For a hotel and casino construction project to be successful, suitable financing arrangements are very important. When things go wrong, mega construction turns into mega litigation – we have recently seen a US$2.9 billion project turn into 6 court cases involving borrowers suing their lenders, other creditors suing the lenders, and lenders suing one another. The following failed project in Las Vegas demonstrates the risks of a complicated project with a complicated financing structure in the current economic climate…

Fontainebleau Las Vegas – A $2.9 billion hotel/casino resort and condominium project on a 24.5 acre site on the “Strip” in Las Vegas, Nevada. Upon completion, the project was to include a 95,000-square-foot casino, a 60,000-square-foot spa, a 3,300-seat performing arts theater, 286,500 square feet of retail space, 353,000 square feet of conference space, nightclubs, a rooftop pool, 24 restaurants and lounges and 1,018 hotel-condominium units.

The financing for the project included $370.0 million of equity contributions, $85.0 million of mezzanine notes, a $675.0 million retail construction loan facility, $675.0 million of second mortgage notes, and a $1.85 billion senior secured credit facility (the “Senior Secured Facility”). The Senior Secured Facility was comprised of three tranches – a $700.0 million term loan tranche, a $350.0 million delayed draw term loan tranche, and an $800.0 million revolving loan tranche.

Under the Senior Secured Facility credit agreement, the lenders which had given their commitments to make the $800.0 million revolving loan tranche were not required to fund the revolving loans unless the delayed draw loans have been fully funded. The revolving lenders refused to honor a request by Fontainebleau to fund the entire $800.0 million revolving loan tranche claiming that funding conditions had not been met including the failure by Fontainebleau to provide additional funds for cost overruns. Shortly after the revolving lenders’ refusal was communicated to Fontainebleau, the revolving lenders terminated their commitments under the Senior Secured Facility credit agreement. Fontainebleau subsequently filed for bankruptcy. At the time of the bankruptcy filing, over $1.5 billion had been invested in the project which was approximately 70% completed.

There are now six active litigations in which our client and the other eight revolving lenders are defendants:

  • Fontainebleau initiated an adversarial proceeding against the revolving lenders for breach of contract and related claims seeking over $3.0 billion in damages as well as the turnover of over $650.0 million of revolving loan proceeds. Motions are now pending before the court and trial is not expected to begin before February 2012. During that time the parties will be conducting discovery.
  • Two groups of the Senior Secured Facility lenders holding term loans and the delayed draw term loans initiated separate adversarial proceedings against the revolving lenders, also alleging breach of contract and related claims. The schedule for trial and discovery proceedings are expected to follow that set forth above in the Fontainebleau litigation. Damages have not been specified but claims in the hundreds of millions if not billions of dollars are expected as discovery proceeds.
  • Contractors holding liens against the real estate collateral securing the Senior Secured Facility have initiated three separate adversarial proceeding against all of the Senior Secured Facility lenders seeking a judicial determination that the contractors’ liens are senior to the mortgage liens securing the Senior Secured Facility. Claims of at least $650.0 million have been alleged in one of the litigations and this amount is expected to increase as discovery proceeds.

In addition to these litigations, Fontainebleau’s bankruptcy proceeding has been converted from a reorganization to a liquidation proceeding. The winning bid submitted by an entity affiliated with Carl Icahn was in the amount of $150.0 million for a construction project that had over $1.5 billion of improvements constructed on the property. It is also estimated that another $1.5 billion will be required to complete the project according to the original plans.

This failed project demonstrates the realities of a complicated project with a complicated debt and equity structure in the current economic climate:

  • The Las Vegas market is not only deeply depressed but overbuilt and the value of the mega projects has dropped dramatically leaving creditors with little or no collateral for the significant loans that they made.
  • Borrowers continue to sue their creditors for failed projects seeking significant damages from lenders which have already made significant but worthless loans creating even more losses then ever expected.
  • Not only do the lenders in these cases face the prospect of significant damage claims and settlements, but they are also incurring significant legal fees and other costs and expenses in defending these claims that will have to be self-funded since the Borrowers and the guarantors are insolvent and the collateral has little or no value.
  • Other creditors – most notably contractors and other lien holders – are looking to all of the lenders to pay for the contractors’ liens and claims either directly or through subordination of the lenders’ liens to the claims and liens of the contractors.
  • Lenders are suing one another claiming that lenders participating in other tranches in the same facility are to be held responsible not only for the claims raised by the Borrower and the contractors but also of the plaintiff lenders which will realize little, if any, from the collateral for their loans.

Although the Fontainebleau litigations are an extreme example of what can happen in a failed construction project where the economy is also in distress, we are seeing similar litigations happening across the country. Moreover, it appears that lender liability claims are being considered more seriously by the courts and some judges are making strict interpretations of documents or simply making determinations or imposing requirements that are not supported by the loan documents but in each case are detrimental to the lenders. While it will take years before the cases are decided and appeals taken, this is a prime example that careful thought should be given to the structuring and documentation of complex debt facilities and that lenders should not make concessions that will turn against them if there are downturns in the economy or losses in the value of their collateral.