Tribal Gaming Enterprise Held Ineligible to File for Chapter 11

by Cadwalader, Wickersham & Taft LLP
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[authors:  Jeffrey H. Taub]

Since the passage of the Indian Gaming Regulatory Act in 1988, casinos owned by Native American tribes have proliferated across tribal lands and have generated billions of dollars in revenue annually. While casinos such as Mohegan Sun and Foxwoods are among the largest and well-known tribal casinos, over 60 exist in the State of California, where many dozen small properties have sprung up throughout the state in recent years, in some cases built in part with the proceeds of high-yield bond debt. This recent growth spurt juxtaposed with the prolonged downturn in consumer spending has clearly demonstrated that numerous tribal casinos, like their mainstream competitors, are overleveraged and need to restructure their financial obligations in order to sustain their operations.

But restructuring a tribal casino differs significantly from the typical casino restructuring. Creditors of non-tribal casinos can use the threat of foreclosure and involuntary bankruptcy to influence negotiations that include outcomes such as creditors receiving equity in the restructured casino in exchange for their claims, subject to regulatory approvals or appropriate structuring. However, a tribal casino’s creditors cannot take a lien in tribal property; thus, their collateral is usually limited to personal property and their remedy-enforcement options are correspondingly limited. In light of a tribal casino’s potential assertion of the sovereign immunity defense, even in cases where credit documents include seemingly adequate waiver language, these remedy-enforcement limitations also extend to the forum and manner in which creditor can exercise such remedies.

Under the unique and somewhat unclear legal landscape in which tribal casinos operate, many tribes have wielded the threat of sovereign immunity or have rested on the leverage inherent in the limited remedy-enforcement options available to their creditors. Despite such assertions of leverage, nearly all tribal gaming issuers have reached consensual restructuring agreements with their bondholders in recent years.  Notable deals include, not only Mohegan Sun, but also smaller tribal casinos such as the Chukchansi Gold Resort and Casino, the River Rock Casino and the Buffalo Thunder Casino Resort.

However, the case of the Santa Ysabel Resort and Casino (the “Casino”), operated by the Iipay Nation of Santa Ysabel (the “Tribe”) is an exception to this trend. While the Casino sought to consensually resolve the modest debt on its balance sheet, in the absence of a deal, the Casino ultimately filed for bankruptcy under chapter 11.

In a significant development that provides some clarity on the legal issues pertaining to tribal gaming enterprises, on September 4, 2012, Chief Judge Peter W. Bowie of the Bankruptcy Court for the Southern District of California dismissed the Casino’s chapter 11 case , holding that the Casino was not eligible to be a debtor under the Bankruptcy Code. The court rejected the Casino’s argument that it was an eligible debtor because it was an unincorporated company that falls within the Bankruptcy Code’s definition of corporation and held that the Casino did not bear the characteristics of an unincorporated company because it could not identify when the entity was created. Instead, the court noted that under the Casino’s theory the unincorporated company would have “just sort of [come] up as vapors from the ground after the mist lifts.”

Background

In 2005, the Tribe borrowed approximately $26 million from JP Morgan Chase Bank N.A. and approximately $7 million from the Yavapai Apache Nation (“YAN”) to finance the construction of a resort and casino on tribal land in San Diego County, California (the “County”).

As is typical for tribal casinos situated within the bounds of California counties, the Tribe entered into a memorandum of understanding with the County under which the Tribe paid the County for law enforcement and other similar services.

Due to higher than expected construction costs, only a casino and restaurant were built. In 2009, the YAN purchased JP Morgan’s note, making it the Tribe’s largest creditor. Subsequently, the Tribe failed to make scheduled loan payments and the YAN obtained several judgments in tribal court against the Tribe totaling approximately $43 million which were subsequently recognized in California state court. The Tribe also stopped making the monthly payments due to the County under the memorandum of understanding, and, in May, 2012 the County levied upon the Tribe’s bank account. Faced with a threatened foreclosure action from the YAN, the Casino filed for bankruptcy protection on July 3, 2012. In the declaration submitted in support of its first day motions, the Casino stated that it was an unincorporated company owned by the Tribe.

