Those Third-Party Opinions: Can Loan Transaction Costs Be Reduced?
To do your deal, do you really need all those third-party legal opinions?
Commercial lenders, both at the senior loan level and the mezzanine loan level, are constantly searching for ways to compete for new loan transactions. Some lenders have chosen to compete on the basis of price, pledging to prospective borrowers that the interest and fees to be charged by the lender (including the lender's lawyers' fees, that are traditionally paid for by the borrower) will be as low as the borrower will find. Other lenders have elected to compete on the basis of service, pledging, among other things, a fast approval process and a streamlined documentation/closing process.
One element of the closing process that increases costs and, on occasion, the time that it takes to close a loan transaction, is the opinion letter from the borrower's lawyer. The lawyer opinion letter has traditionally been considered important by the lender's lawyer, but has never been completely understood or considered as important by either the borrower or the lender.
The purpose of this article is to apprise borrowers, lenders and their counsel about the aspects of a loan transaction that have, over time, become part of the lawyer opinion letter traditionally issued at the closing of a loan transaction. We will also offer some views, in light of the competition referred to above, about the relative costs and benefits of asking for and obtaining an opinion about each of those aspects.
So what aspects of the loan transaction will the borrower's lawyer be asked about? We will categorize them as follows:
- Corporate authority opinions
- Enforceability opinions
- Creation/perfection/priority opinions (in the case of collateralized loans) and
- Due diligence opinions.
Authority opinions — When a lender is preparing to make a loan to a corporate borrower (comparable, but slightly different, authority opinions are required when the borrower is a general or limited partnership or a limited liability company), how does the lender know whether the borrower is in fact organized under the laws of a particular jurisdiction as a corporation? Similarly, when John Doe arrives at the closing of the loan transaction, announces that he is the president of the corporate borrower and states that he has authority to sign all of the loan documents in his capacity as president of the corporate borrower, how can the lender be certain that John Doe is in fact authorized to sign on behalf of the corporate borrower?
Lawyer opinions are the principal vehicle where lenders can be certain that each of these questions is answered affirmatively. The borrower's lawyer will provide the following opinions, that, as a whole, constitute what we have referred to as the "corporate authority opinions."
The first comment typically contained in a lawyer opinion letter states that "the borrower is a corporation duly organized, existing and in good standing under the laws of its state of incorporation." This assures the lender that its borrower has in fact been organized as a corporation and continues to pay all required franchise taxes. In other words, this opinion assures the lender that its borrower is an entity that can enter into a contract and that legal process can be brought against the borrower if the borrower breaches the provisions of the loan documents.
Next, the opinion letter will state that "the borrower has full corporate power and authority to own and lease its properties and to carry on its business as described in the loan agreement." This opinion assures the lender that the borrower's charter, as well as the corporate laws of the state of the borrower's jurisdiction of organization, permit the borrower to engage in the business engaged in by the borrower. If the lender expects that its loan will be repaid with the profits arising from the sale of widgets, the lender wants assurances that its borrower is authorized by the borrower's own charter to sell widgets.
The third opinion states that "the borrower has full right, power and authority to execute and deliver the loan documents and to perform its obligations thereunder," and that "such execution, delivery and performance will not conflict with, or result in a breach of, the borrower's charter or by-laws." These opinions assure the lender that the borrower's charter, as well as the corporate laws of the borrower's jurisdiction of organization, permit the borrower to enter into and perform the obligations contained in the loan documents.
The next opinion states that "the execution and delivery of each loan documents and the performance of the transactions contemplated thereby have been duly authorized and approved by all requisite action on the part of the borrower." This opinion assures the lender that the corporation's board of directors and, if necessary, its shareholders have determined that the specific borrowings contemplated by the loan documents are in the best interests of the corporation and should be and can be entered into by the corporation.
The final corporate authority opinion states that "each of the loan documents has been duly executed and delivered by a duly authorized officer of the borrower." It is this opinion that tells the lender that John Doe is in fact an officer of the borrower and that John Doe has been authorized by the board of directors and, if necessary, the shareholders to execute the loan documents on behalf of the corporation.
The corporate authority opinions are essential to the lender. They are rarely the subject of significant discussion between the respective lawyers for the lender and the borrower, and consequently they do not contribute significantly to the costs of a transaction. To issue these opinions, the borrower's counsel will order a certified copy of the borrower's charter, along with a good-standing certificate, from the secretary of state where the borrower is organized. The borrower's counsel will then review the corporate records of that borrower, paying particular attention to the bylaws and board and shareholder resolutions authorizing the contemplated loan transaction.
