Bankruptcy law needs amending

By Agustin V. Que

JAKARTA (JP): The bankruptcy system reforms, embodied in the government regulation in lieu of Law No. 1 1998 issued on April 22, 1998, were initially welcomed by the Indonesian and international business communities as a commitment to a pragmatic path of reform.

However, more than a year and half after the law was enacted, the current system remains little used by either debtors or creditors and is not contributing to either the reform or the recovery of the Indonesian economy.

A functioning reorganization system must be comprehensive and flexible. This not only means that the substantive bankruptcy requirements in the law should be revised to provide for different creditor classes who should be given equal treatment within classes, there should also be a minimum number of collective petitioning creditors to precipitate bankruptcy.

Creditors should not be allowed to file petitions that are the subject of a contingent or bona fide dispute. Reorganization under the law should lead to a complete and timely debt restructuring with the flexibility to include both small individual debtors with few creditors, and large businesses with numerous creditors and complex corporate structures.

Article 1 of the law stipulates that only one creditor is required to petition for involuntary bankruptcy of a debtor. If a single creditor can prove that the debtor has at least two debts and has failed to pay at least one which is due and payable, the law prescribes liquidation of the debtor.

This standard ignores the collective nature of bankruptcy and benefits no one. Bankruptcy or reorganization should be considered a viable option when the creditors can collectively benefit. A dispute or collection action between two creditors can and should be resolved by the district courts.

The existence of one unpaid debt, often the subject of a bona fide dispute between the debtor and the petitioning creditor over the existence of the debt, does not warrant bankruptcy. However, if the debtor is generally not paying many of its creditors as debts become due, then the debtor needs to either reorganize or liquidate.

The law should be amended to require more than one, say three, creditors to file for a debtor's bankruptcy. A creditor who wants to file a petition against a debtor would then be required to convince two or more creditors that bankruptcy is warranted.

Other creditors should be able to join in the petition; cases should not be dismissed because the debtor paid the petitioning creditors without giving notice to the other creditors. The petitioning creditors should hold a valid claim, secured or unsecured, against the debtor that is not contingent or the subject of a bona fide dispute. None of them needs to hold debt that is due and payable.

The debtor should be declared bankrupt if it is not paying 20 percent of its maturing debts as they become due (there is nothing special about 20 percent, and perhaps 15 percent or 25 percent should be the standard). This calculation is determined by looking at the updated list of creditors along with the status of repayment as provided by the debtor.

The inflexible time limits for suspension of payments under Article 217 militates against the proactive use of the law by debtors which should not be liquidated but are otherwise in need of reorganization. Currently, a debtor filing for voluntary suspension of payments is given an initial 45-day period to reach a suitable agreement with creditors. Creditors can agree to further extensions up to 270 days; however, no provisions therein give the courts the capability to extend or permanently suspend payments beyond 270 days.

Consequently, as there is no court discretion for time extensions, uncooperative creditors can refuse to enter into negotiations and wait until the 270-day period expires and then foreclose or take legal action against the debtor. While this may be a sufficient amount of time to reorganize a small uncomplicated business, it is not unusual for a large, complicated business to take longer to reorganize. For example, Astra International and Bakrie & Brothers both have taken longer than 365 days to reach agreement with their respective creditors.

The law should be amended to give a competent court complete discretion to extend or shorten the 45-day temporary suspension and/or the 270-day permanent suspension for good cause. If the debtor is losing money and has no realistic prospects for reorganization within a reasonable period of time, creditors should have the opportunity to convince the court that immediate liquidation is in order.

Under the present law, a debtor can file for suspension of payments with the ultimate objective of proposing a reorganization plan to its unsecured creditors. However, secured creditors are not bound by the plan unless they consent. Therefore, the possibility of reorganization becomes remote except in the simplest of cases because the bargaining leverage is not balanced between the debtor and the various creditor groups; there is no equal treatment of creditors.

Article 152 should be amended to provide that court-approved reorganization plans are binding upon all creditors, not just unsecured creditors. The law should provide for voting by creditor class. Since secured creditors have collateral, they would be placed in a separate class from unsecured creditors, as it is inherently unfair to place a creditor with collateral in the same class as another without collateral.

