The Rise Of Kirschner Provisions: Where They Come From And What It Means

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:

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…