ABA Section of Business Law

Volume 14, Number 6 July/August 2005

No-Litigation Opinions Can Be Risky Business
Looking at the facts — and beyond
    By Donald W. Glazer and Arthur Norman Field

Don't brush off that closing opinion. The consequences can be catastrophic.

At the closing of a business transaction, counsel for the company often delivers to the party on the other side — the investor, lender or acquirer — a letter, commonly referred to as a "closing opinion," that sets forth in a series of numbered paragraphs counsel's legal opinions on various matters the recipient has requested be addressed. Though each closing opinion must be tailored to a specific transaction, closing opinions in general tend to address many of the same matters in similar ways from transaction to transaction.

A paragraph often included in closing opinions addresses legal proceedings involving the company. That paragraph does not express any legal conclusions (and, therefore, is sometimes referred to as a "confirmation" rather than an opinion). Instead, it simply states a fact, namely that counsel knows of no legal proceedings that have not otherwise been disclosed to the recipient.

In December 2004, the Massachusetts Business Court, following a bench trial that lasted several days, held a Boston law firm liable to the recipient of a closing opinion — the acquiring company in an acquisition — for more than $9 million in damages and costs. Dean Foods v. Pappathanasi, 2004 WL 3019442 (Mass. Super.). The basis for liability was negligent misrepresentation stemming from the firm's giving a no- litigation opinion without disclosing in the opinion a matter the court found the firm should have disclosed.

Decisions in legal opinion cases that go beyond the summary judgment stage are unusual. A decision after a full trial that analyzes the issues in a sophisticated way (as Dean Foods did) is virtually unique. While having no formal precedential value, Dean Foods has been receiving widespread attention from lawyers across the country and is likely to be influential in future litigation. The case has been settled and, hence, will not be appealed.

We testified as expert witnesses at the Dean Foods trial, one for the defendant/opinion-giver firm, the other for the plaintiff/opinion recipient. Although not surprisingly we do not agree on various aspects of the judge's decision, we do agree on lessons that lawyers should take from the case. Those lessons are the subject of this article.

The opinion recounts at considerable length what the judge perceived to be the salient facts. Here is our condensed version:

At the closing of an acquisition, the acquiring company (Acquirer) received an opinion from the law firm representing the acquired company (the Company) that to the firm's knowledge, without investigation, except as disclosed in a schedule to the acquisition agreement: (a) there was no investigation of any kind pending or threatened against the Company and (b) the Company was not "subject to any... continuing" governmental investigation.

The opinion also stated that the firm had no knowledge that any of the Company's representations on which it was relying were untrue. Three months after the closing, the Company received a "target letter" from the U.S. attorney. Ultimately, it pleaded guilty to aiding and abetting tax fraud and paid a $7.2 million fine. The Acquirer sued the firm for negligent misrepresentation in issuing the opinion.

Four partners in the defendant firm were involved in the acquisition. A litigator and a real estate partner had a long-standing relationship with the Company. The transactional lawyer who prepared the opinion and the second-partner opinion reviewer had no prior relationship with the Company. At issue in Dean Foods was whether the transactional lawyer who prepared the opinion had a duty to conduct an inquiry into the facts surrounding a grand jury investigation of a customer (the Customer) of the Company and, if so, whether the inquiry he made was adequate.

The judge found that, based on what the transactional lawyer knew, he had a duty to conduct a further inquiry and that the inquiry he made was inadequate as a matter of customary practice. Finding the opinion to have misrepresented the facts and the opinion-giving firm negligent in preparing it, the judge held the firm to be liable to the opinion recipient for negligent misrepresentation.

The transactional lawyer knew that the U.S. attorney had subpoenaed documents from the Company relating to the Customer in connection with a grand jury investigation into whether the Customer had committed tax fraud. While preparing a disclosure schedule to the acquisition agreement, he spoke briefly to the litigator who had represented the Company in that matter and at the request of the Company had looked into whether the Company had aided the fraud.

The litigator advised him that he did not believe the Company had aided the Customer's fraud. In addition, he gave him his "guesstimate" that the investigation "had probably gone away, with [the Customer] paying a civil fine with heavy penalties for tax evasion."

