Cross-border restructuring in emerging markets
August 2016 | LEGAL & REGULATORY | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
Corporate financial distress and non-performing loans continue to make headlines in all financial markets, but have features in emerging markets that make them particularly challenging. They represent both a risk and an opportunity for international banks and debt investors active outside of their home markets. Debt restructuring in emerging markets has additional dimensions, whether they arise from political risks and economic instability or regulatory and legal uncertainty. This article focuses on some factors to consider before implementing an ‘amend and extend’ style restructuring or a disposal or purchase of loans in emerging markets.
Distressed debt is an asset class for which there is renewed appetite from investment funds. However, debt disposals in emerging markets tend to suffer from a lack of liquid markets, adverse regulation and other legal impediments. For example, in certain jurisdictions, it is not possible to hold security without being licensed locally as a financial institution. In other jurisdictions, cross-border loans must be registered with the central bank and any change to the terms of the loan – including the lender – is also registrable. Registration of a new lender may require the cooperation of the borrower (effectively giving the borrower a veto over the transfer).
So, a debt sale as an exit strategy may not be available in all circumstances. Similarly, potential acquirers of debt will need to consider local regulations and local debt markets (if these exist) at an early stage. However, as has been the case in more established markets, the persistence of non-performing loans have in many places prompted the passing of legislation seeking to facilitate the disposal of loans, particularly to alleviate pressure on banks’ balance sheets. This may well open up opportunities in the near future.
Out of court restructurings preferred
Where an ‘amend and extend’ route is being pursued, out of court restructurings, i.e., consensual arrangements between all or a large proportion of creditors and the borrower, are usually preferred. In countries characterised by weak judicial institutions and untested legal infrastructure, the insolvency regimes often do not offer robust instruments for a court-approved restructuring (in contrast to more developed regimes, such as the English law scheme of arrangements). To give greater certainty of outcomes, contractual arrangements are advisable, although they carry some risks that need to be addressed.
Ability of dissenting lenders to interfere
The key issue in any restructuring is whether a sufficient number of creditors are willing to compromise their claims in the interest of a viable solution that will, over time, generate higher recoveries. In some jurisdictions, statutory regimes are available that permit a cram down, so that dissenting minority lenders are forced to abide by the terms of a majority-sponsored restructuring, e.g., English law schemes of arrangements or US Chapter 11 proceedings. Cram down regimes are usually administered by the courts.
Where cram down is not possible, the question for those creditors seeking a financial restructuring is: to what extent can the work-out proposal accommodate dissenting creditors being repaid ahead of the compromising creditors? Where reliance is placed on a consensual restructuring, the effect of dissenting creditors exercising their rights against the borrower needs to be considered and managed at all stages of the restructuring.
It should be noted that dissenting creditors are not necessarily free riders, i.e., taking advantage of the compromise of others by requiring repayment of their claims that the borrower would not be able to afford. For example, where the local banking industry is characterised by recent bank insolvencies, debt may be held by governmental debt resolution agencies, bad banks or similar wind-down vehicles, or perhaps administered by an insolvency officer. Governmental debt resolution agencies, especially, may be under a statutory prohibition to agree to an extension of maturities or a debt compromise. Other lenders, particularly those whose debt is of a short-term nature, may be commercially unable to commit to a conversion to long-term restructuring and their position will have to be managed.
On the other side of the argument, lenders need to consider to what extent the restructuring agreement will restrict the borrower’s ability to perform its obligations toward dissenting creditors. If so, will any consequent breaches by the borrower of these obligations result in liability for the creditors who are part of the restructuring (for example, under a doctrine of collusive behaviour)?
Streamlining disparate security packages
A financial restructuring brings the interests of disparate lenders together under a unified arrangement aimed at ensuring orderly repayment of the amounts owed to participating creditors, or, if this fails, providing for a coordinated enforcement process. Ideally, all existing security would be transferred to a security agent to be held on behalf of, and enforced for the benefit of all participating creditors. However, this may be difficult or even impossible to implement for a variety of legal reasons – for example, because transfers of security may not be recognised unless in parallel with a transfer of the underlying debt, and security agency may not be a recognised concept under local law. The restructuring agreement and associated documents may try to structure around such limitations.
Enforcing the restructuring agreement
To implement the terms of the work-out, the restructuring agreement will include a stand still arrangement, intercreditor terms and the commercial terms of the restructuring. Where a substantial part of the debt of the borrower is owed to international lenders, the restructuring agreement will usually be governed by the laws of a third party jurisdiction regarded as neutral and predictable (this is often English law). In many jurisdictions, it is advisable for disputes to be referred to arbitration, so as to take advantage of the favourable procedure for enforcing arbitral awards offered by the New York Convention.
Key intercreditor issues include when may a lender enforce the security it holds, and how should that lender share enforcement proceeds with other lenders? Of course, creditors will be concerned to ensure that the restructuring agreement can be enforced against the borrower, not least because creditors will have valid claims under their existing debt documentation already. The more difficult question, however, is whether the restructuring, especially the security sharing provisions, can be enforced against the other lenders.
Not all jurisdictions will readily enforce intercreditor arrangements of this type, so that some reliance will have to be placed on an offshore judgment or arbitral award carrying sufficient weight with the participating lenders. This will be the case where all lenders have activities in the jurisdiction of the intercreditor against which could be enforced or where there is reputational risk. However, in some situations, intercreditor arrangements can come under strain, e.g., if a lender is not fully integrated into the international banking scene, or the local lender has more leverage with the borrower than international creditors, or where a lender itself is in financial difficulties and is either sold to a party that takes a more opportunist view or enters an insolvency process.
Is an IFI involved?
Where an international financial institution (such as EBRD or IFC) is involved, it is more likely that the restructuring will proceed along an internationally recognised pattern, such as the INSOL principles. IFIs may also be able to discipline other creditors and ensure that they cooperate to some extent. Traditionally, IFIs will seek a turnaround of the borrower, so will not be sellers of their loan portion. Investors and co-lenders can take comfort from this, but will need to be able to commit to the investment for the time it takes to achieve a rehabilitation of the borrower. For a debt investor this means that debt by a borrower who has large IFI loans will be a safer investment, but it is more likely to require a long-term commitment from the investor.
A number of challenges arise in cross-border restructurings of debt in emerging markets, the most important of which this article has attempted to highlight. Some of these challenges may be risks that cannot be overcome in the specific circumstances, but careful analysis will identify the risks that the investor or restructuring creditor faces, thereby contributing to an informed decision making process.
Jan Peter Weiland is international counsel and Charez Golvala is a partner at Chadbourne & Parke LLP. Mr Weiland can be contacted on +44 (0)20 7337 8175 or by email: firstname.lastname@example.org. Mr Golvala can be contacted on +44 (0)20 7337 8020 or by email email@example.com.
© Financier Worldwide
Jan Peter Weiland and Charez Golvala
Chadbourne & Parke LLP