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Shocker: U of L has right to buy KFC Yum! Center if Arena Authority defaults

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KFC Yum! Center

KFC Yum! Center … a bargain at twice the price.

(Editor’s note: This post was updated at 1:30 p.m. on August 2. The original version mischaracterized the University of Louisville’s position regarding a National Basketball Association team coming to Louisville.)

Joseph Heller’s iconic book “Catch-22″ revolves around a fictional clause in military rules so absurd it has come to define contradictory, circular logic.

As one of the characters remarks, “That’s some catch, that Catch-22.”

Critics see a Catch-22 in University of Louisville’s lease for KFC Yum! Center – a clause that states U of L has the right to buy the downtown arena in the event of a default.

It’s a Catch-22, critics say, because the University of Louisville Athletic Association controls booking dates, limiting the potential for outside income, while taking the majority of revenue under the lease in an arrangement that’s looking more and more financially untenable.

In essence, the clause sets up scenarios – most of which are highly unlikely – in which U of L officials could refuse to alter the agreement to ensure money is available to service the $348 million in municipal debt issued to build the arena, then buy the arena for a much lower price.

How can this be?

Because Section 47, the “Right of Tenant” clause in the lease, states that U of L essentially has the right to buy the KFC Yum! Center it leases in the event the owner – Arena Authority – defaults.

The section states:

“… before the Mortgagee may solicit or consider any unsolicited offers to purchase the Arena, Tenant will have a period of 90 days after the date on which the Mortgagee acquires title to the Arena to give notice to the Mortgagee that it will purchase the Arena at the price that is sufficient to retire … all then outstanding Arena Bonds …”

And just for the record, “retiring all then outstanding Arena Bonds” doesn’t mean paying the face value because defaults typically involve negotiations leading to debt write-downs or restructurings.

We interviewed three top Louisville attorneys about the clause, and they were unanimous that U of L has a right of first refusal. All three have ties to the university and asked to remain unidentified.

An attorney at a top firm initially described the clause as “unusual,” adding the right to buy the arena after a default “would be typical of what a marquee tenant would want.”

Another attorney and contract expert said, “This is precisely what I would have hoped U of L would do. They’d be crazy not to.”

But a third contract attorney said, “How often have you heard of the tenant having a lease giving them the right to buy a house if the house goes into foreclosure? Wouldn’t that be an incentive to NOT pay rent … or to pay it so slowly it inflicts pain on the owner?”

Mark Hebert, U of L  director of communications, said the clause was included to make certain the U of L mens’ basketball team wasn’t left without a place to play in a worst-case scenario, and to make certain an NBA team wouldn’t play in the arena at the expense of university programs.

“We wanted a seat at the table in case of a worst case scenario of bankruptcy or foreclosure; to protect our lease in case of a change of ownership,” Hebert said, adding that U of L officials didn’t want an NBA owner coming in and getting control of the arena, parking an NBA team there for five years while milking tax incentives, then moving on.

The attorneys we consulted said the clause sets up default scenarios in which the university could appeal to bond holder trustees in default negotiations that might include bondholders cutting a deal to ensure they recovered their principle, if not the interest, or restructuring the debt terms with more favorable interest rates.

But J. Bruce Miller, an attorney who is trying to bring a National Basketball Association team to Louisville, said he’s read Section 47 “at least 47 times.”

Miller said he believes the U of L lease will be thrown out by a bankruptcy court. And yes, he says “Will …”

The high interest rates (between 6 percent and 7 percent) on the bonds combined with the tax shortfall from the taxing district means “without a shadow of a doubt, there will be a default,” he said.

We’ll cover the internal details on the bond issues in another post. Here, we want to simply look at the scenarios Section 47 might generate.

U of L officials from the beginning said an NBA team in Louisville would damage the men’s basketball program. Those officials have repeatedly stated that U of L will not alter terms of the lease, which give U of L’s Athletics Association more than 80 percent of arena revenues.

Critics of the contract say the clause guarantees U of L has no incentive to adjust the contract to increase the amount of money available to service the debt. “It’s crazy. A built-in conflict in trying to get (U of L Coach Rick) Pitino and (Athletic Director Tom) Jurich to agree (to the downtown site),” one critic told us. “They had to do it to get (U of L officials) to agree” to the riverfront location rather than an arena on the Belknap Campus or at the Kentucky State Fair and Exposition Center.

Right now, the arena authority is paying only the interest on the $348 million, which totals about $525 million with interest over 20 years.

In late May, Moody’s Investors Services downgraded the arena bonds to a junk rating because Moody’s analysts doubt the tax increment financing district revenue can service the debt.

The arena TIF district generated only $2.1 million in 2011 versus a forecast of $6.7 million.

From the Moody’s downgrade notice:

The downgrade principally reflects the lower than expected state sales TIF revenues, high operating expenses of the arena, increased dependence on the Metro Louisville’s additional payments, and the weakened financial metrics going forward. The rating outlook is negative. The negative outlook reflects the uncertainty of TIF revenue growth as well as the narrow debt service coverage ratio going forward. Current near to midterm coverage ratio forecasts fall short of initial projections even after taking into account the expected growth of future TIF revenues. TIF revenues may not fully support the arena’s debt service as initially projected in the near future.

For 2012, the authority anticipates being about $3 million short of its $19.9 million payment. In 2018, tax payers will then be responsible for paying both the interest and the principal, which at the current interest rate is about $20 million per annum.

Back when the arena plans were being hashed out, former Arena Authority Chairman Jim Host said the authority “likely would use money set aside for maintenance to cover that gap.” But during the most recent Arena Authority meeting on July 16, board discussions were about the spread between the debt service obligation and actual revenues.

Arena Authority member Dan Ulmer told the board, “We’re responsible to pay the bonds. We have no reserve. The deal was for (AEG) to pay $1 million up front to start to build a reserve.”

Los Angeles-based Anschutz Entertainment Group, owned by the Anschutz family, just received a 10-year contract to manage KFC Yum! Center after the Kentucky Fair Board operating expenses – including inflated salaries for friends and relatives of Fair Board President and CEO Harold Workman – ate up all the operating income.

Arena Authority Chairman Larry Hayes said at the same meeting the Arena Authority’s job is to “pay for this building … or we’re going to be making a call on city tax resources.”

No one from the Arena Authority board would agree to an on-the-record interview. State officials and Arena Authority officials declined to give Insider Louisville a copy of the arena financial report.

State officials referred Insider Louisville to executives at Goldman Sachs in New York for the report. Goldman Sachs officials did not return email requests for comment.

NBA promoter J. Bruce Miller said the U of L clause has never affected his dealing with potential investors in an NBA team.

Ultimately, it won’t matter, Miller added: “You can’t service $350 million in debt with one prime tenant. When the time comes and we have a chance at a quality (NBA) organization, I believe everyone will get quite realistic” making a financial assessment on what’s “best for the community.”

Which he believes is the addition of an NBA team at the arena.

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