Some or all of these capitalization opinions may be given in venture capital and private equity financings (collectively “venture capital financings”) in circumstances where the parties determine that their benefit justifies the cost of preparing them. Capitalization opinions also are given in public offerings of shares, because (i) the SEC requires an opinion on the legality of the shares issued as part of the registration of the shares, and (ii) because underwriters almost always require, especially in an initial public offering, a capitalization opinion as part of their due diligence. Opinions to underwriters in the public offering context typically take different forms from those in venture capital financings, often referring to the information provided in the “Capitalization” or similar section of a prospectus or similar disclosure document, but the meaning of the elements of the opinions given and the work necessary to give them do not differ. The willingness of parties to invest substantial time and resources in giving a capitalization opinion in an initial public offering results in those opinions usually addressing all shares issued and outstanding, whereas that is less common in follow-on public offerings and in a private offering where the time available and resources may be more limited.
Capitalization opinions can address several different matters. These include (a) whether shares addressed in the opinion are or were duly authorized, (b) whether those shares will be or have been validly issued, (c) whether those shares are fully paid and nonassessable, and (d) how many shares and of what type(s) are authorized, issued and outstanding. Capitalization opinions often address some combination of these matters depending on the needs of the opinion recipient and the willingness of the parties to have the opinion giver devote the time and resources necessary to give the requested opinions.
This article looks briefly at each of the above elements of typical capitalization opinions. It then identifies some areas where uncertainty as to the meaning of the opinion or the diligence required to give it can exist and what can be done to avoid that uncertainty.
Authorized Shares
The first sentence of paragraph (a) of the sample opinion above addresses the number and type of shares authorized in the Company’s charter, in compliance with the corporation statute under which it was incorporated. The second sentence of paragraph (a) and the first sentence of paragraph (b) also refer to specific shares as being “duly authorized” (in the case of the example, all the previously issued and outstanding shares in paragraph (a), and the shares to be issued in the transaction in paragraph (b)). An opinion that shares are “authorized” provides assurance that the shares in question are properly authorized under the Company’s charter. The opinion is generally understood to mean that the Company has taken all corporate action necessary to authorize the class or series of shares in question, that such shares are properly reflected in the charter in compliance with the applicable state corporation statute, and that the terms of such shares are permitted under the applicable state corporation statute.
To give this opinion, the opinion giver will confirm that the charter provides for the stated number of authorized shares of each class or series of shares that is the subject of the opinion. A question arises as to whether an opinion giver needs to look behind a certified copy of the charter to determine if the shares reflected there were properly authorized, or whether the existence of the charter is sufficient to establish that authorization. The answer may depend upon the opinion being given and the circumstances. The 1998 TriBar Report (in Section 6.2.1) states that the opinion covers whether the necessary corporate actions (by the board and stockholders) to adopt the relevant charter provisions were in fact properly taken. This would include the proper exercise of any blank check authority if that authority is utilized to create the class or series of shares to which the opinion relates. That report also says the opinion, at least when given in connection with a stock issuance, covers whether the state corporation law permits shares having the characteristics of the shares at issue, whether the provisions of the charter relating to the shares comply with that law and whether a sufficient number of shares exist to be issued in the transaction. In light of TriBar’s statement of the opinion’s coverage, opinion givers who wish to rely solely on a review of the charter should consider, depending on the opinion being given and the circumstances, stating that their opinion is based solely on such review.
Implicit in an opinion that shares are duly authorized is that the corporation that purports to have authorized them in fact exists as a corporation. Because an opinion letter in almost all transactional contexts includes a separate opinion as to corporate status, this does not typically present a practical incremental issue for an opinion giver, at least for shares being presently issued in the transaction. However, were the corporation not to be validly existing (or to have had its corporate powers suspended at any time relevant to the authorization of the shares), depending on the circumstances it may not be possible to provide an opinion that shares purported to be authorized (or issued) at such a time were duly authorized (or validly issued).
