Leverage Loan Update: Millennium Court Decision Confirms Syndicated Loans Are (Still) Not Securities | White & Case LLP
The bottom line: On May 22, 2020, the United States District Court for the Southern District of New York found that heavily syndicated term loans are not “securities”. This decision is very important for the US syndicated loan market. If syndicated term loans were deemed to be securities, they would be subject to federal and state securities laws, including disclosure obligations and the potential liability of issuers and arrangers for improper disclosure. This would require a fundamental change in the way the $ 1.2 trillion syndicated loan market currently operates. However, based on the court’s ruling, participants in the US syndicated term loan market may continue to operate “as is,” noting that plaintiffs have the right to appeal the ruling.
The case: The case was brought by Marc S. Kirschner, the fiduciary litigation trustee established in the Chapter 11 proceeding initiated by Millennium Laboratories LLC (Millennium), a California urine drug testing company. The defendants in that case were the arrangers of a $ 1.775 billion B-term loan that closed in April 2014, 19 months before Millennium filed for bankruptcy. Among other things, the complaint alleged that in marketing materials provided to potential investors, the arranger defendants misrepresented or omitted material facts regarding the legality of Millennium’s sales, marketing and billing practices and an ongoing government investigation. They argued that these actions violated various state-based “Blue Sky” securities laws that should be applied to the Millennium Loan Notes.
decision: Judge Paul Gardephe of the United States District Court for the Southern District of New York dismissed the securities-related causes of action on the basis that the Millennium Loan Notes were not securities. He said that “it would have been reasonable for these sophisticated institutional buyers to believe that they were lending money, with all the risks that this might entail, and without the benefit of disclosure and the other protections associated with it. issuance of securities “.
The justification: In reaching his decision that the Millennium Loan Notes were not securities, Justice Gardephe applied the four-factor test of “family resemblance” proposed by the Supreme Court in the 1990 decision Reves v. Ernest & Young. In Reves, the Supreme Court said that courts should begin by presuming that each “note” is a title, but this presumption can be rebutted if the notes bear a strong “family resemblance” to any of the other instrument categories. as titles listed. by the court, which included “notes attesting to loans made by commercial banks for current operations.” In applying the Reves test, Gardephe J. relied heavily on the decision previously considered to be most directly relevant to the question of whether syndicated loans are securities – the 1992 decision of Banco Espanol de Credito v. Security Pacific National Bank. In Banco, the second circuit applied the Reves test to loan participations and concluded that they were not securities.
The four Reves factors used to determine whether such a resemblance exists are as follows:
(1) The motivations of a reasonable buyer and seller to enter into the loan transaction
By virtue of this factor, the court examined the motivations of both Millennium and the term loan investors and ultimately concluded that this factor did not weigh heavily in either direction. On the one hand, Millennium’s motivation to increase term loans was not an investment or its general use (it was rather for another business purpose – to refinance existing debt and pay a dividend) which, on the basis of of the Supreme Court’s directions in Reves, would indicate that the loan notes were not securities. But on the other hand, the court found that the main motivation for term loan investors was investing, which would indicate that the notes are securities. Given the mixed motivations of buyers and sellers of the loan notes, the court did not find this factor convincing in one way or another.1
(2) The loan note distribution plan
In view of this factor, the court examined the “distribution plan” of the loans, in particular if they are the subject of a “common exchange for speculative or investment purposes”. The court agreed with the arranger defendants that the loans were syndicated to a relatively small group of sophisticated institutional and corporate investors and not offered to the general public. Coming to its conclusion, the court noted that the minimum loan amount that could be assigned to a new lender was $ 1 million, as well as the fact that the loans were not allowed to be assigned to natural persons. or to any other lender. persons (other than affiliates or associated funds), without Millennium’s consent.
(3) Reasonable expectations of the investing public
Considering this factor, the court found it significant that in the marketing materials for term loans, as well as in the credit documentation itself, loan memos were consistently referred to as “loans” and “loan documents”. etc., and investors were consistently referred to as “lenders”. The court dismissed as unconvincing the argument that the inclusion of provisions in the marketing materials and the credit agreement relating to “non-public information” demonstrated that the loans were securities, as well as market comments that Syndicated term loans increasingly included terms that were historically found in high yield bonds. On the contrary, the court noted the absence of precedent for the conclusion that a syndicated term loan is a “guarantee” and concluded that the reasonable expectations of the investing public weighed in favor of the conclusions that the loan notes were not were not titles.
(4) The existence of another regulatory mechanism to reduce the risk of loan notes
By virtue of this factor, the court considered whether the loans are subject to a separate regulatory regime that would render the enforcement of securities laws unnecessary. The court ruled that while the primary objective of federal banking regulators (namely, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Federal Reserve Board) is “likely to be the safety and soundness of banks, rather than the protection of noteholders “, the Supervisor’s guidelines for the sale of loan participations to sophisticated buyers distinguish the syndicated loan market from an unregulated market, and conclude that this factor weighs in favor of the fact that loans are not treated as securities.
In conclusion, the court held that the first factor did not weigh heavily in both directions, and the second, third and fourth factors Reves supported the conclusion that the loan notes were analogous to notes evidencing “the loans issued. by banks for commercial purposes “. Therefore, the court concluded that the presumption that the loan notes were securities had been overcome.
Reactions: In response, Elliot Ganz, general counsel and chief of staff of the Loan Syndications & Trading Association (LSTA), said in a May 26, 2020 statement: “The decision is a victory for the flow of capital to US businesses. Term loans as securities would have upset the expectations of borrowers and lenders and wreaked havoc on the large, and vitally important, market for these loans. We are happy that Judge Gardephe refused to take this path. “Client Alert White & Case 3
On May 27, 2020, Bloomberg’s Davide Scigliuzzo noted that “the biggest players in the $ 1.2 trillion leveraged loan market can breathe a collective sigh of relief – at least for now.”
White & Case LLP will continue to monitor the matter closely in the event of an appeal.
1 While this does not apply in the Millennium case, in many cases syndicated term loans are used to finance acquisitions and other investments. In such circumstances, a court may therefore conclude that this factor favors the treatment of the loan as collateral; however, such an argument would still need to overcome the three remaining Reves factors.