Emerging markets Asian restructurings – more international yet more local?
March 2015 | SPECIAL REPORT: GLOBAL RESTRUCTURING & INSOLVENCY
Financier Worldwide Magazine
The combined effect of developments in domestic bankruptcy regimes in certain key Asian countries, an increased willingness in Asia to adopt ‘international restructuring tourism’ and the continued offshore structuring of debt instruments in Asia have materially impacted the ways in which Asian businesses are restructured. In this brief overview, we explore the evolution of Asian restructurings from the out-of-court ‘consensual renegotiations’ of the 1990s to the current situation that often involves both local and offshore formal restructuring processes. This evolving trend draws from what we see as the simultaneous globalisation and localisation of Asian restructurings.
Historical context: the early years (1990s to 2000s)
In this period (including the Asian financial crisis of the late 1990s), few restructurings in emerging market Asia (meaning most Asian countries but excluding Singapore and Hong Kong whose legal systems have developed more quickly than their neighbours) involved any form of legal process. There was little confidence in legal processes and judicial systems in emerging markets Asia that were perceived as being unpredictable and time-consuming. Local bankruptcy laws were also viewed as being underdeveloped. For example, prior to the Asian financial crisis, Indonesia had a basic bankruptcy law that was a legacy of the Dutch system, and only began to modernise its law in 1997 following pressure from the International Monetary Fund. In China, the Enterprise Bankruptcy Law was many years in the making with an initial draft published in 1994 and the new law becoming effective in 2007.
Against this backdrop, there was little or no interest in using court processes to achieve a successful restructuring. Valiant efforts were, however, made to ‘contractually construct’ restructuring tools that are routinely available in developed court restructuring processes. A good example was the ‘non-signing lender’ concept that was deployed in certain Indonesian restructurings in the late 1990s. This was a contractual term under which, once an agreed majority of creditors approved a consensual contractual restructuring plan, the plan would move forward. ‘Signing lenders’ would be paid in accordance with the plan and cash would be set aside for ‘non-signing lenders’ who would begin to receive payments once they accepted the plan. Of course, the ‘non-signing lenders’ were not bound by the plan but it proved to be an effective psychological tool in shepherding hold-outs into a consensual restructuring in the absence of a legally enforceable cram-down.
With the benefit of hindsight, it may be that the consensual renegotiation model worked largely due to the sheer scale of the debt problems in Indonesia, Thailand and Korea in the late 1990s and early 2000s. The size of the problem meant that debtors and creditors were more open to compromise. However, absent special circumstances, consensual renegotiations are deficient in two major ways: (i) the unavailability of a stay with respect to litigating creditors that is necessary to provide stability from which a restructuring plan may be developed and agreed; and (ii) a legally enforceable cram-down under which hold-outs (i.e., dissenting creditors) can be forced to accept a restructuring plan.
The changing profile of the creditor pool in Asia in recent years is also an important factor in the inadequacy of the consensual renegotiation approach. The arrival of distressed funds in Asia and the existence of a more active secondary market debt trading environment, means that the relationship approach that is generally an important element of consensual renegotiations is less prevalent nowadays in Asia. Major restructurings in Asia will now often involve many creditor constituencies with diverse views and positions – from par lenders to distressed funds to multilaterals and government creditors. Finding consensus is therefore more challenging.
Schemes of arrangement
This changing market landscape means that Asian companies and creditors have begun to consider alternative methods, including court supervised strategies, as a means of achieving a successful restructuring. The scheme of arrangement has emerged as a prominent tool in this respect. For instance, the Indonesian state airline, Garuda Indonesia, achieved a successful balance sheet restructuring through parallel schemes in England and Singapore in 2001. Mobile-8 Telecom Finance Company BV, a company registered under the laws of the Netherlands with its main telecommunications business operations in Indonesia, restructured international bond debt by way of an English scheme in 2011. More recently, Vietnamese state-owned shipbuilder, Vinashin, restructured a syndicated loan facility in 2013 through an English scheme.
