Introduction
In recent years, the inclusion of so-called "Kirschner provisions" in U.S. law governed credit agreements have gained significant traction, particularly in light of evolving litigation and judicial scrutiny surrounding syndicated loan structures. Named after the landmark Kirschner v. J.P. Morgan Chase Bank, N.A et al ("Kirschner") case in the United States ("U.S.") these provisions aim to explicitly set out the reason why a particular syndicated loan can be distinguished from being considered a security pursuant to U.S. federal and state securities laws, which would have significant negative consequences for lenders.
Due to the relatively interconnected nature of the Canadian and U.S. syndicated lending markets, Canadian administrative agents and arrangers should consider including these provisions in Canadian credit agreements, particularly when there is a cross-border element to the transaction as a result of any of the agents, lenders or borrowers having a material connection to the U.S.
Background
In April 2014, Millennium Laboratories LLC ("Millenium") completed a refinancing and dividend recapitalization transaction with a US$1.825 billion senior secured credit facility and term loans up to US$1.775 billion. The original syndicate subsequently sold a percentage of their term loan B commitments to institutional investors, evidenced by promissory notes. At the time of the financing, Millenium was the defendant in a litigation matter and separately under investigation by the Department of Justice ("DOJ").1
Millenium was held liable for over US$14 million in damages in the litigation matter and they settled the DOJ investigation for US$256 million. Shortly thereafter, Millenium filed for bankruptcy protection in November 2015.2
In August 2017, the trustee appointed by the bankruptcy court for the benefit of the note holders, filed a lawsuit against the lenders, claiming, among other things, that the notes were securities under certain state securities laws, and that the lenders had violated securities laws by making misrepresentations relating to the litigation and DOJ investigation.3
The United States District Court for the Southern District of New York ("Southern District") granted a motion to dismiss the lawsuit, ruling that the notes did not meet the test for determining that they would be considered as securities under state securities laws.4
The U.S. Court of Appeals for the Second Circuit ("Court of Appeals") affirmed the Southern District's decision that the notes were not securities. The court arrived at this conclusion through the use of the factors in the U.S. Supreme Court decision Reves v. Ernst & Young commonly known as the "family resemblance test".5 The family resemblance test consists of four factors:
- the motivations that would prompt a reasonable seller and buyer to enter into the transaction;
- the plan of distribution of the instrument;
- the reasonable expectations of the investing public; and
- whether some factor such as the existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of U.S. securities acts unnecessary.6
After applying the four factors of the family resemblance test, the court ultimately found that the notes were not securities. Under the first factor, the court acknowledged that the notes could be viewed as securities based on the motivations of the parties7, but the remaining factors weighed against that conclusion. When analyzing the second factor, the court determined that the plan of distribution did not involve an offer to the general public, which suggested the notes were not securities. For the third factor, the court emphasized that the parties were sophisticated institutional lenders who had certified their experience in extending credit and conducted their own diligence, making it unreasonable for them to have perceived the notes as securities. Finally, the court found that the notes were subject to an existing regulatory framework and secured by collateral, which significantly reduced the risk associated with the instruments – further supporting the conclusion that they were not securities.8
In February 2024, the U.S. Supreme Court declined to hear an appeal of the Second Circuit Court of Appeals decision, thereby upholding the Southern District's original decision.
A Cautious Status Quo for U.S. connected Loans
The Kirschner decision has been widely covered in the U.S. and was closely followed by the Loan Syndications and Trading Association (LSTA) and its members. Although the case did not introduce any substantive change to the U.S. syndicated loan market, it reaffirmed the need for lenders to ensure that the documentation and syndication strategies used in the U.S. syndicated loan market avoid syndicated loans inadvertently being deemed as securities.
However, in addition to ensuring the four factors of the family resemblance test are clearly addressed in the loan documents by following standard syndicated lending practices and documentation, some lenders have implemented additional provisions to minimize the risk of their loans being captured by state securities laws. Such provisions include a clear statement in the loan document as to the intended purpose of the loan as a commercial lending facility and not holding as a security for investment purposes.
Implications for Canadian Transactions
Although the holding in Kirschner is not applicable under the securities laws of Canadian provinces or territories and the family resemblance test has been explicitly rejected in Canada9, where an ostensibly Canadian transaction involves parties (whether agents, lenders or borrowers) with a material U.S. connection, parties should consider including "Kirschner provisions" to obtain further comfort that the loan would not be characterized as a security for the purposes of U.S. federal or state securities laws
Footnotes
1. Kirschner v. JP Morgan Chase Bank, N.A., No. 21-2726 (2d Cir. 2023) at 5.
2. Ibid at 15.
3. Ibid at 16.
4. Ibid at 16-7.
5. Ibid at 25.
6. Ibid.
7. Ibid 6-39.
8. Ibid.
9. The Ontario Court of Appeal held that the family resemblance test did not have any application to the determination of whether a particular instrument or transaction was a security under the Securities Act (Ontario) in Ontario Securities Commission v. Tiffin 2020 ONCA 17 (see our bulletin here).
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
© McMillan LLP 2025
