What’s Nonconsolidation (or NonCon) Opinion Letter?

You’re in the process of refinancing a commercial real property, and the lender tells you that you have to procure a Nonconsolidation Opinion Letter (or a NonCon in industry parlance) before the loan can close. You’re left wondering, “what’s a NonCon?” and “who can I hire to give me a NonCon?”

As to the former, a Nonconsolidation Opinion Letter is a letter prepared by an attorney in the same jurisdiction as the real property, by which the attorney opines to the lender that the property will not be subject to what’s called “substantive consolidation” in the event of a bankruptcy that indirectly involves the property’s owner.

For example, most sophisticated real estate investors don’t own their properties directly – rather, they probably have a revocable trust that owns limited partnerships that in turn own the respective properties. Most sophisticated investors have an individual limited partnership that owns each individual property. For this example, say the Able family indirectly owns two valuable properties, 123 Main Street and 456 Maple Ave. 123 Main is owned by “123 Main, L.P.” (“123”), which is owned in turn by the Able Family Living Trust. 456 Maple Ave. is owned using the same structure, but through an L.P. named “456 Maple Ave., L.P.” (“456”). Assume that each property has a value of over $25MM, and they both have mortgages on them. Also assume that each L.P.’s sole asset is its respective real property.

One might think that if 123 were to declare bankruptcy, but 456 were financially strong, then the real property owned by 456 would be safe and kept out of the bankruptcy and out of the hands of 123’s creditors; however, one would be wrong to think that. This is so because under Section 105(a) of the Bankruptcy Code, a bankruptcy court has broad powers to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code. This includes, essentially, raiding related (but non-bankrupt) entities such as 456 to pay 123’s creditors. Essentially, it’s a tool the bankruptcy court can use to create a larger pool of assets (i.e., by “consolidating” others’ assets into that pool, or “bankruptcy estate”) in order to maximize creditors’ recovery.

The full scope of substantive consolidation is far beyond the scope of this blog post, but believe me when I tell you that it’s complicated and rarely used, but that doesn’t mean it doesn’t scare lenders. As you know, lenders are a risk averse bunch so they tend to require that their borrower provide pretty good protection against risk like substantive consolidation, and this is where a NonCon comes in.

A NonCon is essentially an insurance policy written by a lawyer against the likelihood that a borrower’s asset (which secures a large loan) would be taken away by a bankruptcy court in the event of a related entity’s bankruptcy (“non consolidation” – get it?). In other words, it’s a lawyer’s conclusion that the rug isn’t going to get pulled out from under the lender in the event another entity goes bankrupt, and the lender relies upon that conclusion when making the decision to close the loan.

That’s what a NonCon is, but where can you get one? The answer, surprisingly to many, is that it’s pretty difficult to find a lawyer that can do one. The reason for this is at least twofold: (1) not many lawyers even know what a NonCon is so they are unprepared to prepare one; and (2) lenders are incredibly picky about the form of the NonCon – it’s unlike just about any other opinion letter used in commerce. The difference is that almost all other opinion letters are short, relatively brief things that don’t contain any legal analysis. A NonCon, however, is a completely different animal in that it’s what’s called a “reasoned opinion.” While most opinion letters run five to maybe 10 pages and deals with relatively superficial issues, a NonCon opinion runs upwards of 30 pages and contains a full, detailed discussion of applicable laws (both state and federal) and applies those laws to a deep dive into the relevant facts surrounding the borrower and the entity. The letter’s content is negotiated with a lawyer who represents the lender, and when finalized concludes with the firm statement that a bankruptcy court “will not” order the substantive consolidation of the borrower’s asset with a related entity’s bankruptcy estate. (And if you know lawyers, we don’t usually say things like “will not.” We like the more comfortable “should not,” but that’s insufficient in the NonCon world.)

So you need to find a lawyer who (a) has experience with both corporate and bankruptcy law; (b) knows what a NonCon is; (c) has prepared NonCons in the past; and (d) possesses the knowledge and resources to actually produce the 30-or-so-page letter to the lender’s and its counsel’s satisfaction. As you can imagine, the pool of attorneys who possess all four is small. So small, in fact, that Freddie Mac’s panel of lawyers who represent the lender in NonCon negotiations contains only four lawyers nationwide (at the time of this writing).

I have all four of those criteria, and I’d be happy to discuss your NonCon needs. Give me a call.

Greg Borman is an attorney in San Diego, California, who advises and represents businesses of all sizes and stages, as well as their owners. He can be reached at greg@bormanlaw.com or at (858) 232-7100.

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