What are the attractions of a scheme in implementing a restructuring? The key attraction is the ability to cram down minority dissenting creditors once the plan is approved by the statutory majority of creditors (75 percent in value and more than one-half in number under the UK model) and sanctioned by the court. The threat of a cram-down alters the psychology of a restructuring because hold-outs can no longer be certain that they have leverage. This is crucial in large restructurings in Asia given the increasing diversity of the creditor community. Finding a consensus among a diverse group of creditors is challenging, and the ability to cram down dissenting creditors often becomes the key to a successful restructuring.
The other main advantage is the possibility of obtaining a stay of legal proceedings subsequent to the application to court by a debtor in a scheme proceeding (with any such stay at the court’s discretion). This is sometimes needed in Asia in order to provide the stability necessary to shepherd the deal through (though if there are few assets outside the emerging markets home base of the debtor, this may not be crucial since the challenges inherent in the local legal system may provide a de facto stay). In certain cases (most prevalent in China-related restructurings where the debt issuing entity is a Cayman, BVI or similar entity) a ‘light touch’ provisional liquidator may be appointed over that entity in order to achieve an automatic stay (without having to rely on the discretion of the court in the context of a pure scheme). Such an automatic stay is also likely to be broader than a stay granted by the court in a scheme process. The basic role of a ‘light touch’ provisional liquidator would be to shepherd the scheme through with the added protection of the stay on litigation that a provisional liquidator brings. However, many Asian debtors try to avoid this unless absolutely necessary since the stigma of liquidation, albeit provisional, tends to be off-putting.
Unlike other formal corporate rescue mechanisms, a scheme is not an insolvency proceeding (and was not originally formulated as a restructuring tool). It therefore does not carry the stigma of a ‘sinking ship’ or a failing business. The fact that a scheme can just as readily be a mergers and acquisition tool makes it a more palatable restructuring process in Asia. Just as important is the fact that the debtor retains control over the management of the company. This addresses a fear of loss of control that is often encountered in Asia where there is great resistance to the surrender of control over family-owned businesses.
A scheme – while attractive – does not come without challenges. Asian debtors have to pass the jurisdiction hurdle of the relevant offshore court and, even if the scheme is sanctioned, it has to be recognised (or be capable of being given effect) in the home jurisdiction of the debtor and any other jurisdiction where the debtor has material assets. That said, perfect solutions are rarely available in emerging markets or other cross-border restructurings and the scheme is likely to remain a popular restructuring tool in Asia.
Emergence of the English courts
Most recently, the English courts have taken centre stage in the world of schemes and have become the main port of call for distressed companies in Europe. This trend has also arrived in Asia. The key to the emergence of the English courts is the ease at which foreign (i.e., non-UK) companies may now establish the English courts’ jurisdiction to implement a restructuring through an English scheme. Put briefly, the English courts have recently decided that the mere fact that a credit agreement is governed by English law is sufficient for the English courts to have jurisdiction. This includes cases where the governing law of a credit document is changed to English law in order to give the English court jurisdiction.
The English courts offer Asia-based debtors a high degree of certainty in achieving a successful restructuring. This includes certainty in the experience and commercial-mindedness of judges and the sophisticated approach to complex restructurings in the decision-making of the English courts.
How does the United States feature in the Asian restructurings?
While the United States’ bankruptcy regime is arguably the world’s most ‘welcoming’, debtor-friendly and sophisticated, this appeal has not translated into any significant interest from Asian debtors. The basic jurisdictional nexus required is the holding of property in the United States – which has been interpreted by United States’ courts to include a modest amount of dollars in a US bank account and unused portions of retainers provided by a debtor to local US counsel. The filing of petitions (both voluntarily and involuntarily) under Title 11 of the US Code (Chapter 11) automatically provides a worldwide moratorium against legal proceedings. Many ‘tried and tested’ restructuring techniques are available to debtors in the context of a US bankruptcy proceeding and the efficiency and sophistication of the process should, in theory, be attractive to Asian debtors.
