There’s so much sharp practice in private equity contracts that it’s hard to know where to being describing their tricks and traps. But the train wreck of the Caesars bankruptcy, which was brought to investors by private equity kingpins Apollo and TPG, puts the spotlight on one of the most rancid “heads we win, tails you lose” features of these agreements: sweeping indemnification provisions which no fiduciary should accept.

We’ve attached the indemnification section from Apollo’s most recent “flagship” fund, Apollo VIII, at the end of this post, and have just added the full limited partnership agreement for Apollo VIII to our Document Trove. And to give you a quick preview: it provides for investors to reimburse Apollo for “all losses,” with very narrow carveouts, even if they engage in criminal conduct…if they can dream up a way to claim that they they didn’t know it was criminal.

For those new to the concept, indemnification is a contractual obligation by one party to an agreement to pay another for certain losses, liabilities, or damages. The sweeping indemnification language in private equity agreements evolved, or rather devolved, from mergers and acquisitions advisory agreements. But the circumstances are utterly different. In M&A, you have an active principal, either a CEO or a business owner, and in most cases a board of directors will also have to approve a deal. The M&A advisor is concerned about legal liability, such as being sued by minority shareholders or by the buyer/seller for having second thoughts after the deal has closed. However, investment bankers being investment bankers, the indemnification is broad, generally with only a “bad faith and gross negligence” out.

By contrast, in private equity, the general partner is completely in charge. Why should passive investors give such broad protection against his bad actions when they have no ability to oversee, much the less constrain his behavior? And that’s before you get to the fact that other sections of limited partnership agreements waive the general partner’s fiduciary duty.* One common means of doing that is to provide that the general partner may consider interests other than that of the investors in his fund, including his own interest.

The Caesars bankruptcy puts the role of these indemnification agreements in sharp focus. As we wrote earlier this month:

Private equity firms Apollo and TPG did such an effective and over-zealous job of asset stripping after loading up their 2008 acquisition, Caesars Entertainment, with over $18 billion of debt that they’ve been hauled into court by creditors who are charing the two firms with fraudulent conveyance. And yes, sports fans, the operative word is fraud. The underlying idea is that if a company is insolvent, yet the people in charge divert cash or other assets to themselves, they’ve stolen from creditors and need to give the money back…..

FT Alphaville gives more detail:

Caesars went much further than standard capital market maneuvers, engaging in a series of complex sales of casinos and intellectual property as well as financings, allegedly to benefit its private equity owners Apollo Global and TPG to the detriment of creditors. These gambits included setting up an entirely new public company called Caesars Acquisition Corporation to buy several Caesars properties and the infamous release of a debt guarantee possibly enabled by a perhaps poorly-worded indenture.

Those transfers bothered creditors enough that they filed multiple lawsuits in 2014 and 2015 against various Caesars entities accusing the parent company, Caesars Entertainment Corporation (CEC) and its private equity owners of “looting” the subsidiary company where the assets and the debt were situated, Caesars Entertainment Operating Company (CEOC).

The big question underlying all the claims of fraudulent transfers and breaches of duty is whether CEOC, the subsidiary of CEC, was solvent, or not…

The Examiner concluded claims related to fraudulent transfers, breaches of fiduciary duty, and the aiding and abetting breaches of Caesars management and its sponsors were worth between $3.6bn and $5bn.

But if you read the indemnification language below, you’ll see that if the creditors prevail, Apollo may be able to impose some of these costs on investors like CalPERS, which is doubly exposed, having invested in the Apollo and TPG funds that acquired Caesars. Mind you, this is the indemnification section from Apollo VIII, when the Apollo fund that looted, um, invested in Caesars was Apollo VI, but the provisions are likely to be very similar. We also have a TPG limited partnership agreement in our Document Trove, for a TPG credit fund. But it also has an indemnification section in case you’d like to compare.

