This article was originally published in Global Gaming Business Magazine.
This year’s Covid-19 crisis has jolted the gaming industry. As of May 1, all casinos in the United States, commercial and tribal, were closed. Since then, state by state, gaming regulators have been formulating protocols for reopenings, in consultation with their governors, public health officials, gaming regulators and industry counterparts.
It’s evident that once casinos have fully reopened, the gaming experience will be drastically altered. A seismic shift has taken place.
Casino closures have caused an adverse impact on gaming companies (casino operators, manufacturers/distributors and gaming vendors), their employees and shareholders, as well as state, local and tribal governments that rely on gaming revenue for income.
Suppliers aren’t ordering new product. Conferences and industry events have been canceled. The closures have caused some gaming companies to default on financial covenants with their lenders, adding more stress as they look to get back to business.
When the Coronavirus Aid, Relief and Economic Security (CARES) Act passed in March, the American Gaming Association succeeded in ensuring that the industry was not explicitly excluded from eligibility for relief funds. Gaming was generally included with the resort/hotel industry. But a problem quickly arose when the Small Business Administration (SBA) elected to use a qualifying policy from the late 1990s to exclude companies with more than one-third gaming revenue from eligibility for the Paycheck Protection Program (PPP).
Essentially, this disenfranchised smaller casinos with fewer than 500 employees, including many tribal facilities as well as casinos in Colorado, Iowa, rural Nevada and elsewhere.
Before the initial PPP funding was depleted, the SBA changed the eligibility to allow for 50 percent gaming revenue in 2019, so long as that amount also did not exceed $1 million. This helped some, but not all small Nevada taverns.
In response to intense efforts by the AGA and all segments of the casino industry, Congress then funded additional monies into the PPP program; the SBA finally relented and harmonized its eligibility requirements with what was in the CARES Act to begin with (no casino exclusion for fund eligibility at all). The problem was, by the time this took place, there were many other small businesses in line for these funds. So, it’s not clear how many small casinos will be able to receive PPP funds at the end of the day.
Lessons from the Recession
Based on what transpired during the financial crisis in 2008, the first step most casino operators will take is to seek to manage and reduce their capital expenditures and other expenses to maximize and improve cash flow.
This will likely negatively impact gaming suppliers and vendors as well as the construction trades, as operators spend less on new products and expansions to deal with the reduction in business caused by the closures, reopenings with reduced occupancy, and the cancellation of convention and meetings business.
Companies in the gaming industry (both operators and vendors) are in a precarious position. They’ll need to consult with their lenders to emerge from this crisis and seek to work out acceptable plans so operations can continue. In many cases, this will involve changes in loan covenants/liquidity requirements, payment forbearances and forms of equity participation (board/officer positions and sharing in gaming revenue), as well as changes in officers/owners of the gaming companies themselves. These will obviously trigger gaming regulatory issues that may require licensing or approvals of some form.
In some instances, companies will be able to negotiate with their lenders out of federal bankruptcy court. In other instances, they will have no choice but to go through a formal bankruptcy restructuring process.
Gaming bankruptcies are unique animals, given the inherent conflict between federal supremacy (the Federal Bankruptcy Code and the federal statutory requirement that bankruptcy trustees and debtors operate a business in compliance with valid state law) and the 10th Amendment (state regulatory licensing control).
Gaming licenses are “privileged” in most jurisdictions that don’t automatically flow with the assets, and the value of casino enterprises is dependent on the license remaining in good standing. So it’s vitally important to assure gaming regulatory compliance when going through this process. As casino bankruptcies have become more common, there’s ample precedent where bankruptcy courts and the gaming regulators have consistently worked together in a cooperative manner.
“Keeping the court, creditors and interested parties informed of the status of regulatory issues is key to ensuring an efficient restructuring process,” says Martin A. Sosland of Butler Snow LLP’s Bankruptcy and Restructuring Group, adding, “When the court and creditors are left in the dark, unnecessary motion practice and inefficiencies are bound to occur.”
