Although they have been around for many years, it is becoming more common for a commercial lender to require the borrower’s attorney to provide them with an opinion. At first glance, this may seem like an oddity: why should the borrower’s lawyer advise the lender? The simple answer is that the appraisal provides the lender with assurance that the loan documents are actually enforceable against the borrower. Essentially, the lender relies on the borrower’s attorney to carry out due diligence to verify that the necessary internal legal formalities have been completed by the borrower for the loan documents to be enforceable, which the borrower’s attorney is uniquely able to do.
Before delving further into the benefits offered to a lender by the opinion of the borrower’s attorney, it is helpful to understand what an opinion does not do. When testifying to the lender, the borrower’s attorney does not assure the lender that the loan will actually be repaid, or even that the borrower’s information in the loan documents is accurate. For example an opinion letter:
- fails to represent to the Lender that the financial information provided by the Borrower to the Lender is accurate (if the financial information is verified, the Borrower’s accountant makes this representation);
- fails to assure the lender that the borrower has good title to the real estate security (a title insurance company provides this assurance); and
- Does not assure the lender that the security is of sufficient value (an appraiser provides this assurance).
As mentioned above, the appraisal assures the lender that the loan documents are enforceable against the borrower. Why the loan documents may not be enforceable is the first question that arises. The answer comes primarily from the fact that the borrower of a commercial loan is a legal entity such as a corporation or limited liability company and not a person. In order for a company to be required to repay debts and grant mortgages and security interests, certain internal legal formalities must be followed. If not followed, a court may rule that the loan documents do not bind the borrowing company; It is thus left to the lender to attempt to recover the proceeds of the loan through less certain legal theories such as the doctrines of “quantum meruit” and “unjust enrichment”.
There are a number of conditions that must be met in order for loan documents to be enforceable against a company. They include:
- That the borrower is duly incorporated and validly exists under the laws of the state in which it is incorporated. If the borrower does not exist, they cannot be held liable and have no assets.
- That he is authorized under the borrower’s articles of incorporation, operating agreement or other organizational document to conduct the transaction. Articles of incorporation or company agreements could, for example, prohibit the company from taking on debts in excess of a certain amount or from encumbering its real estate with mortgages.
- That all necessary internal approvals have been obtained. For example, in a corporation, the board of directors must approve the transaction at a duly convened meeting at which a quorum exists or by unanimous written consent; and in a limited liability company, the manager and often the members must approve the transaction. Any required party whose consent is not obtained may contest the validity of the transaction after the loan is completed.
The borrower’s attorney is in a much better position to know the inner workings of the borrower than the lender. The borrower’s attorney may have been involved in the incorporation of the borrower and the drafting of resolutions approving the transaction. Because the attorney may be liable to the lender for errors and misrepresentations in his report, lenders can take comfort in knowing that the attorney will thoroughly investigate these matters before issuing the report. But the truth is that while lawyers have been held liable to lenders for errors and misrepresentations in their reports, the real value for a lender receiving a report is for the lawyer to spot any lurking problems before the report is issued , and fixes them before the loan ends. For example, the attorney might discover a requirement that the members must approve the transaction and that one did not sign, or that a quorum of the board was not present when the board pretended to approve the transaction. In such situations, Attorney will take steps to obtain the necessary approvals, thereby nullifying any subsequent challenge.
Borrowers do not want their attorneys to have to provide expert opinions because of the additional costs involved. You may wonder why it is not enough to provide a certificate from a borrower’s official or a statement from the borrower that all formalities have been complied with. While lenders sometimes take this approach, borrower officials often do not understand the legal concepts involved, and moreover, a certification by an official or a statement by the borrower that all formalities have been complied with renders the loan documents unenforceable – when in fact the formalities have been not complied with.
The cost of an opinion arises from the time it takes for the attorney to conduct their due diligence to ensure all formalities have been complied with. This due diligence is also necessary and comprehensible, since the lawyer is subject to liability for errors. If a borrower wishes to avoid the expense of an appraisal, it is best to raise the matter at the term sheet or letter of commitment stage. However, in today’s commercial lending market, commenting on loan transactions of significant size is common and often unavoidable.[View source.]