As the credit market has begun to thaw, those seeking funds have slowly been able to tap into debt financing markets. Many projects were shelved in the fourth quarter of 2008, and there are needs to access funds to pay for new projects as the United States emerges from the recession. Thus, in the public and private sector there is a need to borrow funds. Indian country, including tribal gaming activities, does not differ from the rest of the United States economy. Tribes were not immune to the consequences of frozen credit markets and now may be able to access debt markets.
In an effort partially to thaw credit markets, in early 2009 Congress enacted the watershed American Recovery and Reinvestment Act (ARRA). The ARRA introduced several new categories of tax-exempt and tax credit bonds. For Indian country, ARRA created a species of tax-exempt bonds, known as Tribal Economic Development Bonds (TEDB), which allows tribes to issue tax-exempt bonds under substantially the same rules that apply to other governmental entities. Normally, under the Internal Revenue Code of 1986 (IRC), as amended, bonds issued by a tribal government must be for the performance of an essential governmental purpose in order to be issued on a tax-exempt basis.
While the challenges from frozen credit markets have eased, financings in Indian country recently received a challenge from an unanticipated source: a court decision from a federal district court in Wisconsin. The decision, Wells Fargo Bank N.A. v. Lake of the Torches Economic Development Corp., No. 09-CV-768 (W.D. WI Jan. 11, 2010), raises questions not only with respect to existing tribal bond issues, but it also presents obstacles for issuing new debt.
The news, however, is not all gloomy for tribal financings. As noted above, the ARRA introduced TEDBs, which provide a greater ability for tribes to access the tax-exempt financing market. In addition, recent guidance issued by the Internal Revenue Service allows tribes to take advantage of other new categories of bonds under the IRC, which provide for an even greater subsidy to issuers.
The New Challenges of Wells Fargo
The recent Wells Fargo decision has received considerable attention in Indian country. The decision has been the topic of numerous law articles and discussions at gaming law conferences, and is the subject of considerable speculation with regard to the effect of the decision on other tribal financings.
It is useful to understand the terms of the bond financing and the reasoning of the court prior to offering a prognosis of what Wells Fargo means for tribal financings. The issuer, Lake of the Torches Economic Development Corp. (EDC), is a special purpose entity formed by the Lac du Flambeau Band of Lake Superior Chippewa Indians. The EDC was formed to own and operate the Lac du Flambeau Tribe’s casino gaming facility, the Lake of the Torches Resort Casino in northern Wisconsin.
In January 2008, the EDC issued $50 million in bonds. The proceeds of these bonds were to be used for two purposes: (1) to refinance and consolidate existing EDC debt related to the Lake of the Torches Resort Casino; and (2) to fund an investment in a Mississippi riverboat casino. Typical for most bond offerings, the bonds were issued pursuant to a trust indenture. The security for repayment of the bonds consisted of a pledge from the EDC of “[a]ll right, title and interest in and to the Gross Revenues of the [EDC], and investment earnings on the Gross Revenues of the [EDC].“ The EDC also granted the bondholders a security interest in casino equipment and related intangible assets.
The indenture contained provisions that directed the flow of funds from casino operations to ultimately secure repayment of the bonds, identified “events of default,” and outlined remedies to bondholders upon an event of default. The flow of funds provisions of the indenture established several funds and accounts that served to collect daily revenue from the Lake of the Torches Resort Casino, set aside funds to make debt service payments on the bonds, release funds to pay operating costs of the Lake of the Torches Resort Casino, and otherwise release funds to the Lac du Flambeau Tribe.
As with virtually all bond documents, the indenture contained several events of default. Among other standard events of default, the indenture apparently obligated the EDC to substantiate expenses to support the transfer of funds to pay casino operating expenses. Upon an event of default, the remedies available to bondholders included: (1) accelerating repayment of the bonds; and (2) appointing a receiver. In addition to identifying events of default, the indenture contained several negative covenants intended to prevent the EDC from impairing the collateral and ensuring performance of its obligations to repay the bonds. The negative covenants included: (1) restricting the EDC’s ability to incur, without consent of a majority of the bondholders, capital expenditures that exceeded 25 percent of the prior year’s capital expenditures; (2) appointing, at the direction of a majority of the bondholders, a management consultant if debt service ratios fell to certain levels; and (3) imposing limitations on the ability to replace certain key management personnel without consent of a majority of the bondholders. From the perspective of bond attorneys and investment bankers involved with bond financings, the events of default and the inclusion of negative covenants is both typical and unremarkable.
The EDC was alleged to have caused four events of default: (1) failing to deposit daily all gross revenues from the Lake of the Torches Resort Casino; (2) using funds for purposes not authorized by the indenture; (3) failing to provide records for inspection as required by the indenture; and (4) failing to provide financial statements. At the request of the sole bondholder, Saybrook Capital LLC of Santa Monica, Calif., the trustee declared the entire principal and interest on the bonds due immediately and commenced suit seeking the appointment of a receiver.
Once the lawsuit was filed, the EDC and the Lac du Flambeau Tribe argued that the indenture was a “management contract” under the Indian Gaming Regulatory Act, 25 U.S.C. § 2701, et seq. (IGRA). A purpose of the IGRA, which authorizes tribal governments to operate casino gaming, is to ensure that tribal governments are the primary beneficiaries of tribal gaming operations. The IGRA permits tribes to enter into so-called “management agreements” that authorize a third party to manage gaming operations. However, such agreements must be approved by the National Indian Gaming Commission (NIGC). Absent approval of the NIGC, a management agreement is void.
