Terra Firma loses EMI as Citibank enforces rights
Terra Firma, the buy-out firm founded by financier Guy Hands, bought EMI for £4.2 billion in 2007 at the top of the credit boom, with debt funding provided by Citibank. Yesterday, Citibank bought EMI from the administrators (PwC) of its holding company (the Holdco) after Holdco defaulted on its loan facilities.
The default may, under the terms of the banking facility agreements, have given Citibank the right to put Holdco into administration. Alternatively (or additionally), the directors of Holdco may have concluded that Holdco should be put into administration in order to avoid the risk of a wrongful trading action.
The principal interest from a legal perspective is the use by the administrators of the pre-pack administration mechanism to transfer EMI to Citibank control.
What is a pre-pack administration?
A pre-pack administration is the sale of a company’s business or assets by an administrator to a buyer that has been lined up by the administrator before the company goes into administration. The sale is completed immediately upon the administration becoming effective. The aim of a pre-pack is to preserve as much value as possible in the underlying business; there is no disruption to its trading, and (depending on the nature of the existing debt) the business is usually transferred with a substantially reduced debt burden, giving the business a greater chance of trading successully in the future.
Pre-packs have been controversial from the perspective of creditors. The buyer of the surviving business is sometimes the previous owner of the now-insolvent company, who is able to continue trading in a new corporate vehicle that uses the assets of the insolvent company but has a reduced debt burden. The creditors of the insolvent company may have a reduced chance of recovering their amounts owed, but the owner effectively retains control of the business.
In an attempt to alleviate these concerns, in January 2009 Statement of Insolvency Practice 16 (SIP 16) was published. SIP 16 requires an administrator to circulate a justification of the pre-pack to the insolvent company’s creditors as soon as possible (i.e. within weeks) after the pre-pack is completed.
The EMI pre-pack
The EMI pre-pack as detailed in this statement by EMI appears to have been straightforward. Holdco was put into administration and its subsidiary, which in turn held all of the share capital of EMI Group Ltd, was then sold by Holdco’s administrators to Citibank for undisclosed consideration (which was presumably nominal). Citibank then completed a debt-for-equity swap to recapitalise EMI Group Ltd.
The end result is that EMI has been recapitalised and now has what its chief executive decribes as a “one of the most robust balance sheets in the industry”. Citibank will have effectively written off, in the debt-for-equity swap, a substantial proportion of the debt owed to it. Terra Firma appears to have lost its entire investment.
The slightly unusual aspect to the pre-pack is that it is the lending bank which has acquired the business of Holdco. Typically, the acquiror of the business would be an unconnected trade buyer or, as discussed above, the previous owner of Holdco. But it is not unprecendented for the senior lending bank to acquire the saved business in this way.
The administrators’ decision to sell to Cititbank
The administrators’s justification of the sale to Citibank will presumably be that the sale enables the surviving EMI business to continue trading with a debt burden that is smaller than if the business had been acquired by a third party, as the administrators will have been aware of Citibank’s intention to write off a substantial proportion of the EMI group debt via the debt-for-equity swap. This in turn should place the other creditors in a better position than if that debt burden had not been so reduced.
The pre-pack also provides certainty of ownership for the business, rather than the instability that might have resulted from a protracted sale process by the administrators.
The administrators will explain their thinking to creditors in their SIP 16 statement, which should be circulated within the next few weeks.
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