SDNY Holds Syndicated Loan Is not a "Security"

The U.S. District Court for the Southern District of New York ("SDNY") held that certain syndicated loans sold to institutional investors are not "securities" and rejected claims of violations of federal and state securities laws.

The Court applied the four-factor "family resemblance" test set out in Reves v. Ernst & Young, 494 U.S. 56 (1990) in determining that loan participations sold to the plaintiffs are not "securities." The Court found that:

  • the motivations of the seller and buyer did not weigh strongly for or against categorizing the loans as securities;
  • the plan of distribution supported the notion that the instruments should be considered loans, because the plan was "relatively narrow";
  • the reasonable expectations of the investing public supported the notion that the instruments should be treated as loans, because the lenders were sufficiently notified that the instruments of participation in the transaction were loans, not "investments in a business enterprise"; and
  • the existence of another regulatory scheme whereby the Court, citing Banc Espanol de Credito v. Security Pacific Nat'l Bank, 973 F.2d 51 (2d Cir. 1992), noted that the federal banking regulators have set forth specific guidelines on the sale of loan participations.

While the Court rejected the plaintiff's claims, it did grant the plaintiff leave to amend its complaint.


The very important lesson to be taken from this case is that documentation matters.

As to Court analysis of Reves, the key issue was likely the third Reves factor: the reasonable expectation of the parties. That is, the Court essentially ruled that an institution purchasing a debt obligation that expressly uses terminology and descriptions consistent with a lending transaction is on notice that the institution does not have the protection of the securities laws. An institutional purchaser of a loan, or a participation in a loan, must be reasonably comfortable with its own ability to conduct diligence and to evaluate the credit transaction.

The Court also dismissed negligent misrepresentation charge and other state law claims. This is consistent with its securities law analysis. That is, the Court took the institutions at their word: that they were conducting their own independent analysis of the loan transaction and were responsible for their credit decision.

The outcome of this case is consistent with the long-held understanding in US lending markets that loans are not “securities”, and purchasers of loans and loan participations should be aware of their responsibility to adequately and independently conduct a credit analysis of the transaction.

Sellers of loans and loan participations should, on the other hand, review their documentation and be as explicit as possible as to the legal characterization of the transaction and as to the obligation of each buyer to make its own credit decision.

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