LEGAL OPINIONS IN MERGER & ACQUISITION TRANSACTIONS

By W. Raymond Felton, Esq. This article appeared in the New Jersey Lawyer, the Magazine December 2002 issue. The parties to merger and acquisition (M&A) transactions typically require opinions from counsel to the opposite party in the deal. The sellers attorneys1 generally give the more extensive opinions. Furthermore, the purchasers attorney will often need to issue an opinion to the purchasers financing source, often a bank or similar financial institution. We frequently see substantial time and effort devoted to the negotiation of these opinions, as the recipients attorney tries to obtain the maximum benefit from the opinion while the attorney rendering the opinion tries to manage the potential liability inherent in the opinion through the use of assumptions, qualifications and exceptions. This article explores some of the issues associated with legal opinions in M&A transactions. Purpose of the Opinion M&A legal opinions serve several purposes. Opinions on behalf of sellers address the legal status of the assets or entity being sold, the sellers title to what is being sold, the sellers authority to sell, the absence of legal and contractual restrictions on the transactions, the sellers compliance with law in effecting the transaction and the enforceability of the transaction documents. More specialized opinions might deal with items such as the status of a patent, the tax consequences of the transaction, a contingent liability issue such as a pending or threatened lawsuit, or compliance with a particular law. These more specialized opinions are generally beyond the scope of this article. Legal opinions have certain indirect consequences as well. In order to render most opinions, counsel must perform a due diligence investigation relating to the subject matter of the opinion, sometimes going beyond what might ordinarily be done by the sellers attorney in the absence of such an opinion. The opinion also serves to negate the benefit to the seller of the attorney-client privilege as to the matters that are the subject of the opinion. Since the opinion is rendered to a third party, the purchaser, seller or lender as the case may be, it is not a privileged communication. Putting aside for purpose of this discussion the ethical considerations raised by representing a party to a transaction who is less than forthright, the need to deliver a legal opinion can compel counsel to advise the client to come clean. Thus, the sellers legal opinion becomes a part of the purchasers due diligence, or less often, vice versa. The Law Governing Opinions While there has been a substantial amount of commentary published on this subject, there are relatively few reported decisions addressing an attorneys liability arising from M&A (and similar) opinions. Presumably, this is because by exercising due care the attorney can effectively manage the risk. In fact, the reported decisions often deal with matters tangential to the opinion itself such as client fraud or the law firms conflict of interest.2 A lawyers liability in rendering a third party opinion is generally based on a negligence standard. The Restatement of the Law Governing Lawyers states that "[f]or purposes of liabilitya lawyer owes a duty to use care to a non-client when and to the extent that (a) the lawyer orthe lawyers client invites the non-client to rely on the lawyers opinionand the non-client so relies, and (b) the non-client is not, under applicable tort law, too remote from the lawyer to be entitled to protection."3 The Comment to this states that "The cause of action ordinarily is in substance identical to a claim for negligent misrepresentation and is subject to rules such as those concerning proof of materiality and reliance."4 While no reported decision in New Jersey directly addresses an attorneys liability for a third-party opinion, the New Jersey Supreme Court did rely favorably on the Restatement language quoted above in Petrillo v. Bachenberg,5 a case that did not involve a formal legal opinion of the type addressed in this article. We will not explore the facts of Petrillo here, but it does stand for the propositions that an attorney may have liability to a third party and that negligence is the governing principle. While the Court in Petrillo analyzed whether, on the facts of that case (sellers attorney in a real estate sale prepared and sent to the buyer a composite percolation test) the attorney had a duty to the third party, it is apparent that the attorney has potential liability to the third party to whom the attorneys opinion is addressed.

