This is the sixth and final of a series of articles in Opinions Matters 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 expressly limit 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.
In examining the issue of who should be allowed to rely on opinion letters issued by real estate lawyers in financing transactions, I 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 opinions in connection with the issuance of debt securities that are secured by real property. If a real estate lawyer is called upon to issue an opinion letter in such a transaction, more often than not the opining lawyer will be acting as local counsel in a large corporate financing that happens to be secured by real property in that lawyer’s state.
Because many real estate lawyers are unfamiliar with securities transactions, some background information may be helpful to put the local counsel opinions in context. As used in this article, “debt securities” means notes (or bonds) issued by a corporation or other entity (usually referred to as the “issuer” or the “company,” rather than the “borrower”), typically with a fixed interest rate and for a relatively long term, to finance various corporate needs such as the acquisition of another company. Unlike the typical note of a borrower in a bilateral real estate loan, the notes are “securities” under federal securities laws and, as such, are issued either in a registered public offering under the Securities Act of 1933, as amended, or in a transaction that qualifies for an exemption from registration, such as a private placement pursuant to Rule 144A. In many cases, the notes will be issued pursuant to and governed by an indenture of trust between the issuer and a financial institution serving as trustee for holders of the notes (the “trustee”).
In a registered offering, the notes will be purchased by one or more financial institutions (the “underwriters”) pursuant to an underwriting agreement, and the underwriters will then promptly resell them to investors in the debt securities market, in reliance upon a prospectus which is part of a registration statement filed with the Securities and Exchange Commission. In the case of a Rule 144A private placement, the notes will be purchased by one or more financial institutions (the “initial purchasers”) from the issuer and then sold in a follow-on transaction to qualified institutional buyers (“QIBs”) pursuant to a note purchase agreement and in reliance upon disclosures in a confidential offering memorandum. The QIBs who purchase from the initial purchasers at some point in the future may also resell the notes that they purchase, but typically they are purchasing the notes to hold for the foreseeable future, or at least until the notes are exchanged for registered versions pursuant to a registered exchange offer.
If the issuer of the notes does not have an investment grade credit, it may be required to secure the notes with collateral, including some or all of its real estate assets. Although any required mortgage, deed of trust, or deed to secure debt encumbering the issuer’s real property to secure the notes (any of which is called a “mortgage”) may be executed and recorded contemporaneously with the issuance of the notes, more often mortgages are provided (and local counsel is asked to issue its opinion letter) after the initial closing, perhaps within 90 or 120 days after the notes were issued. Although the indenture of trust, the underwriting agreement, or the purchase agreement will typically be governed by New York law, each mortgage will be governed, at least with respect to the creation, perfection, and enforcement of any liens, by the law of the state in which the real property is located. Hence the need for the local counsel opinion that is the subject of this article. The party secured by one or more mortgages will be the trustee under the indenture of trust on behalf of the noteholders or, in some cases, a collateral agent for the noteholders (the collateral agent may be the financial institution that also serves as trustee or a different financial institution), in each case as designated in the indenture of trust.
Based on the summary of a debt securities transaction set forth above, the parties that arguably should be named as addressees of the local counsel’s opinion letter, or as parties who are expressly authorized to rely upon the opinion letter, include the following:
Let’s examine each of these parties to determine whether it is an appropriate reliance party in a local real estate counsel opinion letter.
Trustee and Collateral Agent. Inasmuch as the trustee acts on behalf of the noteholders in accordance with the indenture of trust (much like an administrative agent in a syndicated loan, but with even greater fiduciary duties), the trustee would normally be entitled to rely on the opinion letter, either as an addressee or by separate reliance language, regardless of whether the notes are privately placed or issued pursuant to a registered offering. In addition, any separate collateral agent should be entitled to rely on the opinion letter, which typically provides assurances as to the form and enforceability of the mortgage in which the collateral agent is the mortgagee/beneficiary/grantee and which the collateral agent may be called upon to enforce.