The key issue is the reach of the term Triggering Event, which is in the definition section. Here is the set-up:

To the fullest extent permitted by applicable law, the Partnership shall indemnify each Indemnified Person against all losses, claims, damages or liabilities….unless such loss, claim, damage or liability results from any action or omission which constitutes, with respect to such Person, a Triggering Event;

And a Triggering Event is:

With respect to any Person, (a) the criminal conviction of, or admission by consent by or plea of no contest by, such Person to a material violation of United States federal securities laws, or any rule or regulation promulgated thereunder, or any other criminal statute involving a material breach of fiduciary duty, (b) the conviction of such Person of a felony under any United States federal or state statute, (c) the commission by such Person of an action, or the omission by such Person to take an action, if such commission or omission constitutes bad faith, gross negligence, willful misconduct, fraud or willful or reckless disregard for such Person’s duties to the Partnership or the Limited Partners, or (d) a finding by any court or governmental body of competent jurisdiction in a final judgment that such Person has received any material improper personal benefit as a result of its breach of any covenant, agreement, representation or warranty contained in this Agreement or the Subscription Agreements.

The open question is whether the various claims made by the creditors, namely “fraudulent transfers, breaches of fiduciary duty, and the aiding and abetting breaches of Caesars management and its sponsors,” constitute “the commission by such Person of an action, or the omission by such Person to take an action, if such commission or omission constitutes bad faith, gross negligence, willful misconduct, fraud or willful or reckless disregard for such Person’s duties to the Partnership or the Limited Partners.” From a common-sense standpoint, you’d think they would. But Apollo and TPG almost certainly had lawyers in the loop on every important step they took. Unless they disregarded the attorneys’ advice, that would seem to get them off the hook as far as “bad faith, gross negligence, willful misconduct” are concerned. I welcome lawyers weighing in, but as I read it, the Triggering Event waiver carve out violations of fiduciary duty (to the extent they exist, remember they’ve been gutted elsewhere) between the Indemnified Persons and the limited partners. But the creditors are asserting a separate set of fiduciary duties that kick in when a company becomes insolvent. So as I read it, the limited partners are on the hook for successful claims of breach of fiduciary duty by creditors.

And we have the open question of whether fraudulent conveyance constitutes fraud. Again, a layperson would assume it has to. But as this section is set up, Apollo makes the determination of how to interpret the terms; investors have to challenge it if they disagree. The Advisory Committee is simply notified of indemnification claims over $10 million. While the agreement does provide that a payment will not be made over the objections of the Advisory Board, this protection is meaningless for two reasons. First, the investors have to rouse themselves to object when notified, meaning a vote is not stipulated as part of the process. General partners make an art form of stacking their Advisory Committees so that they have a clear majority of complacent, friendly support. Second, as the Financial Times made clear it its story on Caesars, Apollo’s counsel Fried Frank operated in a overly chummy manner. The only thing that is likely unusual about this case is that it came to light. Apollo spreads so much in legal fees across so many firms that it is likely to be able to gin up a favorable opinion in the unlikely situation that it needed one.

So the “who is on the hook for fraudulent conveyance damages” hinges on how creative and cheeky Apollo is willing to be.

Here are some other oh-so-clever provisions from this section:

“If we didn’t think it wasn’t criminal, you are on the hook.” Here is the language:

In addition, indemnification shall be permitted with respect to a criminal Proceeding only if the Indemnified Person did not have reasonable cause to believe that its conduct was unlawful.

As we’ve seen from repeated performances of “I’m the CEO and I know nothing,” highly paid individuals can be remarkably adept at feigning ignorance when it’s important to them. In the absence of incriminating evidence, like e-mails, one can easily imagine how creative a general partner in the hot lights might get. As one lawyer riffed this out, “Oh, yes, my attorney did write that memo saying it was criminal to sell drugs to children. But I thought “children” meant under 12, and we sold them only to teenagers.”

Indemnification payments can be clawed back out of distributions. And the indemnification provisions survive the termination of the partnership.




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