Motion to Dismiss

On August 8, 2012, the YAN moved to dismiss the Casino’s bankruptcy case, arguing that the Casino did not exist independently from the Tribe and that the Tribe itself was not eligible to be a debtor under the Bankruptcy Code. The YAN argued that Bankruptcy Code section 109 limits eligibility to a “person” and a limited amount of specifically listed entities (that did not apply to the Casino). Section 101(41), in turn, provides that the term person includes individual, partnership, and corporation, but does not include governmental unit. Section 101(27) provides that a governmental unit is a “foreign or domestic government.” The YAN argued that the Ninth Circuit had already determined that Indian tribes are governmental units for the purposes of waiving sovereign immunity under Bankruptcy Code section 106. Accordingly, the YAN argued that the Tribe was also a governmental unit for the purposes of section 109 and was specifically excluded from being a debtor under the Bankruptcy Code.

The YAN also argued that the Casino was not an unincorporated company. Although not defined in the Bankruptcy Code, the YAN cited case law from the First Circuit that requires the entity in question to (i) consist of multiple persons joining together and (ii) provide some form of limited liability for its members. The YAN argued that because the Casino was wholly owned and operated by the Tribe, the Casino could not be an unincorporated company. Additionally, the YAN argued that in its prior dealings with the Tribe, the Tribe never held the Casino out as a separate legal entity. The YAN noted that (i) the Tribe had made several representations and covenants in the loan documentation indicating that it was the sole owner of the casino, (ii) the Indian Gaming Regulatory Act requires an Indian tribe to have the sole proprietary interest in any gaming activity, (iii) the Tribe’s gaming compacts with the State of California and the County of San Diego both required the Tribe to own the gaming operations, (iv) numerous Tribal resolutions described the Tribe as the entity with the sole proprietary interest in and responsibility for the gaming operations and (v) proposed debtor’s counsel had signed an engagement letter with the Tribe – not the Casino. Accordingly, the YAN argued that the Casino was not a separate entity and the case should be dismissed.

In its response, the Casino stipulated that, if the court found that the Casino was not a separate entity, the court should dismiss the case. However, based on a synthesis of case law from the Second, Third and Seventh Circuits, the Casino argued for an expansive interpretation of the term “unincorporated company” that would include any entity where many people engaged in a business under a common name. The Casino argued that it would fall within this definition because its employees were in the pursuit of a common business objective of operating the Casino and that it operated with its own management and decision-making structure. Additionally, the Casino argued that loan documents were not dispositive because at the time the loan documents were executed, the Casino had not yet begun operations and that the Casino could operate the gaming operations without violating IGRA or the Tribe’s compacts even though the Casino was a separate entity.

On September 4, the bankruptcy court convened a hearing on the motion. In a brief ruling from the bench, the court held that the Casino had not met its burden of proving that it was an eligible debtor. The court held that the mere fact that the Casino’s employees were acting in concert under a common name was insufficient to create an unincorporated company particularly because nothing in the Casino’s structure provided the employees with limited liability. Additionally, the court noted the importance under bankruptcy and non-bankruptcy law of parties understanding the structure of the entity that they contract with and that entities that wish to achieve the objective of a particular structure should have some characteristics of that structure. However, the Casino had not engaged in any specific activity that would put other parties on notice that it was a separate entity. As a result, the court held that the Casino had not established it was an unincorporated company that was eligible to be a debtor.

Conclusion

Although many practitioners and investors in the gaming sector observing the Santa Ysabel case had hoped for a broad decision on debtor eligibility as applied to Indian tribes and casinos, the court’s decision in Santa Ysabel was narrower in scope in light of its extensive reliance on the unique facts of the case – including the Casino’s lack of formal corporate structure and the Tribe’s prepetition actions. These circumstances led the court to conclude that the Casino was not a separate entity. It remains to be seen whether another court would find that a more sophisticated tribal gaming enterprise whose casino operations are held in an entity with attributes more akin to a traditional corporation could be viewed as separate from its tribe and thus eligible to file for chapter 11 under the Bankruptcy Code.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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