Commentary Regarding Opinions A leading commentary on transactional legal opinions is the Third-Party Legal Opinion Report, including the Legal Opinion Accord (the "Accord") published by the Section of Business Law of the American Bar Association in 1991. The Accord represented an effort to standardize legal opinions by allowing lawyers simply to cite to the Accord in lieu of the litany of assumptions, qualifications and exceptions frequently found in these opinions. Generally speaking, that has not happened in practice. However, many of the principles in the Accord are in fact often used in preparing opinions and some will be mentioned below. Another leading article is the Report of the TriBar Opinion Committee titled "Third-Party Closing Opinions" (the "TriBar Report").6 The Accord and the TriBar Report together fill about 140 pages in The Business Lawyer. We cannot deal here with all the issues covered in these two reports and the numerous other articles they cite, so the reader is encouraged to review them for further information on these opinions. Furthermore, the Committee that produced the Accord has at least twice since published useful guidelines on the subject.7 General Principles Turning to the substance of M&A legal opinions, we begin with some general principles that should, and in most cases do, apply. The first is the so-called golden rule, which is that an attorney should not require an opinion from another firm that the attorneys firm would not give itself. This may not be universally followed, but most attorneys do abide by this principle. Of course, situations do occur where attorneys will say that they would give the opinion if the roles were reversed, knowing the likelihood of that happening in the foreseeable future is remote. Another guiding principle is that an opinion is just that an opinion and not a guaranty of a particular result. It represents merely the attorneys professional judgment. Opinion letters sometimes state that fact, and in at least one reported decision, our Appellate Division recognized this in another context.8

The opinion letter should state to whom it is addressed and that no one else may rely upon it. It may happen that the purchasers lender or other financing source may require that the sellers attorney permit that lender to rely on the sellers attorneys opinion also. The opinion should recite why and at whose request it is given, generally by reference to a specific provision in the acquisition agreement. The opinion should list what documents the attorney has reviewed in the preparation of the opinion, both those documents that are part of the M&A transaction itself and those historical documents of the seller that are part of the due diligence process. The latter category includes both the sellers organizational and governing documents such as the certificate of incorporation, by-laws, minutes and stock records, as well as contracts to which the seller is a party. The opinion should also recite the assumptions made by the opinion giver, such as the validity of signatures on historical documents, the conformity of copies to originals, the validity of certificates from public officials such as good standing certificates, and the accuracy of factual matters. Typically, the opinion of a sellers attorney will assume the Seller holds title to its personal property unless perhaps ownership is evidenced by a certificate of title, as in the case of a motor vehicle. Opinion givers also generally assume that the recipient of the opinion has fulfilled its obligations in the transaction and is acting in good faith. A common qualification to legal opinions is that a particular opinion is limited to the opinion givers knowledge. Examples include an opinion that no litigation is threatened against the attorneys client and that a corporate client has no outstanding options, warrants or the like to acquire its securities. The Accord defines actual knowledge as "the conscious awareness of facts or other information by the Primary Lawyer or Primary Lawyer Group." The Primary Lawyer Group means anyone who signs the opinion, has active involvement in negotiating the transaction, or is primarily responsible for the client representation relevant to a specific opinion. The rationale is that it is unrealistic, from a costbenefit point of view, for the transactional attorney to review all files in the law office for that particular client.9 Facts and Law A legal opinion is by definition an attorneys opinion as to legal matters. It is not, and should not be, an opinion as to factual matters. That a certificate of incorporation was filed in the Office of the Treasurer is a fact. That a corporation was thereby validly created is a legal conclusion. It is important to maintain that distinction. There are a great many facts that underlie an M&A legal opinion: this is the complete minute book, these are the complete stock records, these are all of the sellers contracts, and so on. To the extent that facts cannot be independently verified by the attorney, a certificate of a responsible person (the client or an officer of the client) should be obtained attesting to the relevant facts. While the
Legal Opinions In Merger & Acquisition Transactions by W. Raymond Felton

This article appeared in the New Jersey Lawyer, the Magazine December 2002 issue.