Underwriters and Initial Purchasers. The characterization of the underwriters and the initial purchasers in a Rule 144A offering as reliance parties is not as straightforward. If the mortgage is executed and recorded, and the local counsel opinion is issued, contemporaneously with the execution and delivery of the underwriting agreement or purchase agreement and the issuance of the notes, the underwriters or initial purchasers should reasonably expect to rely on the opinion letter. Under these circumstances, the underwriters and initial purchasers are entitled to the comfort provided by the opinion letter as they seek to market the notes to investors in the public debt markets. On the other hand, if the mortgage and local counsel opinion are provided in a post-closing process (say, within 90 to 120 days after the initial issuance of the notes, which is likely after the notes have been sold on to other investors), the underwriters and initial purchasers have a far weaker claim to being reliance parties in local counsel opinions. Moreover, as a practical matter, local counsel probably will not be provided with a copy of the underwriting agreement or purchase agreement or even be informed as to who the underwriters or initial purchasers were. In such case, the reliance parties should properly be limited to the trustee and, if applicable, the collateral agent. If the underwriters or initial purchasers still retain any of the notes at that time, the trustee can act as their representative with regard to any claim that may need to be asserted against the opinion giver.
Noteholders. Should the parties who actually hold the notes from time to time also be entitled to rely on the opinions provided by local real estate counsel? As noted above, anyone who is an addressee of an opinion letter or who is otherwise expressly allowed to rely on an opinion letter is also a potential plaintiff in a claim against the opinion giver, should an issue arise as to whether any opinion in the opinion letter was correctly rendered. Ideally, the opinion giver should know who such a party is so that the opinion giver can evaluate the risk associated with issuing the opinion letter to that particular opinion recipient. Even if the opinion letter is fully defensible, no law firm wants to be the potential target of claimants looking for deep pockets to recover for losses suffered because, for example, the issuer became insolvent. The greatest risk with an opinion letter that is later challenged is not that the opinion giver will be held ultimately liable for damages, but rather that the cost of defending the lawsuit until resolution by a motion for summary judgment or later will become prohibitively expensive. A law firm issuing an opinion letter to a bank or insurance company in a bilateral loan transaction may take some comfort from the fact that the addressee of the opinion letter is a “known quantity” who may not be likely to assert claims against the issuer of the opinion letter unless, for example, the alleged mistake by the law firm in its opinion letter is clear cut or egregious. In the case of an opinion letter issued to or for the benefit of any holder of the notes, particularly in a registered offering, the potential claimants will be totally “unknown quantities”; they include whoever happens to buy one or more of the notes in the public debt markets during the entire term of the notes.
While the noteholders are entitled to the benefits of the collateral with which the opinion is associated, that is not the same thing as being entitled to rely as individual noteholders on the opinion itself. Moreover, so long as the trustee is entitled to rely on the opinion letter, the noteholders are hardly without recourse if it becomes apparent that a claim should be made against the opinion giver. The trustee acts on behalf of the noteholders and is probably in the best position to evaluate such a claim in the context of the overall transaction. Excluding noteholders generally but specifying the trustee as a reliance party eliminates the possibility of multiple claims and lawsuits from various noteholders for the same alleged error in an opinion.
Such an outcome is also consistent with the “no action” provisions that are customarily included in an indenture. These clauses generally preclude a noteholder who fails to comply with the preconditions of such a clause from initiating any action or pursuing any remedy with respect to the indenture (other than one seeking payment of principal and interest on a note). Such preconditions typically include notice to the trustee regarding the event of default, the submission of a request to the trustee to pursue the matter by at least 25% of the noteholders, the provision of specific indemnity to the trustee, the failure of the trustee to act for a period of time (typically 60 days) and the lack of a countermanding instruction from a majority of the noteholders during such period of time. An indenture for secured notes also typically includes a provision authorizing the trustee (or the collateral agent) to take actions as needed to realize upon collateral in the event of a default.
Therefore, local real estate counsel should avoid general reliance language that would include any holder of a note issued in a debt securities transaction as a beneficiary of its opinion letter. Instead, the opinion letter should limit reliance to the trustee under the indenture, the collateral agent (if applicable), and, in appropriate circumstances as noted above, the underwriters and initial purchasers.
