Spring Flash Sale – The Debenhams Pre-Pack
By: Tom Bannister, Akin Gump Strauss Hauer & Feld LLP
In the long-running saga of the demise of another stalwart of the British high street, Debenhams, a milestone was reached when the business of Debenhams was sold to a lender group by way of an English pre-packaged administration (a “pre-pack”) in April 2019. Aside from a very public falling-out with its largest shareholder in the lead up to the sale, the pre-pack was notable in that it included the provision for a post-sale valuation. This summary note examines the events leading up to the pre-pack, provides an overview of the pre-pack process and reviews the terms of the pre-pack sale.
Debenhams, operating under top holding company Debenhams plc (the “Parent”) and its subsidiaries (together, the “Group”) was, and remains, a well-established chain of primarily UK-based department stores with a history dating back to 1778. Despite being a household name, Debenhams’ business has suffered from the headwinds affecting the UK retail sector generally, that of rising internet retailing, changing consumer behavior, adverse economic factors such as stagnant levels of household disposal income, uncertain political climate negatively influencing consumer confidence and inflationary pressures from rising minimum salary costs, business rates and a weak pound.
Volatile trading in 2017 led to poor results at its year-end on 2 September 2017 which only worsened into 2018. Interim results for the 26 weeks to 3 March 2018 revealed a 2.4% year on year drop in statutory revenue, and a drop in Group EBITDA of 30.6% year on year. Several profit warnings led to suppliers reducing their exposure to the Group and a reduction in credit insurance provision for suppliers. Both measures placed severe liquidity strain on the Group’s ability to continue running its business.
During the second half of 2018, the Group hired restructuring advisors to form and implement an operational restructuring aimed at reducing costs and increasing efficiency. The significant downgrading of the business outlook was reflected in a material non-cash impairment charge to goodwill of GBP 302m reported in the 2018 annual accounts.
Liquidity pressures and new money
At the time, Debenhams’ capital structure comprised a GBP 320m revolving credit facility due June 2020 (the “RCF”) which ranked pari passu alongside GBP 225m of 5.25% senior unsecured bonds due 2021 (the “Notes”). Other liabilities included a small amount of secured finance leases, and substantial operating lease commitments. The Parent was a public company listed on the London Stock Exchange. Significantly, Sports Direct International plc (“Sports Direct”), majority owned by Mike Ashley, built up a 29% position in the Parent during the first half of 2018. On 1 August 2018, the Parent announced an amendment to the fixed charge covenant in its RCF to increase headroom and thus preserved access to the remaining circa. GBP 160m of undrawn facility. Meanwhile, ratings agencies had published multiple downgrades of the Group and the share price of the Parent had fallen around 65% since the beginning of the year.
At the end of 2018, the Group entered into formal discussions with its RCF lenders and noteholders regarding a restructuring solution, including the provision of new money. The Group also received a number of financing and potential acquisition offers from Sports Direct between December 2018 and April 2019, some of which were subject to the condition that Mike Ashley was installed as CEO, but ultimately all were rejected by the Parent’s Board of Directors. The Board cited concerns relating to the conflict of interest presented by Sports Direct’s ownership of direct competitor department store, House of Fraser, as well as the alleged failure of the proposals to address the Group’s holistic funding and restructuring needs.
Meanwhile, the Group obtained additional funding from its lenders, firstly under a GBP 40m bridge loan secured by first ranking fixed and floating security over all of the Group’s assets, and secondly under a GBP 200m new money facility of which GBP 101.25m under a Facility A was immediately available to refinance the bridge loan and address urgent capex needs. Facility A was secured through first ranking fixed and floating security over all of the Group’s assets, and the RCF, Notes and GBP 60m of pensions obligations were also secured through a combination of second and third ranking security provided by Group subsidiaries (but not the Parent). The remaining GBP 98.75m of the new money facility was put in place, but never utilised because conditions to drawdown were never met. On 9 April 2019, the Parent’s Board concluded that the Parent was insolvent and that losses to creditors would be minimised by facilitating a sale of the Parent’s shares in Debenhams Group Holdings Limited by way of a pre-pack. The Parent’s ordinary shares were suspended from trading on the same day.
The pre-pack process
A pre-pack is a process in which, prior to the appointment of administrators, a distressed company and its major creditors collaborate to agree a sale of the business of the company as a going concern. Administrators are then subsequently appointed and the sale implemented on the same day or shortly thereafter. Frequently, the sale is to a newco owned by the senior creditors themselves. It is usual for no creditors’ meetings to be convened and no court hearings applied for. Pre-packs are similar to pre-negotiated or pre-packaged bankruptcies in US Chapter 11 proceedings, although with fewer formalities.
