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A federal district court in New York is currently hearing a case to determine if syndicated term loans are securities under US federal and state Blue Sky securities laws. The case (Marc S. Kirschner v. J.P. Morgan Chase Bank, N.A.) came about when borrowers, Millennium Health, LLC and certain of its affiliates (“Millennium”), in a widely syndicated loan went into bankruptcy. The bankruptcy trustee (the “Trustee”) to certain trusts formed as part of the bankruptcy restructuring brought suit against the lending syndicate, including J.P. Morgan Chase Bank (“J.P Morgan”), as one of the lead arrangers alleging the lenders misrepresented the information provided to the trust’s beneficiaries (as represented by the Trustee) to determine if they wanted to participate in the Millennium syndicate. The Trustee asserts that J.P. Morgan sold its participation of a loan to Millennium which they were aware was having substantial economic and legal difficulty.

Should the Court rule in the Trustee’s favour and declare that loans are securities (and such ruling survive the inevitable appeals process), this would lead to a change in how leveraged loans are put into place. As with high yield bonds and other debt securities, disclosure would need to be put together and shared publicly as the loan was being marketed, with the strict-liability concerns that attach to securities disclosures. This adds time and costs to the process.  Another significant consequence of categorizing loans as securities would be the application of the anti-fraud standard in Rule 10b-5 under the Exchange Act to the loan market.  This would potentially result in the loan market being subject to the same level and standard of disclosure as currently applies to the debt securities markets.

In particular, Collateralized Loan Obligations (“CLOs”) would be severely impacted by a decision in the plaintiff’s favour. According to the amicus brief filed by the Loan Syndications and Trading Association and Bank Policy Institute, CLOs make up 60% of the capital for syndicated term loans. If the loans are classified as securities, in addition to the increased cumbersomeness of the disclosure noted above, CLOs would be less able to contribute to the capital for such loans. Regulations prevent banks from owning interests (through note ownership) in CLOs if the CLO holds securities. Should loan participations in syndicated loans be considered securities, Volcker Rule restrictions would mean that banks would no longer be able to purchase notes from the CLOs who hold such participations. This would lead to a decrease in funding in the market as banks both divested and did not invest in the CLO market.

The case is ongoing and we will continue to update you on any relevant developments.