Part One of this article, published in the last edition of the Restructuring Review, examined recent developments in the gaming industry, focusing on strategies employed by gaming companies to increase liquidity and avoid insolvency. Part Two focuses on how potential buyers can use the bankruptcy process to purchase gaming facilities, free and clear of prior liens, and describes certain complications inherent in the acquisition of this type of asset.
Acquiring Gaming Facilities through Chapter 11
In light of current distressed market conditions, and assuming parties cannot effectuate the out-of-court solutions discussed in the first part of this article, an increasing number of gaming facilities appear to be headed for the auction block in bankruptcy cases. Chapter 11 offers two primary procedural alternatives for a debtor to sell substantial assets. Assets may be sold as part of a reorganization plan under section 1129 of the Bankruptcy Code, so long as the required votes for plan approval are obtained. In the alternative, section 363(b) of the Bankruptcy Code generally allows the debtor to sell property of the estate outside the ordinary course of business. Notably, sales under section 363 of the Bankruptcy Code can occur prior to the filing or confirmation of a plan of reorganization.1
Assets may be sold under section 363(b) of the Bankruptcy Code at either a public or private sale.2 In deciding whether to approve a proposed sale under section 363, courts generally examine whether the sale is consistent with the debtor’s sound “business judgment.”3
The debtor is not bound to accept the highest offer if other factors – such as more favorable payment terms or a potential bidder’s doubts about its ability to finance the purchase – suggest that accepting a lower offer is prudent.4
Pursuant to section 363(f) of the Bankruptcy Code, sales may be made free and clear of a third party’s “interest” in the asset without the third party’s consent. While the Bankruptcy Code does not define “interest,” the majority position, and the position of the Bankruptcy Courts in New York and Delaware, is that the term not only encompasses liens and other in rem property interests but also includes other obligations that “may flow from ownership of the property.”5 Under section 363(f), property will be transferred free of a third party’s interest if the debtor provides adequate protection, and if (i) non-bankruptcy law permits such a sale; (ii) the debtor or trustee receives the consent of the third party; (iii) the third party’s interest is a lien and the purchase price exceeds the value of all liens on the property; (iv) the third party’s interest is subject to a bona fide dispute; or (v) the third party could be compelled, in a legal or equitable proceeding, to accept a monetary settlement.6
In permitting a free and clear sale without third-party consent, courts have required that the third party’s interest attach to the proceeds of the sale. This authorization reflects Congress’s statutory intent to facilitate asset sales in bankruptcy cases while recognizing the validity of secured interests in the debtor’s property.7
As gaming companies seek the protection of Chapter 11, secured lenders must seriously consider whether to take title to their collateral. Secured creditors can do so most efficiently through section 363(k) of the Bankruptcy Code, which permits a secured creditor to “credit bid” for any asset on which it has a lien that is being sold in bankruptcy, with court approval.
Section 363(k) allows a secured creditor’s interest in an asset to serve as a benchmark for other bids and protects that creditor from a sale at a price less than the amount of the lender’s secured claim. The majority view is that the full amount of any allowed claim may be credit bid under section 363(k).8 Moreover, Courts have held that credit bids are equivalent to cash on a dollar-for-dollar basis.9
The recent proposed sale of the Tropicana Atlantic City Casino & Resort provides a good example of the credit bidding process at work. Tropicana’s Atlantic City facility had been managed by a state-appointed conservator since New Jersey authorities revoked the facility’s gaming license in 2007. At the end of March 2009, a group of Tropicana’s secured lenders, headed by financier Carl Icahn, reached an agreement with the conservator to place a $200 million “stalking horse” credit bid in a future auction to be presided over by a Bankruptcy Court under section 363. The Icahn group held a $1.4 billion mortgage on the facility.
The entity controlling the facility subsequently filed for bankruptcy protection in New Jersey on April 29, 2009. Less than two weeks later, the Bankruptcy Court approved the stalking horse credit bid and the bidding procedures and scheduled an auction of the facility during which the Icahn group’s credit bid would be compared against other proposals. After no other proposals materialized, the Bankruptcy Court approved the sale to Icahn group on June 12.10 Icahn Capital LP has also agreed to provide $150 million in “exit financing” to allow Tropicana Entertainment LLC (the parent company of the Atlantic City facility) and its affiliated debtors to emerge from a separate Chapter 11 bankruptcy filed in Delaware in May 2008.
Acquisition Structure, Gaming Regulation and Licensing Compliance
State licensing requirements for gaming facility operators provide a critical overlay to any efforts to purchase or sell gaming assets in and out of Bankruptcy Court.
State Law Licensing Requirements
Parties interested in acquiring gaming facilities, through either an out-of-court asset sale or in connection with a section 363 sale in bankruptcy, must be familiar with the applicable state law licensing requirements that pertain to gaming facility operators. The laws of states in which organized gambling is permitted subject all gaming license applicants to a “suitability” analysis.11 The suitability analysis, which generally involves a detailed evaluation of the applicant’s financial statements and a background check of its officers and directors, often takes several months, making a quick acquisition of a gaming facility, either through a bankruptcy case or out-of-court sale, nearly impossible.