Valid Issuance of Shares
The sample opinion above refers to shares being “validly issued.” Giving this opinion requires that the shares have been “duly authorized,” as discussed above. The “valid issuance” opinion provides assurance that all necessary steps have been taken by the Company’s board and/or stockholders under the applicable state corporation statute and the Company’s charter and bylaws for the proper issuance of the subject shares of the particular authorized class and series. The valid issuance opinion requires a determination that the Company’s board of directors (and its stockholders, if so required under its charter) has taken the steps necessary to issue the shares; this includes adoption of appropriate resolutions authorizing the issuance of the shares and specifying the consideration to be received for them and compliance with the terms of authorizing resolutions, including receipt of the specified consideration for the shares (generally assumed or established by means of a certificate). It also requires, if the state corporation statute specifies that consideration be of a particular type, that the consideration provided for is of the type permitted for the issuance of stock.
Giving this opinion requires that the opinion giver determine that there are sufficient authorized shares of the particular type of stock in question (that is, that the number of authorized shares of the class or series of stock addressed by the opinion does not (or did not) exceed the number of such shares available for issuance under the applicable charter and state corporation statute). It also requires the opinion giver to determine that the action taken to approve the issuance complied with the requirements of the state corporation statute and the Company’s charter and bylaws. For example, this may require an opinion giver to assess (if the share issuance was authorized by a board committee or another authorized person (such as an officer)) whether the state corporation statute permits a committee or such other person to authorize the issuance of stock and, if so, whether that power was appropriately delegated and exercised by the committee or other person.
Where a “validly issued” opinion is given as to some or all of the Company’s previously issued and outstanding shares, the opinion giver must determine that the steps outlined above were taken for each prior issuance of stock covered by the opinion based on the then applicable statute and the provisions of the Company’s charter and bylaws at each such time. Needless to say, this exercise almost always involves significantly more effort and, as a result, opinion givers and recipients should discuss early in a transaction whether the transaction merits doing (and allows the time to do) the work necessary to give this opinion with respect to previously issued shares.
Shares are Fully Paid
In the sample opinion, reference is made to shares being “fully paid.” This opinion provides assurance that the consideration specified by the Company’s board in its resolutions approving the issuance and sale of the stock complies with any requirements under the state corporation statute and the Company’s charter and bylaws. The opinion also confirms that the transaction documents provide for the Company to receive that consideration; the actual receipt by the Company of that consideration is often expressly assumed in the opinion letter.
Where a fully paid opinion is to be provided with respect to all issued and outstanding shares, the opinion requires confirmation that the Company actually received full payment of the required consideration for each share it has issued since inception. Like the “validly issued” opinion on outstanding shares, this may be very time-consuming, and in some cases impossible where records of consideration received no longer exist. For these reasons, the fully paid opinion with respect to outstanding shares is generally based solely upon an appropriate representation in an officer’s certificate that the consideration provided for in resolutions authorizing the prior share issuances was actually received or by an express assumption regarding such receipt.
Shares are Nonassessable
This opinion provides assurance simply that the stock issued is not “assessable” under the state corporation statute or the Company’s charter. Almost no corporations issue assessable stock and doing so generally requires specific authorization in both the Company’s charter and the board’s resolutions. Absent any provision for assessment, and based in part on the fact that almost all corporation statutes limit shareholder liability to the amounts they were required to pay for their shares, this opinion can generally be given if the required payment for the shares was made. In other words, if shares are “fully paid” and are not made assessable under the applicable corporation statute by appropriate corporate action, they are “nonassessable.” Again, the receipt of required payment is generally addressed by reliance on an appropriate officer’s certificate or assumption.
Numbers of Issued and Outstanding Shares
As in paragraph (a) of the sample opinion above, a capitalization opinion may include a statement as to the number of shares of a class or series that are “issued and outstanding.” While traditionally referred to as an opinion, this “opinion” is – or is at least generally intended by most opinion givers to be – just a statement or confirmation of fact: there are X shares issued and outstanding of each class and series addressed. While as a general matter lawyers should not be asked to confirm factual matters, many law firms provide the confirmation as to the number of outstanding shares. They generally do so on a clearly specified basis, which often is a certificate from an appropriate source, such as from the person or entity maintaining the Company’s share register, as to the number of shares issued and outstanding.
