Restructuring: a how-to guide: successful debt restructurings in emerging markets require careful planning by foreign creditors

International Economy, The, Nov-Dec, 2001 by Steven T. Kargman

Since the onset of the Asian financial crisis, many foreign creditors have been faced with the challenge of restructuring troubled loans to private companies in the emerging markets. Foreign creditors have been reminded once again of how difficult and vexing it can be to achieve a successful and timely debt restructuring in the emerging markets.

The Asian financial crisis spawned several large-scale restructurings of borrowers in Asian countries such as Indonesia, the Philippines, Malaysia, Thailand, and Korea. Restructurings have spanned a diverse range of industries and have involved companies and conglomerates with interests in the finance, telecom, auto, cement, and petrochemical sectors, among others. In several of these restructurings, the corporate indebtedness of the respective debtors has totaled more than one billion dollars.

There was also collateral fallout from the Asian financial crisis on borrowers in other regions such as Latin America. Certain companies in this region were adversely affected by contracting demand in Asia, global oversupply of product and the consequent downward pressures on prices.

Although a few years have now passed since the onset of the Asian financial crisis, a number of major restructurings in Asia and elsewhere still remain unresolved. Some of the negotiations with debtors in these markets have proven to be more protracted and tortuous than many foreign creditors may have ever expected when they entered into restructuring discussions with debtors a few years ago. The debtor companies might claim that much of the delay in closing some of these restructurings can be attributed to the intricacies of the specific restructuring transactions or the complexities of their particular businesses and their capital and corporate structures. But foreign creditors in particular might point to additional factors to provide a possible explanation for some of the delays, such as the role of the local insolvency laws and local legal systems as well as the involvement of the "controlling shareholders" or owners of the debtor companies.

Foreign creditors have sometimes been frustrated by the local courts and local insolvency law systems that, among other things, may bear limited resemblance to Western systems. Specifically, in certain instances, foreign creditors may perceive that the local courts and insolvency laws do not provide them with a level playing field for pursuing creditor remedies and relief vis-a-vis local debtors. The insolvency laws themselves may be inhospitable to creditor interests generally, whether the creditors are foreign or domestic. For example, the former Mexican suspension of payments law, which was replaced in May 2000 with a new insolvency law, provided debtors with numerous opportunities for delay. As a consequence, it was not unheard of for suspension of payments proceedings to extend over a period of many years, even ten or more years in some cases. (The Mexican suspension of payments law remains in effect for cases filed before May 2000, and there are still several large cases pending under the old law.)

As a result of such lack of a level playing field, foreign creditors may in certain circumstances either be disinclined to turn to the local courts in the first instance or possibly be faced with adverse court rulings if they do choose to resort to the local courts. In some cases, foreign creditors may have concerns about the fairness and independence of the local courts. They may also have questions about the expertise of local judges, particularly in those systems where non-bankruptcy judges may be assigned to hear insolvency cases with all of their inherent complexities.

In addition, foreign creditors have been faced with some court decisions in the emerging markets that they have found truly baffling. For example, a 1999 court ruling in Indonesia, later reversed on appeal, rejected the bankruptcy petition of the World Bank affiliate, the International Finance Corporation (IFC), on the grounds that the Indonesian debtor, Dharmala Agri-food, was not in default on the principal whose stated maturity date was not yet due. The court reached this result even though the debtor was, in fact, in default on interest payments and the loan had been accelerated.

As well as confronting concerns relating to the local legal system, foreign creditors have not infrequently been faced with the prospect of having to negotiate with the controlling shareholders of these companies, and these may be individuals who represent influential family interests in the local countries. In a number of cases, these controlling shareholders and their extended family may also hold senior management positions in the debtor company, since there is often not the clear distinction between ownership and management that is more typical of Western public companies. Given the possibility that some of these controlling shareholders may occupy prominent and well-connected positions in their respective societies, they may feel that they have limited pressure or incentive to reach a quick or fair settlement with their creditors. Moreover, creditors may find it extremely difficult to dislodge the controlling shareholders from their management positions and/or equity holdings in the restructured company.