attorney should not rely blindly on such a certificate and should do whatever investigation is appropriate under the circumstances, these certificates are a generally accepted component of opinion letter practice. Specific Opinions and Exceptions The following are some of the typical opinions given in M&A transactions by the sellers counsel and, where applicable, the corresponding exceptions. Due Incorporation and Qualification. The seller is duly incorporated and validly existing under the laws of its state of incorporation, and is qualified in all other jurisdictions where required. The first part of this is relatively straightforward, but there is a difference between being incorporated and being validly organized. The latter generally means that an organizational meeting was held, by-laws adopted and shares issued, while the former merely means that the certificate of incorporation was properly filed. The foreign qualification issue is more difficult since each states laws may vary as to what constitutes doing business, which in turn results in the obligation to qualify as a foreign corporation.10 Attorneys try to limit this part of the opinion to situations where the failure to qualify would have a material adverse effect on the Company. Power and Authority. The seller has the corporate power and authority to enter into the transaction. Given that most corporations are now organized for any lawful purpose and that counsel can determine that the necessary shareholder and director approvals were obtained, this typically not a problem.

No Conflict. The seller is not violating any of its governing documents, any contract to which it is a party or any law by entering into the transaction. Again, with the appropriate due diligence, this is relatively easily given. One area of concern, however, is whether any state or federal fraudulent conveyance statutes are implicated in the transaction and, as a result, in the opinion as to compliance with law. Binding Effect. The transaction documents are binding on and enforceable against the seller. This gets a bit more difficult, and certain exceptions are necessary. Customarily, an exception is taken for bankruptcy or other insolvency proceedings, and for equitable remedies about which no opinion can be given. Sellers counsel needs to be sure what this applies to. For example, if the purchase agreement says it is governed by the law of a particular state and the parties agree to submit to that states jurisdiction, is that enforceable? If one of the transaction documents is a restrictive covenant, is that enforceable? Is the provision purporting to grant the buyer the right to an injunction regarding such a covenant enforceable? No Litigation. To opine as to what litigation is pending is not very difficult, but threatened litigation may be. An opinion as to threatened litigation is a situation where the recipient seeks to get behind the attorney-client privilege. It is important for the attorney to limit a threatened litigation opinion to the attorneys knowledge, and to back that up with an officers certificate. The attorney should avoid predictions as to the outcome of any pending or threatened litigation. Title to Assets. There is a real difference here between a stock and asset sale. The attorney is asked to opine on the sellers title to the assets being sold and that the purchaser will obtain clean title. In a stock sale, it should not be a problem in most cases to verify the share ownership. In an asset sale, on the other hand, there is usually no realistic way to verify the sellers ownership of items of personal property. Hence, as noted above, title is often assumed by the opinion giver. One way for sellers counsel to address this is by opining that the purchaser will receive such title as the seller has. No Violation or Breach. The opinion giver may be asked to opine that the client has not breached any contract or violated any law. This is to be distinguished from an opinion that entering into the M&A transaction creates no such breach or violation. This is a very difficult opinion to give absent substantial due diligence. In effect, it requires a complete legal audit of the client, which is usually not realistic. If given at all, it should be limited to material breaches and violations or to those that, if they existed, would have a material adverse effect on the client. Opinions of Purchasers Counsel In a typical acquisition, the opinions of the purchasers counsel will usually be less extensive than that of the sellers counsel. One exception is the case of a "merger of equals" where the opinions will also be equivalent. The purchasers opinion often will include opinions on good standing, due authorization and enforceability. In the case where the

This article appeared in the New Jersey Lawyer, the Magazine December 2002 issue.

