In commercial real estate and other financing transactions, the primary purpose of requiring borrower’s counsel to issue an opinion letter to the lender is to confirm the due diligence of the lender and its counsel as to various matters regarding the borrower and the transaction itself, including that the loan documents constitute valid and binding obligations of the borrower, enforceable against the borrower in accordance with their terms, also known as the enforceability opinion. Requiring the borrower’s counsel to provide an enforceability opinion is a long-standing and deeply entrenched practice in finance transactions that it is routinely accepted and almost never challenged.
But now that practice is being re-examined. A task force of the Working Group on Legal Opinions Foundation (WGLO), has been formed to study whether (a) lenders should consider not requiring enforceability opinions in lending transactions and (b) in those lending transactions for which an enforceability opinion may still be given, an illustrative form of a “sharpened” enforceability opinion should be developed that addresses specific provisions of loan documents of importance to a lender in lieu the more traditional form of enforceability opinion that purports to cover “each and every” provision of loan documents. Although the latter topic will doubtless entail the majority of the task force’s time and effort, this article focuses on the first issue—namely, the circumstances under which no enforceability opinion should be required at all and why that is the better practice under those circumstances.
In most commercial loan transactions, the loan documents are prepared by lender’s counsel using its own forms or the lender’s standard forms. This allocation of responsibility is entirely appropriate, as the party with the most at risk—the lender providing the loan proceeds—expects its own legal advisor to ensure that (a) the loan documents reflect accurately the terms of the loan transaction as agreed by the parties (which borrower’s counsel also has a duty to its client to confirm), (b) the loan documents provide the obligations, rights and remedies that are customarily provided for loan transactions in the state whose law governs the loan documents (referred to hereafter as the “governing law jurisdiction”) and (c) those obligations, rights and remedies will be recognized by the courts of the governing law jurisdiction as legally enforceable—at least for the most part. As a practical matter, and as discussed in greater detail in this article, both the borrower’s counsel and the lender’s counsel understand that each and every provision of the loan documents may not be enforceable strictly in accordance with its terms. In addition, lender’s counsel typically practices in the governing law jurisdiction and presumably is familiar with its laws as they relate to commercial loans.
Even under these circumstances, of course, it’s entirely appropriate for the lender to expect borrower’s counsel to provide certain assurances as to the borrower itself, which assurances are critical to the enforceability of the loan documents against the borrower. Specifically, the borrower’s counsel (or other counsel designated by borrower’s counsel) will provide legal opinions that the borrower is a validly existing entity and (if applicable) is in good standing in its state of formation, that the borrower has the applicable corporate or other power and authority to execute, deliver and perform the loan documents, that the borrower has taken all necessary action to authorize the execution, delivery and performance of the loan documents and has duly executed and delivered the loan documents. These foundational opinions form the “building blocks” for the enforceability opinion, inasmuch as the loan documents would not be enforceable against the borrower unless, among other things, the borrower duly executed the loan documents pursuant to proper authorization. Other opinions from borrower’s counsel may also be appropriate in specific loan transactions, such as an opinion to the effect that the execution, deliver and performance of the loan documents do not violate the borrower’s organizational documents or certain applicable laws and other agreements to which the borrower is a party, as well as opinions relating to mortgage liens, personal property security interests and other matters. In addition, if any of the loan documents are governed by the law of a state in which lender’s counsel does not practice, it’s also entirely appropriate for borrower’s counsel (if it practices in that state) or local counsel practicing in that state to issue an enforceability opinion as to those loan documents.
Under the fact pattern described above, namely, the loan documents are prepared by lender’s counsel who practices in the governing law jurisdiction and the borrower’s counsel has provided the “building-block” opinions, commentators have asked why borrower’s counsel is expected to issue a legal opinion to the lender that the loan documents constitute valid and binding obligations of the borrower, enforceable against the borrower in accordance with their terms? If the primary purpose of an opinion letter is to confirm the lender’s due diligence regarding the borrower and the loan transaction, how does an opinion from borrower’s counsel as to the enforceability of the lender’s own loan documents add anything of value?