Stating the basis for an opinion as to the number of issued and outstanding shares has the benefit of making clearer what the opinion in its traditional form (that “X shares are issued and outstanding”) is intended to mean. While the opinion does not state that the shares issued and outstanding are validly issued, some lawyers are concerned that the opinion might be so understood (and not simply as a statement of the number of shares purportedly issued and outstanding). These lawyers note that shares not validly issued might be neither “issued” nor “outstanding.” They also worry that a recipient may someday claim that the opinion giver must have been doing more than relying solely on a third-party certificate, with what that “more” is being left unspecified but perhaps including doing all the work necessary to say the shares were validly issued. These potential uncertainties lead some lawyers to decline to give the “number of issued and outstanding shares” opinion if they are not doing the work to give the opinion on the valid issuance of outstanding shares that is expressly stated in the second sentence of paragraph (a) of the sample opinion. Other lawyers, however, point out that the common practice of giving a separate opinion on the “validly issued” status of shares when that is meant to be covered indicates that, when that opinion is not expressly included, it is not being given: therefore, an opinion recipient is not entitled to read an opinion that just states the number of shares issued and outstanding as addressing the validly issued status of those shares. While the authors agree that a statement just of the number of issued and outstanding shares should not be understood to address the validly issued status of those shares, they believe it is helpful to be clear as to the basis for that opinion if the validly issued status of the shares is not intended to be addressed.
Shares Issued in the Transaction
It is common for a capitalization opinion to address specifically the due authorization, valid issuance, and fully paid and nonassessable status of the shares to be issued in the transaction in connection with which the capitalization opinion is given. This opinion is illustrated above in paragraph (b) of the sample opinion.
Giving this opinion requires consideration of the same matters discussed above, just with a focus on the specific issuance of new shares taking place in the transaction. This focus usually makes this opinion easier to give, as the opinion giver has likely been involved in both the adoption of the charter provisions authorizing the class or series of the to-be-issued shares (and thus is comfortable that the necessary steps for such authorization have been taken), as well as the adoption of the required resolutions authorizing the issuance of the shares themselves, including the number of such shares, the consideration to be paid for them, and the arrangements made to actually sell the shares to the purchaser(s) and receive the required consideration for them.
When the shares issued can be converted by their terms into other shares (as is usually the case in venture capital financings, where the shares issued are typically convertible preferred shares), opinion recipients often ask for an opinion that the shares issuable upon conversion of the to-be-sold shares will themselves be duly authorized, validly issued, fully paid and nonassessable. Giving that opinion requires, first, that the opinion givers establish that the shares being issued to which the conversion right attaches (i.e., the preferred shares) are themselves duly authorized and validly issued since, if they are not, neither would be the conversion shares. In addition, giving the opinion on the due authorization and valid issuance of the conversion shares requires that the opinion giver consider the existence at the time the opinion is given of sufficient duly authorized shares of the type of shares into which the preferred shares may be converted. However, because conversion will happen, if at all, only at a future time, although the opinion speaks only as of the time it is given, the opinion giver may want to address, in some manner, the fact that it is not possible to know if, at the time of conversion, sufficient authorized shares will actually be available. This can be done in a number of ways, including by means of an express assumption to that effect.
Coverage of Only Relevant Corporate Laws
Capitalization opinions, with one narrow exception, address only compliance with the requirements of the relevant jurisdiction’s corporation statute under which the Company was incorporated, and the Company’s charter and bylaws. They do not address compliance with other laws, including business licensing and securities laws, nor do they address the absence of any filing obligations or conflicts with the rights of third parties arising under other laws, under contracts or otherwise. Opinions on those matters, if given at all, would be given separately.