On the basis of what he heard from the litigator, the transactional lawyer recommended to the chief executive officer of the Company that to be safe the matter should be listed in the disclosure schedule to the agreement. The chief executive officer responded that, for reasons relating to relationships within the selling stockholder group, he did not want to list the matter unless disclosure was clearly required. The transactional lawyer advised him that disclosure was not required, and the matter was not disclosed in the schedule.

Later, when the time came to prepare the opinion, the transactional lawyer, relying on his discussion with the litigator (and without any investigation of his own), gave the opinion the recipient had requested. The judge concluded that the transactional lawyer, based on what he knew, should not have given the opinion without conducting a further inquiry into the facts.

The opinion letter expressly relieved counsel from responsibility for conducting an independent factual investigation. The judge viewed this limitation as irrelevant. The transactional lawyer knew (1) that the U.S. attorney's investigation might result in a tax fraud conviction of the Customer for payments made by the Company and that a risk existed that the Company might be implicated by the Customer as having facilitated the fraud and (2) that his litigating partner had opened a file and explored the possible factual and legal bases for a claim against the Company.

In light of what the transactional lawyer knew, the judge concluded that customary diligence required that the transactional lawyer do more before giving the opinion than simply rely on the conclusion of someone who did not even know that an opinion was being given and whose advice was directed to the question of whether the Company should disclose a matter in a schedule to the agreement.

Although the judge did not rest his decision on the point, the judge also noted in his decision that the firm did not follow its own written procedures in preparing the opinion (see paragraph No. 8, below). In a speech the judge gave on the case after it was settled, he also noted that his decision was colored by the statements in the opinion that the firm had no knowledge that any of the representations on which the firm was relying were untrue, in this case the representation in the agreement that did not disclose the U.S. attorney's investigation.

Here are lessons we take from Dean Foods:

1. The standard to which lawyers are held in preparing opinions is customary diligence. For most purposes, customary diligence involves a national standard. See Comment b to § 52 of the ALI's "Restatement of the Law Governing Lawyers."

2. Opinion preparers need to be familiar with the literature on closing opinions. The Dean Foods decision is replete with references to the TriBar Opinion Committee's 1998 report, "Third-Party Closing Opinions," and quotes extensively from that report. We were co-reporters for that report and referred to it often in our testimony.

While originating in New York, the TriBar Opinion Committee has expanded its membership so that today it consists of lawyers from across the country. The committee issued its first report in 1979 and has issued many reports since then. Its reports, together with reports of the Legal Opinions Committee of the ABA Business Law Section, are generally regarded as the most authoritative sources of guidance on what constitutes customary legal opinion practice on a national level.

The committee's 1998 report (which updated its 1979 report and several subsequent reports) is the committee's most general report, analyzing at length what many standard opinions mean and what work lawyers are customarily expected to do to support them. In his speech commenting on his decision in Dean Foods, the judge referred to the committee's 1998 Report as the "bible" of opinion giving. The decision itself makes clear that lawyers run real risks if they give opinions without taking into account what leading bar association reports say.

3. When the lawyers preparing an opinion learn of adverse information, they must consider whether they may still properly rely on representations by the client and its officers or whether they should conduct their own inquiry into the facts. Knowing what he did, the transactional lawyer in Dean Foods could not (and, in fact, did not) simply rely on the Company's representation in the agreement regarding the absence of any investigations. (The judge concluded, however, that the further inquiry he made was insufficient in the circumstances.).

4. Many firms try to avoid giving no-litigation opinions on the grounds that they are purely factual in nature and simply repeat a representation by their client in the agreement between the parties. When firms are unsuccessful, they normally seek to limit the opinion's scope. All no-litigation opinions are not the same:

(a) Some no-litigation opinions only cover litigation affecting the transaction. Others are much broader, covering litigation affecting the company generally. Because opinions covering litigation affecting the company generally address more proceedings, they create — almost by definition — a greater risk of mistake. Moreover, if as is common, they use a materiality standard (usually defined) to limit the number of legal proceedings covered, they call for the decisions regarding what is and is not material that themselves create an opportunity for misjudgment.

