CHICAGO — A federal court ruling that lets the Lac du Flambeau tribe off the hook for repayment of $46.6 million of tribal gaming revenue bonds could harm the municipal market as a whole because the ruling undercuts investor rights in bond indentures and confidence in disclosure, the National Federation of Municipal Analysts warns.
The organization announced Thursday that its board of governors voted to take the rare action of submitting a friend of the court brief with the Seventh Circuit Court of Appeals in Chicago, which will review the case of Wells Fargo Bank NA against Wisconsin-based Lake of the Torches Economic Development Corp. The corporation is the tribe’s corporate entity.
The organization attributed its decision to the “important implications” the ruling could have on the municipal market because “two main principles fundamental to municipal bonds” are under attack in this case. The issues are investor reliance on issuer and counsel disclosure and standard severability clauses in bond indentures.
The bond trustee in May appealed the January decision by Judge Rudolph T. Randa of the U.S. District Court for the Western District of Wisconsin dismissing the case. It originally filed last December by Wells Fargo on behalf of the sole bondholder, California-based Saybrook Capital LLC. The trustee sought the appointment of a receiver because Lake of the Torches had violated terms of the bond indenture.
Randa rejected the request and ruled that the tribe was not required to repay the taxable bonds because the trust indenture’s structure required federal approval. He ruled that terms of the trust indenture giving bondholders significant control over casino operations in some circumstances effectively made it a management contract, which must have the approval of the National Indian Gaming Commission.
“Without prior approval, the entire contract is void,” the opinion read.
Investors have raised concerns that the ruling could sour interest in tribal bonds. Some lawyers counter that it provides a roadmap for how to structure future deals.
The NFMA’s concerns are more sweeping.
“Although tribal financing constitutes a small portion of the municipal market, the precedents set by the lower court ruling on this case have potentially far-reaching ramifications for the market as a whole, if they are allowed to stand,” said NFMA chairman Mark Stockwell. “The ruling challenges both the right of bond investors to rely upon disclosure and opinions, and the sanctity of repayment obligations in bond documents.”
The litigation began in December when Wells Fargo sought to enforce bondholder rights under the trust indenture after declaring an event of default on the bonds and accelerating repayment of the 2008 bonds.
Attorneys for the Lake of the Torches EDC argued that appointment of a receiver was not warranted and that the bond documents gave too much managerial power to bondholders. They said the contracts should be “void and unenforceable as unapproved management contracts.”
Randa agreed, writing that the trust indenture included limits on capital expenditures without bondholder approval, allowed bondholders to hire a management consultant if debt-service coverage fell below a certain threshold, and gave bondholders the ability to replace key casino leaders.
Well Fargo argued in its motion to vacate the decision that the indenture was to secure repayment of the bonds, not to impose management terms. The bank said the bond issue terms should be considered separately from the trust indenture as a collateral contract. The court rejected that position, countering that the documents are still part of the overall indenture.
The NFMA takes no position on whether the indenture violates federal law. However, it does oppose the court’s position that it is “unreasonable” to rely on an issuer’s representation, through disclosure and opinions, that the indenture did not violate federal rules.
“In light of such reasonable reliance, an issuer should not be able to assert positions that contradict the issuer’s prior representations as a means of nullifying its repayment obligation and giving the issuer a windfall,” the NFMA amicus brief reads.
On the court’s refusal to sever those provisions in the indenture that violated federal law and allow the repayment obligation to remain intact, the NFMA argues that “severability clauses exist in almost all bond documents and are intended by the parties to be applied by courts to both excise certain contractual provisions deemed invalid and to preserve the remaining provisions agreed to as an enforceable contract.”