For example, in practice, bankruptcy judges have almost always made gaming regulatory approval a condition for a debtor to successfully exit bankruptcy. Likewise, gaming regulators have timely processed and investigated the necessary individuals/entities to allow a debtor to successfully exit bankruptcy, and have taken appropriate steps to approve debtor-in-possession (DIP) financing, and/or other credit arrangements in bankruptcy.
Part of the reason for this is the acknowledgement, from both regulators and the bankruptcy court, that it’s preferable to keep casinos open and operational, if possible, during a bankruptcy process. This enhances value for creditors, but also allows the states to continue to receive gaming taxes.
In addition, employees remain employed and vendors remain in place during the proceedings. A hallmark in this is keeping the gaming licenses in good standing. This has even been able to happen when there have been multi-jurisdictional bankruptcies involving multiple commercial gaming regulatory agencies.
A bankruptcy case can be commenced either voluntarily (by the debtor) or involuntarily (by a group of creditors). While possible, involuntary cases are rare—accounting for less than one-tenth of 1 percent of all filings.
Types of Bankruptcy
There are two primary types of bankruptcy cases: Chapter 7 (liquidation) and Chapter 11 (reorganization).
Chapter 7 cases are for companies that don’t have the cash flow to justify continuing operations. Chapter 11 cases are generally for companies with adequate cash flow to continue operations and restructure their obligations; however, companies may file Chapter 11 to undertake an orderly liquidation.
Initially, a debtor in a Chapter 11 case has the exclusive right to propose a plan of reorganization. This allows the debtor to negotiate with its creditor constituencies. Creditors are generally classified into these categories: (a) classes of secured creditors; (b) classes of unsecured creditors; and (c) classes of equity interests.
The debtor’s primary objective is to garner sufficient support from the various creditor classes to achieve agreement upon and confirmation of a plan of reorganization for the company. To the extent that it can happen, the process can move more quickly.
If consensus doesn’t arise, the debtor’s exclusive right to propose a plan may expire or be terminated, allowing creditors to propose a plan.
Often, debt structures, collateral values and other considerations make a traditional reorganization through a confirmed plan impractical. In these situations, the debtor may propose a sale process under Section 363 of the Bankruptcy Code. This essentially is an auction to the highest bidder. A sale process can also, at times, be part of an agreed-upon transaction or a reorganization plan.
Most often, the debtor will identify a stalking horse bidder, negotiate a sale contract, and seek bankruptcy court approval of a sale process. Upon approval by the court, an auction date is set and the highest bidder prevails, winning the right to purchase the company’s assets—contingent upon the highest bidder obtaining all required gaming regulatory approvals.
“Understanding the regulatory aspects unique to gaming assets is of paramount importance,” says Sosland. “These aren’t your typical sales of a manufacturing facility, and require access to professionals that understand both the restructuring and regulatory overlay.”
If a debtor who enters Chapter 11 needs capital to fund ongoing operations to keep the casino open and operational, that debtor may seek DIP financing. Senior secured lenders are often the most likely candidates to make a DIP loan, because an approved DIP loan will solidify the secured creditor’s priority and preserve the value of the assets which serve as collateral for its pre-petition loans.
Another alternative in the chapter context is a process where the debtor and creditors agree to a prepackaged plan of reorganization before the company enters bankruptcy. This essentially means that the negotiations that would normally take place post-filing occur before the case is filed and, if successful, result in a restructuring support agreement (RSA).
If the company can obtain commitments from a sufficient number of creditors in the various classes to ensure that its plan can be confirmed, the company will file a Chapter 11 case and its plan on the same day and seek prompt confirmation of the plan to which creditors have already agreed. Obviously, this streamlines the Chapter 11 process and minimizes the delays and expense associated with the formal bankruptcy process.
It’s vital to have proactive communications with gaming regulators, both in advance of a bankruptcy filing and during the bankruptcy proceeding itself. Regulators don’t want to be blindsided and learn of a licensee’s bankruptcy after the fact.
