• Are a Promissory Note and a Loan Agreement a Security under the IL Securities Law?

    Banking and Business Monthly – April 2022

    Steven A. Migala • Apr 25, 2022

    Are a Promissory Note and a Loan Agreement a Security under the IL Securities Law?

    On April 15, 2022, the Illinois Appellate Court’s First District decided Dvorkin v. Soderquist, 2022 Ill. App. 201368 (Ill. App. Ct. 2022). The plaintiff in Dvorkin made several claims, but this article will focus on the appellate court’s decision that the trial court was correct in ruling that the promissory note and loan agreement at issue were not a security and therefore the defendants did not violate the Illinois Securities Law of 1953 (“ISL”). The appellate court also held that the plaintiff failed to plead facts sufficient to allege fraud and remanded the case for further proceedings on the remaining counts of the complaint. Id. at ¶ 96.

    Section 2.1 of the ISL defines a “Security” as “any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, viatical investment, investment fund share, face-amount certificate, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas or other mineral lease, right or royalty, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into, relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘security’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. ‘Security’ does not mean a mineral investment contract or a mineral deferred delivery contract; provided, however, the Department shall have the authority to regulate these contracts as hereinafter provided.” 815 ILCS 5/2.1.

    The court in Dvorkin noted that it has previously established that “a promissory note under which the plaintiff was solely a ‘passive lender’ who ‘did not look to profit from the transaction other than by its ordinary charges for lending money’ was not a security under the Securities Law.” Id. at ¶ 80 (quoting Boatmen’s Bank of Benton v. Durham, 203 Ill.App.3d 921, 927-28 (1990). Further, the court reasoned that Illinois courts “have emphasized that a security within the meaning of the securities laws is a contract, transaction, or scheme whereby one person invests his money in a common enterprise on the theory that he expects to receive profits solely from the efforts of others.” Id.

    The court was not persuaded by the plaintiffs’ claim that they “expected to receive profits from the efforts of others, in the form of a 5% share in [the defendants’] net profits.” Id. at ¶ 81. The court reasoned that the loan agreement and promissory note at issue failed to fulfill the requirements of a security. Id.

    Notably, the Dvorkin court pointed out that neither the loan agreement nor the promissory note contained any provision for the plaintiffs to receive any percentage of the defendants’ profits, gross, net, or other income. Id. Further, the “entire agreement” clause in the loan agreement provided that it, the promissory note, “and any attached schedules and exhibits contain the entire agreement of the Parties hereto with respect to the matters covered and the transactions contemplated hereby, and no other agreement, statement or promise made by any Party hereto, or by any employee, officer, agent or attorney of any Party hereto, which is not contained herein will be valid or binding.” Id. The court further held that the “entire agreement” clause in the loan agreement and the reference in the promissory note to only the loan agreement, did not create a “membership agreement” nor was there any oral membership agreement concerning the plaintiffs. Id. at ¶ 82.

    The Dvorkin case makes clear that a conventional loan evidenced by a promissory note and a loan agreement is often not a security under the ISL despite the seemingly clear definition of a “Security” under the ISL. This case also demonstrates the impact of an “entire agreement” clause (also known as a “merger” or “integration” clause). For further inquiries or questions, please contact me at smigala@lavellelaw.com or at (847) 705-7555.