Friday, December 19, 2014

Caesars, Asset Stripping Allegations, and Absolute vs Relative Priority

FT Alphaville, a feature at, put up an amazingly thorough post (may be gated but you can register and read it for free) yesterday (12/18) on the current restructuring and related lawsuits brought by bondholders of Caesars Entertainment Operating Company, a slighltly-less-than-wholly-owned subsidiary of publicly traded Caesars Entertainment Corporation.  Cleverly, it's called "Et tu Caesars".  The article gives you org charts, stock price charts, recovery estimates from the rating agency Fitch's, links to the four complaints, a 475-slide powerpoint prepared by Blackstone that appears to be the basis of discussing restructuring with the first lien, and walks the reader through the significance of all these materials in admirably efficient fashion.  The graphics are too much for me to cut and paste the article in here, so I will provide a brief summary of what the dispute centers on:

Recall the two companies mentioned above, CEC and CEOC.  When the LBO was done back in pre-crisis times, CEC owned 100% of CEOC.  CEOC issued the bonds that the plaintiffs hold.  CEC gave a parent guarantee of those bonds.  Pretty normal stuff. 

Then, post-financial crisis, the outlook for the owners ever getting a return on their money became bleaker.  Creatively (other words are used as descriptions), a plan was hatched and in fact executed to transfer eight valuable properties from CEOC (bond issuer subsidiary) to CEC (parent guarantor).  So what, one might ask, if they're both liable for the debt?  Well, that is where creativity (or alternative term  -- the complaint uses words like "rob" "Steal" "plunder" and "pillage") hit a new height.  I'll quote from the FT Alphaville post:

"The second step is to terminate the obligation of the parent to make good on the debt.
CEC attempted to terminate the guarantee by selling a 5 per cent stake in CEOC for $6.15m which, according to the indentures, releases the guarantee because it is no longer wholly-owed by CEOC. Note the apparent absurdity in selling a stake that values CEOC equity at $120m when it holds $18bn in total debt.

"As was reported in May, the guarantee release is provocative because of nebulous wording in the debt documents ...."

"But it gets more complicated. As it turns out, at the same time of the CEOC equity sale, CEOC sold $1.75bn in first-lien term loans (B-7 tranche) that did come with an amended parent guarantee for the B-7 term loan along with other existing term loan holders who agreed to certain concessions.
And just who bought the fateful stake in the seemingly worthless CEOC equity that triggered the release of the parent guarantee? According to a Debtwire article cited in the first-lien complaint it is the hedge funds who simultaneously bought the B-7 bank debt."

In addition, assets were transferred from CEOC (again the bond issuer) to additonal affiliates at least one of which, Caesars Acquisition, is outside the CEC family altogether, but is partly owned by the same shareholders (Apollo, TPG and others) who own CEC. 

This is very hard ball, and certainly provides good, lively and I imagine lucrative employment for lawyers in an otherwise sluggish restructuring activity.

I do encourage the reader to visit the FT site, and read the post. It's very well done (for anyone let alone a journalist). 

I only have one comment to add to it, apropos of the theme I have been developing in recent posts.  How you react to the shareholders' actions here should be consistent with how you come down on the issue of absolute priority vs. relative priority that has surfaced, once again, in bankruptcy policy debates.  What the shareholders have done, economically, whether or not contractually permitted, is simply take some, but not all, of the debtor CEOC's assets away from the creditors who relied on them when credit was first extended, for themselves, leaving the creditors with a diminished return, effectively mitigating the $6B in losses the shareholders would otherwise suffer upon a strict application of absolute priority by spreading about $2B of that loss around among the CEOC  bondholders, who stand to receive, subject to further negotiation or litigation, around 70% of their claim, if I read the Fitch's material correctly. 

This is in form and principle, if not in amount, exactly what some recent proposals and arguments have contended should become the norm in chapter 11 reorganization plans, a further evisceration of the absolute priority rule to one in which an out of the money class, which could be pre-petition equity, receives value out of the recoveries that would otherwise belong to the senior creditors.  I won't repeat the arguments or my views on them again here.  I only want to connect the dots between this currently-out-of-bankruptcy-but-not-for-long situation and the broader absolute priority debate for now.  Because the holidays are coming and it's time for a little break!

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