There’s so much sharp practice in private equity contracts that it’s hard to know where to begin 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 narrow carveouts. Even losses from criminal conduct are subject to indemnification…if the party can dream up a credible-sounding way to claim that they they didn’t know their actions were 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, who is advised by his own counsel and often hires consultants and other advisors. 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 or 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 both 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. It also has an indemnification section in case you’d like to compare.
The key issue is the scope of the term Triggering Event, which is in the definitions 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 carves 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 Apollo limited partners are on the hook for successful claims of breach of fiduciary duty by Caesars 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 interprets 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 pretty much 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 Paul Weiss operated in a overly chummy manner. The only thing that is likely to be unusual about Paul Weiss’s behavior is that it came to light. Apollo spreads so much in legal fees across so many firms that it is has high odds of being able to gin up a favorable legal opinion in the unlikely event 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.
We also encourage readers to have a gander through the Apollo VIII limited partnership agreement. A couple of its noteworthy provisions:
Apollo has its own version of KKR Capstone, KKR’s captive consulting firm. As descried at length in the Wall Street Journal, investors assumed that KKR Capstone was an affiliate of KKR and hence its services were covered by their management fee, when in fact KKR was billing Capstone to portfolio companies as a third-party provider.
You can find the relevant section for Apollo’s consulting firm by searching for “Apollo Investment Consulting LLC” which appears under the defined term “Consulting”. It’s clearly an affiliate and Apollo, unlike KKR, doesn’t try to pretend otherwise. Instead, they simply carve it out completely from the management fee offset. In addition, a search on LinkedIn shows only two individuals listed as ever having worked for this organization. That suggests a lot of fees may be run through it for very little actual effort (for instance, they “supervise” consultants like McKinsey and Bain that do the real work).
Apollo also has “Special Fees,” which are the portfolio company fees generally. That section says that “Investment Banking” fees are subject to management fee offsets. Yet later, the very paragraph states that any fees paid to the Apollo “Affiliated Broker Dealer” are carved out. So what’s the difference between an “Investment Banking” fee and a “Broker Dealer” fee? Not a lot, it seems.
And remember, what is really scandalous about these provisions isn’t that Apollo asked for them. Anyone who does business with Leon Black should recognize that they are dealing with a fabulously aggressive character. The outrage is that investors went along.
This provision also makes a mockery of the pet claim that comes regularly from limited partners, that they spend a great deal of effort on making sure their interests are aligned with those of the general partners. In fact over 60% of the income for large general partners comes from fees that do not depend on performance, which means they get rich whether or not the fund does well. In the case of Apollo, on the Caesars’ deal, it got back its equity contribution via the transaction fees it charged to close the deal. And thy have indemnification against “losses” even when they have no skin in the game. Nice work if you can get it.
Update 7:00 PM. Hoisted from comments. By Ed Walker, former state securities regulator and staff member to the FCIC:
The idea of a fraudulent conveyance is one of those remarkable things in law that sound like one thing, but are in fact another. In bankruptcy cases, 11 USC Sec. 548 governs. Here’s a link: https://www.law.cornell.edu/uscode/text/11/548. The operative provisions define a fraudulent conveyance as one of two things. First, the transfer was intended to hinder, delay or defraud creditors. Second, the transfer was made for less than full consideration and either a) either before or after the transfer was complete the debtor was insolvent, or b) after the transfer the debtor had insufficient capital for the business it plans to undertake; or c) the debtor intended to incur debts that it could not repay.
The first head requires proof of intent, which is hard. Most cases are brought under the second heading, parts b and c, because there is no issue of intent. That means that there is no criminal case to be proved, despite the fact that the statute is written this way to cover the problem of proving fraudulent intent. There is no proof of fraud in these cases either, and whether the action meets one of the other levels is unlikely as Yves points out. So, most likely the fraudulent conveyance action is not a Triggering Event, and indemnification is permitted even if the transfer is set aside.
Note that the General Partner is in a position to settle the case, as Dino Rino says above, and that will mean no issue of intent will arise, and the damages become subject to indemnification, or at least a lawsuit will be required by a group of investors who have already proven themselves mostly incompetent and who will have already lost a bunch of money.
