "Trustee"), in his capacity as trustee, brought an action against the Original Lenders alleging violations of various state securities laws; negligent misrepresentation; breach of fiduciary duty; breach of contract; and breach of the implied covenant of good faith and fair dealing in connection with the sale of the Notes.⁵

In June 2019, the Original Lenders moved to dismiss the Trustee's complaint. In May 2020, the District Court granted the Original Lenders' motion to dismiss. It dismissed the state-law securities claims because it concluded that plaintiff failed to plead facts plausibly suggesting that the Notes are "securities" under Reves.⁶

Kirschner Decision

The Second Circuit affirmed the district court's dismissal, concluding that the subject syndicated loan bore a "'strong resemblance' to one of the categories of 'notes' held not to be a security: "'[L]oans issued by banks for commercial purposes.'"⁷ In reaching this conclusion, the Second Circuit applied the "family resemblance" test first articulated by the United States Supreme Court in Reves.

Under this test, which the Supreme Court applied to determine whether promissory notes are securities,⁸ there is "a presumption that every note is a security."⁹ "[T]hat presumption may be rebutted only by a showing that the note displays a strong resemblance . . . to one of the enumerated categories of instrument" that are not securities.¹⁰

To determine whether the note in question displays a "strong family resemblance" to one of the types of notes that are not considered securities, Reves instructs that courts should consider the following four factors:

1. the motivations...