Restructuring: a how-to guide: successful debt restructurings in emerging markets require careful planning by foreign creditors.
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.
In light of all of these formidable obstacles facing foreign creditors when working on restructurings in the emerging markets, foreign creditors would be well advised to focus on developing comprehensive and cohesive strategies for managing the restructuring process. The aim of these strategies would be to accelerate the process for reaching restructuring solutions as well as to enhance the leverage of foreign creditors in the negotiation process itself, or at a minimum to neutralize some of the advantages of the debtor in this process.
The creditors should ultimately adopt a multi-faceted strategy for effectively managing and advancing the restructuring process. The following are three possible components of such a broader strategy framework:
Developing a Workable Creditor Steering Committee Structure. In most restructurings, at the outset of the process, the creditors generally form a steering committee to coordinate creditor interests and handle negotiations with the debtor. But some steering committees operate more effectively than others do, and therefore it is critical that this first step by the creditors in organizing and forming a steering committee be given the consideration and attention it deserves.
In designing a steering committee, creditors generally seek to have creditors with the largest exposures represented. They also seek to have the steering committee be representative of what may possibly be a diverse universe of creditor interests. Thus, while each steering committee will be slightly different in its particular composition, a steering committee might consist of, among others, one or more of the following types of creditor institutions: commercial banks (both local and foreign), bondholders, sovereign export credit agencies, international financial institutions, and host government financial institutions and agencies. In each instance, whether a particular creditor constituency will be represented on a given steering committee may depend on various factors that are taken into account by the creditors organizing the committee. Such factors may include, for example, whether a particular creditor constituency or individual creditor holds a significant portion of the outstanding debt; whether a particular class of creditors made their loans at the holding company or operating company level; or whether certain creditors have purchased their debt at deep discounts and thus may have a different perspective and different recovery expectations than original lenders to the company.
A steering committee may consist not just of foreign creditors, but also possibly of the important domestic creditors as well. To the extent possible, foreign creditors should try to develop good working relations with the important domestic creditors, even if at times these two groups of creditors may have divergent perspectives and interests. Depending on the specific circumstances of a given restructuring, domestic creditors can be important allies for the foreign creditors in the restructuring process. In some restructuring situations, it is virtually inevitable that foreign creditors will have to work with large and important domestic creditors. In Indonesia, for example, the Indonesian Bank Restructuring Agency (IBRA), a government agency, has been a participant in a number of large Indonesian corporate restructurings.
Although it is important to have a representative steering committee consisting of major creditors to the debtor, if the steering committee is too large, it may complicate the task of the creditors considerably. In the first place, formation of a large steering committee may make it difficult to reach consensus within the committee on both procedural and substantive matters. Moreover, it may also prevent decisions from being reached quickly so that the steering committee can respond to the debtor on a broad range of issues in a timely manner. Finally, and perhaps most importantly, it may convey to the debtor an impression that the creditors are disorganized and even in some disarray, which may then hinder the effort of the creditors to present a united front to the debtor in any negotiations.
While it may not please those institutions that are excluded, a steering committee may be much more effective in the long run if the creditors can find a way to narrow the membership on the committee to a compact group, perhaps ten institutions or fewer. If this proves to be impossible, the steering committee members might as an alternative designate a smaller group of creditors to serve as an executive committee that will then assume the leadership role and chief negotiating responsibilities for the steering committee as a whole.
As a practical matter, forming a steering committee may be seen by many creditors as a mere housekeeping issue. Yet unless the formation of the steering committee is handled properly at the outset of the restructuring process, it can potentially have long-term negative consequences on the ability of the creditors to reach a timely restructuring solution. In fact, the creation of an unwieldy steering committee structure may give the debtor an excuse not to cooperate in moving the process forward in a serious way. The debtor may complain, with or without some justification, that it is impractical to make confidential and sensitive business and financial presentations to a steering committee whose full membership can only be accommodated, for example, in an extremely large meeting room. Similarly, the debtor may also complain that it is difficult to engage in substantive, detailed and frank discussions and negotiations with such a large group of creditors.