Capitalization opinions do address compliance with stock issuance and ownership provisions of the relevant corporation statute and the Company’s charter and bylaws. This would include, in addition to compliance with the provisions discussed above, compliance with restrictions, if any, related to who is permitted to be a stockholder. For example, if the Company is a professional corporation, the valid issuance opinion could not be given if the corporation statute requires a stockholder of a professional corporation to be a licensed professional and the purchaser is not such a person.
The narrow exception referred to above is when a corporation is incorporated under a corporation statute but operates in a regulated industry and is subject to another law of the same jurisdiction which imposes requirements on the issuance of shares; in that case, an opinion that shares are duly authorized and validly issued (and for that matter fully paid and nonassessable) addresses compliance with applicable requirements of both the corporation statute and the regulatory law.
Public Offerings
As mentioned at the beginning of this article, capitalization opinions are routinely given in public securities offerings, and determining when shares are duly authorized, validly issued, fully paid and nonassessable is no different in a public transaction than in a private one. In addition, the SEC requires the issuer’s counsel in a registered public offering to provide an “Exhibit 5” opinion that states that the shares to be sold in the offering will, when sold in the manner described in the registration statement, be legally issued, fully paid and nonassessable.
In Staff Legal Bulletin No. 19 the SEC Staff has provided guidance as to what it believes counsel must address in order to give the Exhibit 5 opinion, which guidance is consistent with the discussion of capitalization opinions above. In particular, SLB 19 states the SEC’s views that:
- “Legal issuance” means (1) the Company is validly existing, and the shares are duly authorized; (2) all required corporate action to approve the issuance of the shares has been taken; and (3) the shares are or will be issued in compliance with the applicable state corporation statute, the Company’s charter and bylaws, and the applicable board resolutions;
- “Duly authorized” (not an explicit opinion, but as the term is used in the SEC’s definition of “legal issuance”) means that the Company, under the applicable state corporation statute and its charter and bylaws, has the power to issue the shares, and has taken all corporate actions necessary to exercise that power;
- “Fully paid” means that the consideration received by the Company satisfies, in both type and amount, the requirements of the applicable state corporation statute, the Company’s charter and bylaws, the board resolutions approving the issuance, and any applicable agreements (because the opinion must be filed before the registration statement becomes effective, the SEC Staff does not object if counsel assumes that the Company will receive the required consideration); and
- “Nonassessable” means that the person who acquires the shares will not be liable, solely because of the person’s status as a stockholder, for assessments or calls on the shares by the Company or its creditors.
As is the case with private offerings, the scope of opinions given to underwriters in public offerings varies. For example, almost all initial public offering transactions will include an opinion on the validity of all issued and outstanding shares (and not just those sold in the offering). Subsequent public offerings by the same issuer may include an opinion as to the authorized capital stock, but may limit a validity opinion to the shares sold, and the Company and its underwriters will often rely on a confirmation from the Company’s transfer agent for the number of issued and outstanding shares.
Why are Capitalization Opinions Often Considered Difficult?
Capitalization opinions, depending on their coverage and the circumstances, can sometimes be difficult to give. This is largely because of the extent of work required to give the opinion in the full form set forth in paragraph (a) of the sample opinion at the beginning of this article (i.e., addressing not only shares to be issued, but also previously issued shares). That opinion requires the opinion giver to determine that each class and series of shares of the Company has been duly authorized. This generally requires looking at each instance where a class or series of shares was authorized (or increased) in the charter to confirm the proper corporate actions were taken to authorize the shares, and that the Company had the power at the time under the then applicable state corporation statute to issue shares with the terms provided. The full opinion then generally requires the opinion giver to review each issuance of such authorized shares to determine that the issuance was valid: that is, that it was properly authorized by proper corporate action, that any steps required by the corporation statute or charter (such as fixing the consideration permitted under the statute for issuance of shares) were taken, and that there was sufficient authorized stock (taking into account any previously issued shares and other shares if any required to be counted under the corporation statute) to accommodate the issuance. It further generally requires at least an assumption as to the Company’s receipt of the specified consideration for the shares.
