Closing opinions are letters that attorneys issue for the benefit of parties to a transaction. With these letters, attorneys attest on behalf of their clients to the enforceability and legal status of deals. These letters can reduce information asymmetries and can function as a type of deal insurance.
That said, descriptions of what lawyers actually do when they issue closing opinions turn out to be deceptively complex. As a consequence, the questions of what lawyers should do, or what they could do, when they issue closing opinions can fall out of focus.
Deal lawyers should consider new ways in which opinion letters could affect clients’ commitments—especially corporate commitments regarding social values or standards. Given the signaling function of opinion letters, and the market interest in portfolios that reflect particular values, closing opinions may very well have under-explored utility.
Many say that closing opinions are not worth the expense and that they persist because of entrenched conventions. Others observe that it is difficult to determine when a closing opinion is cost-justified. If a letter reveals important information about a transaction, it can be well worth its cost. If it does not, it may cost considerably more than the value of the information provided.
Legal opinions serve a signaling function in markets: They are relevant to persons other than the companies signing the deal. Typical non-parties interested in closing opinions include rating agents. After all, opinions signal that a deal conforms to legal standards and should be priced as such. In the context of asset-backed securities, for example, closing opinions assure investors that a company conveyed assets to a special purpose vehicle (SPV) in a sale—not to secure debt—and that the SPV is a legal entity distinct from the company such that it would not be consolidated with the company in bankruptcy. Attorneys for the company issue “true-sale” and “non-consolidation” opinion letters for the benefit of investors, but accountants and rating agents often rely on the letters as well. An issuance of asset-backed securities generates non-parties interested in specific forms of closing opinions.
Given the role of opinions in financial transactions, can opinions be a method for signaling fulfillment of normative commitments that companies make, such as commitments to heightened environmental standards or specific social values? What is the private ordering potential of closing opinions?
Some question how effective opinions are at conveying useful information, given that they are often highly qualified and difficult to interpret. Opinions practice has resisted centralized best-practices or regulation. While some critics find a highly qualified opinion to be of little value, others find that the uncertainty such an opinion can convey is itself valuable information about a deal.
Consider this information-generating function in the context of project finance. Numerous, major banks have become Equator Principles Financial Institutions (“EPFIs”), pledging to fund only projects that meet the heightened environmental and community-impact standards articulated in the Equator Principles. The Equator Principles attempt to hold project borrowers to higher standards than local regulations require. The principles cross reference International Finance Corporation (“IFC”) and World Bank requirements for projects in various industries.
However, critics observe that EPFIs do not necessarily require borrowers to comply with the principles. The Equator Principles’ implementation mechanisms are a matter of private ordering, enforceable at the banks’ election. Equator Principle 8 is titled “Covenants.” Under Principle 8, EPFIs commit to include covenants in financing documentation requiring the borrower to be in compliance with the principles. EPFIs face no liability and have no obligation to exercise remedies if a project is out of compliance.
Project financings typically require closing opinion letters that cover enforceability and perfection of security interests, corporate due authorization, and the like. Such letters often include a “no violation of law” opinion, which requires the issuing attorney to state that the client will not violate laws by entering into the subject transaction. In a project finance deal, the issuing attorney’s client is the project entity—a company formed to own and run a specific project, such as a dam, manufacturing facility, or utility. The recipient and beneficiary of the opinion is the project lender—a bank or syndicate of banks. Again, many major project lenders are EPFIs.
Parties interested in signaling compliance with the Equator Principles could issue an opinion that recognizes the principles—and the IFC and World Bank standards—as “law” for purposes of a “no violation of law” opinion. The opinion qualifications would clarify that the Equator Principles are “laws” applicable to the transaction. If a project company’s attorney refused to render such an opinion to an EPFI, that would be information about the transaction that interested non-parties did not have before. The information may or may not indicate failure to comply with the Equator Principles, but it is information, nonetheless.
Lawyers typically assume the underlying facts on which their legal opinion is based. They do not do the fact-finding that underlies an opinion but rely on representations of clients. Rendering a legal opinion, however, can require clients to make factual representations that they would otherwise avoid. Also, attorneys issuing opinions do not (generally speaking) assume facts to be true that they know are false.
Closing opinions can be costly. Generally speaking, the costs fall on the issuing attorney’s client. In theory, if banks commit to the Equator Principles, and a corporate debtor seeks project financing from EPFIs, then costs of Equator Principles compliance should be priced into the deal. However, because adoption of the principles does not create legal liabilities, this may not be the case. The question of allocating the transaction costs associated with the kind of hypothetical closing opinion discussed here is a subset of the larger question of costs surrounding Equator Principles implementation.
In short, in transactions where the parties express commitment to certain norms, and non-parties have an interest in adherence to those norms, opinions could offer more information about compliance. This information, then, could become important for investors seeking issuances or funds that reflect particular social values or standards.
This post comes to us from Professor Heather Hughes at American University’s Washington College of Law. It is based on her article, “Non-Party Interests in Closing Opinion Letters,” available here.