Avoiding Gambling in a Risky Business/ Acquisition, Leasing and Financing of Casinos. Jeffrey P. Zucker Lionel Sawyer & Collins Las Vegas, Nevada

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1 Avoiding Gambling in a Risky Business/ Acquisition, Leasing and Financing of Casinos Jeffrey P. Zucker Lionel Sawyer & Collins Las Vegas, Nevada American College of Real Estate Lawyers Philadelphia, Pennsylvania September 18, 1997 through September 20, 1997 The author thanks Robert D. Faiss, Dan R. Reaser and Elaine S. Guenaga of Lionel Sawyer & Collins and Patricia M. Kerins of Sills Cummis Zuckerman Radin Tischman Epstein & Gross, who have given generously of their time and expertise.

2 2 I. Introduction The heavy regulation of gaming in most jurisdictions requires that any real estate practitioner in the field be particularly sensitive to the great degree to which those regulations can impact a transaction, both in expected and perhaps not so obvious ways. Occasionally the regulatory structure will be reflected in the documentation itself, but more often its pervasive influence will affect the structure of the transactions themselves and thus must be kept in mind from the incipiency of a transaction. II. Sales In the case of sales of gaming properties, the requirement that the purchaser be licensed before it can continue to operate gaming at the applicable premises means that except in extraordinary circumstances a purchaser will require that its obligation to purchase be conditioned on the receipt of all applicable permits. See, e.g., Nev. Rev. Stat (1995); N.J. Stat. Ann. 5:12-1 et seq. (West 1996); Miss. Code Ann (3)(c) (1996). In addition, the buyer will need sufficient time between contract and closing to go through the licensing process. The time required for licensing is subject to many variables such as complexity of the applicant's businesses, prior licensing and existing agency case load, but in Nevada and New Jersey a period of nine months to one year is not unusual. In addition, Nevada statutes require at least a ninety day period between execution and closing. Nev. Rev. Stat The licensing requirement may be of as much concern to the seller as the buyer. At the end of a long licensing process if the buyer is denied licensing it may not be practicable to find a new buyer at the same price. While even the most reputable of buyers can experience licensing problems over what may appear to be minor issues, a seller would be advised to try to minimize these risks. Sales to existing licensees may be helpful, but as noted, are no guaranty. The buyer could also be requested via warranty to provide the "personal" information required by the applicable gaming jurisdiction. (A copy of the relevant section of the Nevada form is attached as Appendix 1.) Prospective sellers have been known to independently investigate their buyers. In any event, the seller would be well advised to conduct enough due diligence with respect to the buyer one way or the other to red flag any problems at the beginning, rather than at the end, of what can be a long process. In the case of acquisitions by private investors, rather than public entities, the investors in the buyer would also want assurances that their enterprise will not be jeopardized by the problems of a single investor. Therefore, adequate representations and buyout provisions are a necessity. However, the general broad discretion given to gaming authorities in the licensing process can result in substantial problems in actually drafting these provisions. See, e.g., Nev. Rev. Stat ; N.J. Stat. Ann. 5: Trying to accommodate the position of an investor who does not want to lose his or her investment merely because a regulatory agency expresses some concern with a former business partner and the interests of an investor group

3 which does not want to spend substantial amounts of time and money, and perhaps jeopardize the entire investment, in satisfying those concerns often appears to be impossible. In addition to the obvious, the gaming regulatory scheme can impose many specific requirements which may be traps for the unwary. For example, in Nevada, no part of any earnest money may be paid or transferred to a seller without regulatory approval. Nev. Gaming Comm'n Reg (1993) (hereinafter N.G.C.R.). Similarly, a contract for the sale of a gaming premises must specifically set forth who will be responsible for prior gaming taxes. Nev. Rev. Stat These requirements are particularly important in acquisition of sites for new projects. Las Vegas casinos may only be located in specified areas. Nev. Rev. Stat In many states with "riverboat" gaming, casinos must not just be located on a body of water, but on a specific body of water and the number of sites may be limited. See, e.g., Miss. Code Ann (4) and (5); Ind. Code and (1996). These specific requirements differ in each jurisdiction. They may not be logical, but they must be accommodated. III. Financing and Leases The long term nature of financing and lease relationships only amplifies the issues discussed above, since no investigation or warranties can adequately cover future events. While it is common in such transactions to provide that loss of a license (or even acts which are anticipated might result in loss of a license) are events of default, as will be seen below, such provisions may not be much solace in practice. A. Financing Certain financing transactions may require prior approval by the applicable gaming authorities. E.g., N.G.C.R In addition, regulatory authorities usually retain jurisdiction over the licensee's relationship with its lenders and can order those relationships terminated if they believe the licensee's continued relationship with the lender is undesirable. See, e.g., N.G.C.R ; N.J. Stat. Ann. 5:12-63, 64, 76, 80 and 88. As a practical matter, however, in the case of institutional lenders a licensee should not expect the requirement to impose any material risk upon it. Each jurisdiction may also impose certain specific requirements on financing transactions or enforcement proceedings. For example, in Nevada, prior regulatory approval is required for the sale of slot machines. Nev. Rev. Stat However, probably the most important concern for a lender is that to continue operation of a gaming establishment after foreclosure the new purchaser must obtain the necessary approvals prior to that time. This does not accommodate the typical foreclosure process. While bankruptcy proceedings may provide the time and means by which a property can continue to be operated prior to its transfer to a new owner, financing institutions are not likely to look upon bankruptcy laws as existing for their protection. Some lenders have tried to solve the problem by getting the debtor to agree to manage the property until the sale to a new licensee, but it is doubtful that if actually faced with 3

