United States: SEC Staff Issues Legal Bulletin On Legality And Tax Opinions

On October 14, 2011, the Division of Corporation Finance of the Securities and Exchange Commission issued a staff legal bulletin (the "Legal Bulletin") that provides guidance on the legality and tax opinions required to be filed in registered offerings of securities.¹ These opinions are commonly referred to as Exhibit 5 and Exhibit 8 opinions. The Legal Bulletin addresses in detail the requirements for these opinions (and related consents), as well as sets forth a series of "do's" and "don'ts," including a discussion of assumptions that they deem acceptable and others that the Staff does not believe are appropriate. In addition, the Staff provides guidance for how to deal with certain types of issuers, such as foreign entities and non-corporate entities (e.g., limited liability companies and limited partnerships), and certain types of transactions, such as shelf offerings, medium-term note programs and exchange offers.

In our experience, the Staff has been regularly commenting on the legality and tax opinions filed with registration statements in recent years, particularly focusing on the assumptions, qualifications and exceptions included therein. Accordingly, the Legal Bulletin is long-awaited published guidance reflecting the Staff's views on the requirements for these opinions. In many cases, a registration statement cannot be declared effective by the SEC, and usable for the sale of securities, until these opinions have been cleared by the Staff. By following the guidelines set forth in the Legal Bulletin, issuers and their counsel may avoid time-consuming back and forth with the Staff during the registration statement review process.

The Legal Bulletin is divided into two principal parts – the first addresses legality opinions and the second addresses tax opinions. This memorandum highlights some of the notable aspects of the Legal Bulletin.

Legality Opinions

Registration statements filed under the Securities Act (e.g., for securities offerings, exchange offers, etc.) are required to include as an exhibit (typically Exhibit 5) an opinion of counsel as to the legality of the securities being offered. In general, for equity securities, the opinion is required to state that the shares when sold will be legally or validly issued, fully paid and non-assessable.² For debt securities, the opinion must state that the debt securities will be binding obligations of the registrant.

Although opinions for registrants that are corporations organized in Delaware are generally straightforward, opinions become more complicated when the registrants are foreign entities or are organized outside of the states in which their primary counsel are admitted to practice. In addition, issues may arise when there are non-corporate registrants or when the offerings are conducted on a delayed or continuous basis. In the Legal Bulletin, the Staff provides specific guidance for these and other situations, some of which we highlight below.

Equity Securities of Non-Corporate Registrants. The Staff provides a detailed discussion with respect to opinions for non-corporate registrants, such as limited liability companies and limited partnerships. The Staff recognizes that the term "non-assessable" does not have a statutory equivalent for limited liability companies, limited partnerships or statutory trusts. Accordingly, the Staff suggests that the opinion for these registrants include what the Staff refers to as a "functional equivalent" of the opinion required for a corporation – whether purchasers of the securities have any obligation to make payments or contributions to the registrant or its creditors (other than the purchase price for the securities) solely by reason of the purchasers' ownership of the securities. The Staff also recognizes that the phrase "fully paid" is not applicable to non-corporate registrants, and states that they do not expect counsel to separately opine on this.³

Shares of Stock of Foreign Corporate Registrants. Counsel for foreign corporate registrants are required to furnish opinions with respect to the laws of the registrant's jurisdiction of incorporation on the same basis as a U.S. registrant. The opinions need not specifically use terms such as "non-assessable," however, they should address these terms based on their meaning as understood under U.S. law.

Debt Securities and Guarantees. The enforceability opinion must address the law of the jurisdiction governing the debt securities and each guarantee of the debt securities, as well as the law of the jurisdictions in which the issuer and guarantors are organized. For example, where an indenture for a corporation organized under California law is governed by New York law, the enforceability opinion needs to address New York law, as well as valid existence, power and authority and due authorization of that issuer under California law. Therefore, in situations where the jurisdiction of organization of the issuer or a guarantor is different than the jurisdiction governing the debt securities, the legal opinion must sufficiently cover both jurisdictions or a separate local counsel opinion must be filed as an exhibit, together with the related consent of such local counsel.⁴ When foreign counsel is required to deliver an opinion, they should be made aware of the requirements of the Legal Bulletin for delivering their opinion, which may not permit certain exceptions that are customary practice in their jurisdiction.

Options, Warrants, Rights and Convertible and Exchangeable Securities. The legality opinion must address the securities underlying the options, warrants, rights and convertible and exchangeable securities if these underlying securities are also being registered.

Shelf Offerings. If a qualified opinion is filed with the shelf registration statement at the time of effectiveness (e.g., the opinion includes assumptions regarding due authorization or assumes that the number of shares to be sold will not exceed the amount authorized in the charter), then an unqualified opinion must be filed by the closing date of the shelf takedown.⁵ This unqualified opinion may be filed with a Form 8-K or Form 6-K that is incorporated by reference into the shelf registration statement or with an exhibits-only, immediately effective post-effective amendment filed pursuant to Securities Act Rule 462(e).

Medium-Term Note (MTN) Programs. For MTN programs, where debt securities are offered on a continuous or episodic basis, the Staff sets forth two alternative approaches to satisfying the requirement for providing an unqualified legality opinion. One option is similar to the approach described above for shelf offerings – a qualified opinion may be filed with the registration statement, so long as an unqualified opinion is filed at the time of the takedown. Alternatively, the issuer may file with the MTN prospectus supplement what the Staff refers to as a "forward-looking" opinion that assumes the securities in the MTN program will be legally issued, and then provide an unqualified opinion within the text of the pricing supplement with respect to a particular takedown (rather than separately filing an opinion as an exhibit). The Legal Bulletin includes sample language.

