The Limits of Lawyering: Legal Opinions in Structured Finance

Steven L. Schwarcz* Significant controversy surrounds the issuance of legal opinions in structured-finance transactions, particularly where accountants separately use these opinions, beyond their traditional primary use, for determining whether to characterize the transactions as debt. Reflecting at its core the unresolved boundaries between public and private in financial transactions, this controversy raises important issues of first impression: To what extent, for example, should lawyers be able to issue legal opinions that create negative externalities? Furthermore, what should differentiate the roles of lawyers and accountants in disclosing information to investors? Resolution of these issues not only helps to demystify the mystique, and untangle the morass, of legal opinion giving, it also affects the very viability of the securitization industry, which dominates American, and increasingly global, financing. * Stanley A. Star Professor of Law & Business, Duke University School of Law; Founding Director, Duke Global Capital Markets Center. E-mail: schwarcz@law.duke.edu. The author thanks, for their invaluable comments, James Boyle, John C. Coffee Jr., C. Ronald Ellington, Arthur Field, Donald W. Glazer, Scan Griffith, Susan Komak, Jonathan Macey, Barry Nakell, Richard Painter, Nancy Rapoport, Robert Rasmussen, Daniel Schwarcz, William Simon, participants in a Columbia Law School symposium on this Article sponsored by the Center for Corporate Governance, and participants in faculty workshops at Cornell Law School, Duke University School of Law, Fordham Law School, and University of North Carolina School of Law. He also thanks John Douglas, Andrew Hecht, Rori Bailin, and especially Jesse H. Rigsby, IV, for research assistance, and Mike Laussade, Jennifer Curtin, and their colleagues at the Texas Law Review for excellent editorial assistance. Although the author is a consultant and possible expert witness in a case involving legal opinions in structured finance, the views expressed in this Article are entirely his own and intended to be impartial. In a vital area of finance, lawyers are being increasingly criticized,1 and sometimes even threatened with liability,2 for issuing traditionally required legal opinion letters.3 Although their primary use is to assure investors and rating agencies on bankruptcy issues,4 these so-called "true sale" and "nonconsolidation" opinions are often separately used by accountants for advising that structured-finance transactions5 should be characterized, in a company's financial statements, as "off-balance-sheet financing" rather than debt.6 The former characterization allows a transaction to be accounted for as a sale of assets and not a borrowing-the rationale being that the assets are (as the opinions provide) legally sold by the company to a separate entity,7 and even bankruptcy of the company will not reverse that sale or allow a court to consolidate the assets of the company and that separate entity.8 Thus, the company engaging in the transaction does not have to show additional debt on its balance sheet.9 Structured-finance transactions include securitization, project finance, and similar transactions in which companies originating financial assets, such as accounts receivable, loans, or lease rentals, utilize special-purpose vehicles (SPVs, sometimes referred to interchangeably as special-purpose entities or SPEs) to facilitate the transaction. In a typical securitization transaction, for example, the company (sometimes referred to as the "originator") sells rights to payment from the financial assets to a wholly owned SPV, which in turn transfers these rights to an independent SPV, which in turn issues securities to capital market investors. The independent SPV uses the proceeds of the issuance to pay the first SPV for the financial assets, and the first SPV then uses those proceeds to pay the originator. The investors, who are repaid from collections of the financial assets, buy the securities based on their assessments of the value of the financial assets. …