March 20, 2024 - This week, almost 300 people joined the LSTA’s webinar on the history and implications of the Kirschner case. As we’ve discussed many times over the past years, the Kirschner case raised the issue of whether syndicated term loans (also known as Term Loan Bs) are securities under state and federal law, an issue of profound importance to the loan market. After a seven-year journey through the courts, the United States Supreme Court last month declined to hear Kirschner’s petition for certiorari, thereby leaving in place a decision by the U.S. Circuit Court for the Second Circuit (the “Second Circuit”) affirming that these loans are not securities.

Lara Samet Buchwald and James Florack, partners at David Polk, joined Elliot Ganz on the panel. Ms. Samet Buchwald represented one of the defendants in the litigation and Mr. Florack has worked closely with the LSTA since 2017 to analyze and understand the implications for the loan market were a court to rule that loans are subject to the securities laws. Mr. Ganz supervised the LSTA’s two amicus briefs in the case and was a member of the LSTA’s policy team that engaged on this issue.

Ms. Samet Buchwald began with a review of the case, which was initially filed in 2017 in New York State court but quickly removed by the defendants to federal court (the Southern District of New York (SDNY)) in accordance with the Edge Act. In May 2020, the court ruled that the loans to Millennium Labs that were the subject of the litigation were not securities and granted the defendants motion to dismiss. Kirschner appealed to the Second Circuit, which, after oral argument, affirmed that syndicated term loans are not securities. Kirschner’s petition for certiorari to the U.S. Supreme Court was quickly denied, thus ending the case once and for all.

Ms. Samet Buchwald made several important points: (i) Moving the case to federal court was important since federal courts are more experienced and attuned to complex cases like Kirschner; (ii) Although the case presented a broad threat to the loan market, it is important for lawyers to litigate the case before them, focusing on the key legal issues at hand. Having amicus support that addresses issues like potential disruptions to the markets is very helpful in that context. Conversely, as Mr. Ganz noted, it is important for amicus litigants to understand that the principals’ lawyers are running the show and that they are there for support; if the principal lawyers win the case, the amicus also prevails.

Mr. Ganz then described the LSTA’s five-year advocacy role in the case across three realms: judicial, regulatory and congressional. The LSTA initially engaged in 2019 with an amicus brief to the SDNY and, in 2022, with another to the Second Circuit. Last year, after the Second Circuit invited the SEC to weigh in with its views on whether syndicated term loans are securities, the LSTA engaged with regulators at the SEC, Treasury, the OCC and the Federal Reserve, explaining why loans, as a matter of law are not securities and have not been treated as such by congress or the regulators. The LSTA also explained at great length the enormously disruptive consequences of treating loans as securities. Finally, in anticipation of the possibility that the SEC might submit an amicus brief arguing that loans are securities, the LSTA engaged with several members of Congress and their staff to develop interest in filing a counter-amicus (which was not needed after the SEC decided not to respond to the Second Circuit’s request). Mr. Ganz pointed out that none of the three approaches would have been possible if the LSTA had not been positioned well before the Kirschner case. On the judicial side, the LSTA had been analyzing the implications of loans being treated as securities since 2007 and had a robust amicus litigation track record and process already in place. On the regulatory side, the LSTA policy team regularly met with key members of each of the relevant agencies and developed important relationships. On the congressional side too, the LSTA developed critical bipartisan relationships with important members of the House Financial Services Committee and the Senate Banking Committee.

Mr. Florack then addressed the question of what we’ve learned from the Kirschner case. Because the Second Circuit’s decision involved a straightforward application of the precedential tests on whether a note is a security outlined by the Supreme Court in Reves v. Ernst & Young (as applied by the Second Circuit in Banco Espanol), there was much to take away. On the first prong of the Reves test, whether motivations of the parties were commercial (like a loan) or investment (like a security) the court concluded that “the pleaded facts indicate that the parties’ motivations were mixed. At this early stage of application of the first Reves factor tilts in favor of concluding that the complaint plausibly alleges that the Notes are securities.”  Although this prong is confusing in modern markets, the loan market has responded by frequently inserting into credit agreements acknowledgements from the parties that the purpose of the loan is commercial rather than investment. Parties are also even more careful to refer in their marketing and other materials that the parties to loans are lenders rather than investors and to refrain from referring to loans as investments. Put differently, “words matter.”  It was also clear from the opinion that prohibiting the assignment to natural persons was important and it is obvious that this restriction is critical moving forward.

Finally, while the Supreme Court’s denial of certiorari was the end of the Kirschner case, the panelists grappled with whether it is the end of the question of whether loans are securities. On the litigation front, it is important to note the nature of the plaintiff in Kirschner and his unique motivations. As a bankruptcy trustee funded by the estate, he was in a position to take on a high reward/low probability case; this could happen again, perhaps in a context where the facts are less clear. From the regulators’ perspective, it is hard to imagine that the banking agencies would be comfortable having loans subject to the securities laws, but the SEC, which has long taken the position that loans can be securities depending on the facts and circumstances, could continue to scrutinize the loan market and jump in if the market strays from current practice.

A replay of the webinar and the presentation materials are available here.

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