Exchange Offers. If shareholder approval is required to issue shares in an exchange offer and the approval is sought following the mailing of the Form S-4, the Staff will accept a legality opinion that assumes shareholder approval will be obtained, so long as an unqualified opinion is appropriately filed by post-effective amendment or on Form 8-K or Form 6-K no later than the closing date of the exchange offer.

Do's and Don'ts. The Staff also discusses what they view as acceptable and not acceptable practices with respect to legality opinions.

• The Staff lists the following as examples, among others, of appropriate assumptions or qualifications in legality opinions:

• Alternatively, it is not appropriate for counsel to assume:

• In addition, the Staff states that it will not accept any language that purports to limit reliance on the opinion, such as stating that the opinion is being rendered solely for the company or the board of directors.
• Finally, the Staff discusses that counsel may opine as to a jurisdiction where it is not admitted to practice so long as the opinion does not exclude the law of that jurisdiction or state that such counsel is not qualified to opine on the law of that jurisdiction.

Tax Opinions

Under Regulation S-K of the Securities Act, a tax opinion is required for all Form S-11 filings (registration of securities for certain real estate companies), filings to which Securities Act Industry Guide 5 applies (registration statements relating to interests in real estate limited partnerships), roll-up transactions and other registered offerings where "the tax consequences are material to an investor and a representation as to tax consequences is set forth in the filing."⁶ The tax opinion typically is filed as Exhibit 8 to the applicable registration statement. The Legal Bulletin provides examples of transactions that generally involve material tax consequences. These include mergers or spin-offs that the registrant represents are tax-free, as well as transactions offering significant tax benefits and transactions the tax consequences of which are so unusual or complex that investors would need an expert's opinion to make an informed investment decision (e.g., debt offerings with unusual original issue discount issues, certain rights offerings, limited partnership offerings, certain offerings by foreign issuers).

Both a long-form tax opinion (filed as an exhibit and summarized in the prospectus) and a short-form tax opinion (confirming the tax disclosure in the prospectus is the opinion)⁷ are permissible under the Legal Bulletin. In each case, the tax opinion must identify and address each material tax consequence on which an opinion is being given and set forth the basis for the opinion. A mere description of the law is not sufficient.

The Legal Bulletin states that tax opinions may be conditioned or qualified, provided the conditions and qualifications are adequately described in the registration statement. Assumptions on which a tax opinion are based must be disclosed, and a tax opinion cannot assume the tax consequences of an issue, nor can it assume relevant facts that are known or readily ascertainable. If there is a lack of authority, conflicting authority or significant doubt about the tax consequences of a transaction, a "should" or "more likely than not" opinion can satisfy the tax opinion requirement, but the Staff expects that both the reasoning for lack of "will" opinion certainty and the degree of uncertainty will be explained in the opinion. As with a legality opinion, a tax opinion cannot state or imply that only the registrant or its board is entitled to rely on it.

The Legal Bulletin provides that tax opinions generally must be filed before the registration statement is declared effective, but describes one exception to this rule. In a merger qualifying as a tax-free reorganization, if the merger agreement includes a non-waivable condition that a tax-free reorganization opinion will be delivered at closing and the prospectus discusses the substance of the closing opinion, then the tax opinion can be filed prior to closing as an exhibit to a post-effective amendment or, in some cases, a Form 8-K or Form 6-K. If, however, the tax opinion condition is waivable, the registrant must file the tax opinion before effectiveness of the registration statement and must recirculate/resolicit if the condition is waived and the change in tax consequences is material.

Footnotes

1 Staff Legal Bulletin No. 19 may be accessed on the SEC's website at http://www.sec.gov/interps/legal/cfslb19.htm . Although the Legal Bulletin represents the views of the Division of Corporation Finance, it is not a rule, regulation or statement of the SEC.

2 In order for the registration statement to become effective, the opinion must state that the securities are legally issued. However, the Legal Bulletin states that the registration statement may become effective even if the opinion states that the securities are not fully paid or are assessable, provided there is adequate disclosure about partial payment or assessability.

3 The Staff states that the "legally issued" opinion, as well as the "no obligation to make payments" opinion, address whether the registrant will have received the full consideration.

4 However, the Legal Bulletin notes that pursuant to Securities Act Rule 436(f), consent of local counsel may not be required where the opinion of the transaction counsel relies on the local counsel opinion (as compared to situations where the transaction counsel's opinion assumes the legal conclusions contained in the opinions expressed by local counsel).

5 The qualified opinion must be signed and filed prior to the registration statement becoming effective.

6 The Legal Bulletin states that an IRS "revenue ruling" addressed to the registrant that covers all the material tax consequences of the proposed transaction also can satisfy the tax opinion requirement. A revenue ruling is an official published interpretation of the tax law and generally is not addressed to a specific taxpayer. Thus, we assume the Legal Bulletin's intended reference was to a private letter ruling, which is a written statement issued by the IRS to a taxpayer that interprets and applies the tax laws to the facts of the taxpayer's transaction.

7 The prospectus can state that the tax opinion addresses "federal income tax consequences" or the "material federal income tax consequences." However, the Legal Bulletin provides that the Staff does not accept the use of the terms "certain" or "principal" because those terms raise a concern that the opinion may be omitting a material tax consequence.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.