Obviously my favorite financial news story so far this week is The Tale of the $450 Million 'And.' This is the story of Caesars Entertainment, which last week announced a series of transactions that had the effect of removing its guarantee of some of its Caesars Entertainment Operating Co. subsidiary's $18 billion of debt. This was bad for that debt:1
Over all, investors have lost something like $450 million on CEOC's bonds with the evaporation of the guarantees. The way Caesars got out of its guarantee is that it sold 5 percent of the equity of CEOC "to institutional investors in a private transaction" for $6 million and change.2 And that's enough to get rid of the parent company guarantee of the CEOC bonds. As the indenture provides (emphasis added):
The Parent Guarantee shall terminate and be of no further force or effect and the Parent Guarantor shall be deemed to be released from all obligations under this Article XII upon:
(i) the Issuer ceasing to be a Wholly Owned Subsidiary of Caesars Entertainment;
(ii) the Issuer’s transfer of all or substantially all of its assets to, or merger with, an entity that is not a Wholly Owned Subsidiary of Caesars Entertainment in accordance with Section 5.01 and such transferee entity assumes the Issuer’s obligations under this Indenture; and
(iii) the Issuer’s exercise of its legal defeasance option or covenant defeasance option under Article VIII or if the Issuer’s obligations under this Indenture are discharged in accordance with the terms of this Indenture.
And since CEOC ("the Issuer") is no longer a wholly owned subsidiary of Caesars, the guarantee went away.
OR DID IT?
Bondholders may argue that because two of the actions are linked by “and” in the document, extinguishing the guarantee requires Caesars to satisfy all three clauses.
I don't know what to tell you. As readers of words, those bondholders seem to be right. "The guarantee goes away upon X, Y and Z" does sound like you need X, Y and Z all to happen before the guarantee goes away. That's just what "and" means.
On the other hand, the indenture obviously means to say "or." It would make no sense to say that CEOC has to (i) stop being a wholly owned sub and (ii) merge into another company and (iii) pay off or defease all its debts for the guarantee to go away. Like, if CEOC paid off all its debts, but didn't merge into another company, would Caesars still be obligated under the guarantee?3
So this looks like a mistake, but the sort of mistake that a court probably wouldn't read too literally. So I wouldn't bet on the bondholders' chances of challenging the de-guarantee-ification successfully.
But what I really like here are all the scoldy quotes about how bondholders should read indentures more carefully:
“This reminds investors to be diligent about reading indentures and making sure that they understand the implications of the way they’re drafted,” said Alex Bumazhny, an analyst at Fitch Ratings, who believes bondholders can challenge the action. “That’s going to be a major focal point” ...
“In this context, we think it may make more sense to read the 'and’ as an 'or,’ which would allow for this type of release,” said Justin Forlenza, an analyst at independent credit-research firm Covenant Review LLC who has researched Caesars’ covenants. “It speaks to the importance of bond investors really digging into the documents and reading them very carefully.”
What? Come on! How does this situation speak to the importance of bond investors really digging into the documents? Digging into this document would lead you only to madness. There you'd sit, reading the 111-page indenture, until on page 106 you found this "and." "Aha!" you'd shout, "We can challenge this transaction because they said 'and' instead of 'or.' I've made my firm a fortune!" And then you'd go to your lawyer and he'd be like, no, come on, that's not really how it works, there are no $450-million "ands" in the world. And you'd be like "I READ 111 PAGES FOR NOTHING."4
On the other hand, I guess if you had read this indenture just carefully enough to notice that Caesars could remove the parent guarantee by selling a 5 percent stake in the subsidiary, but not carefully enough to get hung up on the "and" thing, then you'd be glad you had? Not because you could do anything about it now, just because you'd maybe price that risk in when deciding whether to buy the bonds. Caesars thinks everyone knew about it:
“This was a guarantee of convenience included in the indentures at Caesars’ request, so that consolidated financials could be filed” said Stephen Cohen, a spokesman for Caesars. “Our creditors knew from the beginning that we always had the power to terminate the guarantee. The language of the indentures clearly provides that the guarantee terminates upon the sale of CEOC stock, and there is overwhelming market agreement on that point.”
But I am not quite so sure. The front page of the offering document for the bonds says, "The notes are irrevocably and unconditionally guaranteed by Caesars Entertainment Corporation," which almost makes it sound like the guarantee was irrevocable and unconditional.5 And there's no risk factor for "we can take away the guarantee whenever we feel like it, just by selling a little bit of stock." Really, it does seem a little unusual for bonds to have a parent company guarantee that the parent can take away whenever it feels like it.6 So maybe that would have been a good thing to notice, there on page 106.
Really, though, this is at least as much a story about how issuers should read indentures more carefully. Or write them more carefully I guess? Caesars thought that it agreed to one thing (parent guarantee of convenience that it could take away at any time), while bondholders may or may not have thought that they agreed to something else (real credit support from parent guarantee). But the thing they actually signed up for doesn't reflect what anyone thought.
This indenture was clearly written at four in the morning by a junior associate at a law firm, and whether or not it allows Caesars to do what it wants to do is pretty much a matter of dumb luck. If the junior associate had written "or," we wouldn't be here. He wrote "and," so we are. If he'd written "I AM SO TIRED AND I HATE BONDS," it probably would have made it into the final indenture as easily as the "and" did. Who was checking?
The entire edifice of modern financial capitalism is built on 100-page documents drafted by exhausted 26-year-olds and read by nobody. The reason disputes like this always bring out people talking about how important it is to dig deep into the documents is that nobody ever does.
That's the 9 percent of 2020, of which there is $1.5 billion outstanding, and which yielded around 12 percent as of last Monday and north of 14 percent by Wednesday.
2 There's a bunch of other stuff too, including some asset sales, a new credit facility, and a tender offer for some CEOC bonds.
3 Or, how could clause (i) -- stop being a wholly owned sub -- have any meaning if you also had to satisfy clause (ii) -- merge with a company that is not a wholly owned sub? You could just get rid of clause (i) if it really meant that. Courts are into reading contracts in ways that make sense. There's no way to make this contract make complete sense, but torturing the meaning of "and" a bit is probably preferable to making the entire provision ridiculous.
4 I mean, or not, I don't know, maybe they'll win. I'd bet against it but it's not impossible. It really does say "and."
5 That's technically the exchange offer prospectus; the actual Rule 144A offering memorandum isn't publicly filed. On page 70 there is a description of the guarantee, which tracks the indenture (and says "and.")
To contact the writer of this article: Matt Levine at firstname.lastname@example.org.
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