In a private equity fund, this kind of transfer is anticipated. The whole point is to screw the acquired company for the benefit of the managers and perhaps a few dollars to the investors. There are many cases where creditors have accused the managers of fraudulent conveyances, and many have been won by the creditors either in full or by settlement. This is a known risk, that the investor’s money is being used primarily to benefit the managers. Therefore the investors should not indemnify the managers, and in fact should not bear any of the costs or expenses of defense or investigation. with regard to any claim of a fraudulent conveyance.
_____
* The SEC has taken the position that private equity fund managers nevertheless have a fiduciary duty under the Investment Company Act of 1940. However, that does limited partners less good than one might think, since only the SEC can bring an action under the Investment Company Act.
Apollo-Investment-Fund-VIII-Indemnification-Sanitized
Apollo Investment Fund VIII Indemnification Sanitized
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– 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.
I begin to understand why you recommended Mandelbrot for an economics primer.
– A cloud is made of billows upon billows upon billows that look like clouds. As you come closer to a cloud you don’t get something smooth, but irregularities at a smaller scale.
More specific for private equity:
– A fractal is a mathematical set or concrete object that is irregular or fragmented at all scales
Thank you for making my case about legalized fraud in this dispute. Damn that pesky fine print. The bankruptcy judge in this case has had it with all the parties and instructed them to settle or he will throw the case out and send it to liquidation. The fraud claim is just a spot of bother. More than anything, this is a face saving maneuver. The creditors were playing with Other People’s Money and while they have substantial egg on their face, they also may have skeletons in their closet when all parties were on the best of terms. Only so much pressure will be applied. When you hire lawyers to chase down the money you’ve already lost in cases like this, it’s already too late. This was a train wreck hiding in plain sight from day one. Hard to feel sorry for such sophisticated investors.
To the extent that LPs are public pension funds which have a fiduciary obligation to their beneficiaries, could whoever signed off on these be sued, personally, for their complicity in this scheme to loot their clients?
In theory pension plan beneficiaries would have the standing to sue, as well as arguably California taxpayers, who would suffer by ultimately backstopping CalPERS. However, it could be tricky in the cases of CalPERS, since in effect many local government bodies contract their pension management to CalPERS. That might insulate them in many cases.
On the one hand, as a beneficiary, you would be suing yourself, since any damages would come out of plan assets, which is your and other pensioners’ money. But in states like California and Illinois where the pension commitments have a pretty strong legal protections, the plan would have to get the money from somewhere to cover the damages. On the other, a suit could be conceived (to your point) to target key individuals rather than to be about money damages. In California. board members of public pension plans are personally liable, although they have directors and officers insurance to give them a lot of cover. And they have government indemnification too, as does staff. But the flip side is these agencies are political bodies, and a serious suit (one that went somewhere and exposed dirty laundry) would get the legislature and the press on the pension funds’ case. Those are the two things they are really afraid of.
The response by the officers and directors will be that they were advised by fiduciary counsel as well as other professionals, so you’d need to impugn them as conflicted. The problem is that it’s pretty hard to get someone for being derelict in their duty when they’ve gotten advisors to sign off. But a suit could expose the issue of capture and could put everyone on the defensive.
However, the interesting play would be for the beneficiaries association to personally sue Leon Black and Apollo for using former CalPERS board member Al Villalobos as placement agent for these funds, not just Apollo VI for the Caesar’s fraud, but also other Apollo vehicles.
It can be argued, based on Villalobos’s own pre-suicide bankruptcy filings against Black and Apollo, that undue influence was exercised on CalPERS staff by Apollo acting through its agents, in particular on former board member and former CEO Fred Buenrostro, who has admitted taking kick-backs from Villalobos (who had an exclusive placement deal with Apollo) and is pending sentencing in federal district court in San Francisco. The current CEO, current CIO, and current GC of CalPERS are all cronies of Buenrostro and have been spinning wildly attempting to cover-up the extent of the “heads-I-win-tails-you-lose” deals that the board was hoodwinked the into believing had been properly vetted.
