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Appellate Panel Upholds Voiding of Wisconsin Tribe's Bond Indenture

CHICAGO — A federal appellate panel in Chicago last week delivered a mixed opinion in a dispute over whether a Wisconsin tribe is on the hook for repayment of $47 million of debt, upholding the district court’s voiding of the bond indenture while overturning its refusal to consider other documents in an argument over the tribe’s sovereign immunity.

The case pits bond trustee Wells Fargo Bank NA, which represents the sole bondholder, Saybrook Capital LLC, against the issuer of the taxable tribal gambling bonds, Lake of the Torches Economic Development Corp., which serves as the corporate entity for the Lac du Flambeau tribe.

In late 2009, Wells Fargo sought to enforce bondholder rights under the trust indenture after declaring an event of default on the bonds and accelerating bond repayment. The trustee sought the appointment of a receiver, arguing that the tribe had violated terms of the bond indenture. Lawyers for the tribe argued that appointment of a receiver was not warranted and that the bond indenture should be invalidated because it gave too much managerial power to bondholders in violation of federal rules.

In early 2010, Judge Rudolph Randa of the U.S. District Court for the Western District of Wisconsin agreed, and ruled that the tribe was not required to repay the debt because the trust indenture gave bondholders significant control over casino operations, rendering it a management contract.

Under the 1988 Indian Gaming Regulatory Act, the National Indian Gaming Commission must approve managerial contracts. The law was aimed at protecting Indian gaming from the likes of unscrupulous investors or organized crime. The decision invalidated the tribe’s waiver of immunity against legal proceeding as a sovereign nation. Wells Fargo appealed and the sides argued their case before a Seventh Circuit Court of Appeals panel in Chicago last October.

The panel agreed with Randa that the trust indenture handed enough control over to bondholders to require federal approval.

“The parties’ failure to secure such approval renders the indenture void in its entirety and thus invalidates the corporation’s waiver of sovereign immunity,” the panel wrote in its opinion dated Sept. 6. The waiver is needed for the case to proceed through the U.S. court system.

However, the panel left the case open, finding that Randa erred in refusing to allow Wells Fargo to pursue its position in an amended complaint that other bond-related documents such as the offering statement, bond resolution, and other legal documents provided a separate and enforceable waiver of sovereign immunity. The trustee’s attorneys argued that the documents should be severed from the indenture, but the district court ruled that the documents were so closely linked that they too were void.

“Upon the filing of such a complaint, the district court should address the issue of whether, now that the indenture has been determined to be void, Wells Fargo has standing to litigate claims on behalf of the bondholder,” the panel wrote. “The court also must determine whether the collateral documents, when read separately or together, waive the sovereign immunity of the corporation with respect to any such claims.”

A bondholder attorney said his clients were reviewing their options with regard to a possible appeal of the opinion on the management contract, and praised the portion of the opinion that keeps the case alive. Wells Fargo can seek a rehearing before the full appellate court or appeal to the Supreme Court.

“We are pleased with the court’s decision that we can continue to pursue a legal remedy,” said James Klenk of Sonnenschein Nath & Rosenthal LLP.

An attorney for Lake of the Torches could not immediately be reached.

In the opinion, the panel described as problematic provisions in the indenture that require certain revenues be deposited in a trust fund and apply conditions to their use, giving Wells Fargo control over withdrawals. The indenture also restricts capital expenditures unless bondholders approve.

“This provision allows the bondholders to control the amount that the corporation can spend on capital expenditures related to the casino, a major prerogative in determining the present and future direction of any corporate entity,” the panel wrote.

The indenture also allows bondholders to require the retention of a management consultant when debt-service coverage ratios fall below a certain threshold.

“It permits the consultant, who must be approved by a representative of the bondholders, effectively to direct the operations of the casino and thereby transfers management responsibility over the gaming operation into the hands of a party other than the tribe,” the panel wrote.

Even greater controls are handed to the bondholders in the event of a bond default, allowing them to hire new management.

“Taken together, the provisions discussed above transfer significant management responsibility to Wells Fargo and the bondholder and therefore render the Indenture a management agreement,” the panel found.

The panel said it weighed those provisions against others that supported the argument against the indenture’s status as a management contract. The indenture does not transfer explicitly to the trustee or bondholder responsibility for daily operations, employment, or financial procedures and it allows the tribe to maintain control over licenses, permits, accounts payable and records.

Municipal bond participants in the tribal sector and broader market are closely following the case for the precedent it would set. Investors have raised concerns that the ruling could sour interest in tribal bonds while some lawyers counter that it provides a roadmap for how to structure future deals.

While the trustee has presented testimony arguing widespread use of similar language in tribal bond contracts, others have said the Lake of the Torches deal was unique. The National Federation of Municipal Analysts — in a rare friend-of-the-court brief — warned that the Randa decision could harm the municipal market as a whole because it undercuts investor rights in bond indentures and confidence in disclosure.

Little seems resolved, however, by the appellate decision. In a review published this week, attorney Len Weiser-Varon of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC wrote: “The appellate ruling represents the view of one federal circuit on a controversial matter, and leaves this particular case in an unresolved status.”

The taxable bonds were sold through the tribe’s EDC in January 2008 in a private placement with Saybrook at a 12% interest rate. Stifel, Nicolaus & Co. was underwriter and Godfrey & Kahn SC was bond counsel. Proceeds refunded existing obligations, with $16 million funding a loan for a failed riverboat project, the Grand Soleil Project, in Natchez, Miss., while $5 million went into a reserve. Profits from the Natchez project were supposed to repay the bonds. That project faltered, straining the tribe’s finances.

The EDC is a corporate entity chartered by the Lac du Flambeau band of Lake Superior Chippewa Indians, which is based on an 86,000-acre reserve in Vilas County. The band has 3,415 members and is governed by a 12-member council. It operates a casino, hotel, and convention center.

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