Particularly in municipal bond financing, payment of debt service, and the security for the indebtedness, is typically limited to a defined source of funds. If the issuer becomes distressed, however, holders of the bonds often seek to reach beyond the prescribed funding source, but the documentation may well foreclose them from doing so. This is just what happened in a recent California appellate case, Wells Fargo Bank, N.A. v. Cabazon Band of Mission Indians (Cal. App., 4th Div. June 2016), in which the holder of indenture debt was unable to convince the courts to expand the scope of funding or security for its debt.

The Facts

In 2006, the Cabazon Band of Mission Indians (the “Tribe”) borrowed money to build a new parking garage for a resort and casino. The debt had an original principal amount of approximately $56.5 million, but was subsequently paid down to approximately $41 million. It was issued under an indenture for which Wells Fargo Bank served as trustee. The resort and casino was operated by the East Valley Tourist Development Authority (the “Authority”), as an instrumentality of the Tribe. Revenues from the casino were used to cover the operational costs of the resort and casino, and the balance of the revenues were distributed by the Authority to the Tribe for maintenance of the tribal government and service to tribe members.

Under the indenture, the Tribe was required to maintain a “custodial account” at Wells Fargo, into which it was required to deposit all of the Distributable Authority Revenues (the “DAR”) promptly after receipt. DAR is variously defined, but the definition principally utilized by the appellate court was “gross revenues, receipts, distributions, dividends, income and other amounts” payable to the Tribe by the Authority, including all moneys deposited by the Authority to the custodial account at the direction of the Tribe, but excluding payment by the Authority to the Tribe for services rendered.

In August 2007, the Authority obtained a bridge loan in the amount of $153 million through Merrill Lynch to refinance existing debt, construct improvements at the resort and casino and pay transaction costs. The bridge loan provided for a control agreement that required all revenues to be deposited to an account under the control of Merrill Lynch as administrative agent upon the occurrence of event of default.

Thereafter, the Authority and the Tribe experienced financial problems as a result of the general economic downturn, and there were several iterations of a restructuring of both the indenture and the bridge loan. Up until 2012 the Tribe was able to comply with its obligations under the indenture debt. In March 2012, however, the Tribe ceased to service the indenture debt. The Authority continued to operate the resort and casino, but the Tribe no longer deposited DAR payments into the custodial account, and the administrative agent for the loan took control of the deposit account through which all of the resort and casino revenues were funneled. The bridge lenders did permit the Authority to pay $668,000 a month to the Tribe in order to fund the Tribe’s essential government services.

Wells Fargo instituted an action in California trial court seeking damages for breach of contract on the indenture and also asking the court to provide it with injunctive relief that would prohibit the distribution of any funds to the Tribe and compel the Authority to deposit DAR payments into the custodial account with Wells Fargo. On cross motion for summary judgement the trial court ruled that the Tribe was indeed in breach of the indenture, but declined to provide Wells Fargo with the requested injunctive relief. On appeal, the appellate court affirmed.

The Court’s Analysis

Wells Fargo advanced three arguments: First, that all revenues received by the Authority from the operation of the resort and casino were payable to the Tribe, and therefore the security interest of Wells Fargo extended to these revenues even before they were deposited into the custodial account. Second, that the Tribe had an obligation to deposit distributions into the custodial account, whether or not they constituted DAR. And Third, that the Authority itself had an obligation to deposit funds into the custodial account for payment of the indenture debt.

The appellate court dispatched all three arguments. The pledge agreement providing for the deposit of the DAR to the custodial account required that funds be deposited to the account in accordance with the bridge loan agreement. Under the terms of the bridge loan, the Authority was not permitted to make distributions to the Tribe post-default, so that there were no funds “payable” to the Tribe. Moreover, by the terms of the pledge documentation, the only security for the indenture debt was the custodial account at Wells Fargo. Therefore, post-default, the indenture trustee had neither a right nor a security interest in any revenues of the resort and casino. The court also rejected Wells Fargo’s argument that the Tribe had an independent obligation to deposit funds into the custodial account, an apparent attempt to reach the funds permitted by the lenders to be paid to the Tribe by the Authority for tribal governance and function. The only obligation was to make deposit of the DARs, the court said, of which there were none post-default. Finally, the Authority had no obligation to deposit funds into the custodial account, the court reasoned, as there was no privity between the Authority and Wells Fargo.

Takeaways

Obviously, the Cabazon case turns on its specific facts and the peculiar terms of the debt documentation that governed the relationship between the Tribe and the Authority on the one hand and among the holders of indenture debt and bridge loan debt on the other. Nonetheless, the case highlights a common issue often faced by holders of muni-debt. While revenues of the borrower may have a common or interrelated source, the noteholders’ recourse for payment and/or security interest may not arise until the funds are deposited into a specified account, and funds may never reach that account because they are picked off by other creditors with supervening rights. Debt holders should not assume that courts will be sympathetic to arguments that reach beyond the plain meaning of the documentation to expand the type of issuer revenues that support the debt.