Although they have been around for many years, it is becoming more common for a commercial loan lender to require that the borrower’s counsel provide it with an opinion letter. At first blush, this may seem like an oddity: why should the borrower’s lawyer be advising the lender? The simple answer is that the opinion letter gives the lender assurance that the loan documents will in fact be enforceable against the borrower. Essentially, the lender is relying on the borrower’s counsel to undertake due diligence on whether the necessary internal legal formalities by the borrower have been satisfied, such that the loan documents are enforceable, which the borrower’s counsel is uniquely situated to undertake.
Before going further into the benefits provided to a lender by the opinion letter from the borrower’s counsel, it is helpful to understand what an opinion letter does not do. When giving an opinion to the lender, the borrower’s counsel does not assure the lender that the loan will in fact be repaid, nor even that the representations made in the loan documents by the borrower are accurate. For example, an opinion letter:
- Does not assure the lender that the financial information provided by the borrower to the lender is accurate (if the financials are audited, the borrower’s accountant provides that assurance);
- Does not assure the lender that the borrower has good title to the real property collateral (a title insurance company provides that assurance); and
- Does not assure the lender that the collateral has sufficient value (an appraiser provides that assurance).
As mentioned above, the opinion letter does assure the lender that the loan documents will be enforceable against the borrower. Why the loan documents might not be enforceable is the first question that comes to mind. The answer primarily arises from the fact that the borrower on a commercial loan will be an entity, such as a corporation or a limited liability company, and not a person. For an entity to become obligated to repay indebtedness and to grant mortgages and security interests, certain internal legal formalities must be followed. If they are not followed, a court may hold that the loan documents do not bind the borrowing entity; thus, leaving the lender to try to recover the loan proceeds through less certain legal theories, such as the doctrines of “quantum meruit” and “unjust enrichment.”
There are a number of conditions that must be satisfied for loan documents to be enforceable against an entity. They include:
- That the borrower has been duly formed and is validly existing under the laws of the state in which it was formed. If the borrower doesn’t exist, it can’t be liable, nor own assets.
- That under the borrower’s bylaws, operating agreement, or other organizational documents, it has the power to undertake the transaction. For example, bylaws or an operating agreement might prohibit the entity from incurring debt over a certain amount or mortgaging its real estate.
- That all requisite internal approvals have been obtained. For example, in a corporation, the board of directors must approve the transaction at a duly called meeting at which a quorum is present or by unanimous written consent; and in a limited liability company, the manager, and often times the members, must approve the transaction. Any requisite party whose approval is not obtained can challenge the validity of the transaction after the loan has closed.
The borrower’s lawyer is in a much better position to know about the inner workings of the borrower than the lender. The borrower’s lawyer may have been involved in forming the borrowing entity and in drafting resolutions approving the transaction. Because the attorney has potential liability to the lender for mistakes and misrepresentations made in its opinion, lenders take comfort knowing that the attorney will thoroughly investigate these matters before issuing the opinion. But the truth is, that while attorneys have been found liable to lenders for mistakes and misrepresentations in their opinion letters, the real value to a lender receiving an opinion letter is that the attorney will discover any lurking problems before the opinion is issued and fix them before the loan closes. For example, the attorney might discover a requirement that the members must approve the transaction and that one has not signed off, or that a quorum of the board of directors was not present when the board purported to approve the transaction. In such situations, the attorney will take steps to secure the necessary approvals, thereby negating any challenge down the road.
Borrowers dislike being required to have their attorneys provide opinion letters due to the extra cost involved. They may wonder why it is not sufficient to submit a certification by an officer of the borrower, or a representation by the borrower that all formalities have been followed. While sometimes lenders will take this approach, the officers of the borrower often do not understand the legal concepts involved and moreover, a certification by an officer or a representation by the borrower that all formalities have been followed does not make the loan documents enforceable—if in fact the formalities have not been followed.
The cost of an opinion letter arises from the amount of the time the attorney must spend undertaking their due diligence, assuring that all formalities have been followed. Once again, this due diligence is necessary and understandable because the attorney is exposed to liability for mistakes. If a borrower wishes to avoid the cost of an opinion letter, it is best to bring up the matter at the term sheet or commitment letter stage. However, in today’s commercial lending market, opinion letters on loan transactions of substantial size are common and often cannot be avoided.
Jonathon L. Goodling is a partner at Miller Nash LLP, where his practice focuses on real estate finance law. He is a member of the Opinion Letter Committee of the Real Estate and Land Use Section of the Oregon State Bar and a member of the Opinion Letter Committee of the American College of Mortgage Attorneys.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