To reduce costs, have best-placed lawyer do
The borrower's lawyer is much better placed, when compared to the lender's lawyer, to issue the corporate authority opinions. As counsel to the borrower, the borrower's lawyer has prepared, or at least has better access to, the charter, bylaws and board and shareholder resolutions that support these opinions. For purposes of reducing transaction costs, it is always desirable to have the lawyer that is best placed to draw the necessary legal conclusions issue the corresponding lawyer opinion.
Enforceability opinion — This opinion states that "the loan documents constitute the legal, valid and binding obligations of the borrower, enforceable in accordance with their terms." The purpose of this opinion is to assure the lender that if the borrower violates a particular provision of the loan documentation, the lender will have the ability to use the court system to require the borrower, either through the payment of damages or otherwise, to rectify the violation.
To deliver an enforceability opinion, the borrower's counsel will conduct a provision-by-provision review of the loan documents. For each provision, the borrower's lawyer will determine whether a court would enforce the provision or find reason not to enforce the provision. If the borrower's lawyer concludes that a court might not enforce a particular provision, the lawyer will draft an exception to the enforceability opinion. Because the enforceability of certain provisions contained within a typical loan documentation package are in doubt, the borrower's lawyer needs to draft, and the lender's counsel needs to review and respond to, many exceptions to the standard enforceability opinion. The drafting of these exceptions, coupled with the review and subsequent fine-tuning of these exceptions by lender's lawyer, causes substantial costs and even occasionally delays the closing.
We concluded above that corporate authority opinions are essential to the lender. With respect to the enforceability opinion, however, it is not clear that the costs of obtaining the opinion (principally lawyers' time) outweigh the benefits to the lender. At least three arguments suggest that the lender should forego requesting this opinion.
First, in contrast to the corporate authority opinions, it is the lender's lawyer, rather than the borrower's lawyer, that is best placed to determine which provisions of the loan documents are enforceable and which might not be enforceable. It is the lender's lawyer who drafts the loan documents and it is the lender's lawyer who usually has greater expertise than the borrower's lawyer regarding the enforceability of each provision of the loan documents.
Moreover, it is part of the lender's lawyer's responsibility to advise its client as to all legal risks, including potential unenforceability of portions of the loan documents, and to assure its client that the transaction is accurately documented. As a result, it can be argued that the lender should look to its own counsel for a listing of those provisions of the loan documents that might not be enforceable and for an explanation of the potential consequences to the lender as a result of those provisions not being enforced.
Second, we suspect that many lenders simply do not care about the enforceability opinion or whether certain provisions of their loan documents are potentially unenforceable. Lawyer opinion letters are frequently firmed up on the eve of the closing, and rarely does lender's counsel communicate to its client the exceptions to the enforceability opinion. It is our belief that lenders understand that at least a few of the provisions contained in their standard loan documentation are of questionable enforceability, and that they look to their own counsel to assure them that the most important provisions are enforceable.
Lenders do not make loans with the expectation of reaching the deep pockets of the borrower's counsel and its malpractice insurance carrier. The lender simply wants to know that if the borrower does not repay the loans as scheduled, the lender will have the ability to obtain a judgment against the borrower for outstanding principal and accrued interest and, in the case of collateralized loans, to act against its collateral. Whether or not the lender is able to enforce many of the other rights and remedies contained in a typical loan documentation package is of secondary importance.
Third, because lenders traditionally use the same form loan documents from transaction to transaction, it seems repetitive and wasteful to ask for an enforceability opinion in every transaction. We recognize that from transaction to transaction the borrowers can be located in different states and that certain provisions of a standard loan documentation package may be enforceable in one state and unenforceable in another. Nevertheless, it is unlikely that the differences among the states are that significant with respect to the enforceability of the loan documents taken as a whole, and it is likely (with the exception of usury laws) that the provisions of the loan documents that are susceptible to significant variations regarding enforceability among the states are not that material to the lender.
In most cases, regardless of the state where the borrower is located, the loan documents provide that they will be governed by the laws of the jurisdiction in which the lender has its principal place of business. Accordingly, exclusive of the choice-of-law provision, it may be irrelevant whether the loan documents are enforceable under the laws of the jurisdiction where the borrower has its principal place of business. That jurisdiction is frequently the state in which the borrower's counsel is licensed to practice.
But what if lawyers are in separate jurisdictions?
