BROKEN PROMISES

Published: Sunday, December 3, 1995
Edition: THIRD
Section: NATIONAL
Page: A1
Byline: By JEFFREY MEITRODT Staff writer

Text:

There wasn't much the New Orleans City Council failed to get when it negotiated a casino lease with Christopher Hemmeter in the spring of 1993. Thirty million dollars in upfront cash payments. A 5 percent stake in what was then expected to be the world's largest casino. Ambitious minority hiring goals.

But the council, over the objections of two of its most outspoken members, refused to make one demand that would have significantly rewritten the worst-case scenario unfolding today in U.S. bankruptcy court.

The city could have required Hemmeter, and later his partners in Harrah's Jazz Co., to buy a one-time insurance policy that would have given New Orleans the money needed to complete the half-finished casino that sits at the foot of Canal Street.

In the real estate world, it's known as a performance bond, and against the advice of City Councilwomen Peggy Wilson and Jackie Clarkson, Hemmeter and the partnership he later formed with Harrah's and a group of nine local businessmen was never forced to buy one.

Instead, the casino company agreed to a package of "completion guarantees" that city and state officials are beginning to recognize might not be worth the paper they're printed on.

"We should be in the driver's seat right now, but instead we're in a corner where we have to give concessions or be left with a blight in the heart of our downtown," said Clarkson, now a state representative for New Orleans. "I think it's pathetic."

Since Harrah's Jazz Co. filed for Chapter 11 bankruptcy Nov. 22, local officials have been trying to find out if the company is going to live up to its commitment to complete the permanent casino.

So far, the answers have been discouraging.

In a hearing Tuesday before the state casino board, company officials said the refusal of one of their lenders, Bankers Trust, to disburse $175 million in loan proceeds effectively nullified Harrah's guarantee to finish the project.

The announcement sent shock waves through the casino board, which, like the city, thought it had an escape-proof commitment from the casino company.

But one of Harrah's local partners, who asked not to be identified, says the company "sandbagged" the casino board. While the company "unconditionally" and "irrevocably" guaranteed to the board it would finish the permanent casino, that guarantee, which is part of the state's contract with Harrah's, is subject to two conditions.

First, Harrah's is off the hook in the event of "force majeure," legal language for such disasters as nuclear war, acts of terrorism and riots. Second, the guarantee is void if the project's lenders fail to make available previously committed money.

"They ran a fast one on the board," said the casino investor, who is part of the Jazzville group. "This board thought that $175 million loan was a sure thing."

The city's negotiators apparently did a better job, because the city's completion guarantee has no escape clauses.

Under the city's deal, the responsibility for finishing the project rests with Embassy Suites Inc., an affiliate of Harrah's that is not in bankruptcy.

Ralph Berry, a spokesman for the casino's parent company, Memphis-based Harrah's Entertainment Inc., said all of the company's "obligations under the completion guarantees . . . are suspended, since Harrah's Jazz was unable to obtain loans or available funds under the bank credit facilities agreement."

"Obviously, Harrah's has put the city in a very bad position, and the city has to make sure Harrah's follows through with what it agreed to do," said Ed Markle, a local lawyer and chief legal adviser to former Mayor Sidney Barthelemy during lease negotiations. "All we need to do now is sue Embassy Suites."

Mayor Marc Morial declined to comment on his view of the city's legal position on the completion guarantee.

Performance bonds costly

A trip to the courthouse might have been averted if the City Council had backed Clarkson's proposal that the casino developer be required to buy a performance bond.

But back in 1993, when the city struck its deal with Hemmeter, most of Clarkson's colleagues, as well as the city's advisers, said a performance bond was an unnecessary expense.

Las Vegas lawyer Bruce Leslie, who represented the council in lease negotiations, said council members said if Harrah's was forced to buy the performance bond, the cost would have come out of other concessions to the city.

