Why do legal opinions matter?
In a recent post referring to Ted Wang’s “simple series A” proposal, I noted that I would separately discuss legal opinions.
Non-lawyers, and lawyers new to transactional practice, have probably never really heard of a legal opinion or what it does. Briefly, the legal opinion letter is a carefully prepared document that is designed to allow a third party, i.e., not the client, to “rely” on what is stated in the opinion letter.
Why does someone in a deal want a legal opinion from the other party’s lawyer? There is the stated reason and the deeply true reason. The stated reason is that the lawyer/law firm writing the opinion letter is liable to the third party for what is said in the opinion letter. That might be simple or difficult to prove, and you can imagine that when lawyers draft contracts about their own liability, they are even more stereotypical in terms of drafting convoluted long sentences that exclude all the important things and attempt to remove the liability and responsibility that you were looking for in the first place.
What’s the deep reason? Someone I worked for framed it this way: the purpose of the legal opinion is to put enough fear in the lawyer that it triggers a frank conversation with the client, protected by the other party’s attorney-client privilege, that might reveal important facts unknown to the lawyer that will affect the transaction. In other words, if I’m on the hook, I’m going to be extra sure to ask you for all the documents related to earlier sales of stock, convertible debt, or other money raised. By creating a process for this outside of the inter-party negotiations, the legal opinion balances the tendency for a party not to talk about “bad” news. [As an aside, this is the smartest thing I ever heard that guy say. HT to you know who.]
As for how this affect’s Ted’s proposal: Ted suggested that opinions drive up costs because of firms’ concerns about risk. While good lawyers are going to do the necessary work to track down the operative facts so that their clients do not make false representations and warranties, there are always (a) those who cut corners, for whom the opinion may bring some back on course and (b) those who make mistakes, for whom the opinion process is unlikely to correct anything since I doubt that opinion reviewers are interested in re-doing the work to test a capitalization opinion, for example.
But as an investor, I do want the other party to have the benefit of getting all the legal advice I’m paying for. As a company, it’s almost always better to adjust a deal to work around a few changed facts than try to fix things afterwards when you’re already in the wrong. And, although investors are paying, in effect, for the pre-deal legal advice if the funding goes through, it’s odd that the cases where it matters most are those where the process reveals a dealbreaker.
Where do I come out on this? As a company-side lawyer, I think that the opinion could be dropped without huge problems, but I fall into the class that thinks we should have correct reps and not tread down the “hopefully true” path without some deliberation and frank discussion with the other side. As investor’s counsel, I could see myself legitimately advising clients to forgo opinions to save money when I knew the company lawyer personally. I could not see extending the reputation of one well-known lawyer to an entire firm, but maybe to a small group or team that practices together.
What do you think about not asking for legal opinions? Are there other purposes they serve for you?