In this era of rushed financings and hectic corporate restructurings, internal controls and procedures are more important than ever. Adding litigious shareholders and debtholders to the mix means it’s never been more important to make sure the right sets of eyes review transaction documents and the right quality controls are in place.

A couple of stories brought to us today, courtesy of two large public companies, should strike fear into the hearts of chief financial officers, treasurers and lawyers alike. They serve as cautionary tales about how lack of attention to detail may lead to investor lawsuits and ultimately to unforeseen liability.

Caesers Entertainment
Mid-2014, Caesars Entertainment undertook a series of transactions that effectively removed its guarantee of a portion of $18 billion of debt issued by a subsidiary. In a complex restructuring transaction, Caesars got out of the guarantee basically by selling 5% of the subsidiary’s equity to institutional investors in a private transaction, relying on unclear language in the indenture (shown in the box to the right) to obtain a release of the parent company guarantee of the those bonds.
Essentially, the provision allowing for the release of a guarantee set forth three separate conditions, only the latter two of which were connected by the word “and”. Bondholders argued that extinguishing the guarantee required Caesars to satisfy all three clauses. However, even a less-than-thoughtful read of the provision would indicate that it only makes sense if the “and” were an “or”. Which leads one to believe this was all just the result of a drafting mistake.

Of course, you could say that, because the bondholders should have read the indenture carefully before investing, they should have appreciated the error.  Whether that’s a fair expectation is probably too controversial to address here.

Unfortunately, the disclosure in the related offering document was inconsistent with Caeser’s interpretation of the guarantee release provision. Furthermore, it seems this situation is perfectly suited for a risk factor like “By the way, we can extinguish this parent guarantee just by selling a negligible amount of the subsidiary issuer’s stock” (more eloquently written of course!).

Causes of action seeking to reinstate the parent guarantee are currently a part of the bankruptcy proceedings of Caesars’ main operating unit. In addition, Caesars faces at least four lawsuits by creditors seeking to undo the series of refinancing and asset transfers that were consummated before bankruptcy proceedings were instituted. In January, a federal court refused to dismiss one of the noteholder claims by holding that the removal of the creditor guarantors and the asset transfers were a violation of the Trust Indenture Act.

Even if courts side with Caesers based on a practical read of the indenture provision, Caesars will have spent valuable time, effort and resources on an issue that could have been prevented by a careful review of the indenture.

General Motors Liquidation
In late 2008, General Motors began the process to pay off a 2001 credit financing and directed its counsel to prepare the documents necessary to release the administrative agent’s security interests from that existing loan. GM’s lawyers prepared termination statements to release the security interests, but inadvertently included the release of a different lien – on all the equipment and fixtures at 42 GM facilities – related to a financing completed earlier in 2008. Neither GM, the agent, nor any of the lawyers for either party noticed the error, and the termination statements (including the termination related to the 2008 financing) were filed with the agent’s approval.

Fast forward to 2009 – GM files for bankruptcy and the improper termination is discovered. The unsecured creditors committee filed a lawsuit asking the bankruptcy court to hold that the agent was unsecured on the 2008 financing due to the filing of the termination statement. As expected, the agent argued that the filed termination statement was void and invalid because it never authorized the filing of a termination statement related to the 2008 financing. In other words, the agent argued that its subjective intention should govern regardless of the facial validity of the termination.

The Second Circuit disagreed. In its opinion earlier this year, the court held that subjective intent was irrelevant since the agent had authorized the filing of the termination statement, even though it was mistaken as to what it was releasing. It appears that the agent’s $1.5 billion claim in the GM bankruptcy will be treated as unsecured, an outcome that may be hard to explain to the lender pool that thought its lending risk was protected by collateral security.

The Culprit
I cannot pretend to know where the breakdown occurred, or what may have prevented it, in either of these specific instances. More generally, however, the culprits tend to fall into the following categories:

• use of form documents and precedents, particularly in the case of a frequent issuer/borrower
• lightening-speed transactions involving unreasonable turnaround demands
• over-reliance on inexperienced personnel
• siloed responsibilities where individuals are not given “big picture” context
• post-negotiation fatigue, which leads to a lack of focus on documentation and execution

The Moral
While it might seem like a tall order to ask that company personnel – whether in the legal, finance or treasury departments – read cover-to-cover lengthy, dry debt documents and technical, cumbersome lien releases, more robust internal procedures over contract execution might have prevented costly oversights like these.

The lessons to be learned from these snafus extend to all aspects of any capital raise or financing transaction. It is essential that a company institute proper procedures and oversight protection to ensure that the implementation of financing documents (including later amendments) is done properly and reflects the business deal. It may be the rare case that involves a mistaken release on a billion dollar loan, but this kind of mistake is destined to happen without the right eyes to review. While the money spent on outside counsel should result in bulletproof drafting and execution, their efforts are unfortunately not a substitute for the review and involvement of company personnel that are in the trenches on negotiation.

A related issue is whether related disclosure about a transaction accurately reflects all of the materials terms if, as in the Caesers case, the operative documents are ambiguous – or worse, do not reflect the actual intent of the parties. The inability to timely gather and communicate to management the accurate terms of a transaction could put the company’s internal controls over financial reporting and disclosure controls in jeopardy.