By Matt Yurus
Why did dozens of creditors strive to head off Caesars Entertainment Corp.’s filing bankruptcy in Chicago for its largest subsidiary, Caesars Entertainment Operating Company Inc.?
Essentially, they believed that Caesars Entertainment Corp. “robbed CEOC of its assets in order to screw the creditors,” explained Anthony Casey, a professor of law at the University of Chicago.
And there might be other advantages in Chicago for Caesars Entertainment and its subsidiary CEOC.
Caesars Entertainment, which is owned by TPG Capital and Apollo Global, did in fact file in Chicago’s U.S. Bankruptcy Court for Chapter 11 protection of its subsidiary CEOC, but only after the creditors alleged Caesars Entertainment transferred to itself a bundle of CEOC’s assets for less than market value or for no value at all, in effect creating a “good Caesars” and a “bad Caesars.”
CEOC manages and operates 44 properties under the brand names Caesars, Harrah’s and Horseshoe, including two casinos in the Chicago area. Its bankruptcy filing listed debts totaling more than $18 billion but assets of only about $12 billion.
Seeing this shortfall, the creditors, of which there are more than 50, filed suit in the U.S. Bankruptcy Court in Delaware hoping to preempt the expected Chicago filing by Caesars Entertainment. But the Delaware judge turned them down. Since their strategy failed, Caesars Entertainment may now have legal advantages it would not have otherwise had.
So why Chicago?
“There is a view that the 7th Circuit [the U.S. Court of Appeals in Chicago] is more friendly in its law to the type of third-party releases that Caesars and its advisors want,” said Bruce Markell, a professor of law at Northwestern University and retired U.S. bankruptcy judge.
Such third-party releases would release Caesars Entertainment, the parent company, and its non-bankrupt units, affiliates and associates from claims brought by creditors.
Possible benefits from Chicago’s legal precedents
In Airadigm Communications Inc., the 7th Circuit Court of Appeals in Chicago ruled in 2008 that to confirm a company’s Chapter 11 reorganization that includes third-party releases over the objection of an “impaired class,” two conditions must be satisfied.
First, the plan must be made in good faith, not prohibited by law and meet other administrative requirements of the U.S. Bankruptcy Code. Second, the plan must be “fair and equitable.”
Bankruptcy courts in Illinois must follow this arguably debtor-friendly precedent when considering whether to approve CEOC’s Chapter 11 reorganization plan, and consequently its request for third-party releases.
Once the court has approved the plan, it can be overturned on appeal only if the court abused its discretion in its review of the case’s facts or misapplied the law.
At this point, “you can cram [the reorganization] down the objecting creditors,” said Anthony Casey, a professor of law at the University of Chicago.
In Delaware, debtors can also force their reorganization plan over creditors’ objections but only in more limited circumstances, according to Casey.
The U.S. Bankruptcy Court in Delaware requires the objecting creditors to overwhelmingly accept the plan, including the third-party releases, and requires the debtors to pay all or substantially all of the debts claimed by the creditors.
CEOC also asserts that the Chicago court’s rulings governing the “assumption of executory contracts” are more beneficial to it and also to its creditors. A bankrupt company that is permitted to assume a contract means that it is allowed to honor an existing contract and therefore not lose expected revenue, moneys that can then be paid to creditors.
The practical implication in this case is that CEOC is less likely to have to terminate contracts that could negatively impact its yearly cash flow by as much as $40 million; termination would leave even less assets for the creditors.
This argument may have been presented before the Delaware court to make CEOC’s request to file the case in Chicago seem less self-interested and more about the financially at-risk creditors, according to Casey.
Judge Gross finds Caesars behavior ‘suspect’ and ‘serious’
Judge Kevin Gross of the U.S. Bankruptcy Court in Wilmington, Delaware, transferred the creditors involuntary petition to force Caesars Entertainment’s largest unit into bankruptcy to Chicago on Jan. 28.
Caesars Entertainment has many professionals located in Chicago, as well as in New York, and owns one casino, Harrah’s, in Joliet, Illinois, and another in Hammond, Indiana, approximately 20 miles from downtown Chicago. Caesars frequently told Judge Gross that “Chicagoland” is a “focal point” of its operations, jargon to support a change of venue based on convenience.
In his opinion, Judge Gross wrote that the “interest of justice narrowly supports” venue in Chicago. Caesars’ contention that “it will best be able to reorganize its affairs” in Chicago “is entitled to just enough deference” to proceed in that forum despite filing three days after the creditors filed in Delaware, Judge Gross stated.
Judge Gross made clear that his decision to transfer the case was not an endorsement of Caesars’ reorganization efforts, finding that Caesars’ conduct was “suspect” and that the creditors allegations concerning “the fraudulent transfer of very substantial assets” is serious.
