In all types of different business transactions, the parties to the transaction rely heavily on their own counsel to negotiate business and legal points, and to draft the transaction documentation to reflect the terms which have been agreed. Each party will typically also be involved in undertaking due diligence with respect to the other parties to the transaction, and the benefits and risks being assumed by that party, and may rely on representations and warranties provided by the other parties. In addition, often one party will require a written legal opinion from counsel to another party to the transaction which is directed to the requiring party as a condition to the closing of the transaction.
Third party legal opinions are more common in certain types of transactions than others. For example, in financial transactions (such as bank financings), these formal opinions have been described as “a fixture of the American legal scene.”1 In private company acquisition (M&A) transactions, the buyer may require a legal opinion from counsel to the target company or selling equity holders.2
These third party legal opinions, however, do not come without significant legal time and resulting expense. Opining lawyers will understandably work very hard to negotiate a legal opinion with stated limitations to minimize the possibility of a claim against the opining law firm. These limitations may include seeking to keep substantive statements as narrow as possible, relying on certifications and other statements by the client and others, defining and limiting the materials reviewed, and stating exceptions and exclusions broadly. Buyer counsel will negotiate to resist these limitations of the opining law firm, to maximize the “value” of the opinion to the buyer as the opinion recipient. In addition, it takes considerable time by the opining law firm to review all of the materials underlying an opinion, and many firms require multiple-partner or opinion committee review and approval of any written opinion letters.
Target legal opinions seem to be used less frequently in private company M&A transactions.3 This article will examine why.
Theoretically a buyer could request that any particular matter be addressed in a target counsel opinion. As a practical matter, however, there are fairly well established customs and practices for these opinions—both as to the required topics as well as to specific language and customary qualifiers, exceptions, assumptions and documents reviewed. In recent years, the scope of “customary practice” has been the subject of resources developed by leading practitioners as well as professional organizations such as the American Bar Association (ABA), and some of these organizations have developed and published proposed “model” opinions,4 which have gained varying degrees of acceptance.
In broadest terms, in an M&A transaction, a target counsel legal opinion is most appropriate for legal issues best assessed, or easily verified, by target counsel. For example, because target counsel is typically involved in preparing the necessary shareholder and director votes and resolutions approving the transaction (and in determining whether related by-law or other provisions regarding quorum, meeting notices, etc., have been followed) that counsel is in the best position to opine that the transaction has been duly authorized.
Other topics often found in target counsel legal opinions include: 5
On the other hand, target counsel legal opinions typically will not cover matters that cannot be reasonably verified by the opining counsel (including issues that are impacted by the legal status or actions of the buyer) or purely factual matters or issues.6 Another reason occasionally suggested for insisting on a target counsel legal opinion is that it will prevent the target from later taking a position inconsistent with the opinion letter or that it will restrain the opining lawyer from representing the target in any claim at odds with the opinion.7 However, while the opining lawyer may be unwilling or unable to represent the target in such circumstances, it seems unlikely that the target itself would be prevented from asserting a defense even if inconsistent with the legal opinion.8
Finally, some buyers believe that a target counsel opinion can serve as a “backstop” or “insurance” for its own diligence lapses or for the target's own representations and warranties as to the matters covered in the opinion. From a buyer's perspective, however using a third party opinion as a backstop to due diligence may be of limited utility. For example, opinion letters are typically much more narrow in scope than the corresponding target representations and warranties, and, moreover, while lawyers can be held responsible for intentional misconduct, recklessness or negligence, they usually cannot be held liable “merely for being wrong”—as opposed to a target's liability for breach of representation or warranty (which generally does not depend on state of mind or intent in M&A transaction documents: being “merely wrong” is enough in that context). 9
The topics identified above are most frequently seen in “general” third party legal opinions in an M&A context. A buyer may, depending upon the specific circumstances, look for such an opinion to cover additional specific issues, including as to patents, tax, and litigation generally (i.e., beyond claims relating to the transaction itself).
In 2011, the ABA released its Private Target Mergers and Acquisitions Deal Point Study.10 This study looked at purchase agreements covering 100 private company transactions that occurred in 2010. These transactions ranged in size from $25 million to $960 million, across a broad range of industry sectors. Previous ABA studies published in 2009, 2007 and 2005 looked at terms of private company purchase agreements for transactions closed in 2008, 2006 and 2004, respectively. While the scope and presentation is not always identical, these four studies provide a means to see how parties to M&A transactions are agreeing to many key deal points, and to determine whether there are any trends or changes in how these deal points are resolved over several years. While law firms, accounting firms, investment bankers and other professionals also publish “deal point studies,” those tend to be focus on a limited number of key points (often just one topic, such as the study of “material adverse effect” clauses). The then-current ABA studies are sometimes cited by practitioners as reflective of “market” parameters for any covered topic in the private company M&A world.
According to the 2011 ABA study, 27% of the agreements included the delivery of a target legal counsel opinion as a closing condition. The 2009, 2007, and 2005 studies reported that requirement in 58%, 70% and 73% of agreements, respectively. Looking at these studies, there has been a steady and significant decrease in requiring target closing opinions in the agreements reviewed from 2004 through 2010 (from 73% to 27%). Lawyers are generally slow to change the ways in which M&A deal points are most commonly resolved, and this decline in requiring a target legal counsel opinion is quite significant when compared overall to deal points covered in the ABA studies—many of which are “holding consistently steady,” not trending in either direction, “bounce” up and down a bit over the four studies, have one or two year changes which do not yet reflect a trend, or are trending in a direction but at a slower pace than the target legal counsel opinion issue.
The chart below shows the trends in how private company M&A agreements reflect (or don't) the delivery of a target counsel legal opinion as a condition to the buyer's obligation, based on the four ABA studies:
While the ABA studies report how deal points are being resolved in M&A documents, they do not explain why some deal points may evolve over time. So while at present there is no way to extrapolate from the ABA studies the various and many considerations that go into the decision making with respect to any given M&A deal point, it appears that M&A lawyers and their clients are concluding on an increasing basis that the benefits of a target counsel legal opinion simply do not outweigh the costs (in time and expense).
The following factors may be influencing the cost-benefit analysis as to third party legal opinions:
This does not mean a third party legal opinion is never appropriate. There may in fact be circumstances where such an opinion is warranted and of real benefit to the buyer. For example, if the target has had no prior experience in M&A transactions (e.g., a family business being sold by the family members) but has competent, long-standing counsel, the buyer understandably may want the additional comfort that a legal opinion may offer, recognizing that experienced opining counsel would likely apply a rigorous diligence standard to the statements within his or her opinion.12 The same reasoning may apply if the buyer has general concerns as to the overall quality of the information produced by the target in response to the buyer's due diligence inquiries.
Assuming that the ABA studies reasonably reflect general practice in private company M&A transactions, it appears that more practitioners are agreeing not to require a target legal counsel opinion as a condition to the buyer's obligation to close the transaction.
As is always the case, however, the specific facts and circumstances “on the ground”—as opposed to any particular “market study”—should govern how practitioners on both sides approach and work through this issue.
Daniel Avery is a Director and Co-Chair of the Business Law Group at Goulston & Storrs, in Boston. Daniel Weintraub is Managing Director and General Counsel of Audax Group, in Boston.
This represents the first in a series of articles by the authors on trends in mergers & acquisitions.
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