Bankruptcy law needs amending

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.