Conversely, if done correctly, the formation of a manageable and lean steering committee structure can contribute to much more efficient internal consultations and sharing of information among the creditor group. Furthermore, it can also lead to much more focused and disciplined discussions and negotiations with the debtor.
Establishing Realistic but Ambitious Timelines and Milestones. As noted above, if the debtor is left to control the process, restructurings in the emerging markets can potentially extend over many years. The debtor may have declared or instituted a debt service moratorium during this period, in which case the creditors by and large may not be receiving any debt service payments. (If during such a debt standstill the debtor has decided to make debt service payments to selected creditors, this may raise questions about the fairness and even the long-term viability of the standstill.) The creditors therefore need to be pro-active in trying to manage the timing and pacing of the process, since, depending on the circumstances, time is generally on the debtor's side. Specifically, creditors should clearly set forth their expectations for when they expect to see certain key milestones completed.
For example, if creditors and the debtor are discussing the possibility of pursuing a certain restructuring plan, the creditors should propose a specific and firm deadline for drafting and signing a term sheet. In addition, if the creditors are expecting to receive items from the debtor such as a detailed restructuring plan, a revised and updated business plan, or new financial and cash flow projections, the creditors should communicate timelines to the debtor for producing these items. To be sure, there may be some negotiation with the debtor on whether the deadlines proposed by the creditors are appropriate or realistic. Nonetheless, at least in proposing deadlines, the creditors will have taken the first step in setting some parameters for discussions on timing and on the broader issue of how to keep the restructuring process moving forward.
A corollary to having the creditors propose timelines and associated milestones is that the creditors should be vigilant if the debtor appears to be using delaying tactics to forestall a restructuring solution. The debtor may use the negotiations on certain preliminary documents as a stalking horse for delaying the substantive aspects of the restructuring process. Such preliminary documents include confidentiality agreements, which are important to permit the creditors to begin their due diligence investigation of the debtor, as well as engagement letters and/or escrow agreements that establish the arrangements for the retention of financial advisers and legal counsel. Thus, if the creditors see that the debtor or its advisers are raising extraneous or non-substantive issues in negotiating a confidentiality agreement or other similar documents so that the process of negotiation for such documents ends up taking a few months instead of a few weeks, then this should raise a red flag for the creditors. The creditors should ask themselves whether the debtor is trying in good faith to move the process forward or whether the debtor is instead more interested in delay and obstruction.
If the latter is the case, the creditors should immediately bring this to the attention of the debtor and prod the debtor to get on with the business at hand of advancing the restructuring process. Nevertheless, if there are continued and repeated delays by the debtor over a period of time, this may force the creditors to re-evaluate whether a consensual restructuring with the debtor is in fact feasible or rather whether the creditors should instead consider pursuing whatever other options are available, such as any available options under the applicable insolvency law.
Understanding the Local Insolvency System and the Local Legal Framework. Some foreign creditors may make the mistake of approaching emerging market restructurings as if they can simply extrapolate their home country insolvency laws and the underlying principles of such laws to the relevant emerging market jurisdiction. But as one of my steering committee colleagues has quite properly observed apropos of this mindset: " ... We're not in Kansas anymore." It is of critical importance that foreign creditors involved in an emerging market restructuring make a special effort to understand the local insolvency laws and the local legal systems. Even in an out-of-court, consensual restructuring situation, the creditors must be aware of this local legal framework for several reasons.
First, certain independent-minded creditors not on the steering committee of lead creditors may turn to the courts to seek creditor remedies. Irrespective of whether such individual creditors are acting with the approval of other creditors or even of the steering committee itself (which may well be seeking a consensual restructuring), the actions of these individual creditors in the local courts can have an important and potentially profound effect on the interests of the broader creditor constituency. The precise nature of the effect on the broader constituency will depend on various factors, such as the type of relief sought (e.g., a basic debt recovery action versus a winding-up or other insolvency action) and the terms and scope of any court order that is ultimately issued.