As Sosland says, “Early and frequent communication with regulators is as important as communications with the court and creditors.”
Compliance and Communication
Richard Kalm, executive director of the Michigan Gaming Control Board—who dealt with a casino bankruptcy during the 2008 financial crisis—says, “We’ve found that direct lines of communication between the director and casino CEOs during times of transfers of interest, restructuring or during time of crisis lead to quicker, more confident decision-making by the entity and the board.
“Our casinos want to comply, but don’t want unknown regulatory action. So if we can discuss concerns ahead of time, the subsequent decisions can more readily fall in place for them. In turn, we have a much better understanding for the causation of their actions and can make suggestions to avoid any regulatory pitfalls.”
Similarly, Brian Ohorilko, administrator of the Iowa Racing and Gaming Commission, comments, “Most jurisdictions have fairly specific requirements for their licensees with respect to financing and what should be reported to the respective regulatory authority. The good news for licensees operating in multiple jurisdictions is that many states have similar or identical requirements. The best advice I would give to licensees is to communicate with their regulators on a routine basis, as concerns or opportunities are presented. In many instances, the regulatory body can assist licensees by advising of the proper filings and disclosures that need to be made if they find themselves in an unfamiliar position.
“In addition, the regulatory body will appreciate understanding the challenges of the licensees in their state to appropriately respond to questions that may come up by various policy makers.”
Sandra Douglass Morgan, chairwoman of the Nevada Gaming Control Board, has this observation: “A very few number of cities were hit as hard as Las Vegas by the 2008 financial crisis and recession, which resulted in a number of Nevada gaming entities filing for bankruptcy protection. At that time, the Nevada Gaming Control Board assembled a team with management from each division and the Attorney General’s Office to discuss case status and ensure applications were ready for board and commission consideration and disposition.
“I anticipate this group will be reconstituted to address the return of the gaming industry due to the Covid-19 crisis. Regular and consistent communication with the Gaming Control Board is imperative and critical. Given our history of addressing bankruptcy-related matters, the board is ready and able to provide guidance on the relevant Nevada statutes and regulations to ensure that applications are processed as quickly and efficiently as possible.”
Having a productive dialogue with the gaming regulator also will help maintain the licenses applicable to the company during the bankruptcy process. To keep the licenses active and in good standing, it’s important to identify these in advance of a proceeding and to regularly track dates when renewal filings need to be made.
It’s also important to continue to comply with reporting obligations to the gaming regulators and adhere to requirements for debt approval/debt covenant approvals (DIP loans), as well as filing the necessary applications required by a confirmed plan of reorganization so the company can emerge from bankruptcy as soon as possible.
In some instances, regulators may allow the application process to commence sooner than the date of plan confirmation. Again, it’s important to have an open, consistent dialogue with all gaming regulators to move through the process as quickly as possible.
Native American financing for tribal gaming enterprises/casinos has unique considerations, as it’s not clear whether a tribe can afford itself of the federal Bankruptcy Code. Further complicating the issue is tribal reluctance to waive tribal sovereign immunity. Accordingly, bankruptcy proceedings may not be an option for tribal gaming enterprises on Indian lands. That said, the same restructuring principles apply, just outside of a court proceeding.
In conclusion, Covid-19 has caused a seismic shift that’s impacting the entire economy. It means companies in all segments of the gaming industry must take proactive steps to manage expenses, work with lenders and gaming regulators to rework or reframe debt covenants, which, in some cases, may require either formal or informal business restructuring.
If restructuring becomes necessary, the question then is: Can the parties achieve this outside a formal bankruptcy process? In many cases, formal detailed transactions memorializing the deals struck between the constituencies are a viable path. If such deals can’t be struck, then a formal reorganization plan confirmed by a bankruptcy court is the likely path.
Regardless of whether a transactional deal is struck or whether there’s a formal reorganization plan, it’s vitally important to keep gaming regulatory considerations in mind in finalizing the process.