Cost of Enforceability Opinions. Aside from the incongruity (or some may say the unfairness) of requiring an enforceability opinion from borrower’s counsel under those circumstances, consider also the unnecessary costs this approach imposes on the borrower. Opinion negotiations are often extensive and acrimonious, as borrower’s counsel and lender’s counsel debate not just the precise language of each opinion within an opinion letter but also the appropriate assumptions, exclusions and qualifications related to each such opinion. Enforceability opinions and the related assumptions, exclusions and qualifications probably occupy the majority of the time spent in negotiating opinion letters and the bulk of the language in any opinion letter. Although bar organizations have proposed illustrative language for borrower’s counsel to use in issuing enforceability opinions, lender’s counsel often is not familiar with opinion literature on the subject and frequently refuses to accept the language that the legal opinion reports have suggested. The result is continuing negotiations, delays and increased costs—costs borne by the borrower, who is responsible for paying both the fees of its own counsel and the fees of lender’s counsel incurred in those negotiations. In addition, if borrower’s counsel does not practice in the governing law jurisdiction, the borrower will be required to incur the cost of retaining its own local counsel in that jurisdiction to give the enforceability opinion while it’s regular counsel gives the other opinions typically provided—an additional cost that adds little value when the lender’s counsel should be able to ascertain the enforceability of lender’s counsel own documents.
Benefit of Enforceability Opinions. Even if borrower’s counsel provides an enforceability opinion in addition to the entity opinions, it is often so qualified that its value to the lender is questionable. Historically, enforceability opinions were qualified only in two respects: the effect of bankruptcy and creditors rights laws and the effect of equitable principles. Under current practice, however, bankruptcy and equitable principles are just the beginning of the qualifications typically included in opinion letters, as many opinion givers, concerned that their opinion letters will be interpreted to apply to each and every provision of the loan documents, increasingly provide a “laundry list” of practically everything that can go wrong in trying to enforce one provision or another. The 2012 Opinion Report takes a somewhat different approach but with perhaps even more far-reaching effect. Its generic unenforceability qualification states that “certain provisions” of the loan documents may not be enforceable, without specifying which provisions those are, and then provides affirmative assurance that any such unenforceability will not render the loan documents invalid as a whole or preclude (a) judicial enforcement of the obligation to repay the note and any guaranty, (b) the acceleration of the debt upon a material default by the borrower or (c) foreclosure of the security documents upon maturity or acceleration. Regardless of the approach, the lender may be hard-pressed to say what is and is not enforceable in its loan documents, based upon enforceability opinion of borrower’s counsel.
The value of an enforceability opinion may also be questioned based upon the fact that few, if any, enforceability opinions have been the subject of lawsuits by opinion recipients seeking to recover damages from opinion givers, other than, perhaps, where the unenforceability arose from issues such as lack of proper authorization by the borrower entity rather than from the unforceability of the specific language of a loan document. One of the most high profile lawsuits in recent years involving a third party opinion letter—Dean Foods Co. v. Pappathanasi, resulting in a judgment of over $9 million against the law firm that issued the opinion letter, related not to the enforceability opinion that was provided but rather the so-called “no-litigation” opinion, which of course is really a confirmation of fact rather than a legal opinion.
Fannie Mae Loans. There is also precedent for lenders not requiring enforceability opinions from borrower’s counsel under the circumstances described above. Fannie Mae, for example, generally does not require enforceability opinions in loans to finance multifamily projects unless substantial changes are made to its loan document forms in a particular loan transaction. In the typical single project financing, Fannie Mae’s loan documents are governed by the law of the state in which the project is located, and the loan documents have been reviewed and approved by Fannie Mae’s local counsel in that state. Although Fannie Mae does require an enforceability opinion if substantial changes are made to its form documents, that approach presumably is justified by the fact that Fannie Mae does not consult with the local counsel who approved its forms in the particular state as to whether the changes for a particular loan would have some effect on enforceability. In a conventional loan, if lender’s counsel practices in the state whose law governs the loan documents, it should not matter whether substantial changes were made to the lender’s form of loan documents because lender’s counsel can make the determination if the changes affect enforceability.