"There was a recognition that that money could be better spent on a school district or something else," Leslie said. "This was revenue to the city that the city could use, rather than posting a bond, which would just be an additional expense."

Another argument, Leslie said, was that the cost of a bond would have been prohibitive. "The developer represented to us that a performance bond would be unavailable, or would be excessive in cost," he said.

But experts said either Hemmeter or Harrah's Jazz Co. could have bought a performance bond for about $6 million, roughly one fifth of the money Hemmeter agreed to give the city before starting construction.

By obtaining a performance bond, the buyer is insured against the collapse of a real estate project, since the policy provides enough money to complete construction.

In small projects, such as a neighborhood shopping center, a performance bond typically costs 0.5 percent to 1 percent of the construction budget, said Allan Kotin, a Los Angeles real estate consultant whose firm, Sedway Kotin Mouchly Group, specializes in big private-public partnerships.

On larger projects, such as the casino, the figure can run as high as 3 percent of construction costs. Kotin said Harrah's probably could have bought a bond for its $400 million casino for 1.5 percent to 2 percent of costs, or $6 million to $8 million.

"It's a very expensive, single-purpose insurance policy," Kotin said. But, he added, "it's always enforceable."

Guarantee hard to enforce

That isn't the case with completion guarantees, which the city and the state accepted in lieu of performance bonds.

"In point of fact, completion guarantees prove very difficult to enforce," Kotin said. "In the real world, what they really do is raise the threshold at which you break the deal."

In other words, by agreeing to a completion guarantee, a developer puts the assets of his corporation at risk because the other party, in this case the city and state, can sue to force performance.

Markle said the city's completion guarantee should hold up, and he predicted that Embassy Suites, as required by the company's one-paragraph completion guarantee, will eventually pay the estimated $200 million to $250 million needed to complete the casino.

But another former adviser to the city, who asked to remain anonymous, is less confident.

"I am told by lawyers, which I am astonished by, that the federal trustee in a bankruptcy case can ignore a state or a privately negotiated contract," the adviser said. "None of my lawyers told me I was negotiating a hard-sought paragraph that had no economic value if it occurred."

In retrospect, this consultant said, "I wish to hell we had" a performance bond. "I'd love to have an uninvolved third-party with a contractual obligation to complete this project," he said.

3 advisers made the deal

The job of negotiating a deal with Hemmeter, and later Harrah's Jazz, fell primarily to three city consultants: Ron Nabonne, Barthelemy's longtime unpaid legal and political adviser; Markle, a local lawyer; and Donald Zuchelli, who has managed development projects nationwide.

Markle and Zuchelli now work for the Rivergate Development Corp., the city's casino oversight board.

Councilwoman Wilson, who supported Clarkson's performance bond proposal, said the city was poorly served by its advisers.

"I always felt like the consultants were on the other side, and I told them so," Wilson said. "They were part of the cheering squad. I don't think they took tough positions to make sure we protected the city."

Not surprisingly, the consultants disagree.

Markle said the team deserves credit for winning dozens of concessions from the casino developers, including the completion guarantee.

"Harrah's didn't want to give a completion guarantee at all," Markle said. "That had to be negotiated, and at first they wanted all kinds of exceptions. But our position was that there were no exceptions."

Though Clarkson argued for a performance bond, the city's consultants tried to deflect her, in part, one adviser says, because they thought they had fooled Harrah's into agreeing to a guarantee that was tougher than the company wanted.

"I kept telling Jackie to keep her mouth shut," said the adviser who spoke on the condition of anonymity. "I did not want Harrah's to know that I thought we had an unconstrained completion guarantee. The more she pushed (a performance bond), the more nervous I got."

Clarkson, who ultimately voted for the casino lease, says she was unfairly accused of being "anti-casino."

"I personally felt I could no longer get rid of the casino, so I'd better make it as good as I could make it," she said. "I just wanted to make sure we were protected. I was afraid that they were going to test the market at our expense."