However, the Nevada Gaming Control Board recently announced plans to create a new entity to streamline review of “applications and ancillary processes for approval to bring gaming licensees out of bankruptcy.”12 While the ability of this new entity to expedite the licensing process in Nevada remains untested, its creation reflects recognition by gaming authorities of the challenges that current market conditions impose on the existing regulatory structure.
Although the statutory factors governing a suitability analysis vary considerably by state, the analysis becomes further complicated in every jurisdiction when the applicant (or in certain cases, the entity controlling a certain percentage of the applicant) is a public or private corporation, limited partnership or other type of corporate entity.13 In addition, unlike a private party that likely has a core gaming business already subject to suitability analysis, lenders that are forced to take equity in lieu of cash are likely unfamiliar with, or less willing to subject themselves to, the rigors of a suitability review.
Nevada gaming law is illustrative of the complications inherent in a corporate entity’s application for a gaming license. Under Nevada law, all officers and directors of any private gaming corporation that “holds or applies for a state gaming license” must be individually licensed and, therefore, individually subject to the state’s suitability analysis.14 The Nevada Gaming Commission may also mandate that “all individual stockholders, lenders, holders of evidence of indebtedness, underwriters, key executives, agents or employees” of a private corporation be individually licensed if such a mandate serves the public interest.15 Similar individual licensing requirements apply to the general and limited partners of a limited partnership; the members, directors, and managers of a limited liability company; and the officers and employees of holding and intermediary companies.16
Licensing and suitability requirements are relaxed in some jurisdictions for publicly traded corporations. Nevada law only requires the individual licensing of all officers, directors and employees of a publicly traded corporation applying for, or holding, a gaming license which the Nevada Gaming Commission determines will play an “active and direct role” in gaming operations.17
In the event a licensed gaming entity becomes “owned in whole or in part” by a public company, Nevada requires the public company to register with the Nevada Gaming Commission and provide the Nevada Gaming Control Board with information, including the financial structure of the public company, the names of all officers, directors and any employees engaged in the administration or supervision of the activities of the gaming licensee subsidiary, and the names, addresses and number of shares held by holders of its equity securities. 18 In addition, any holder of more than 10% of any class of voting securities of the public corporation must apply to the Nevada Gaming Commission for a finding of suitability.19
In contrast to Nevada, New Jersey gaming law does not distinguish between publicly traded and private corporations, and requires all corporations applying for a gaming license to disclose the names and criminal histories of all directors, officers and principal employees, the equity holdings in the corporation of all directors and officers, and a description of officer and director salaries and profit-sharing arrangements. 20
Corporate entities interested in acquiring a gaming facility – without subjecting their directors and officers to a suitability analysis – should explore the possibility of creating an acquisition vehicle to complete the transaction. One option would be to establish a new company that would acquire a facility’s title and assets (the “PropCo”). The PropCo would then lease the facility to a second new company (the “OpCo”) for a fixed rent. As only the OpCo would be responsible for the management for the facility, the suitability analysis should be limited to this entity. However, revenue flowing from the OpCo to the PropCo and up to the parent organization would be limited to rent payments, therefore, the parent organization would have no direct interest in gaming profits.
Another alternative to limit exposure to a suitability analysis could be to structure the acquisition of a gaming facility through a “blind trust.” In this scenario, a corporate entity that acquired a gaming facility would exchange its interest in the facility for shares of common stock in a corporate trust. The suitability inquiry would be limited to a review of the trust agreement and the background and qualification of any trustees.
However, restrictions on trust earnings would be necessary to create the required degree of separation between the trust and its corporate shareholder. The corporate shareholder would also have to delegate all management decisions to the newly licensed trustees. As with an OpCo-PropCo structure, the parent company would retain the right to profit from a future sale of its interest in the trust.
In those jurisdictions where suitability requirements for publicly traded companies are relaxed, an acquisition could also be structured through the creation of a new public company. Any bid contingent on the creation of a new public company would require state authorization allowing the new company to file registration documents with the SEC within a specified period following closing of the sale.
In Nevada, where the holders of a specified percentage of a public company’s stock would be subject to a suitability examination, the new corporate charter would void any incremental stock held by a single beneficial owner exceeding the suitability threshold. While establishing a public company is both costly and complex, such cost and effort may be justified by the licensing benefits described above.
Most industry experts predict no meaningful recovery in the American gaming industry until at least 2010, and even that estimate appears modest. In the coming months, investors in gaming companies should study efforts made to generate cash and increase liquidity, recognize and evaluate opportunities to participate in debt exchanges, and carefully consider proposed modifications to credit agreements. In addition, those parties with interests secured by gaming facilities should understand how section 363 of the Bankruptcy Code guarantees their right to meaningfully participate in any sale of the facility following a Chapter 11 filing by a credit bid. However, these parties must also consider state law licensing requirements, which can complicate the acquisition of gaming facilities, and become familiar with the various acquisition vehicles that may offset such complications.