Bankruptcy law needs amending<\/p>\n
By Agustin V. Que<\/p>\n
JAKARTA (JP): The bankruptcy system reforms, embodied in the
\ngovernment regulation in lieu of Law No. 1 1998 issued on April
\n22, 1998, were initially welcomed by the Indonesian and
\ninternational business communities as a commitment to a pragmatic
\npath of reform.<\/p>\n
However, more than a year and half after the law was enacted,
\nthe current system remains little used by either debtors or
\ncreditors and is not contributing to either the reform or the
\nrecovery of the Indonesian economy.<\/p>\n
A functioning reorganization system must be comprehensive and
\nflexible. This not only means that the substantive bankruptcy
\nrequirements in the law should be revised to provide for
\ndifferent creditor classes who should be given equal treatment
\nwithin classes, there should also be a minimum number of
\ncollective petitioning creditors to precipitate bankruptcy.<\/p>\n
Creditors should not be allowed to file petitions that are the
\nsubject of a contingent or bona fide dispute. Reorganization
\nunder the law should lead to a complete and timely debt
\nrestructuring with the flexibility to include both small
\nindividual debtors with few creditors, and large businesses with
\nnumerous creditors and complex corporate structures.<\/p>\n
Article 1 of the law stipulates that only one creditor is
\nrequired to petition for involuntary bankruptcy of a debtor. If a
\nsingle creditor can prove that the debtor has at least two debts
\nand has failed to pay at least one which is due and payable, the
\nlaw prescribes liquidation of the debtor.<\/p>\n
This standard ignores the collective nature of bankruptcy and
\nbenefits no one. Bankruptcy or reorganization should be
\nconsidered a viable option when the creditors can collectively
\nbenefit. A dispute or collection action between two creditors can
\nand should be resolved by the district courts.<\/p>\n
The existence of one unpaid debt, often the subject of a bona
\nfide dispute between the debtor and the petitioning creditor over
\nthe existence of the debt, does not warrant bankruptcy. However,
\nif the debtor is generally not paying many of its creditors as
\ndebts become due, then the debtor needs to either reorganize or
\nliquidate.<\/p>\n
The law should be amended to require more than one, say three,
\ncreditors to file for a debtor's bankruptcy. A creditor who wants
\nto file a petition against a debtor would then be required to
\nconvince two or more creditors that bankruptcy is warranted.<\/p>\n
Other creditors should be able to join in the petition; cases
\nshould not be dismissed because the debtor paid the petitioning
\ncreditors without giving notice to the other creditors. The
\npetitioning creditors should hold a valid claim, secured or
\nunsecured, against the debtor that is not contingent or the
\nsubject of a bona fide dispute. None of them needs to hold debt
\nthat is due and payable.<\/p>\n
The debtor should be declared bankrupt if it is not paying 20
\npercent of its maturing debts as they become due (there is
\nnothing special about 20 percent, and perhaps 15 percent or 25
\npercent should be the standard). This calculation is determined
\nby looking at the updated list of creditors along with the status
\nof repayment as provided by the debtor.<\/p>\n
The inflexible time limits for suspension of payments under
\nArticle 217 militates against the proactive use of the law by
\ndebtors which should not be liquidated but are otherwise in need
\nof reorganization. Currently, a debtor filing for voluntary
\nsuspension of payments is given an initial 45-day period to reach
\na suitable agreement with creditors. Creditors can agree to
\nfurther extensions up to 270 days; however, no provisions therein
\ngive the courts the capability to extend or permanently suspend
\npayments beyond 270 days.<\/p>\n
Consequently, as there is no court discretion for time
\nextensions, uncooperative creditors can refuse to enter into
\nnegotiations and wait until the 270-day period expires and then
\nforeclose or take legal action against the debtor. While this may
\nbe a sufficient amount of time to reorganize a small
\nuncomplicated business, it is not unusual for a large,
\ncomplicated business to take longer to reorganize. For example,
\nAstra International and Bakrie & Brothers both have taken longer
\nthan 365 days to reach agreement with their respective creditors.<\/p>\n
The law should be amended to give a competent court complete
\ndiscretion to extend or shorten the 45-day temporary suspension
\nand\/or the 270-day permanent suspension for good cause. If the
\ndebtor is losing money and has no realistic prospects for
\nreorganization within a reasonable period of time, creditors
\nshould have the opportunity to convince the court that immediate
\nliquidation is in order.<\/p>\n
Under the present law, a debtor can file for suspension of
\npayments with the ultimate objective of proposing a
\nreorganization plan to its unsecured creditors. However, secured
\ncreditors are not bound by the plan unless they consent.