Lenders' lawyers have resorted to a number of mechanisms to deal with the situation where the loan documents choose the laws of one particular jurisdiction and the borrower's lawyer is licensed to practice in another jurisdiction. First, the lender may ask the borrower's lawyer for an opinion that the loan documents will be enforceable under the laws of the jurisdiction in which the borrower's lawyer is located. This opinion has some value to the lender if the borrower is located in the same jurisdiction as its lawyer and if the choice-of-law provision turns out to be unenforceable.
Alternatively, lenders' lawyers may ask the borrower's lawyer to state that the loan documents are enforceable under the laws chosen by the loan documents, assuming that those laws are identical, substantially similar or comparable to the laws of the jurisdiction where the borrower's lawyer is located. The authors believe that this solution, although prevalent, is somewhat contrived and of relatively little value.
For all of these reasons, obtaining an enforceability opinion from the borrower's lawyer may be of very little, if any, practical value in protecting the lender's rights. While each lender will have to make its own decision, it is our view that in this day of competition among lenders, many lenders will begin to break from tradition and forego requesting the enforceability opinion. Such a decision would serve to reduce closing costs as well as the friction that can surround the delivery of an opinion letter.
For those lenders that elect to forego requiring the enforceability opinion, we would suggest:
asking for a simple opinion that a contract has been formed on the execution and delivery of each loan document by an authorized officer (this alternative was offered in the 1991 Third-Party Legal Opinion Report of the Section of Business Law of the American Bar Association, that report contains the commonly referred to "Legal Opinion Accord"),
asking for an enforceability opinion about isolated, yet important provisions of the loan documents, including the choice-of-law provision and the interest provisions, and
conducting a discussion with their own counsel regarding the provisions of the loan documentation that may not be enforceable and the potentially adverse consequences that could result.
Creation/perfection/priority opinions — In the case of collateralized loans, the borrower's lawyer is often asked to give an opinion that the loan documents are sufficient to create a security interest in favor of the lender and that all necessary actions have been taken to perfect that security interest. On occasion, the borrower's lawyer is also asked for an opinion that the security interest that has been created and perfected will have priority over any competing security interests. When analyzing the relative costs and benefits of requesting and receiving creation, perfection and priority opinions, the arguments made above with respect to foregoing the enforceability opinion also apply to the creation, perfection and priority opinions.
Lender: Go to right jurisdiction for advice.
As is the case with the enforceability opinion, in most cases the lender's lawyer is better placed to issue an opinion than the borrower's lawyer. The lender's lawyer, through repetition, is generally more familiar with the nuances of creating and perfecting liens in a variety of types of collateral in a variety of jurisdictions. Moreover, reporting services such as Commerce Clearing House have prepared excellent charts, tables and summaries that, in lieu of the opinion or the borrower's lawyer, can easily apprise lender's counsel of the nuances that exist among jurisdictions. Naturally, for certain of the more complex nuances, it is advisable for the lender's lawyer to seek advice from counsel located in the jurisdiction that has such nuances, or require the borrower to obtain an opinion from a lawyer in that jurisdiction.
It is the experience of the authors that because of the relative uniformity of the Uniform Commercial Code through the United States, and because of the presence of reporting services that describe the variations among the jurisdictions, lenders should feel comfortable using their own experienced counsel to advise them on matters of creation, perfection and priority of security interests in personal property. Lenders should, however, understand that their own counsel is usually not licensed to practice law in the jurisdictions in which much of the collateral is located and, therefore, is not intimately familiar with, and should not be viewed as the definitive authority on, the laws of those jurisdictions.
Due diligence opinions — This category of opinions is designed to provide the lender with the benefit of the knowledge obtained by the borrower's lawyer in connection with its representation of the borrower. Certain of these opinions are legal in nature and others are more factual. Those of a predominantly legal nature include opinions that:
the execution, delivery and performance of the loan documents will not result in a breach or other violation of any of the terms, conditions or provisions of any law or regulation (including applicable usury laws), order, writ, injunction or decree of any court, government or regulatory authority;
the execution, delivery and performance of the loan documents will not result in a breach or other violation of any of the terms, conditions or provisions of certain enumerated and material agreements, instruments and documents to which the borrower is party or by which the borrower's property is bound;
the execution, delivery and performance of the loan documents will not constitute grounds for acceleration of the maturity of any enumerated and material agreements, indentures, undertakings or other instruments to which the borrower or its property may be bound or result in the creation or imposition (other than in favor of the lender) of any lien, charge or encumbrance on, or security interest in, any of the borrower's property; and
the execution, delivery and performance of the loan documents do not require the consent or approval of, the giving of notice to, any exemption by, or any registration, declaration or filing with or the taking of any other actions in respect of, any government or regulatory authority.