The use of the pre-pack to implement restructurings has grown following the introduction of out-of court appointments of administrators and their acceptance by the courts. The process has been lauded as a method by which companies continue trading post sale, which in turn facilitates preservation of employment. Other practical advantages include the speed of the sale, lower professional costs, faster access to funds from the purchaser, and the fact that the process can be entirely out-of court which means that costs are arguably lower than alternative processes, such as schemes of arrangement which require a minimum of two court hearings. Such advantages are principally posited upon the theory that pre-packs minimise value destruction, meaning recoveries to creditors should theoretically be higher than a non-prepacked sale in administration.
However, pre-packs have also attracted criticism on a number of grounds, including that unsecured creditors are disenfranchised by the process, which by its nature lacks transparency and therefore accountability; that the terms of the sale are presented to the creditors as a fait accompli and are hard to challenge; that the process is inherently inconsistent with the primary object of the administration regime, namely the rescue of an insolvent debtor as a going concern, because the pre-pack facilitates a sale of the business rather than the debtor’s rescue; and that the speed of the sale can in fact lead to lower recoveries to creditors due to the lack or lower quality of marketing of the business. Pre-packs that involve a sale to management (being “connected parties”) have been criticised as facilitating a subversion of the statutory insolvency waterfall and aiding the sale of the business at an undervalue.
The Debenhams pre-pack
The lenders of the new money facility appointed FTI Consulting LLP as administrators under section 14(1) of Schedule B1 of the Insolvency Act 1986, which permits the holder of a qualifying floating charge (meaning a floating charge(s) over the whole or substantially the whole of a debtor company’s property) to appoint an administrator directly, without the need to apply to the court for an order. The appointment was made on 9 April 2019, and the sale of the Parent’s entire interest in its subsidiaries to a newco owned by the secured lenders of the new money facilities was concluded on the same day. Shareholder recovery was zero.
Where no marketing exercise has been conducted prior to a pre-pack, it is typical for a valuation exercise to be carried out (which, in practice, will almost inevitably support the sale price as being reasonable). This is indeed what happened in Debenhams, where an independent valuation analysis was conducted by BDO which concluded that the enterprise value of the companies sold was substantially lower than the aggregate financial and pensions obligations of the group.
However, somewhat atypically, the Debenhams pre-pack provided for a post-sale marketing of the Group. Whilst some pre-packs provide for a payment top-up by the purchasing entity in the event that the transferred group is subsequently sold for a higher price within a certain number of months of the date of the administration, a full public marketing process conducted post pre-pack sale is unusual. Per the SIP 16 report which the administrators were required to publish explaining the reasons why a pre-pack was pursued, the purpose of the post-sale marketing was to “determine for the [Parent’s] benefit whether, against expectations, there is a bidder, with the benefit of a marketing process run on a stabilised platform, that would buy the business for a price” that would potentially yield returns for shareholders. Given the publicity surrounding the pre-pack and the ferocity of the criticism levelled at the sale by Mike Ashley, it is likely that management, the lenders and the administrators decided to run a post-sale marketing exercise out of an abundance of caution to reduce the risk of challenge by Sports Direct and any other disgruntled creditor or shareholder left out of the money. The sale process was ultimately concluded in May 2019 with only two bids submitted, neither of which were of sufficient value to allow for the full repayment of the Group’s debt.
Ongoing summer reductions
Debenhams continues to roll out its restructuring plan under its new ownership. Steps taken since the pre-pack sale include two company voluntary arrangements (“CVAs”) which will effect the closure of up to 22 stores in 2020, among other cost cutting actions. As an insolvency process, CVAs are attractive because they can be implemented entirely out of court, thereby saving cost and adverse publicity. However, one of the key drawbacks to using the CVA as a restructuring implementation tool is that a challenge can be brought on the grounds of unfair prejudice or material irregularity by a creditor or member who had the right to vote in respect of the CVA up to 28 days from the date that the voting reports are filed with the court, or the date that such creditor or member became aware that the meeting had taken place. Therefore, there is a continuing period of uncertainty for the debtor company or the consenting creditors even after the proposals have obtained the requisite levels of consent in the CVA meetings.
Although challenges to CVAs are typically very rare, it has been reported that applications challenging the Debenhams CVAs have been made by certain parties, including unsurprisingly Sports Direct.