Eventually, the council ruled against requiring a performance bond of either Hemmeter or Harrah's Jazz. Hemmeter teamed up with Harrah's and the Jazzville group a few months before the state awarded the group an operating license in 1994.

The consultants said they figured a completion guarantee would be effective because Harrah's couldn't afford to jeopardize its operations in other parts of the country. Moreover, they were reassured by the size of Embassy Suites, the guarantor, which has billions of dollars in assets.

But the advisers acknowledge they didn't make Harrah's get a price on a performance bond.

"Assume you get a performance bond from XYZ Insurance Co.," Markle said. "Then say Harrah's has defaulted and we ask the insurance company to perform. Who says they can't go bankrupt, too? Then what good is the performance bond."

Experts, however, say that would be a remote possibility.

Bill Thompson, an expert on gambling at the University of Nevada-Las Vegas, said the city's biggest problem was its focus on how much upfront cash it could squeeze out of the casino.

"They were greedy when they should have been cautious," Thompson said. "They should have realized that if the casino makes money, they all make money. They didn't have to take it all up front."

So what happens next?

"This thing hasn't played out yet," said Leslie, the attorney who represented the City Council. "It's a little early for people to be pointing fingers at each other. All we know for sure is Harrah's has filed for bankruptcy, and there is nothing the city could have done to prevent that from happening."

Loopholes in contract

As bad as the city's position might be, the state's is worse. At the same time the council was putting the finishing touches on its no-escape-clause completion guarantee, the casino board was giving Harrah's Jazz what it wanted: loopholes.

"The question is: Why didn't they (the casino board) do what they were supposed to do and make sure the money was there for Harrah's to do the things it had committed to do?" City Councilman Jim Singleton said. "They're the enforcement agency. We only negotiated a lease with them."

Max Chastain, chairman of the state casino board, said the board wasn't aware that a significant loophole existed in its contract with Harrah's. He said the board didn't think Bankers Trust could withdraw its loan commitment.

Moreover, Chastain said there were concerns that the cost of a performance bond would be passed onto Harrah's partners, perhaps squeezing minority investors out of the project.

Nevertheless, Chastain says he thinks Harrah's is in a tighter position than it realizes.

By claiming that the Bankers Trust action nullifies its completion guarantee, he said, the casino company has exposed itself to potential criminal prosecution.

Chastain, a former FBI agent, has a fairly complicated chain of reasoning. If the bank's money was not available last month, as Harrah's claims, then the company should not have signed its contract with the state, which was contingent on financing.

"If they're correct, and the investment funds were not available, then the operating contract never took effect and they were operating illegally," Chastain said.

Conversely, if the money was available, as Harrah's told the board when it signed the contract in 1994, then the state's completion guarantee is still in effect, Chastain said.

Either way, Chastain acknowledged, the board will have to fight it out with the company in bankruptcy court.

"No one has convinced me that this completion guarantee isn't going to be honored," Chastain said. "It may be dragged out in the courts, but I think we're on real solid ground."

Thompson isn't so sure. He says he thinks the casino company deliberately positioned itself to get out of the New Orleans casino by inserting the Bankers Trust loophole into its completion agreement.

"I bet they had their eyes on that from the beginning," Thompson said. "I think they put that in knowing full well they might want to bail out on this project. And they wanted to be able to blame it all on the bank."

Illustration: When the city and the state negotiated deals with Harrah's to build the casino, they could have required an insurance policy guaranteeing that the building would be finished. Neither chose to do so. Now as construction is halted, fear is growing that a protracted, expensive court fight may be necessary to make Harrah's keep its promise - and even that might fail.

STAFF PHOTO ILLUSTRATION BY GEORGE BERKE AND G. ANDREW BOYD

1992: HEMMETER'S PALATIAL VISION WAS CONSIDERED TOO GRAND.[COLOR]

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1993: THE STATE REJECTED JAZZVILLE'S RENOVATED RIVERGATE PLAN.[COLOR]

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