The current economic crisis facing the United States (and the world, for that matter) is also impacting the casino gaming industry. The reason for this is that many institutional investors on Wall Street, as well as private equity firms and large national/international banks, either own equity in or have lent money to public and private gaming companies. Further impacting the situation is that many of these commercial loans were made in the last couple of years and with high debt leverage ratios, in anticipation that casino revenues would stay at historical levels. The recent drop in casino revenues is likely to result in many gaming companies not being able to meet their income covenants and other potential defaults. This essentially results in a scenario where a gaming company might not be able to generate enough revenue to pay its debt obligations. To relate this to a consumer situation, it is as if a homeowner purchased a $500,000 house two years ago and, at that time, had the income to pay the mortgage. Today, that same homeowner has experienced a drop in income whereby he or she only has income to pay for a house worth $300,000.
Why Gaming Companies May Need to File Bankruptcy
As with most commercial loans, a lender to a gaming company expects that the borrower will repay according to the terms of the credit facility. These loans are typically secured against the possibility of default by taking security interests in the borrower’s assets. Loan documents also typically have financial covenants. Some types of security require prior gaming regulatory approval to be effective (i.e., pledges of stock of privately owned companies).These approvals are typically obtained before a transaction closes and the lender borrower relationship begins.
Loans to licensed gaming companies often create a unique situation that impacts a lender’s ability to foreclose on the collateral. For instance, lenders cannot assume control of a Nevada gaming business without prior gaming regulatory approval. Moreover, certain gaming assets can’t be transferred without prior gaming regulatory approvals.
Sophisticated borrowers may attempt to use the gaming regulatory structure to their advantage against unsophisticated lenders. A borrower can use a lender’s inability to take over gaming operations without the appropriate licenses as leverage to renegotiate the terms of a loan transaction after a borrower default. Lenders also don’t want to force their hand in such an instance because the only quick way to gain control of a gaming borrower’s business would be to cease gaming operations,which would adversely impact the value of the collateral.
Negotiations between gaming lenders and borrowers often result in a bankruptcy restructure that allows the business to remain open, employees to remain employed, and the borrower and its creditors to explore ways by which to maximize the value of the bankrupt company to maximize the return to creditors. In some instances, a lender and a senior borrower may agree to reorganize the company outside of bankruptcy but must file a bankruptcy petition to achieve the agreement because of other creditors.
There are other common ways for a gaming bankruptcy to occur. In some cases, the borrower may voluntarily file without having reached an agreement with any of its lenders. In others, a group of creditors may cause an involuntary filing. Either way, the bankruptcy becomes a venue for determining how the debtor will be restructured and what happens to its assets. Within the confines of a bankruptcy action, rights of foreclosure may ultimately come into play and be exercised under the umbrella of the bankruptcy court. The gaming regulatory agencies and the bankruptcy courts work in tandem to administrate gaming bankruptcies that are in the best interests of the bankrupt estate in a manner consistent with gaming laws and regulations.
Types of Gaming Bankruptcies
There are three types of bankruptcies that are typically filed by casino debtors:
1. Chapter 11 reorganization with a debtor generates enough cash flow to continue operations and/or has significant debtor-in-possession financing to justify the bankruptcy court, allowing the debtor to continue to operate during the bankruptcy and allowing the debtor to offer a plan of reorganization to its creditors and to the bankruptcy court. Examples of this type of bankruptcy are Stratosphere Casino and Hotel, Fitzgeralds Gaming Corporation and the Aladdin Casino and Hotel. In each of these instances, the casinos were able to stay open and continue operations while a reorganization plan was circulated to the creditors and the court.
2. Chapter 11 reorganization with a debtor that either does not generate enough cash flow to continue operations or does not have adequate debtor-in-possession financing to fund the bankruptcy long enough to go through a plan of reorganization process. In this instance, the bankruptcy court may order a Section 363 sale of the debtor’s assets,which results in the property being marketed for sale. In such an instance, a stalking horse bidder will be solicited and an auction will take place. In this scenario, the equity owners of the debtor are able to participate in the auction and bid for the assets. Examples of this type of bankruptcy are The Resort at Summerlin and Stateline Casino. In both of these instances, the casinos were able to stay open with the agreement that a sale process would be initiated right away.
3. Chapter 7 liquidation with a debtor doesn’t generate positive cash flow and doesn’t have the ability to obtain debtor-in-possession financing to continue operations. In this type of situation, the bankruptcy court and the gaming regulators work together to appoint a trustee to take over operations and make efforts to liquidate or sell the assets. Examples of this type of bankruptcy are The Maxim Hotel and Casino and Fitzgeralds Reno (when it was the sole remaining asset of Fitzgeralds Gaming Corporation that couldn’t be sold when the buyer declined to purchase that property along with the other three).
Regardless of the type of casino bankruptcy, once a bankruptcy is filed, the fiduciary duty of the operators of the casino shifts from the equity owners of the company to the bankruptcy estate itself (and, more specifically, to all of the creditors).The point here is that the casino’s operations should be allowed to continue so as to maximize revenues in order to make it more likely that all creditor constituency groups are able to recover as much as possible. Generally, the prior owner’s equity is wiped out and is worth nothing, as the equity is last in priority to be paid out (i.e., all creditors would need to be paid in full to allow any payment to the equity).
