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August 29, 2023

Second Circuit Upholds Notes Issued From Syndicated Loans Are Not Securities in Kirschner


On August 24, 2023, the Second Circuit affirmed a holding by the Southern District of New York in Kirschner v. JPMorgan Chase Bank, N.A., et. al., 2023 WL 5437811 (2d Cir. 2023),1 that notes issued as part of a syndicated loan transaction are not securities. In doing so, the Second Circuit also upheld the analysis and conclusion typically arrived at and relied upon by lenders under Reves v. Ernst & Young, 494 U.S. 56 (1990) when entering into syndicated loan transactions.


The borrower in this case, Millennium Health LLC Inc. (Millennium), operated a urine drug testing company. In 2012, two days after the U.S. Department of Justice (the DOJ) subpoenaed Millennium in connection with possible violations of federal healthcare laws, Millennium obtained term and revolving loan facilities provided by several lenders. At the time of closing those facilities, Millennium was also engaged in litigation with a competitor over alleged violations of federal kickback statutes. As the investigation and litigation continued, one of the lenders sought to refinance these facilities. In 2014, Millennium obtained an approximately US$1.775 billion term loan facility (the 2014 Term Loan Facility) to refinance the existing facilities, pay a shareholder distribution, redeem certain outstanding financial instruments, and pay fees and expenses related to the 2014 Term Loan Facility. Loans under the 2014 Term Loan Facility were evidenced by promissory notes and governed by documents which contemplated further assignment, but only with the consent of both Millennium and the administrative agent. The initial lenders under the 2014 Term Loan Facility (the defendants in the case, many of which were lenders under the 2012 facility) syndicated the loans thereunder to additional lenders, including banks and investment funds, using a “Confidential Information Memorandum” providing certain information about Millennium. After the closing of the 2014 Term Loan Facility, Millennium lost its litigation against its competitor, resulting in approximately US$15 million of compensatory and punitive damages awarded to the plaintiffs. Later that year, Millennium settled its litigation with the DOJ for US$256 million. In October 2015, Millennium voluntarily filed for Chapter 11 bankruptcy. As part of the bankruptcy proceedings, a trustee was appointed for a trust established for the benefit of lenders under the 2014 Term Loan Facility that acquired notes thereunder and have claims in the bankruptcy proceedings. The trustee brought suit in the Supreme Court of the State of New York claiming, among other things, violations of state securities laws. The case was subsequently removed to the United States District Court for the Southern District of New York. The district court dismissed the securities law claim, finding that the trustee failed to plead facts plausibly suggesting that the notes were “securities” under the landmark precedent, Reves. The trustee appealed to the United States Court of Appeals for the Second Circuit.

Second Circuit Affirms Notes Not Securities

The Second Circuit reviewed the district court’s case de novo, applying the Reves test. Under Reves, courts apply the “family resemblance test” to determine whether a note is a security. The family resemblance test includes four factors: (1) motivations of the parties, (2) plan of distribution of the notes, (3) reasonable expectations of the investing public, and (4) other risk-reducing factors rendering regulation as a security unnecessary (such as the existence of another regulatory scheme). Courts employ the test by starting with the presumption that all notes are securities and then examining the four factors to determine whether a note was issued in an investment or in a commercial or consumer context. In analyzing the four factors, courts compare the notes at issue to a “judicially crafted” list of instruments that are not securities, and if the court determines the note bears a “strong resemblance” to the financial instruments on the list, then the note is not a security.

Below is a brief summary of how the Second Circuit applied the four factors in Kirschner:

  • Motivations of the Parties — The Second Circuit weighed this factor in favor of the notes being securities because of the parties’ mixed motivations: the borrower’s motivations were commercial, but the lenders’ motivations were investment since they could expect to receive a valuable return on investment via interest earned.
  • Plan of Distribution — The Second Circuit weighed this factor against the notes being securities because the various restrictions and requirements on assignment of the notes made them unavailable to the general public.
  • Investing Public’s Reasonable Perceptions — The Second Circuit weighed this factor against the notes being securities because the “Confidential Information Memorandum,” with limited exceptions, consistently referred to the borrower’s obligations as loans and the participating lenders as lenders, and required the purchasing lenders to represent that they were sophisticated and experienced institutional entities with respect to the extension of credit to entities similar to Millennium, all of which created a reasonable perception that the notes were loans and not investments or securities.
  • Other Risk-Reducing Factors (Such as the Existence of Another Regulatory Scheme) Rendering Regulation as a Security Unnecessary — The Second Circuit weighed this factor against the notes being securities because the notes were secured by collateral and other federal banking regulators (i.e., the Office of the Comptroller of the Currency, the Federal Reserve Board of Governors, and the Federal Deposit Insurance Company) had issued specific policy guidance addressing syndicated loans and the reduction of risks to banks and, ultimately, consumers. The Kirschner court specifically addressed that not all lenders needed to be directly subject to the policy guidance of the banking regulators since their guidance was designed to protect consumers as well as the banks.

For the reasons stated above, the Second Circuit found that the notes here bore a strong resemblance to “loans issued by banks for commercial purposes,” and as such affirmed that the notes were not securities.

Takeaways for Lenders from Kirschner

Lenders in syndicated loan facilities can breathe a sigh of relief. The Kirschner court upheld that notes issued under syndicated loan transactions are not securities and did so under the existing Reves precedent. However, the Reves test nonetheless begins with the presumption that notes are securities, so it is critical that lenders continue to remain vigilant in how they structure their loan syndications to remain within the parameters of Reves. Lenders should consider the following takeaways from Kirschner:

  • Consider how the combination of restrictions and requirements for assignment affect the extent to which notes could be considered to be offered and sold to the general public. In Kirschner, these restrictions and requirements included borrower and administrative agent consents, types of permitted assignees, sophistication of permitted assignees, and the size of a proposed assignment. The court also noted that the number of lenders by itself was dispositive of whether the notes were available to a broad segment of the public. The court did not address how it may have analyzed transactions with less restrictive conditions to transfer, such as those permitting transfers without borrower or administrative agent consent but only subject to requirements to satisfy conditions that would come within any exemptions from registration (e.g., Securities Act Section 4(a)(2) or Rule 144A).
  • Adhere to formalities, which were useful to the court in determining that the investing public at large could not reasonably have expected that the notes were securities. In Kirschner, the court relied on certifications made by the lenders in determining the lenders’ sophistication, experience, and diligence (as creditors) as well as the fact that notes were allocated only to those institutional entities that submitted “legally binding offers.”
  • Be wary of wording — although the Kirschner court rejected the plaintiff’s argument that a few “isolated references” to the term “investor” created a reasonable expectation that the notes had an investment purpose, the court was nonetheless silent on how it may have analyzed the factor if such verbiage had been more prevalent. Likewise, the court heavily leaned on the tight wording used in the certificates and assignment provisions in determining the plan of distribution and the reasonable expectations of the investing public with respect to the notes.
  • Consider whether a different outcome may have resulted if the notes had not been secured by collateral or if the syndicate had not included at least some lenders that were banks subject to the policy guidance referenced in the opinion.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. Only the Westlaw court reporter citation was available at the time of the writing of this Advisory.