UK and EU Loans. Perhaps even more instructive than Fannie Mae’s requirements as to enforceability opinion is the opinion practice followed in the United Kingdom and other European countries. In the United Kingdom, counsel “holding the pen” provides the enforceability opinion. In other words, if lender’s counsel drafts the loan documents, lender’s counsel will provide an opinion to its client, the lender or, in a syndicated credit facility, the agent for the lenders, as to the enforceability of those documents. In fact, lender’s counsel also usually provides its client with the foundational opinions as to the borrower’s entity status, power and authority, due authorization and execution and delivery, assuming that the borrower was organized in the U.K. The opinion letter from lender’s counsel is not typically shared with the borrower or its counsel.
In most European Union countries, lender’s counsel who prepared the loan documents also typically provides an enforceability opinion to its client. However, unlike the U.K, the foundational opinions relating to the borrower are usually provided by the borrower’s counsel, after negotiation with lender’s counsel who must approve the form of those opinions.
Although lender’s counsel issues the enforceability opinion in the U.K. and in EU countries, that is not to suggest that lender’s counsel should do so in the United States, nor should lender’s counsel in the U.S. issue the foundational opinions regarding the borrower as is the practice in the U.K. Rather, the change in opinion practice proposed here is simply that, in the typical fact pattern described above, no enforceability opinion should be required of either party’s counsel because the lender can rely on the competence of its own counsel to prepare loan documents that accomplish their purpose in compliance generally with the laws of the governing law jurisdiction and because the marginal benefit to the lender of requiring borrower’s counsel to issue an enforceability opinion is outweighed by the costs involved in doing so. By contrast, if lender’s counsel does not prepare the loan documents or use the lender’s standard forms or if lender’s counsel does not practice in the governing law jurisdiction, requiring borrower’s counsel (or local counsel retained for that purpose) to issue an enforceability opinion would likely be entirely appropriate.
Regardless of how persuasive the arguments in favor of eliminating the requirement for an enforceability opinion may be, experienced practitioners would acknowledge that lenders in the United States have required enforceability opinions from borrower’s counsel for decades and decades, and they are likely to resist changing such a long-standing practice. But other aspects of opinion practice have changed significantly in recent years, and there’s reason to be optimistic that the practice of always requiring an enforceability opinion under the circumstances described above also will change.
Beginning with James J. Fuld’s seminal article on opinion practice almost fifty years ago, “Legal Opinions in Business Transactions – An Attempt to Bring Some Order Out of Some Chaos,” and continuing with the establishment of the TriBar Opinion Committee, the Legal Opinion Committee of the ABA’s Business Law Section, the Committee on Legal Opinions in Real Estate Transactions of the ABA’s Section of Real Property, Trust and Estate Law and many other national, state and local bar organizations, including more recently (in 2006) the Working Group on Legal Opinions, a legal opinion community has developed to study opinion practices and propose changes in those practices where lawyers recognize that historical practices are no longer justified in modern commercial transactions. For example, at one time it was customary practice to require borrower’s counsel to opine that its client was not in default under any other agreements to which it was a party, that its client, or its client’s project being financed, was in compliance with all applicable laws or that its client possessed all applicable licenses and permits necessary to own and operate the project being financed. Such overly broad opinions, while once common, have been consigned to the legal opinion dustbin, and lender’s counsel instead rely on their own due diligence regarding such matters.
Admittedly, it is the opinion recipients—lending institutions—and not borrowers who need to be persuaded to change the practice of always requiring an enforceability opinion in U.S. loan transactions. Hopefully, however, if the task force and other bar organizations recommend that such requirement be re-evaluated, the enforceability opinion will cease being an automatic feature of every opinion letter and instead will be limited to those circumstances where the benefit of such an opinion justifies its cost.
