The system is bankrupt

The steep decline in the number of bankruptcy lawsuits filed with the Commercial Court in Jakarta by no means indicates a strong recovery in the business sector but is simply further evidence of distrust by businesses in the bombed-out, corrupt court system, especially the bankruptcy regime.

The bankruptcy system itself is almost bankrupt. As the Indonesian Association of Receivers (AKPI) said last week, the number of bankruptcy litigations filed with the Commercial Court fell 54 percent to only 27 cases in the first nine months, as against the same period last year. That was much smaller than the annual average of 100 cases filed in 1999 and 2000.

This sorry development has once again made it as imperative and urgent as ever to speed up amendments to the 1998 Bankruptcy Law, which has long been overdue.

The Government white paper on the new reform agenda, unveiled last week to replace the International Monetary Fund program later this year, stipulates revision of the law as one of the new set of measures to be taken to improve legal certainty. However, there is no definite time schedule set for completion of the amendment process.

Amendments to the law would not immediately make the bankruptcy regime more effective and credible, nor would they make the court, which was established in 1999, and its judges, much more credible. Yet, revision of the rules of the game would nevertheless be a good start to improve the system, to make the procedures more clear-cut and the proceedings more accountable and transparent.

The absence of an efficient and effective bankruptcy mechanism has not only undermined the process of corporate restructuring, as debtors can make successive appeals to reduce the likelihood of a quick resolution, but has also created a large number of zombie companies. As these zombie firms have simply stopped servicing their debts they possess advantages against those that painstakingly endeavor to service their debts, thereby distorting market competition.

Yet more damaging to the long-term foundation of sound economic growth is the loss of opportunity created by the 1997 economic crisis to cleanse the corporate sector of inefficient businesses, which had in the past thrived mostly on the benefits of corruption.

The inadequate bankruptcy system should also be blamed for the slow recovery in new lending by the banking industry. Commercial banks will remain averse to new lending if their right to recover loans is not secure. Experience in other countries has shown that stronger powers for creditors to recover their claims in insolvency are associated with more business access to credit.

The present law is perceived by businesses as being too debtor-friendly, as can be seen from the much greater number of cases won by debtors than creditors. Worse still, some of the few court decisions that were given in favor of creditors were greatly questionable and bizarre, such as the bankruptcy decision against Indonesian-Canadian insurance company Manulife in mid- 2002.

Creditors agree that the bankruptcy court is merely a remedy of the last resort that will be taken only against debtors in bad faith or those who are simply not willing, rather than unable, to settle their debts. Yet, a reliable and credible bankruptcy regime is an essential component of the commercial laws needed to create legal certainty in the business sector.

After all, creditors prefer debt workout to bankruptcy proceedings because a viable company has a much higher value than a liquidated one, thereby generating a higher rate of loan recovery for creditors. The proceeds from the sale of liquidated assets are only a fraction of their normal market price.

The main objective of a credible bankruptcy system is to force distressed debtors to negotiate with creditors in good faith or expedite the liquidation of default debtors who are beyond any bailout through debt workout.

Amending the 1998 Bankruptcy Law should not mean establishing a sophisticated bankruptcy regime modeled on those in developed countries, since such a sophisticated system would not be appropriate to our institutional capacity.

The proposed amendments should focus on addressing the competence and integrity of the Commercial Court by strengthening its mandate, streamlining its procedures and operations and allocating more resources for the training of judges and bankruptcy administrators in insolvency proceedings and practice.