Legal Opinions that a Mortgage Grants a Valid Lien and is in Recordable Form

Introduction

As a condition to the closing of a commercial loan secured by real property, it has become increasingly common for lender’s counsel to request, among other things, (a) an opinion from borrower’s counsel that the mortgage or deed of trust (either of which is called a “mortgage” in this article) securing the loan grants a valid lien on the real property described in the mortgage and (b) an opinion that such mortgage is in proper form to be accepted for recordation in the appropriate land records in the state where the real property is located. This article discusses, first, whether such opinions are appropriate to request or to give and, second, because lender’s counsel may not care about whether such opinions are appropriate and may expect those opinions regardless, how the opinion language should be crafted so as to avoid overly broad statements that may unnecessarily expose the opinion giver to liability.

An opinion as to the enforceability of a mortgage is a separate matter and is outside the scope of this article. Also not discussed herein is the due diligence needed to give the requested opinions, as such due diligence is a matter of state law and therefore will vary accordingly from state to state.

Appropriateness of the Opinions

Are such opinions appropriate for lender’s counsel to request? The “golden rule” of opinion practice states that an opinion giver should not be expected to give an opinion that counsel for the opinion recipient would not give in similar circumstances and that an opinion giver should not decline to give an opinion that it is competent to give and would ordinarily give under such circumstances. However, in the abstract, the golden rule hardly answers the question whether such opinions should be requested or given, without a careful analysis of the law and the context in which such opinions are requested. Consider, therefore, some reasons for and against such opinions.

Why the Opinions Should be Given

To a lender, these opinions may seem elementary in any loan transaction with real estate collateral. Surely a lender is entitled to assurances that the mortgage grants a valid lien on the real property to secure the loan and that the mortgage can be recorded so as to “perfect” such lien. Both are fundamental to the business expectations of the lender, particularly in single-asset real estate loans. The fact that borrower’s counsel may be giving an enforceability opinion as to a mortgage does not provide any assurance, implicitly or otherwise, as to whether the mortgage grants or creates a valid lien, just as an enforceability opinion as to a security agreement does not mean that a valid security interest has been created under the Uniform Commercial Code.

How, then, thinks the lender, could borrower’s counsel possibly object to opining as to such fundamental issues?

Why the Opinions Should Not be Given

The reason for not giving such opinions is very simple: title insurance. Almost every commercial loan transaction with real estate collateral will involve a lender’s title insurance policy. The standard form of a loan policy of title insurance promulgated by the American Land Title Association (6/17/06) states in relevant part that:

Title Insurance Company . . . insures as of the Date of Policy . . . against loss or damage sustained or incurred by the Insured [i.e., the lender] by reason of:

. . . .

9. The invalidity or unenforceability of the lien of the Insured Mortgage upon the Title. This Covered Risk includes but is not limited to insurance against loss from any of the following impairing the lien of the Insured Mortgage

. . . .

(f) a document not being properly filed, recorded or indexed in the Public Records including failure to perform those acts by electronic means authorized by law;

Note that with a title insurance policy there is no requirement that the insured prove that the title insurance company was negligent in some respect—only that a covered loss occurred. If the lien of the insured mortgage on the real property described in the policy is invalid, the lender is entitled to recover from the title insurance company for any loss the lender suffered on account of that invalidity, up to the limits of, and pursuant to the terms of, the policy.

By contrast, a legal opinion is not an insurance policy, and lawyers issuing legal opinions are not in the business of processing and paying claims. Among other things, a lender seeking to recover its losses suffered because it relied upon a legal opinion that the mortgage granted a valid lien or was in recordable form would need to prove not just that it suffered a loss but also that the lawyer issuing the opinion failed to exercise the competence expected of lawyers in similar situations.

But, lender’s counsel might assert: why shouldn’t the lender get both—a title policy and a legal opinion? The answer requires an understanding of the proper role of a legal opinion in a loan transaction. A legal opinion is issued as part—and only part—of the due diligence that a lender undertakes in order to be assured that all of the conditions to the loan closing have been satisfied. If there are other, adequate means of providing such an assurance, lender’s counsel should not insist on duplicative assurance in a legal opinion. In fact, in providing comfort that a mortgage grants a valid lien, a title insurance policy provides far greater protection than a legal opinion would, for the reasons noted above. By contrast, if a loan will be secured by a security interest in personal property under the Uniform Commercial Code (the “U.C.C.”), it is entirely appropriate for lender’s counsel to request that the opinion letter include an opinion to the effect that the security agreement grants a valid security interest in the borrower’s rights in such collateral and that, upon filing a financing statement in the appropriate filing office, such security interest will be perfected. In that case, the legal opinion as to a U.C.C. security interest fills a gap in the lender’s due diligence because title insurance applies only to real property, and there is no equivalent insurance generally available for U.C.C. security interests. There is no such gap with regard to a mortgage that is the subject to a loan title insurance policy.