Second, important creditors might want to consider whether they can achieve more favorable results by filing for a court-ordered reorganization of the debtor, or even a court-ordered liquidation of the debtor, than they can achieve through an out-of-court restructuring, particularly where the consensual restructuring process appears to be stalling. The extent to which these insolvency options are realistic in a particular case will depend on the local legal framework and how the local laws are applied in practice. For example, in certain jurisdictions, even though liquidation may formally be an option under the local insolvency law, it may be exceedingly difficult as a practical matter for creditors to force a debtor into liquidation. On this type of issue, local counsel can serve a particularly valuable function in advising foreign creditors on how the local insolvency laws are actually applied in practice.
Third, the debtor in an out-of-court restructuring may ultimately decide to turn to the courts for insolvency protection, and the creditors will want to understand the potential ramifications of such a move, preferably even before the debtor pursues such a course of action.
Finally, as a general matter, the local insolvency laws may affect which party potentially has greater leverage in the negotiation of a consensual restructuring. For instance, this may be the case where the restructuring negotiations are occurring simultaneously with a reorganization-type proceeding involving the debtor. If the local law as applied permits the debtor to do so, the debtor may be perfectly content to have such a proceeding continue uninterrupted for as long as possible since the debtor may be relieved from its debt service obligations during this period. As a result, the debtor under such circumstances may feel less pressure to reach a timely and/or fair restructuring deal with its creditors assuming that it can continue to meet its working capital and other needs as a going concern.
Generally, if a steering committee or individual creditors wish to protect themselves on the local law front, they will need to hire competent and experienced local counsel to help navigate and interpret the local legal system. In addition to retaining international "deal" counsel, a steering committee may also decide to retain local corporate/restructuring counsel and possibly even local litigation counsel, subject to the specific needs and procedural posture of the case. However, if the steering committee decides that it needs to have both local corporate and local litigation counsel working on the case at the same time, the steering committee should ensure that both counsel are approaching the case in a coordinated fashion and communicating regularly with each other, which is not necessarily always the case in complex emerging market restructurings.
Individual creditors may approach the issue of hiring local counsel on the basis of their individual institutional objectives and needs, including the size of their individual exposure, as well as on the specific facts and circumstances of the restructuring. Although individual creditors that are members of a steering committee may decide to rely upon the steering committee's local corporate counsel, in certain circumstances they may decide to retain separate local litigation counsel. Such local litigation counsel may be assigned such important tasks as filing creditor claims for recognition in court in any pending insolvency proceeding, which, depending on the jurisdiction, can be a highly formalistic and technical process.
If a decision is made to hire local counsel, it should be acted upon as early as possible in the restructuring process. The pool of highly qualified local counsel that can handle complex and sophisticated financial matters in general, and restructuring and insolvency matters in particular, may be somewhat limited in these jurisdictions, especially where there is a large creditor body involved and thus where there is strong demand for the services of local counsel. If they act too late, foreign creditors may find that all of the best local counsel have already been retained by other creditors or by the debtor and its affiliates. Potential conflict issues at law firms may also become more of a factor in the selection process the longer creditors wait to choose local counsel.
In short, foreign creditors need to bear in mind that they may not have the wide choice of counsel that they would have in their home jurisdictions. Indeed, in some emerging market jurisdictions, there may be only a small number of full-service corporate law firms that have the capabilities of handling a full-blown debt restructuring of a substantial debtor company. The number of highly qualified litigators and litigation firms may be similarly constrained.
As foreign creditors have discovered from some of their experiences in the post-Asian financial crisis era, they can potentially face serious obstacles in advancing and closing restructurings in the emerging markets. Without a well-developed strategy in place, foreign creditors may find themselves at a serious disadvantage vis-a-vis the local borrower in the restructuring process. Although a well-developed creditor strategy will not necessarily guarantee a successful restructuring outcome, it will at least enable foreign creditors to focus on how they can more effectively and expeditiously advance their interests on potentially unfamiliar and difficult terrain.
Steven T. Kargman, formerly General Counsel of the New York State Financial Control Board, is currently Counsel with the Export-Import Bank of the United States. The views expressed are solely the views of the author and do not necessarily represent the views of the Export-Import Bank or of the U.S. Government.
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|Author:||Kargman, Steven T.|
|Publication:||The International Economy|
|Date:||Nov 1, 2001|
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