I, for one, would love to see this scenario play out. There are plenty of retired lawyers and judges with time on their hands who also have a stake as CalPERS and JRS beneficiaries — if they wanted to work together on such a lawsuit. Leon Black and Apollo are where the money went. It should be disgorged for the benefit of the taxpayers who are otherwise on the hook for the pensions CalPERS is required to guarantee under the California constitution.
I do like that…particularly since the Steptoe report whitewash depicts Apollo as victim, when Leon Black has never been anyone’s victim, and the agreement that Apollo signed to make restitution was a napkin doodle (see here for details: http://www.nakedcapitalism.com/2014/03/calpers-private-equity-scandals-steptoe-johnson-report-whitewash.html)
The big problem is that Black will bury anyone who opposes him in legal costs. I had a billionaire former client (~#80 on the world list, worth about $18 billion at the time) sue JP Morgan for losing $100 million on a $1 billion cash management account which had strict guidelines about putting the $ in safe liquid stuff. They dumped toxic garbage into it in the summer of 2007.
JPM put three pricey law firms against him. The whole point was to make the exercise way more costly for him.
The difference here is that there are literally thousands of retired lawyers and judges dependent on CalPERS — remember, the California Judicial Retirement System (JRS) is managed by CalPERS.
CalPERS is currently engaged in a glossy “nothing-to-see-here-move-along” advertising campaign to lull beneficiaries into thinking that they’re making their numbers. I just got a mailer touting the illusory returns that they’ve front-loaded into these PE deals. If the real numbers became known, a massive pool of very talented lawyers could be mobilized against these crooked deals — pro bono.
Wait, lemme get this straight — these guys expect me to indemnify them *and pay for the privelege* if they engage in criminal activity?
You gotta be kidding. WHY would anyone sign that??? Even my very blue-collar co-workers know better than that, they would catch a clause like that in a heartbeat and say “nope”…
. . . WHY would anyone sign that??? . .
The pension fund signing officers are afraid they won’t get the Sunday afternoon pleasure cruise on the Pirate Equity luxury galleon. Plus, it isn’t their money.
“Other people’s money.”
In addition, there is a huge amount of groupthink on Wall St: you don’t want to stick out in a bad way, so you have to play in PE. And Apollo and TPG are ‘top shelf’ names. It takes nads to stand up and say FU to these guys, and it’s usually only the very big asset managers who can get away with it. But then again, it’s other people’s money.
The most troubling aspect of it all is that is has become a game of how much you can get away with. No one cares whether an action or an indenture provision is good or right; you ask for everything, and take as much as you can get. That’s the rot at the heart of the system.
Wall Street uses the language of a predator.
We have all read about a financier subject to a fawning profile in a business rag use the expression “I kill what I eat” or “making a killing” as if the customer is there to satisfy a sadistic pleasure.
It boggles my mind why anyone would sit at any table with them, knowing you were the meal. I view heavy debt as a way to force people to the table. Then one is eaten by the predator, one slow painful bite at a time, over a lifetime.
More importantly, this is a hostage situation. Not only do investors own a proverbial sh*tte sandwich, they will have to pay a king’s ransom in legal fees in order to attempt to enforce the narrow exceptions to this unconscionable agreement, compounding their losses even further. Most of the investors would rather pretend that this isn’t happening than realize the losses.
Reminds me of this from another thread:
– Because Uber drivers aren’t traditional employees, but independent contractors who assented to Uber’s anticompetitive terms, they are plausibly co-conspirators under the U.S. Supreme Court’s 1939 ruling in Interstate Circuit v. U.S., according to the plaintiffs.
This sounds similar to the ‘freedom of contract’ rationale for striking down child labor laws, among others.
Bible Revelation 9:11
New International Version
They had as king over them the angel of the Abyss, whose name in Hebrew is Abaddon and in Greek is Apollyon (that is, Destroyer).
Apollyon is Greek for Apollo. They might as well have called their PE firm SATAN’S GLOBAL MANAGEMENT.
Leon Black and Josh Harris are both members of the treasonous Council On Foreign Relations also Josh Harris is an adviser to the treasonous NY Federal Reserve.
The Apollo fund that put up the equity for Caesars — is this the same fund whose CalPERS investment was investigated for having been secured via kickback a couple years ago? (Both were around 2007-08 I believe.)