Legal Opinions In Merger & Acquisition Transactions by W. Raymond Felton

purchaser pays some or all of the purchase price by issuing shares of its common stock (usually when the purchaser is a publicly traded company), the opinion may address the SEC registration status of the shares and, if they are not registered, the applicable exemption from registration. Opinions of Borrowers Counsel More often than not, purchasers of businesses will finance the acquisition through a loan from a bank or other financial institution. The lender will generally require an opinion of counsel to the borrower/purchaser dealing with many of the same types of issues as in the sellers attorneys opinion discussed above. Of course, the focus will be on the loan documents rather than the M&A documents. The most problematic issue in these opinion letters arises in the remedies opinion. The typical scenario is the lenders request for an opinion that the loan documents are enforceable against the borrower. Those documents invariably provide the lender with a variety of remedies in the event of default. The Borrowers counsel inserts exceptions to the enforceability opinion in the event of bankruptcy or insolvency proceedings, judicial discretion in granting injunctive relief, and similar qualifications. The lender then says it understands all that but wants counsel to opine that, notwithstanding all those exceptions, the lender will enjoy the "practical realization," or words to that effect, of the provisions in the loan documents upon default. The Accord does not analyze this phrase, and no reported opinions have been found judicially interpreting "practical realization." Space does not permit an analysis of what this really means, but suffice it to say that borrowers counsel should only give it with the utmost caution. Another opinion to be avoided or given carefully to a lender is an opinion as to priority of a security interest. It is one thing to opine that a security interest has been created, or even perfected, but the Uniform Commercial Code and other provisions governing priority of security interests are somewhat involved, and a number of qualifications and exceptions may be necessary. Reliance on Third-Party Opinions Opinions of counsel sometimes are based on opinions of other attorneys. A common situation is when the law of another jurisdiction may be relevant and the principal attorney utilizes the services of local counsel. There are two approaches to this. The principal attorney can have the third partys opinion be addressed to the principal attorney, who then incorporates it into his or her opinion and opines on the issue in reliance upon the third partys opinion. The other approach is for the third partys opinion to be addressed directly to the ultimate recipient, thereby leaving the principal opinion giver out of it. The principal opinion giver should prefer this because it minimizes that attorneys risk of liability if the third partys opinion is flawed. Governing Law It is important to state in the opinion that it is based on the law of whatever jurisdiction in which the attorney is admitted to practice and that no opinion is expressed about the laws of other jurisdictions. For the most part this is not a major problem for New Jersey practitioners but there are two typical situations where an issue arises. One, noted above, is opining that the client company is authorized to do business in all jurisdictions where the nature of its business requires. The other is when the company is incorporated somewhere other than New Jersey, often Delaware, and opinions as to good standing and compliance with corporate requirements is requested counsel needs to be careful in giving such opinions, if they are given at all. In conclusion, the rendering of legal opinions is inherently fraught with risk, but with adequate due diligence and careful drafting, the risk is manageable.

This article appeared in the New Jersey Lawyer, the Magazine December 2002 issue.

Legal Opinions In Merger & Acquisition Transactions by W. Raymond Felton

Endnotes 1. For convenience, this article refers to the parties to an M&A transaction as the seller and purchaser even though those terms are not technically correct in a merger. 2. See, e.g., Klien v. Boyd, 1998 U.S. App. LEXIS 2004,1998 WL 55245 (3d Cir., 1998) and Milbank Tweek Hadley & McCloy v. Chan Cher Boon, 13 F.3d 537 (2d Cir. 1994). 3. Restatement of the Law Governing Lawyers, Chapter 4, Section 73. 4. Id. 5. The Business Lawyer, Vol. 47, No.1, p.167 (1991). 6. The Business Lawyer, Vol. 53, No.2, p. 591 (1998). 7. "Legal Opinion Principles", in The Business Lawyer, Vol. 53, No. 3, p. 831 (1998); "Guidelines for the Preparation of Closing Opinions", in The Business Lawyer, Vol. 57, No. 2, p. 875 (2002). 8. Stewart v. Sbarro, 142 N.J. Super 581,590 (App. Div. 1976). 9. Accord, Sections 6A and 6B, The Business Lawyer, Vol. 47, No. 1, p. 180. 10. See below for discussion of governing law. W. Raymond Felton is a partner in Greenbaum, Rowe, Smith, Ravin, Davis & Himmel, LLP in Woodbridge and Roseland, where he practices corporate and securities law. He is the Chair of the Corporate and Business Law Section of the New Jersey State Bar Association and can be reached at rfelton@greenbaumlaw.com.

This article appeared in the New Jersey Lawyer, the Magazine December 2002 issue.

Legal Opinions In Merger & Acquisition Transactions by W. Raymond Felton