This does not mean that it is never appropriate to request or to give such opinions as to mortgages. In some commercial lending transactions secured by real property, title insurance may not be provided at all. In many corporate lending transactions, for example, the company’s personal property assets such as accounts receivable and inventory may constitute the bulk of the collateral for the loan, and any real property collateral may be incidental from a loan underwriting standpoint. Under those circumstances, the lender may not require a loan title insurance policy even though mortgages are granted on the company’s real property assets in the opinion giver’s state; therefore, lender’s counsel may argue that an opinion as to whether the mortgage grants a valid lien and is in recordable form is a necessary and appropriate for the lender’s due diligence. Even where title insurance is being obtained as to any real property collateral, lender’s counsel may be a non-real estate lawyer who is unfamiliar with how title insurance really works and what sort of protection it provides to a lender, other than having a vague understanding that it provides information as to the status of title to the real property. The latter situation seems to occur most often with multi-state financings in which borrower’s local counsel is issuing a legal opinion with little or no involvement in the title insurance or the real estate collateral itself, where lead lender’s counsel and lead borrower’s counsel are located out of state, and where each has delegated responsibility for documenting the real estate collateral and obtaining local counsel opinions to junior lawyers in their firms.

Of course, even if lender’s counsel fully understands the significance of title insurance issued with respect to real estate collateral, borrower’s counsel may not be able to dissuade lender’s counsel from requiring the opinions in question due to the other “golden rule” that applies in loan transactions: namely, the person with the gold makes the rules. As with so many aspects of a loan transaction, the leverage almost always remains with the lender and lender’s counsel to impose such closing conditions as they determine in their discretion to be appropriate, which usually includes the issuance of such legal opinions as they have become accustomed to requesting and receiving. The last thing that borrower’s counsel wants is for a client to think that the borrower’s lawyer or law firm is unwilling to provide a legal opinion that to a person not issuing an opinion letter seems perfectly reasonable and that, in any event, is standing between the client and the funding of the loan. In the last analysis, this may dictate that an opinion that a mortgage grants a valid loan and an opinion that a mortgage is in recordable form will be given upon request regardless of any arguments as to its being inappropriate, although such an opinion would be rare in many states or within metropolitan regions in others.

Crafting the Opinions

Although there are different ways to express the opinions in question, the following represents a common formulation for each:

1. The Mortgage is in sufficient form to grant a valid lien on the Borrower’s right, title and interest in the Real Property to secure the Loan and the other indebtedness described therein.
2. The Mortgage is in sufficient form to be accepted for recordation in the State of ____________.

Note that both opinions only address whether the “form” of the mortgage is adequate to grant a lien and to be accepted for recordation, not whether the mortgage actually grants a valid lien or will in fact be accepted for recordation. This distinction is critical to limiting the exposure of the opinion giver to issuing an opinion that the opinion giver can determine is correct. It also reflects the recommendations of the two most recent and authoritative reports on the subject of opinion letters in real estate finance transactions.

An opinion that a mortgage actually grants a valid lien on the real property described—as distinguished from an opinion as to the form of the mortgage—would mean, among other things, that the mortgagor owns a sufficient interest in the real property to grant such a lien; if the mortgagor does not own the property in question, the granting clause in the mortgage will be ineffective. If the opinion giver has not examined the title to the property to ascertain the mortgagor’s interest, the opinion giver cannot opine that such a lien has in fact been granted. Of course, that is precisely why title insurance is the logical substitute for this opinion: a lender’s title insurance policy insures that the mortgagor does own the property and that the lien of the “insured mortgage” is valid and enforceable, in addition to insuring the priority of the mortgage and as to the existence or nonexistence of other title encumbrances.

It should be noted that another approach is for the opinion giver to make an express assumption that the mortgagor owns a sufficient interest in the property to grant a valid lien and then to give an opinion that the mortgage grants a valid lien in the property. Alternatively, lawyers sometimes will state that they have relied upon the lender’s title insurance policy in giving such an opinion. Although these approaches may limit the opinion giver’s exposure to a claim that the mortgagor did not own the property purported to be conveyed by a mortgage, the simpler and more direct opinion language set forth above as to the form of a mortgage, instead of the effect of the mortgage, avoids the possibility that an opinion giver may fail to include necessary assumptions or matters of reliance in the opinion letter and keeps the focus of the opinion letter on what is most important, namely, whether the lawyers prepared the loan documents in the proper form to accomplish the desired objectives rather than on the status of title to the collateral that the lawyers are usually not in a position to determine.