While the Bankruptcy Code technically requires that, upon the filing of bankruptcy protection, a casino is to cease issuing and honoring pre-petition chips and recognize only new“post-petition chips,” this is not how the issue is handled. Practically, a debtor casino could not compete in the highly competitive industry if it was required to strictly follow certain requirements of the Bankruptcy Code. For this reason, upon the filing of a Chapter 11 petition, a casino debtor will file “firstday motions”with the court.
First-day motions request the bankruptcy court’s approval of various transactions that will allow it to continue uninterrupted operations during the bankruptcy proceeding, including recognition of the aforementioned prepetition chips. They are designed to ensure that the debtor can maintain normal business operations with customers, employees, suppliers, customers and other stakeholders. The ultimate goal is to allow the debtor to continue generating funds to support ongoing operations, which will permit the debtor to satisfy creditors and successfully complete its plan. Common first-day motions seek authorization for payment of pre-petition payroll and related employee expenses, payment of the pre-petition claims of “critical vendors,” emergency use of cash collateral, debtor-in-possession (DIP) financing, pre-petition chips and tokens (as well as ticket-in, ticketout vouchers), and the appointment of the debtor’s bankruptcy counsel, financial advisers and accountants.
In a casino bankruptcy, first-day orders facilitate the continued operation of the casino. Casino customers must be able to exchange their cash for gaming chips and the race, and sports book and keno operators must be allowed to accept bets on future events and pay winners on demand. To maintain operations, the casino must honor each of those prepetition obligations of the debt post-petition pursuant to a first-day order. First-day orders that are typically obtained to authorize payment of gaming chips and tokens in the ordinary course of business address claims to casino cash, honor sports-book wagers and deposits, authorize the debtor to retain pre-petition charge card accounts and honor tour and travel commitments and other pre-petition room deposits.
During a Chapter 11 bankruptcy case, the debtor will propose a plan of reorganization based on its negotiations with creditors. There are several restructuring alternatives available to casino debtors seeking protection under Chapter 11 of the Bankruptcy Code. Among the alternatives are refinancing outstanding debts, selling assets pursuant to Section 363 of the Bankruptcy Code or a plan of reorganization, or converting debt to equity. Most plans of reorganization will include a combination of these restructuring alternatives.
In many cases, the easiest restructuring alternative available to a casino debtor is to refinance its existing debt. Lenders need to be aware that, as with the initial debt transaction itself,when a casino debtor proposes to refinance existing debt, the lenders are subject to being called forward by gaming regulators for full suitability investigations. Gaming regulators generally have the discretion to call lenders forward for licensing, but this is rarely exercised if the lenders are bona fide banking institutions. In addition, the refinancing of debt may require the gaming authorities’ prior approval of the transaction. The debtor’s ability to approve the plan of reorganization will likely be dependent on the lender and/or transaction being approved by the gaming authorities.
An equity swap is another restructuring option available to a casino debtor. In order to effectuate the equity swap, a significant portion of the debtor’s creditors must accept the debtor’s plan of reorganization (at least two-thirds in amount and a majority in number of those creditors voting in the class whose claims will be subject to conversion into equity of the reorganized). An equity swap will likely create gaming licensing issues for the lenders,which will vary depending upon the nature of the entity in bankruptcy (public or private) and the jurisdictions in which that company does business.
A third restructuring option available to a casino debtor is to sell its assets to a third party. Any sale of assets by the casino debtor is subject to the bankruptcy court’s approval, as well as gaming regulatory approval. An asset sale may be very beneficial to a creditor who is unwilling or unable to undergo the licensing or suitability scrutiny that is required in an equity swap. In the sale process, only the buyer and its insiders and affiliates will undergo such scrutiny. However, there are potential downsides for creditors with the asset sale. The asset sale is not guaranteed to yield the best recovery for creditors. Additionally, there is no assurance that the buyer will be able to obtain the required licenses in a timely manner.
Lenders may be able to afford themselves certain licensing exemptions (i.e., public company status of the bankrupt entity, institutional investor status for members of the lending group, nonvoting stock), but if the lenders want to have an operational role with members of its constituency serving as officers, directors or key employees (or otherwise exercising control over casino operations), these individuals would need to be identified and go through the full licensing process. Many large institutions and other creditors may not want their organizations or management to be subject to the intense regulatory review. Until a creditor is found to be suitable by the gaming authorities, it cannot receive as distribution an equity interest in the reorganized debtor under the plan of reorganization.
In regard to Chapter 11 bankruptcy scenarios, any plan of reorganization or sale would need to go to the applicable gaming regulatory agencies for a licensing investigation after the bankruptcy court’s ruling. This essentially means that the debtor retains control of the operation, pending the license investigation. The gaming license investigations that may be necessary can range from a full-blown new gaming investigation of a company that has never before been licensed in a jurisdiction (which would take the most time) to an updated investigation of a company that is already licensed in a jurisdiction. Of course, the more jurisdictions in which a gaming company does business, the more gaming regulatory agencies that come into play. In this current economic climate, it is likely that some gaming companies will file bankruptcy. Gaming regulators are no doubt monitoring this situation closely and will be an integral part of the process as these companies restructure their debt and potentially some creditors convert their debt into equity during the reorganization process.
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