Creditors allege Caesars induced or coerced fraudulent deal
Before Caesars Entertainment filed Chapter 11 protection for its largest subsidiary, CEOC, it siphoned valuable assets away from the now bankrupt unit for less than fair market value or for no value at all, leaving the unit with unsustainable debts, according to the lower-ranking creditors. This resulted in Caesars Entertainment’s no longer having to guarantee it subsidiary’s debts, which the creditors contend was the spirit of a previous agreement between Caesars Entertainment and the creditors.
Judge Gross wrote that Caesars Entertainment negotiated a proposed restructuring package with key higher-priority creditors, namely the first lien bank lenders and the first lien noteholders.
Under the negotiated agreement, Caesars Entertainment would contribute $1.5 billion to CEOC in exchange for its third-party releases of Caesars Entertainment and its affiliates. CEOC would also restructure into a real estate investment trust, provide 100 percent recovery to the first lien bank lenders and provide 92 percent recovery to the first lien noteholders.
First lien noteholders took the deal.
The second lien noteholders, the creditors who were only offered 10 to 12 percent recovery, filed suit in Delaware alleging that this was an effort to “induce or coerce” the higher-ranking creditors into accepting the reorganization plan.
They further argued that Caesars Entertainment offered additional payments of up to $206 million in exchange for higher-ranking creditors to more quickly agree not to sue for “default-related rights” that might have existed before Jan. 12.
Similar arguments are now likely to be presented before Judge Benjamin Goldgar in Chicago.
Under the agreement proposed by Caesars, in addition to receiving third-party releases, it would not have to pay the overdue interest it owes to the creditors, and it would not have to guarantee CEOC’s debts, according to the creditors’ petition.
The agreement proposed splitting CEOC into two companies, OpCo, an operating entity, and REIT, a real estate investment trust. The agreement also offers the lower-ranking creditors, on account of their $4.5 billion principal debt, their prorated share of a minority interest in PropCo, a newly formed property company, according to the creditors’ petition.
Far from satisfied by Caesars Entertainment’s offer, the creditors asserted in their petition, “The Debtor’s precipitous financial deterioration is attributable, in significant part, to a series of transactions between it and persons who are insiders and/or affiliates.”
These creditors argue that they are owed $225 million in interest payments and a principal amount totaling $4.5 billion.
Determining whether or not the allegations are true
Whether these insider dealings are permitted depends on the facts of the case, said Gary L. Kaplan, a bankruptcy and restructuring lawyer and a partner in Fried Frank’s New York office.
To succeed, the creditors will have to prove that these assets were transferred at less than the reasonably equivalent value, and that the plan was built around “fraudulent conveyances.”
“Fraudulent conveyance is not actually fraud,” Kaplan said. “It can be fully done with honest intentions.”
For example, a business that runs into financial trouble and needs cash fast could legitimately sell assets under fair market value, he said.
Even though the Chicago district is more favorable to [Caesars] than Delaware’s, he said, the outcome is still “difficult to predict.”
The case could settle, be dropped or be enjoined
Bruce Grohsgal, a visiting professor in business bankruptcy law at Widener University in Delaware, said there is “many forks in the road” before the issue of third-party releases becomes the “crucial part of the case.”
The parties could reach a settlement or a different class of creditors could bring a lawsuit that would also benefit the objecting creditors, prompting them to drop their immediate suit, for example.
These negotiations, however, are “more likely to be hotly contested,” Grohsgal said, “if Caesars’ plan does not provide for a material sharing of the company’s asset value with objecting creditors who are partially secured or are entirely unsecured,” he later clarified in an email.
Bloomberg reported that U.S District Judge Shira Scheindlin delivered a “fatal blow” to Caesars in her ruling on a related lawsuit in the U.S. District Court’s Southern District of New York in Manhattan on the same day that Caesars sought Chapter 11 protection in Chicago.
Judge Scheindlin rejected Caesars’ motion to dismiss the suit, finding that if the creditors’ allegations about valuable assets being siphoned away from the bankrupt unit, CEOC, are true, and thus prompted the parent’s termination of guarantees of the subsidiary’s debts, it would be in violation of the Trust Indenture Act of 1939, an act that is meant to ensure that the rights of noteholders are not jeopardized.
Casey, the law professor at the University of Chicago, said Caesars could move to enjoin these cases.
He explained that enjoining the cases would prevent the related case in Manhattan from moving forward and would force the parties in those cases to follow the Chicago court’s ruling, where the law is more favorable to Caesars.
Grohsgal said he “appreciates that there might be some circuit court advantage,” but “you still have to ‘cram down’ any dissenting class that is standing in your way.”
“The judge still has to decide if it is fair and equitable under the circumstances.”