Risk Management for Legal Opinions: Limiting Who May Rely on Your Opinion Letters in HUD Multi-Family Housing Projects

This is the fourth of a series of articles examining the question of who should be allowed to rely on an opinion letter issued by a real estate lawyer in a financing transaction and how that reliance should be expressed (and limited) in the opinion letter.

As noted in the previous articles in this series, lawyers do get sued over legal opinions, and many opinion claims are asserted that never make their way into a court.  One important risk management tool by law firms that issue third party opinion letters is to limit expressly who may rely on an opinion letter because courts recognize that a legal opinion may be relied upon only by its addressee and by any other person expressly authorized to rely.  Limiting who may rely on an opinion letter, therefore, necessarily limits the potential plaintiffs when things go wrong.

HUD-Insured Loans

In examining the issue of who should be allowed to rely on opinion letters issued by real estate lawyers in financing transactions, we previously noted that the appropriate reliance parties are determined in large part by the type of financing transaction.  As indicated, most financing transactions in which real estate lawyers issue opinion letters (as lead counsel or as local counsel) tend to fall into one of these categories:  portfolio loans, conduit loans, HUD-insured loans, Fannie Mae/Freddie Mac loans, syndicated loans, and debt securities.  This article examines the appropriate reliance parties in loans to finance a specific real estate project (e.g., multifamily housing) originated by a portfolio lender and to be insured by the Federal Housing Administration of the Department of Housing and Urban Development (“HUD”).

Section 207/223(f) of the National Housing Act provides a federal mortgage insurance program in which HUD may insure lenders of multifamily housing projects against loss on mortgage defaults.  Its purpose is to improve the availability of loan funds and permit more favorable interest rates, thereby facilitating the purchase or refinancing of existing multifamily rental housing.  In a HUD-insured loan, there are two parties that customary opinion practice would dictate as appropriate reliance parties:  (a) the lender, which originates the loan and usually continues to own and service the loan after closing, and (b) HUD, which insures the lender against loan defaults and may need to enforce the loan documents after paying an insured claim.  As noted in previous articles, lenders often expect an opinion letter to permit reliance by their successors and assigns, and one might also expect HUD to insist that its successors and assigns be permitted to rely as well.

However, customary opinion practice and the usual expectations of lender’s and borrower’s counsel do not apply in the case of HUD-insured loans.  HUD mandates that borrower’s counsel use only form HUD-91725M (Rev 04/11), “Opinion of Borrower’s Counsel,” when issuing an opinion letter for a HUD-insured loan.  The instructions accompanying the HUD form of opinion state that, except for limited changes required by local law or by the unique or programmatic nature of the transaction, “the format of the Opinion must be followed and is not open to negotiation.”   The HUD form of opinion is addressed to the lender, to the lender’s attorney, and to HUD.  In addition, the last paragraph of the HUD form states that “The foregoing confirmations and opinions are for the exclusive reliance of HUD, [and Lender OR Lender and Lender’s counsel], and have been made, presented, and delivered for the purpose of influencing an official action of HUD in insuring the Loan, and may be relied upon by HUD.”

Addressing the opinion letter to the lender and to HUD is entirely appropriate since both parties, as originator and holder of the loan and as insurer of the loan, have a vital interest in the accuracy of the matters covered by the opinion letter.

However, normally borrower’s counsel would be justified in refusing to address an opinion letter to the lender’s attorney unless the lender’s attorney were relying on the opinion of borrower’s counsel to issue its own “umbrella” opinion that covered the same subject or that depended on the borrower’s counsel opinion for one or more of the “building blocks” necessary to issue the opinion of lender’s attorney.  For example, lender’s counsel might be relying on the entity status, power and authority, due authorization, and due execution and delivery opinions from borrower’s counsel in order to give to the lender an enforceability opinion as to the borrower under the loan documents.  Of course, in most cases, lender’s counsel does not give an opinion to the lender as to the borrower, and even if it did, the trend in opinion practice for many years has been toward so-called “unbundled” opinions—namely, separate opinions by different lawyers directly to the lender on different aspects of the transaction with assumptions as to certain matters covered by other lawyers in their opinions. This results in the aggregate of the opinions issued by the different lawyers to the lender covering all of the bases without the necessity for any lawyer to rely on the opinion of any other lawyer.

Regrettably, HUD still requires borrower’s counsel to address its opinion letter to the lender’s attorney, regardless of whether reliance by lender’s counsel is necessary or consistent with customary opinion practice.  In 2014, when HUD last considered revisions to its forms of loan documents, including its form of opinion of borrower’s counsel, representatives of the RPTE Committee on Legal Opinions in Real Estate Transactions met with lawyers in HUD’s Office of General Counsel and argued that, among other things, HUD’s requirement for the opinion letter of borrower’s counsel to be addressed to lender’s attorney was contrary to customary opinion practice.  HUD declined to change that requirement.  Although the last paragraph of HUD’s form references “Lender OR Lender and Lender’s counsel” in brackets in stating who may rely on the opinion (perhaps suggesting that such parties can be omitted in that paragraph), borrower’s counsel should not assume that either lender or  lender’s counsel are not entitled to rely on the opinion.  So long as lender and lender’s counsel are addressees of the opinion letter, regardless of whether they are mentioned in the last paragraph, they are by definition “reliance parties.”

However, the HUD form of opinion of borrower’s counsel does not mention “successors and assigns” of the lender or of HUD.  Therefore, the discussion between lender’s counsel and borrower’s counsel that often takes place regarding this issue, and that usually results in limitations on such a clause, should not be necessary.  In fact, adding any language as to successors or assigns would violate HUD’s mandate to adhere strictly to the format of its form of opinion.