Approval of the plan should be the result of a majority vote within each creditor class, with the decision binding on the minority, even on dissenting members. Negotiations would then take place between the creditor classes to balance their respective claims. In addition, nonconsenting creditor classes should be "required" to accept payment in full over a reasonable period of time.

This "required treatment" framework ensures that all classes of creditors will be treated equally and fairly during the suspension payments period, thereby allowing all parties to retain bargaining leverage to negotiate the length of the payment period at an appropriate interest rate. As a result, reorganizations -- not liquidations -- of debtors are facilitated: The going concern values of debtors are preserved, unsecured and secured creditors are repaid in due course and employees retain their jobs.

Although the court decision for suspension of payments automatically halts efforts by creditors to foreclose on real property, it does not prohibit banks from freezing and setting off debtors' accounts held within the banks for debt repayment.

If this happens, the debtor cannot operate during the suspension of payments period because it would not have any working capital. The reorganization is thus doomed from the start. The law should be amended to allow the debtor, with approval of the court, to use the cash collateral in its bank accounts if the secured bank lenders are given reasonable protection.

Additionally, businesses in the midst of reorganization will generally require post-bankruptcy petition financing, usually from new lenders. While Article 67 provides for new borrowing by debtors during the suspension of payments period, it should be amended to enable the court-appointed receiver to encumber property with a senior or junior ranking lien to facilitate financing, thereby giving businesses the foundation for a fresh start.

The critical test here is to ensure that the value of the collateral held by the creditors is worth more than the debt owed, irrespective of the ranking of the security.

Consider the following. A property developer files for suspension of payments on debts of Rp 45 billion. These are owed to banks and secured by a mortgage on an office building that is substantially complete but lacks only a sprinkler system to receive a certificate of occupancy.

If the sprinkler system is installed, the building will be worth Rp 55 billion because a tenant has already committed to lease it if a certificate of occupancy were obtained.

Installation of the sprinkler system will cost Rp 1 billion, but no existing lender will provide this amount because of legal lending limits. A new lender has agreed to provide the financing for the sprinkler system provided it receives a first mortgage on the building.

Clearly, the court should give the developer the right to borrow the Rp 1 billion to install the sprinkler system and to grant the new lender a first mortgage on the building. The existing bank lenders would then be relegated to a second lien, but the value of their collateral would be enhanced and their claims given additional protection.

Further, the law does not contain a provision for discharge for individuals who have provided personal guarantees to secure corporate borrowings in liquidation, and it is unclear under the law if the individual is discharged in reorganization.

Shareholders and/or directors who personally guarantee corporate debt (very common throughout Asia) should have the right to be legally discharged after liquidation of their personal assets occurs; however, intentional acts of fraud and certain intentional tort obligations should not be discharged.

A clear discharge provision is critical to provide debtors the incentive to voluntarily reorganize and/or cooperate with the receiver in liquidation. The "fresh start" concept would allow debtors, who are otherwise hopelessly mired in debt, in many instances as a result of the economic crisis, to resume productive lives.

There should be special discharge provisions to deal with problems created by the economic crisis. Many Indonesian businesses that would normally be able to meet their debt obligations have been devastated by the devaluation of the rupiah and its obvious effect on the local economy.

Any revision of the law should grant corporate debtors a discharge from that portion of their debts specifically attributable to the Indonesian economic crisis. To qualify for this special discharge, however, the debtor must conclusively establish to the court's satisfaction that it would otherwise have been able to meet its obligations.

The key to a successful resolution of the Indonesian corporate debt problem is preservation, not liquidation, of the corporate sector. Viable businesses should be given a fresh start to reorganize and attempt to recover the unprecedented losses arising from the Asian financial crises and the downward spiral of the rupiah.

The House of Representatives should amend the law as soon as possible to promote reorganization of distressed businesses and preserve going concern value for the benefit of employees, creditors, shareholders, taxing authorities and the Indonesian economy as a whole.

Agustin V. Que, Ph.D. is a financial adviser with PT Gunung Sewu Kencana. The views expressed in this article are his own and do not necessarily reflect those of PT Gunung Sewu Kencana.