4 the issue a lender would feel comfortable letting its defaulting debtor continue to manage the property after foreclosure. B. Leases Prospective landlords to gaming operators must consider the possibility that they themselves will be required to be licensed. For instance, until recently Nevada gaming authorities held that percentage rent constituted "payments based on earnings, profits or receipts from gaming" and thus required any landlord under such a lease to be licensed. Even when licensing is not mandatory, the gaming authorities may, and particularly in the case of larger transactions usually do, require that the landlord be licensed. See, e.g., N.G.C.R (landlord licensing discretionary); N.J. Stat. Ann. 5:12-82 (landlord licensing mandatory). The licensing process can be time consuming, costly and very invasive. While appropriate agreements can resolve the problems of cost and allocate the risk of delay in opening, they cannot prevent the landlord from being involved in, at best an annoying, and possibly an embarrassing, investigative process. The gaming tenant may well have more at stake in the landlord's licensing than the landlord, for while a denial is merely the loss of an opportunity to the landlord, it can constitute the loss of the tenant's entire investment. The same investigations and warranties that hopefully would protect a seller from committing itself to an unlicensable buyer should reduce the risk to a tenant of being unable to operate because of an unlicensable landlord. Such measures do not, unfortunately, protect against problem assignees or subsequent acts or omissions of an originally satisfactory landlord. Lease provisions making landlord licensing problems an event of default are small comfort in the face of an order from a gaming authority to either cease dealing with a landlord or shut down. Prior approval of landlord assignees is contrary to general leasing practice and would probably be vigorously resisted. Furthermore, such approval rights, at most, provide protection for one moment in time only. The best practicable protection appears to be a covenant by the landlord permitting the tenant to buy the fee interest in the event of a landlord licensing default. In some jurisdictions such a requirement is mandatory. See, e.g., N.J. Stat. Ann. 5:12-82(c)(5). In other jurisdictions, like Nevada, the factors discussed above regarding intra-investor gaming buyout provisions are equally applicable here and result in a wide variety of provisions which only have in common the fact that they leave both parties dissatisfied. As in the case of sales and financings, both parties must also be aware of the specific quirks of each jurisdiction. For example, N.J. Stat. Ann. 5:12-82(c) sets forth specific requirements which must be included in casino hotel leases. 4

5 5 IV. Indian Gaming The primary law applicable to real estate transactions on Indian lands is the Indian Gaming Regulatory Act of 1988 (hereinafter I.G.R.A.), as interpreted and implemented by the Regulations of the National Indian Gaming Commission (hereinafter N.I.G.C.). A. Management Contracts and Land Leases The usual means of outside involvement in casinos on Indian lands is a management contract. A "management contract" is "any contract, subcontract, or collateral agreement between an Indian tribe and a contractor or between a contractor and a subcontractor if such contract or agreement provides for the management of all or part of a gaming operation." 25 C.F.R (1997). If relevant the non-indian operator may also lease land or facilities. Management agreements are subject to approval by the Chairman of the N.I.G.C. 25 U.S.C. 2710(d)(3), (9) and 2711(a)(1) (1995). Leases are subject to approval by the Secretary of the Interior. 25 U.S.C. 81 (1995). There are also specific substantive and procedural provisions which must be included in each management agreement or lease. 25 U.S.C. 2711; 25 C.F.R. pt. 531 (1997); 25 C.F.R (1997). B. Enforcement Indian tribes are sovereign entities. Therefore, the enforcement of management agreements, leases and financing instruments are subject to federal and tribal, but not state, law. In some cases the federal or tribal law may be sufficient. For example, federal law contains detailed provisions regarding lease enforcement. 25 C.F.R In other circumstances, such as mortgage foreclosure, there may be no applicable law. Care must be taken to recognize and try to compensate for these lacunae. As an example, assignments of rents, rather than mortgages, may have to be used as the prime security. It is also important that the relevant agreement include a sovereign immunity waiver by the tribe and involved tribal entities. In the absence of a properly drafted sovereign immunity waiver, a contractor may have very limited recourse in disputes with the contracting tribe or tribal entity. Sovereign immunity waivers typically provide that disputes related to interpretation and enforcement of the contract will be resolved in the United States District Court with jurisdiction of the situs tribal lands. The waiver provisions should be specific and explicit.