(b) Opinion recipients typically request coverage of "threatened" as well as pending litigation. What constitutes a threat, however, can be in the eyes of the beholder, and a complaint (such as a customer complaint letter) that originally was regarded as minor can look very different in hindsight after it has blossomed into full-blown litigation. Those preparing an opinion, therefore, often try to limit it to "pending litigation." If they do not succeed, however, they usually seek to limit coverage to litigation "overtly threatened in writing" (with a few adding after "writing" the further limitation that the threat be made "by a potential claimant").

(c) Some no-litigation opinions state that counsel knows of no investigations to which the client is subject that have not been disclosed to the opinion recipient. The risk of covering investigations is that what constitutes an investigation can be less than clear at the time an opinion is given. In Dean Foods, for example, the judge found that based on what he knew, the lawyer preparing the opinion should have looked further into the inquiry the U.S. attorney was conducting into the alleged tax fraud by the Customer of the Company even though the Company had not received notice from the U.S. attorney that it was being investigated.

With no bright-line test available, a failure to pursue a matter may be seen, in retrospect, as it was in Dean Foods, as "averting one's eyes." If an opinion covers investigations, therefore, the lawyers responsible for preparing it should exercise an abundance of caution before deciding that a set of facts that might constitute an investigation to which the client is subject does not require disclosure.

(d) While limitations in an opinion letter may be helpful in defending an opinion, if those preparing a no- litigation opinion have knowledge (or even a suspicion) of relevant and adverse information, limitations may provide false comfort. The knowledge they have may be judged later to have raised a red flag, requiring further inquiry into the facts before deciding whether a matter calls for disclosure.

5. When participants in a transaction (whether the parties or the stockholders or directors of a party) are at odds, the lawyers preparing an opinion should consider whether the losers are likely to sue and, if so, on what grounds. Will the losers challenge the authorization of the transaction? Will they allege it was unfair? Have the two sides been feuding for a long time? Are they already engaged in litigation? Can the opinion preparers realistically know everything that is going on?

When a transaction is contentious, opinion preparers should pause before finally signing off on an opinion and ask themselves whether further inquiries are in order, whether additional express limitations might be helpful, and, indeed, whether under the circumstances they should give the opinion at all.

6. Opinion preparers should give more thought than they may have in the past to what questions to ask and how much to rely on other lawyers in their office in preparing an opinion. When an issue arises and they know that relevant information is available within their firm, they should review it and not simply rely on conclusory statements by others regarding its content. Dean Foods makes clear that the lawyers preparing an opinion have an obligation to make their own professional conclusions regarding the opinions they give, and that includes making their own judgments regarding the factual underpinnings of those opinions.

7. Opinion preparers should avoid stating expressly in their opinion letters that they are unaware of (or that nothing has come to their attention that leads them to believe that there are) any inaccuracies in the factual representations or certificates on which they are relying. Such statements can be read as providing negative assurance and, if incorrect, may serve as a basis for a claim even if all the opinions given are correct. Ordinarily, negative assurance should only be given to financial intermediaries (such as placement agents and underwriters) in securities offerings to assist them in establishing defenses from liability under the securities laws. See Report of ABA Task Force on Securities Law Opinions, Negative Assurance in Securities Offerings, 59 Bus. Law. 1513 (2004).

8. Customary practice does not require firms to prepare file memos explaining the basis for their opinions. However, if a firm has a policy that memos be prepared, that policy needs to be taken seriously. In Dean Foods, the firm had such a policy and did not follow it. While not determinative of the outcome, the very fact that the firm's failure to follow its policy was an issue meriting comment by the judge demonstrates the risk of establishing procedures and then ignoring them.

Not that long ago, cases involving legal opinions were few and far between. That is no longer the case. Claims against opinion givers are no longer uncommon, and the damages being sought are in the tens of millions and even billions of dollars. Lawyers need to recognize that their assets and insurance coverage may represent the "deep pocket" that those who have incurred losses in a failed enterprise may look to when they have no one else from whom to seek compensation.

Now is the time for firms to turn a critical eye to the opinions they are giving, the procedures they are following in giving them and the educational tools they are providing opinion preparers. Recent litigation underscores the risk of treating an opinion as just another closing document. Notwithstanding the enormous pressures to close generated by an active transactional practice, firms need to keep reminding themselves that each time a partner signs the firm's name to an opinion, that partner is putting the assets of the firm, as well as the partner's own assets, on the line.