Nevertheless, Asian debtors and Asia-based creditors have not really embraced the US bankruptcy system. Firstly, there is an inherent anxiety among Asian debtors that a Chapter 11 process is a lawyer-driven and litigious process. Secondly, unlike a scheme, the Chapter 11 process and the stigma associated with being seen to be involved in a bankruptcy does not sit well with family-controlled Asian debtors. Thirdly, there is sometimes a fear among directors and officers of Asian companies that a US bankruptcy proceeding could create a forum in which they could be sued and the cost and risk of reputational damage is off-putting. This fear is amplified by the number of fraudulent preference actions, securities litigation and derivative actions in the US and the notoriety of US class-action law suits in Asia. Fourthly, there is also a perceived risk of being ‘trapped’ in a Chapter 11 process with no ability to ‘simply reverse’ from the process as in an English scheme. These factors have led to an under-enthusiastic use of the US bankruptcy regime in Asian restructurings.
Localisation and Asian processes
The globalisation of Asian restructuring and the embrace of ‘restructuring tourism’ is just one chapter in the recent Asian restructuring story. There has also been a simultaneous review (and in some cases rewriting) of domestic bankruptcy laws in a number of significant emerging markets Asian countries, most notably Indonesia and China.
Indonesia has modernised its bankruptcy laws – initially (at the encouragement of the IMF) in 1997/1998, and again in 2004. A key development has been the arrival of a corporate rescue mechanism or a suspension of debt payment obligation (PKPU) process. PKPU is essentially a court-supervised rehabilitative procedure which protects the debtor from enforcement actions from creditors through an automatic moratorium, and which allows the debtor to work out a debt restructuring or composition plan with its creditors. The absolutely key ingredient of a PKPU is the statutorily prescribed timeline (a maximum of 270 days which has been strictly adhered to) for the restructuring to be approved by the creditors and the court. A failure to achieve the requisite voting thresholds in support of the composition plan within the timeline will result in the liquidation of the debtor. The importance of the PKPU process can be seen from the high-profile restructurings that have featured a PKPU in recent years. This includes Arpeni Pratama Ocean Line, Berlian Laju Tanker and Trans Pacific Petrochemical Indotama. Indeed, there were 73 PKPU petitions filed in Indonesia in 2014 alone, and 84 in 2013.
China introduced a new Enterprise Bankruptcy Law in 2007 (following a thorough review of the US and English insolvency regimes). Under this law, a debtor or a creditor may apply for reorganisation, a corporate rescue mechanism which gives a debtor protection from litigation whilst it reorganises its business and prepares a reorganisation plan which will be voted on by the creditors, (thereby resembling the United States’ Chapter 11 process). Alternatively, a debtor may apply for a composition process, a court-supervised procedure which allows the debtor to propose a composition agreement to creditors (similar to an English scheme). Any application under the Enterprise Bankruptcy Law is subject to the broad discretion of the Chinese court in deciding whether to accept it as a bankruptcy case which may restrict debtors’ access to the Chinese courts. There have also been questions raised with respect to the efficacy of the automatic stay given its limited nature and uncertainty in the manner in which it operates.
To date, the journey in the localisation of Asian restructurings has not been a smooth one. The ‘tussle’ between local and foreign creditors inevitably intensifies when there is a domestic legal process. Local creditors may well feel that they will do better in – or at least be better able to control – a local restructuring process so there is increased tension among creditors. Foreign creditors may legitimately feel disadvantaged in a domestic proceeding and this is often exacerbated by the nature of offshore debt instruments in Asia – where offshore creditors are not infrequently structurally subordinated to local creditors.
The contemporaneous globalisation and localisation of Asian restructurings reflects the rise of Asia and the global nature of emerging markets Asian companies. This will inevitably grow as Asia and Asian companies become a bigger part of global business. Creativity and openness of mind to new restructuring strategies for Asian companies is likely to be a consistent restructuring theme in the future. A critical question is whether a link or connection between local Asian legal processes and processes outside Asia will be established. How this question is answered may constitute the next chapter in the Asian restructuring story.
Bertie Mehigan is a partner at Ashurst LLP. He can be contacted on +65 6602 9177 or by email: firstname.lastname@example.org. The author would like to thank Darinne Ko and Anthony Wijaya for their assistance with this article.
© Financier Worldwide