Issues Relating to “Local Law”

An opinion that a mortgage is in recordable form addresses the requirements of state law as to recordation, not whether a particular clerk of a recording office will accept it for recordation. Unless an opinion letter expressly purports to address “local” law, it is understood to apply only to law that is applicable on a state-wide basis. Many lawyers expressly exclude local laws from their opinion letters, but such exclusion is implicit even if not stated. There are two aspects to this principle. First, occasionally a clerk’s office may establish its own supplemental rules or its own interpretation to the relevant state recording statutes. Those rules or interpretations may be inconsistent with the statutes or how the state courts would interpret them. Because an opinion letter states what the law is as adopted by the state legislature and as interpreted by the state supreme court, the opinion giver should not be liable for inconsistent rules or the quirks or misinterpretations of a clerk. Particularly in regard to local counsel opinion letters for opinion recipients not based in the opinion giver’s state, the opinion giver may be giving this opinion with regard to property located in an area of the state where the opinion giver does not regularly practice, and the opinion giver may not know—and should not be expected to know—any peculiar rules or interpretations of a particular clerk that are not consistent with state law.

On the other hand, many clerks will accept documents for recordation even if they do not strictly comply with the recording requirements of the state recording statutes, or they may elect not to impose all of the requirements of the state recording statutes that, by their terms, are discretionary with each clerk. In this case, the opinion giver is hardly exposed to liability if it failed to insist that a mortgage conform to all of the statutory requirements and the mortgage is recorded by a clerk anyway. However, this does not mean that the opinion giver should not ordinarily insist on full compliance with all of the statutory requirements before it gives the opinion. As noted above, the opinion giver may not know which of the statutory requirements a particular clerk will insist upon and which it will not. Equally important, because the opinion addresses state law, it doesn’t matter if a particular clerk typically waives certain statutory requirements. In other words, the opinion states that the mortgage is in recordable form under state law; it does not address the practice of a particular clerk. Although correctly stating an opinion is fundamentally important to limiting the risks associated with legal opinions, correctly stating an opinion even when no liability will be incurred if stated incorrectly shows that the opinion giver knows the law and understands opinion practice, thereby demonstrating the opinion giver’s professionalism as a lawyer.

Note also that the opinion as stated above does not specify a particular clerk’s office where the mortgage will be recorded. This is consistent with the proper interpretation of such an opinion that it applies to state law and not any local rules of a clerk’s office that may differ. On the other hand, even if the opinion did specify the clerk’s office in which the mortgage was to be recorded, the failure of the clerk in that office to accept the document due to a local requirement that is inconsistent with the state recording statutes should not, at least in theory, impose liability on the opinion giver, inasmuch as its opinion was limited to state law. Of course, the fact that the practices of particular clerks may occasionally vary from the recording requirements of state law points to the importance of relying on title insurance rather than a legal opinion as to the issue of recordability. Once a title insurance policy is issued or irrevocably committed to be issued, a title insurance company cannot deny a claim because a particular clerk declined to follow state law upon submission of a mortgage for recordation.

Recording Taxes

Finally, an opinion that a mortgage is in recordable form should not be interpreted to mean that all necessary recording or mortgage taxes have been paid or to require the opinion giver to make that determination. Stating that a mortgage is in “recordable form” merely means that it satisfies the requirements of state law as to the form of a mortgage to be accepted for recordation, not whether other requirements for recordation (such as the payment of recording taxes) that do not relate to its form must also be satisfied at the time it is presented to the clerk. Of course, adding an express exclusion in the opinion letter as to any opinion with regard to recording or mortgage taxes required to be paid upon presentation of the mortgage should eliminate any misunderstanding. On the other hand, including an assumption that all recording or mortgage taxes have been paid would be unnecessary and inappropriate in many states, inasmuch as payment of such taxes is a separate issue from whether a mortgage is in recordable form and may not be a prerequisite to the recordability opinion. In addition, the opinion recipient may properly object to such an assumption to the extent that it may also be relied upon for any enforceability opinion with regard to the mortgage, inasmuch the failure to pay all requisite recording or taxes may not affect its enforceability or, once it has been recorded, the validity of its recordation.