\nTherefore, the possibility of reorganization becomes remote
\nexcept in the simplest of cases because the bargaining leverage
\nis not balanced between the debtor and the various creditor
\ngroups; there is no equal treatment of creditors.<\/p>\n
Article 152 should be amended to provide that court-approved
\nreorganization plans are binding upon all creditors, not just
\nunsecured creditors. The law should provide for voting by
\ncreditor class. Since secured creditors have collateral, they
\nwould be placed in a separate class from unsecured creditors, as
\nit is inherently unfair to place a creditor with collateral in
\nthe same class as another without collateral.<\/p>\n
Approval of the plan should be the result of a majority vote
\nwithin each creditor class, with the decision binding on the
\nminority, even on dissenting members. Negotiations would then
\ntake place between the creditor classes to balance their
\nrespective claims. In addition, nonconsenting creditor classes
\nshould be \"required\" to accept payment in full over a reasonable
\nperiod of time.<\/p>\n
This \"required treatment\" framework ensures that all classes
\nof creditors will be treated equally and fairly during the
\nsuspension payments period, thereby allowing all parties to
\nretain bargaining leverage to negotiate the length of the payment
\nperiod at an appropriate interest rate. As a result,
\nreorganizations -- not liquidations -- of debtors are
\nfacilitated: The going concern values of debtors are preserved,
\nunsecured and secured creditors are repaid in due course and
\nemployees retain their jobs.<\/p>\n
Although the court decision for suspension of payments
\nautomatically halts efforts by creditors to foreclose on real
\nproperty, it does not prohibit banks from freezing and setting
\noff debtors' accounts held within the banks for debt repayment.<\/p>\n
If this happens, the debtor cannot operate during the
\nsuspension of payments period because it would not have any
\nworking capital. The reorganization is thus doomed from the
\nstart. The law should be amended to allow the debtor, with
\napproval of the court, to use the cash collateral in its bank
\naccounts if the secured bank lenders are given reasonable
\nprotection.<\/p>\n
Additionally, businesses in the midst of reorganization will
\ngenerally require post-bankruptcy petition financing, usually
\nfrom new lenders. While Article 67 provides for new borrowing by
\ndebtors during the suspension of payments period, it should be
\namended to enable the court-appointed receiver to encumber
\nproperty with a senior or junior ranking lien to facilitate
\nfinancing, thereby giving businesses the foundation for a fresh
\nstart.<\/p>\n
The critical test here is to ensure that the value of the
\ncollateral held by the creditors is worth more than the debt
\nowed, irrespective of the ranking of the security.<\/p>\n
Consider the following. A property developer files for
\nsuspension of payments on debts of Rp 45 billion. These are owed
\nto banks and secured by a mortgage on an office building that is
\nsubstantially complete but lacks only a sprinkler system to
\nreceive a certificate of occupancy.<\/p>\n
If the sprinkler system is installed, the building will be
\nworth Rp 55 billion because a tenant has already committed to
\nlease it if a certificate of occupancy were obtained.<\/p>\n
Installation of the sprinkler system will cost Rp 1 billion,
\nbut no existing lender will provide this amount because of legal
\nlending limits. A new lender has agreed to provide the financing
\nfor the sprinkler system provided it receives a first mortgage on
\nthe building.<\/p>\n
Clearly, the court should give the developer the right to
\nborrow the Rp 1 billion to install the sprinkler system and to
\ngrant the new lender a first mortgage on the building. The
\nexisting bank lenders would then be relegated to a second lien,
\nbut the value of their collateral would be enhanced and their
\nclaims given additional protection.<\/p>\n
Further, the law does not contain a provision for discharge
\nfor individuals who have provided personal guarantees to secure
\ncorporate borrowings in liquidation, and it is unclear under the
\nlaw if the individual is discharged in reorganization.<\/p>\n
Shareholders and\/or directors who personally guarantee
\ncorporate debt (very common throughout Asia) should have the
\nright to be legally discharged after liquidation of their
\npersonal assets occurs; however, intentional acts of fraud and
\ncertain intentional tort obligations should not be discharged.<\/p>\n
A clear discharge provision is critical to provide debtors the
\nincentive to voluntarily reorganize and\/or cooperate with the
\nreceiver in liquidation. The \"fresh start\" concept would allow
\ndebtors, who are otherwise hopelessly mired in debt, in many
\ninstances as a result of the economic crisis, to resume
\nproductive lives.<\/p>\n
There should be special discharge provisions to deal with
\nproblems created by the economic crisis. Many Indonesian
\nbusinesses that would normally be able to meet their debt
\nobligations have been devastated by the devaluation of the rupiah
\nand its obvious effect on the local economy.<\/p>\n
Any revision of the law should grant corporate debtors a
\ndischarge from that portion of their debts specifically
\nattributable to the Indonesian economic crisis. To qualify for
\nthis special discharge, however, the debtor must conclusively
\nestablish to the court's satisfaction that it would otherwise
\nhave been able to meet its obligations.<\/p>\n
The key to a successful resolution of the Indonesian corporate
\ndebt problem is preservation, not liquidation, of the corporate
\nsector. Viable businesses should be given a fresh start to
\nreorganize and attempt to recover the unprecedented losses
\narising from the Asian financial crises and the downward spiral
\nof the rupiah.<\/p>\n
The House of Representatives should amend the law as soon as
\npossible to promote reorganization of distressed businesses and
\npreserve going concern value for the benefit of employees,
\ncreditors, shareholders, taxing authorities and the Indonesian
\neconomy as a whole.<\/p>\n
Agustin V. Que, Ph.D. is a financial adviser with PT Gunung
\nSewu Kencana. The views expressed in this article are his own and
\ndo not necessarily reflect those of PT Gunung Sewu Kencana.<\/p>",
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