Wells Fargo presented the question whether the indenture amounted to a “management agreement” under the IGRA. Under the IGRA, a management agreement is generally defined as a contract that provides for the management of all or part of a tribal gaming operation. Courts have identified the granting to a third party some authority with respect to tribal gaming operations as a necessary condition for a contract to qualify as a management agreement under the IGRA. The Wells Fargo court concluded that “the security provided for the [payment] of the bonds was the existing casino facility in Lac du Flambeau.” In conjunction with the negative convents of the EDC, as outlined above, the court held that “[a]ll of these provisions give bondholders the opportunity to exert significant control over the management operations of the casino facility.” Accordingly, the court both quickly and easily concluded that the indenture was a management agreement under the IGRA. Consequently, because the NIGC never approved the indenture, it was void as a matter of law.
Regardless of whether as a matter of law the Wells Fargo decision is correct, the effect of the decision may be disastrous for tribal financings for several reasons. First, there will be increased costs for tribes to access debt markets. Some commentators have suggested that Wells Fargo is an anomaly because the indenture had many unique provisions. This view may seem naïve and even the product of inexperience with bond financings to professionals in the commercial gaming industry, but Indian gaming experts generally see the decision as both expected and correct under the IGRA. However, debt markets undoubtedly will view any financing with a tribe as more risky, and this in turn will translate to higher interest rates. Moreover, bond counsel and underwriters’ counsel may now insist on NIGC review as a condition to issuing their respective legal opinions, a step that responsible Indian gaming attorneys have long required for transactions with which they have been involved. The Wells Fargo transaction apparently followed commercial form, and the parties obviously saw no need to have it reviewed in the context of the IGRA.
Second, there is a question with respect to whether the impact of Wells Fargo will extend to other tribal financings. Bond counsel, investment bankers and—most importantly—the markets tend to be reactionary when a bond issuance goes bad. Thus, for example, if an issuer or guarantor has anything remotely to do with a tribal casino, it would be reasonable to expect demands for a NIGC review. Remember too that the proceeds of the bonds issued by the EDC at issue in Wells Fargo were, in part, to be used to fund an investment in a non-Indian casino. This non-IGRA regulated activity seems to have been lost in the shuffle, because the security on the bonds extended to the Lake of the Torches Resort Casino. Thus, the use of proceeds may not necessarily mitigate uncertainty with regard to tribal financings that do not concern gaming projects.
Ultimately, there appear to be no short-term winners from the Wells Fargo decision other than the Lac du Flambeau Tribe, which is in a position to demand new and more advantageous terms for the outstanding $46.6 million debt—a debt that it currently has no legal obligation to pay. Still, while the EDC may be able to legally escape repaying nearly $50 million in debt, as a direct product of this litigation, it could in the future very well be shut out of debt markets or be granted access only at exceedingly high interest rates. Other tribes may suffer similar fates because debt markets may view tribal financings as more risky than previously believed. The inevitable cost to tribes could well be higher interest rates unless they can persuade the financial community that the failure to secure NIGC review and approval was a failure of the professional financial advisers to that transaction—not a fault with the overall Indian gaming industry. Finally, attorneys and investment bankers involved with tribal financings will have a healthy dose of anxiety. This will translate to (1) pushing tribal issuers to jump through more hoops to issue bonds and, hence, increase the costs of issuance; and (2) involving experienced Indian gaming attorneys in transaction reviews to insure that critical requirements unique to tribal casino projects have not been overlooked.
Opportunities in Finance
Many of us have grown weary of the all the doom and gloom—especially those of us living in the transactional world. In the spirit of the notion that the news is not all bad, there are new opportunities in Indian country finance that may prove to be beneficial to tribal governments.
The introduction of TEDBs by the ARRA has expanded the ability of tribal governments to access the tax-exempt debt markets. The benefit of issuing debt on a tax-exempt basis is the substantially lower interest rates that issuers pay. TEDBs cannot be issued to finance any portion of a building in which Class II or III gaming is conducted or housed or any other property actually used to conduct gaming. Nevertheless, a TEDB can be issued to finance other governmental purposes. A precondition for issuing a TEDB is for a tribe to receive a volume cap allocation. The ARRA established a $2 billion national volume cap. On Feb. 22, 2010, the IRS issued a news release announcing that the second $1 billion tranche of TEDB volume cap had been allocated among 76 tribal governments.
The conclusion of a recent IRS General Counsel Memorandum opens another opportunity for tribal governments with a TEDB allocation. The General Counsel Memorandum concluded that a tribe with a TEDB allocation can issue a TEDB as a Build America Bond (BAB). BABs are a hugely popular and successful new category of bonds authorized by the ARRA. A BAB is a new form of bond that provides for a federal tax credit equal to 35 percent of the amount of interest payable on an interest payment date. The attraction to issuing bonds as BABs is that, at the election of the issuer, a BAB is eligible to receive a direct subsidy payment from the federal government in lieu of the tax credit. That is, on each interest payment date an issuer of a so-called “direct payment” BAB receives a payment from the federal government equal to 35 percent of the interest payable. Economically, an issuer is always better off electing to receive the direct payment rather than receiving the tax credit. Hence, the recent General Counsel Memorandum creates a significant opportunity for tribal issuers to participate in the popular BAB market and potentially lower overall borrowing costs.
Final Thoughts
The thawing of frozen credit markets should help tribal governments access capital to finance long-awaited projects, but tribal financings face a new challenge in contending with the ramifications of the recent Wells Fargo decision. While some commentators have attempted to downplay the effect of the decision, many experienced investment bankers and bond attorneys have good reason to be concerned that Wells Fargo may very well introduce new obstacles for tribes to access debt markets on reasonable terms. Ultimately, Wells Fargo reinforces the notion that parties developing and financing tribal casinos need both experienced finance attorneys and experienced Indian gaming attorneys when contemplating their financing. While substantial obstacles remain, there are new opportunities for tribal governments to access tax-exempt financing markets, provided that the bond transaction is properly structured.