Apollo VI is one of the funds in which the late Al Villalobos acted as placement agent for Leon Black with CalPERS. See the complaint against Villalobos and former CalPERS CEO Fred Buenrostro, L.A. Sup. Ct. case SCI07850 and Villalobos’ Ch. 11 bankruptcy filing in Nevada, Case No. 3:10-bk-52248-gwz
You’d think that this contract alone, with all it’s indemnification aforethought, would be clear proof of intent to defraud – because it virtually states that so much law is up in the air about their slippery deals that investors might have to bail them out. This in turn says they are most definitely fraudulent because they are not dealing in anything we have come to think of as a “security” or a proper investment for a pension fund. And I’ve heard that the IRS usually wins its fraudulent conveyance cases – so maybe there is hope for nailing all these embezzlers. But the question really is, as buddha asks, Why would anyone sign this crap? Let alone a fiduciary.
Apollo Globle management has McGraw-Hill Education as an asset under management. McGraw-Hill Education is one of the largest publishers of the treasonous Common Core Educational Materials. Check out this video of a former Chinese slave turned American patriot, explain why Common Core should be called Commie Core.
https://www.youtube.com/watch?…
The idea of a fraudulent conveyance is one of those remarkable things in law that sound like one thing, but are in fact another. In bankruptcy cases, 11 USC Sec. 548 governs. Here’s a link: https://www.law.cornell.edu/uscode/text/11/548. The operative provisions define a fraudulent conveyance as one of two things. First, the transfer was intended to hinder, delay or defraud creditors. Second, the transfer was made for less than full consideration and either a) either before or after the transfer was complete the debtor was insolvent, or b) after the transfer the debtor had insufficient capital for the business it plans to undertake; or c) the debtor intended to incur debts that it could not repay.
The first head requires proof of intent, which is hard. Most cases are brought under the second heading, parts b and c, because there is no issue of intent. That means that there is no criminal case to be proved, despite the fact that the statute is written this way to cover the problem of proving fraudulent intent. There is no proof of fraud in these cases either, and whether the action meets one of the other levels is unlikely as Yves points out. So, most likely the fraudulent conveyance action is not a Triggering Event, and indemnification is permitted even if the transfer is set aside.
Note that the General Partner is in a position to settle the case, as Dino Rino says above, and that will mean no issue of intent will arise, and the damages become subject to indemnification, or at least a lawsuit will be required by a group of investors who have already proven themselves mostly incompetent and who will have already lost a bunch of money.
In a private equity fund, this kind of transfer is anticipated. The whole point is to screw the acquired company for the benefit of the managers and perhaps a few dollars to the investors. There are many cases where creditors have accused the managers of fraudulent conveyances, and many have been won by the creditors either in full or by settlement. This is a known risk, that the investor’s money is being used primarily to benefit the managers. Therefore the investors should not indemnify the managers, and in fact should not bear any of the costs or expenses of defense or investigation. with regard to any claim of a fraudulent conveyance.
This is really helpful, thanks!
Thanks for the excellent breakdown. The mafia calls it a “bust out” and a “skim”.
i’m a total nubie when it comes to contract language for PE “financial products”,
yet i’m struck by how similar such seems to clauses being included in current IoT product EULA’s;
total indemnification for the purveyor & product fitness constraints are engineered by entrained
legalize to be rendered non-existent.
with the breakdown of the rule-of-law in the west, i can’t see how this ends well for either pursuit.
you have to imagine (or do some research) that PE brought in a lot of positive returns over a certain period, though the looting seems to result in diminishing returns and negative performance
it’s hard to litigate when your returns are negative, though certain investors are vast
When my kids go on field trips, they often come home with waivers which actually include gross negligence.
I’ve refused to sign many times yet I seem to be the only weirdo pushing back… I keep on being told that it would not hold up in court. When I tell them that I don’t want to have to go to court or that one has to have a lot of money to go to court I’m still looked at as a freak. The probabilities are so low you see that I guess everyone thinks my brain has computation problems.
It’s everywhere. The general population is desensitized. They don’t seem to understand that all these clauses are leading us down the slippery road to mediocrity.