The wider implications of the EMI case

The suit between Terra Firma and Citi means a great deal to Guy Hands and his firm’s LPs. It could also have serious implications for the M&A market.

On Wednesday morning, Guy Hands, the founder and chairman of Terra Firma, took his seat in the witness box of court number 26 in the Rolls Building, the modern home of the UK's High Court of Justice. His cross-examination at the hands of famed barrister Mark Howard QC, representing Citi, will continue until at least Monday. 

This is part two of the legal battle between Terra Firma and the New York-headquartered bank. Terra Firma, which claims Citi pushed it into buying EMI under false pretences in 2007, lost the first round – a court case which took place in New York in 2010 – but that verdict was overturned in 2013, opening the door to a retrial. The ill-fated investment in EMI ultimately cost investors in Terra Firma's second and third funds around £1.6 billion ($2.3 billion; €2 billion), which the firm is seeking to win back from Citi in the courtroom. 

The case has clear implications for Citi, Hands and LPs in Terra Firma's funds: in short, reputation and a substantial amount of money. 

For the LPs, a successful claim could mean a marked improvement in the performance of their investments. Terra Firma Capital Partners III, the €5.4 billion 2006-vintage fund which bore the brunt of the EMI investment, was valued at 0.6x investors' money as of March 2016. Approximately a third of that fund's equity (circa €1.6 billion) has been absorbed by the EMI loss . If that money could be returned – according to a “back of a cigarette packet” calculation – it would push the fund nearer to 0.9x. 

The significance of the case for Hands' reputation varies depending on your perspective. 

If you are Citi's legal counsel, this case represents yet another roll of the dice by a man whose reputation has been destroyed and sees this as a route to redemption. “The outcome of this litigation is extremely important to you professionally and personally. That is correct?” asked Howard in the early stages of his questioning. “This is how you resurrect your reputation. 

If you are Hands, the opposite is true: this legal process – pursued in the interest of investors – has further tarnished his already battered reputation. His ambitions for Terra Firma to become a “mega-firm” have been thwarted not necessarily by the investment loss relating to EMI, but by the aftermath. 

“What has caused our problem, is that we haven't moved on,” Hands told the court. “The reality is lots of firms lost £1.5 billion or more and moved on.” 

The ramifications of the case could, however, reach wider than the principal players (and their investors). 

Part of Hands' testimony under cross-examination focused on the allegedly common practice of leaking information between bidders in an auction process (in direct contravention to the non-disclosure agreements signed by the parties involved). 

“I can give you examples of numerous auctions in which confidential information is disclosed. It's something that happens on an everyday basis in the City,” said Hands under oath. While you don't want information on your bid leaked to other bidders, “you assume it will happen”, he added. 

If the judge, Mr Justice Burton, ultimately gives credence to Hands' claims – that auctions are frequently “gamed” – the Financial Conduct Authority (FCA) could be compelled to investigate: either this specific case or wider market practice. 

While tight resources at the FCA mean it tends to focus more on protecting consumers than corporate investors, “things could be different if the evidence suggests there's a widespread market integrity or efficiency problem of some kind”, says one senior regulatory lawyer who previously worked at the regulator. 

“The FCA would find it difficult not to investigate, especially in today's environment, if the court criticised it for not identifying and tackling common market problems sooner, or it did something else to draw the FCA's attention to specific issues,” he said. 

Understandably, this case continues to draw a lot of attention, from both the private equity industry and beyond.