The foregoing opinions are predominantly legal in nature because they require the borrower's lawyer to review the loan documents against applicable laws and against existing documents in order to reach the legal conclusion that such laws and documents will not be violated by the execution, delivery or performance of the loan documents.
The due diligence opinions that are more factual, rather than legal, in nature, include opinions that to the knowledge of the borrower's lawyer (the phrase "the knowledge of the borrower's lawyer" should be defined as the knowledge of the lawyers that have devoted substantive attention to the legal affairs of the borrower, including the consummation of the financing represented by the loan documents):
no judgments are outstanding against the borrower, nor is there now pending or threatened, any litigation, contested claim or governmental proceeding by or against the borrower or affecting the borrower's property;
the borrower is not in default with respect to any order, writ, injunction or decree of any court, government or regulatory authority or in default in any respect under any law, order, regulation or demand of any governmental agency or instrumentality, a default under which would have a material adverse effect on the borrower or its business; and
the borrower owns or possesses or is licensed or otherwise has the right to use all licenses, permits and other governmental approvals and authorizations, operating authorities, certificates of public convenience, authorizations and other rights necessary for the operation of its business.
Receipt of the due diligence opinions provides the lender with assurances that certain adverse situations do not exist and will not be caused by the execution, delivery and performance of the loan documents. Receipt of these opinions is not meant as a replacement for the lender's own due diligence process. In fact, borrower's counsel, in objecting to the delivery of these opinions, will often state that the lender can do its own due diligence, thereby obviating the need for the opinion of borrower's counsel.
While borrower's counsel is correct that the lender can do its own due diligence, requiring the lender to do so will in general require the lender to duplicate work already performed by borrower's counsel. As a result, we conclude that in order to reduce transaction costs, it is appropriate for lenders to ask for, and receive, the due diligence opinions referred to above.
In addition to arguing that the lender can obtain the information requested by the due diligence opinions through its own investigation, borrower's lawyers frequently argue that the factual due diligence opinions are not appropriate because they are not entirely legal in nature. While it would be inappropriate to ask the borrower's lawyer for an unqualified opinion on factual matters, it is not inappropriate if the opinion is limited to the "knowledge" of the borrower's lawyer. Similarly, if the knowledge limitation is present, the borrower's lawyer should not be able to argue that the lender is attempting to expand the scope of the work to be performed by the borrower's lawyer.
As previously stated, while it is up to the lender to conduct its own due diligence investigation, the lender should be entitled to the benefit of any knowledge obtained by the borrower's lawyer. If the borrower's lawyer were asked by its own client to conduct a thorough due diligence investigation, the knowledge of the borrower's lawyer should be extensive, thereby resulting in a diminution of the work that needs to be performed by the lender, and if the borrower's lawyer has done little due diligence investigation, the due diligence work to be done by the lender remains significant. However, at least the lender has the benefit of whatever work has been done by the borrower's lawyer.
They may have value, but at what cost?
In writing this article we have tried to analyze the opinions traditionally delivered in connection with a loan transaction to determine whether, notwithstanding tradition, those opinions are valuable in protecting lenders' rights. An important part of this analysis was to determine whether the borrower's lawyer or the lender's lawyer is best placed to issue the opinion. In short, we have sought to reduce transaction costs by having work performed by the low-cost provider. Another important element was to evaluate what, if any, practical value the borrower's lawyer opinion adds to ensuring that the lender receives the benefit of its bargain.
While we have endorsed foregoing certain standard opinions, such as the enforceability opinion and the creation and perfection opinions, borrowers, lenders and their counsel should understand that we are not suggesting that these opinions are without value. Instead, we are suggesting that their value does not necessarily justify the cost. In other words, if a lender has the goals of reducing transaction costs and streamlining the closing process, that lender may be able to enhance the achievement of these goals by giving up the value of certain lawyer opinions. It would not be unreasonable, however, for a lender to determine that in a particular situation it is necessary or desirable for the lender to obtain one or more of the enforceability, creation and perfection opinions.
The Legal Opinion Accord that was referred to earlier was an effort made by lawyers to standardize opinions in order to reduce the costs and acrimony that frequently accompany the negotiation of opinions. The authors hope that this article furthers the process initiated by the drafters of the accord by causing lender's lawyers to evaluate the relative costs and benefits of requesting and receiving certain opinions in the context of their lending clients' overall goals.
Ms. Snider is chief administrative officer and general counsel at Heller Financial, Inc., headquartered in Chicago.