Caesars’ Bankruptcy Plan: Already Under Attack?

Events are happening quickly these days with Caesars Entertainment.  On January 13, holders of second lien notes issued by Caesars Entertainment Operating Company (“CEOC”) filed an involuntary chapter 11 petition against CEOC in the U.S. Bankruptcy Court for the District of Delaware.  Two days later, CEOC itself filed a voluntary chapter 11 petition in the U.S. Bankruptcy Court for the Northern District of Illinois, setting up a venue fight over the bankruptcy case.  And later that same day, the U.S. District Court for the Southern District of New York entered a Memorandum Opinion denying in large part two motions to dismiss filed by CEOC’s parent, Caesars Entertainment Corporation (“CEC” and with CEOC, “Caesars”), in response to a lawsuit brought by holders of notes issued by CEOC.  While the impact that the District Court’s decision will have on CEOC’s bankruptcy is uncertain, the Court’s ruling is notable as being the first examination of Caesars Entertainment’s pre-bankruptcy financial maneuvering and highlights some problems that could arise in the bankruptcy proceeding.

The facts of the District Court case are relatively straightforward.  According to plaintiffs’ allegations, CEOC issued $1.5 billion in notes, $750 million due in 2016 and $750 million due in 2017.  The notes were subject to two separate indentures, both of which included unconditional guarantees by CEC and provisions prohibiting CEOC from divesting its assets.  The noteholders alleged that in 2014, Caesars’ new owners instituted a plan (the “2014 Transaction”) to put CEOC into bankruptcy while protecting the owners from CEOC’s creditors.  As part of this plan, supplemental indentures were issued that effectively left CEC free to transfer CEOC’s assets without any obligation to back CEOC’s debts.  The purchase price paid for the notes of the noteholders who approved the 2014 Transaction was a 100% premium over market, in exchange for which the accepting noteholders agreed to (1) support any restructuring proposed by Caesars, (2) consent to the termination of CEC’s guarantees, and (3) consent to the modification of the covenant restricting disposition of substantially all of CEOC’s assets.  In essence, Caesars paid off a sufficient number of noteholders in order to allow Caesars to modify the governing documents so as to permit a divestiture of CEOC’s assets and the termination of CEC’s guarantees.  These actions, according to plaintiffs, violated Section 316 of the Trust Indenture Act of 1939 (the “TIA”) and breached the indentures.

Taking the complaint’s allegations as true for purposes of the motions to dismiss, the District Court held that plaintiffs had sufficiently alleged a violation of Section 316(b) of the TIA by CEC (the case against CEOC had been stayed by virtue of the bankruptcy filing, and therefore the Court’s ruling applies only to CEC).  Section 316(b) prohibits a company, outside of bankruptcy, from altering its obligations to pay principal and interest arising under bonds without the consent of each bondholder.  The Court found that plaintiffs had adequately alleged that the 2014 Transaction was an impermissible impairment of plaintiffs’ right to payment under the notes.  The Court rejected CEC’s argument that there was no impairment because CEOC was not in default of its obligations to make payments, instead finding that transferring away CEOC’s assets and eliminating CEC’s guarantees to backstop the debt “constitutes an impairment of the right to sue for payment.”  According to the Court, the notion that Section 316(b) was meant to protect only against formal modifications of the legal right to receive payment was “unsatisfying.”   Furthermore, removing the CEC guarantees through the 2014 Transaction was an impermissible out-of-court restructuring and was “exactly what TIA Section 316(b) was designed to prevent.”  The Court also held that plaintiffs’ state law claims were not barred by the no-action clauses in the indentures, and that plaintiffs’ had adequately alleged breach of the indentures.

The effect that this decision against CEC will have in CEOC’s bankruptcy case is unclear.  What is clear, however, is that the 2014 Transaction is central to CEOC’s bankruptcy reorganization.  The 2014 Transaction represents the culmination of months of negotiations between CEC, CEOC and their major creditors and underpins the proposed bankruptcy reorganization under which first lien noteholders would receive a 92% recovery, while junior noteholders would receive pennies on the dollar.  Even though the Court’s ruling was made in the context of a motion to dismiss where the Court has to accept plaintiffs’ allegations as true, the decision will certainly provide increased leverage to investors claiming that they are being shortchanged in CEOC’s bankruptcy plan.  The decision will also cause CEOC to file a motion, sooner rather than later, seeking to extend the protections of the automatic stay to its parents and affiliates, including CEC.

We will continue to keep you advised of interesting developments in the CEOC bankruptcy, including the outcome of the venue fight, which is set for argument this week in the District of Delaware.