Article courtesy of Dorothy Lila Foster (Akin Gump)
Kirschner v. JP Morgan Chase Bank, N.A., 79 F.4th 290 (2d Cir. 2023)
Overview:
The U.S. Court of Appeals for the Second Circuit examined whether the District Court for the Southern District of New York had subject matter jurisdiction over an action arising from a syndicated loan transaction under the Edge Act, 12 U.S.C. Section 632, and also whether the District Court erroneously dismissed the Plaintiff’s state law claims because the Plaintiff failed to plausibly suggest that syndicated loan notes are securities. The Second Circuit determined that the District Court had subject matter jurisdiction under the Edge Act because the action arose out of transactions involving foreign banking. In considering whether the syndicated term loan was a security, the Second Circuit applied the four-factor “family resemblance” test as set forth in Reves v. Ernst & Young, 494 U.S. 56 (1990), and determined that the notes were not “securities”; therefore, the Second Circuit concluded that the District Court’s dismissal of the Plaintiff’s state law securities claims was not erroneous.
Full Summary:
Millennium Health LLC, Inc. (“Millennium”) was a California-based urine drug testing company. In March 2014, JP Morgan Chase Bank, N.A., Citigroup Global Markets Inc., Citibank, N.A., Citicorp USA, Inc., Citicorp North America, Inc., BMO Capital Markets, Bank of Montreal, SunTrust Robinson Humphrey, and SunTrust Bank (the “Initial Lenders”) agreed to provide Millennium a $1,775,000,000 term loan and the parties agreed that the Initial Lenders could syndicate it. Sixty-one lenders received allocations of the term loan, and sub-allocated it to approximately four hundred lenders, of which approximately half were foreign entities. Subsequent to this refinancing transaction, and soon after reaching a $256,000,000 settlement with the U.S. government related to litigation involving its billing practices, Millennium filed for chapter 11 bankruptcy protection. Marc S. Kirschner (“Plaintiff”) was appointed trustee on behalf of the lenders that had purchased notes, and he brought a series of claims in New York state court against the Initial Lenders that had facilitated the syndicated loan transaction. The Plaintiff’s complaint alleged violations of state securities laws, including that Millennium made actionable misstatements and omissions to investors. The Initial Lenders thereafter filed a notice to remove the case to the U.S. District Court for the Southern District of New York. The District Court determined that it had jurisdiction over the matter under the Edge Act and it subsequently granted the Initial Lenders’ motion to dismiss the Plaintiff’s state law claims on the grounds that the Plaintiff failed to plausibly suggest that the notes issued are securities under Reves v. Ernst & Young, 494 U.S. 56 (1990).
On appeal, the Second Circuit first considered whether the District Court had subject matter jurisdiction over the action pursuant to the Edge Act. The Second Circuit evaluated the three elements under the Edge Act, agreeing with the parties that the first two elements were satisfied because the action is civil and at least one of the parties to the action is an “Edge Act Bank” (i.e., a federally chartered corporation). The Second Circuit then specifically considered the third element, which is whether the suit arose out of transactions involving international or foreign banking by JPMorgan Chase Bank, N.A. The Second Circuit concluded that the third element was satisfied because JP Morgan Chase Bank, N.A. engaged in international or foreign banking when it assigned its interests in the term loan to foreign lenders. Accordingly, the Second Circuit determined that the District Court had jurisdiction to consider the matter under the Edge Act.
The Second Circuit then considered whether the Plaintiff plausibly suggested that the notes are “securities” under Reves v. Ernst & Young, 494 U.S. 56 (1990). Under Reves, courts must apply a “family resemblance” test to determine whether a “note” is a “security.” The Reves family resemblance test requires considering the following factors: (1) the motivations that would prompt a reasonable seller and buyer to enter into the transaction; (2) the plan of distribution of the instrument; (3) the reasonable expectations of the investing public; and (4) whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Act of 1933 and the Securities Exchange Act of 1934 unnecessary.
The Second Circuit held that the first factor weighed in favor of concluding that the notes are securities because although Millennium’s motivation appeared to be “commercial,” the lenders’ motivations were in the nature of “investment”, as they expected to profit from their purchase of the notes. However, the Second Circuit held that the remaining factors weighed in favor of concluding that the notes are not securities, because the notes were not available for purchase and/or assignment to the general public, the lenders were sophisticated institutional entities which were on notice that the notes were loans and not investments in a business, and the notes were secured by collateral (which is a risk-reducing factor) and federal regulators have issued specific policy guidance addressing syndicated loans. Accordingly, upon the Second Circuit’s review of the pleaded facts, the Second Circuit concluded that the notes bear a strong resemblance to one of the enumerated categories of notes that are not securities, specifically “[l]oans issued by banks for commercial purposes.” Therefore, the Second Circuit held that the District Court’s dismissal of the Plaintiff’s state law claims was not erroneous, as the Plaintiff had failed to plead facts plausibly suggesting that the notes were securities under Reves.
