October 2022 in Brief: Legal Opinions & Ethics

Legal Opinions

Update on “Valid When Made” Rule

J.W. Thompson Webb, Miles & Stockbridge P.C.

In the Fall 2020 issue of In Our Opinion, we wrote about the so-called “Madden-fix Rules”— a rule adopted by the Office of the Comptroller of the Currency (the “OCC”) clarifying that an assignee of a national bank has the right to collect interest at the same rate as the national bank on loans originally made by the national bank, and a comparable rule adopted by the Federal Deposit Insurance Corporation (the “FDIC”) with respect to loans made by state-chartered banks. The rules codified the common law doctrine of “valid when made” to the effect that a loan, if valid when made, is not rendered usurious by a subsequent transfer.

Several states challenged the OCC rule in a lawsuit filed in the United States District Court for the Northern District of California. The same states, joined by other states, challenged the FDIC rule in a separate lawsuit in the same court. On February 8, 2022, the District Court granted summary judgment in favor of the OCC and the FDIC in those cases. The states did not appeal the District Court’s decisions. Thus, the “valid when made” rules continue to provide support for opinion givers giving enforceability opinions on loan agreements, including their interest rate provisions.

We also wrote about the “true lender” rule proposed by the OCC in 2020 to establish when a national bank or federal savings association is the “true lender” on a loan made when a third party is involved in the loan. The rule stated that, if a national bank or federal savings association is named as the lender in the loan agreement or funds the loan, it is the “true lender.” The rule clarified applicability of federal preemption of state licensing and usury laws with respect to non-bank parties involved in loans, regardless of when the bank parties became involved in the loan. The rule took effect December 29, 2020. Alleging that the OCC exceeded its authority in issuing the rule, several states challenged the rule. However, the “true lender” rule was overturned by Congress under the Congressional Review Act on June 30, 2021, and so is not in effect.

Opinion givers, when considering enforceability opinions on loan agreements, including their interest rate provisions, may take comfort from the Madden-fix Rules as to the “valid when made” concept. They must still be mindful, however, that a non-bank partner, subject to different usury rules in some states, may be found to be the true lender.

This piece originally appeared in the Summer 2022 issue of In Our Opinion, the newsletter of the ABA Business Law Section’s Legal Opinions Committee. Read the full issue and previous issues on the Legal Opinions Committee webpage.

Update on Delaware Decision Lessons for Duly Authorized Opinions

Stanley Keller, Locke Lord LLP

In the Winter 2020–2021 issue of In Our Opinion, the newsletter of the ABA Business Law Section’s Legal Opinions Committee, I described the decision of the Delaware Court of Chancery in Stream TV Networks, Inc. v. SeeCubic, Inc. in which the Court, noting the common law doctrine that enables a board of directors of an insolvent corporation to authorize the transfer of assets to creditors without stockholder approval, held that stockholder approval under section 271 of the Delaware General Corporation Law (“DGCL”) was not required for the corporation to transfer substantially all its assets to its secured creditors without a formal foreclosure proceeding. Because the Court viewed a provision of the corporation’s certificate of incorporation requiring approval of the corporation’s Class B stockholders for a transfer of substantially all the corporation’s assets to be similar to DGCL section 271, it held that this class vote provision also did not apply to the transfer to the secured creditors.

In June 2022, the Delaware Supreme Court reversed the decision of the Court of Chancery and held that the class vote provision of the certificate of incorporation applied apart from DGCL section 271 and required by its terms approval by the Class B stockholders for the asset transfer as an “other disposition” without any insolvency exception. The Supreme Court went on to indicate that if there were a common law insolvency exception, which has never been clearly adopted by any Delaware court, it did not survive the enactment of section 271. In support of this conclusion, the Supreme Court observed that recognizing an insolvency exception not provided for in the DGCL would create uncertainty and undermine the predictability that is crucial for Delaware corporations.

For purposes of giving duly authorized opinions, the Delaware Supreme Court decision means that provisions in a certificate of incorporation requiring specified corporate action, such as a separate class or series vote, are to be given effect as a contractual right, interpreting clear and unambiguous terms according to their ordinary meaning. When the provision differs materially from a related statutory provision, it is not necessary to look to the meaning of the statutory provision. On the other hand, the decision does not mean that interpretations of a statutory provision are not relevant when interpreting provisions similar to the statutory provision (such as the meaning of “substantially all the assets”). The Supreme Court also clarified that the requirement of DGCL section 271 for stockholder approval for a “sale, lease or exchange” of all or substantially all the corporation’s property and assets is to be applied without any exception for transfers to creditors by an insolvent corporation.

This piece originally appeared in the Summer 2022 issue of In Our Opinion, the newsletter of the ABA Business Law Section’s Legal Opinions Committee. Read the full issue and previous issues on the Legal Opinions Committee webpage.

Update on Disclosure of Government Investigations

Stanley Keller, Locke Lord LLP

We previously wrote in In Our Opinion about the challenges of deciding on the need to disclose government investigations and to deal with them in financial statements, including in responses to auditors, particularly when the investigations are in an early stage. A recent federal court decision, Noto v. 22nd Century Group, Inc., held that the failure to disclose a government investigation violated the federal securities law anti-fraud provisions. The decision underscores our earlier message about the need to understand the facts underlying the investigation as best one can and to try to anticipate how the investigation and any potential charges are likely to evolve.

The Noto decision involves a class action alleging violation of Rule 10b–5 under the Securities Exchange Act of 1934 due to the company’s failure to disclose an investigation by the Securities and Exchange Commission (“SEC”) into the company’s financial accounting controls. The Court of Appeals for the Second Circuit reversed the dismissal of the action by the District Court, which had held that the company had no duty to disclose the investigation. Instead, the Court of Appeals found that under the circumstances the failure to disclose the SEC investigation made the company’s statements about its accounting deficiencies misleading. The company had disclosed the accounting deficiencies, said that it was undertaking remediation efforts, and subsequently stated that it had completed the remediation, but it did not disclose that an SEC investigation was pending. The Court of Appeals indicated that the failure to disclose the investigation could cause a reasonable investor to make an overly optimistic assessment of the risk of the underlying problem. The Court also noted that the company, in response to a media report, denied knowledge of any SEC enforcement proceeding or investigation, and the Court found that false denial to be an admission by the company of the materiality of its nondisclosure.

The decision in Noto does not disturb the holding in Richman v. Goldman Sachs Group, Inc. that an investigation on its own is not a “pending legal proceeding” required to be disclosed under Regulation S-K Item 103 until it reaches a stage when the government agency makes known that it is contemplating filing suit or bringing charges. Instead, the Court of Appeals in Noto based its decision on the principle that, even when there is no independent duty to disclose, once a company speaks on a subject it has a duty to tell the whole truth. Here, the Court referred to the series of statements that triggered the duty to disclose the SEC investigation, and it is not clear which, if any, of the statements would itself have triggered the duty. While the Court referred to the company’s false denial of the existence of an SEC investigation, it did not base its decision on that affirmative misstatement as opposed to the omission of disclosure. The false denial, however, may have influenced how the Court viewed the omission.

The Noto decision adds to the challenges of deciding whether to disclose a government investigation to the auditors in an audit response. The decision highlights the relevance of a company’s public disclosures in making that decision. If anything, the Second Circuit’s Noto decision is likely to encourage earlier disclosure of government investigations.