On 24 August 2023, the US Court of Appeals for the Second Circuit examined the question of whether a syndicated term loan was a security in the case of Kirschner v. JP Morgan Chase Bank, N.A.1 The court applied the "family resemblance" test set forth in the US Supreme Court case of Reves v. Ernst & Young2 in holding that the loan was not a "security." Accordingly, the securities law action in relation to the loan was dismissed, upholding the long-standing market convention that correctly structured syndicated loans are not securities.

In this edition, we look at several key takeaways for market participants to follow to ensure that syndicated loans are not characterized as securities.

In depth

The question of whether a loan, an investment, or another instrument is classified as a security under US federal and state laws is of critical importance to issuers and financial institutions. Firstly, under Section 5 of the US Securities Act of 1933, unless an exemption applies, it is unlawful for any person to offer to sell any security unless a registration statement is first filed with the Securities and Exchange Commission (SEC), and it is unlawful to sell such security unless a registration statement is declared effective by the SEC.

Complying with the SEC's disclosure requirements requires the issuer to go through a rigorous diligence exercise and provide broad disclosure about its business and operations, resulting in a lengthy prospectus that comes at a considerable cost in terms of transaction fees and management's time diverted from the business. In addition, elaborate securities fraud laws apply to securities both at federal level and at state level (those applying at state level are known as "Blue Sky Laws"). This means increased scope for exposure to both civil and criminal liability for issuers and underwriters, as the disclosure documentation in connection with such securities offerings must not contain any material misstatement or omission. Given these costs and the enhanced liability of a US securities offering, it is crucial to know when an instrument is and is not a security. The recent ruling by the US Court of Appeals for the Second Circuit in Kirschner v. JP Morgan Chase Bank, N.A. handed down on 24 August 2023 provides significant comfort for secondary loan market participants not wishing to find their activities under the purview of US securities regulators.

1. No. 21-2726 (2d Cir., 24 August 2023)
2. 494 U.S. 56 (1990)

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