The foregoing can involve a great deal of work when a company has issued shares of different types and for differing consideration (including exercise of options or conversion privileges) over a substantial period of time. That work may not be justified in many contexts. As a result, parties to a transaction where capitalization opinions may be requested should discuss these opinions and their scope early in the transaction. In so doing, they should give due regard both to the benefits of the opinions to be provided and to the time and cost entailed in their preparation. In the context of larger equity offerings, the parties may decide that capitalization opinions of some type (at least addressing the due authorization and valid issuance of the shares to be issued in the transaction) may be appropriate (and necessary in a public offering), and they will provide the opinion giver and its client the time and resources required to give the requested opinions. In many other contexts, the work will not be worth the time, cost and effort.
When giving the capitalization opinions discussed in this article, opinion givers are entitled to make appropriate assumptions and establish facts in the same manner as they do with other opinions. An opinion giver can rely on information provided by an appropriate source (for example, board or stockholder resolutions certified by an appropriate corporate officer) unless in the circumstances such reliance is unwarranted. For example, opinion givers will obtain and need to rely on the accuracy of information about outstanding shares provided by the party maintaining the company’s share register. When provided records of corporate actions necessary to support a share authorization or issuance such as board and stockholder resolutions, an opinion giver can rely on that information, just as it might if provided similar information in connection with an opinion on an agreement, without any further investigation. Opinion givers (again, absent circumstances suggesting reliance is unwarranted) can assume (without so stating) the same matters they do in other contexts, such as compliance with fiduciary duties. Opinion givers in appropriate circumstances can also make use of presumptions like the presumption of regularity (as where there are gaps in corporate records but there is no reason to believe the action for which documentation is missing did not take place).
It is possible (and in some contexts not unusual) for an opinion giver to encounter in the course of conducting diligence information that calls into question whether all appropriate corporate actions have in fact been taken by those with the authority to take those actions. In such cases, additional diligence may be required and, when necessary, appropriate steps (including any necessary ratifications or validations) taken to ensure that all corporate actions required to support a valid share issuance have been taken and therefore that an opinion to that effect can be given.
The opinion giver may find it advisable to state expressly what has and has not been done to support the opinion. For example, an opinion might state that it is based solely upon a review of the Company’s current charter (as amended), together with any resolutions authorizing the issuance of the particular shares that are to be issued in the transaction that gives rise to the opinion. This limitation may or may not be acceptable to an opinion recipient depending on the circumstances. And, like other limitations on the scope of diligence that otherwise might be expected as a matter of customary practice, a more limited review should be expressly noted (for example, “our opinion is based solely on ...”).
How Should Opinion Givers Approach Requests for Capitalization Opinions?
Given the issues discussed in this article, opinion givers asked to give some form of a capitalization opinion might approach what they are willing or able to do as follows:
- Ask whether the transaction warrants a full capitalization opinion of the type set forth at the beginning of this article. If the parties wish to provide for such an opinion, the opinion giver should ensure that the parties understand the scope of work required and will allow the opinion giver the time and resources necessary for it to give the requested opinion.
- If the opinion is to be limited to some degree, ensure that the meaning of and basis for the opinion proposed to be given is clear.
- Specify the sources of information upon which the capitalization opinion is based, and that the opinion giver will be relying on the completeness of all the materials provided to it by the Company and any other sources of information.
Make appropriate use of certificates from appropriate sources to establish facts. As with any other opinion, if information comes to the attention of the opinion giver suggesting reliance on the provided information is unwarranted, it should conduct appropriate additional diligence (and take any appropriate remedial actions or make any appropriate disclosures) so that the requested opinion might be given.
Capitalization opinions can be challenging, especially when the opinion addresses all shares issued and outstanding rather than just the shares to be issued in the transaction in connection with which the opinion is given. They typically are not (as opinions given in public and private offerings demonstrate) impossible to do, but the potential work necessary to give them demands that the parties agree as to what the transaction really requires (which is often not an opinion on all issued and outstanding shares) and be willing to give the opinion giver the time and resources necessary to give the opinion requested.
