17 May, 2016

Indonesia is a jurisdiction which sometimes receives bad press from a restructuring and insolvency perspective. However, over the past 10 years, the Indonesian restructuring process called the Suspension of Debt Payment Obligations (“PKPU”) has evolved into a process that is well understood, offering a degree of certainty as to how the procedure will work in practice, and where Indonesian creditors, in particular, feel far more comfortable using the process to drive the restructuring.  To better understand the PKPU process we spoke with Damien Coles, Restructuring Partner at Kirkland & Ellis in Hong Kong, wherein he explained the process, its history, and the issues that international creditors continue to face today in Indonesia.

Conventus Law: Conversation with Damien Coles, Partner, Kirkland & Ellis 

Indonesia is a jurisdiction which sometimes gets a bad press from a restructuring and insolvency perspective, which is justified but that’s only half of the story. The Indonesian restructuring process PKPU has developed very rapidly over the last 10 years. It’s developed from a position where it was effectively never used to one where it has become a mechanism which is regularly used for restructuring the debts of an insolvent Indonesian company. That means we now have a position where the PKPU process is well understood, where there is a degree of certainty as to how the process will work in practice, and where Indonesian creditors, in particular, feel far more comfortable using the process to drive the restructuring. The PKPU process has developed and it’s here to stay.

There clearly are still issues in relation to the treatment of international creditors. There’s clearly local bias and issues in relation to corruption. The expectation of a lot of others who are involved in the Indonesian restructuring market is that, slowly but surely over the next 10 years, those issues will start to be resolved. 

Indonesia is a rapidly developing economy. It has a very young population and it has huge untapped natural resources. It’s also the fourth largest population in the world, scheduled to overtake U.S. at some point during this century so it’s an economy which is developing and growing in that way and has an expanding middle and consumer class and needs an effective mechanism to work at corporate distress. 

Indonesia has only been a democracy since 1998 after the fall of Suharto, a lot of the Indonesian government institutions were damaged and the Indonesian judiciary was also in a very weak situation. Those government institutions are redeveloping and re-emerging. The Indonesian judiciary is going through the same process, and I would expect that as the Indonesian government, economy and judiciary mature, some of the problems which international creditors have encountered with the PKPU process will start to be ironed out.

Conventus Law: How do insolvency laws regarding foreign creditors in Indonesia compare to other jurisdictions in Southeast Asia?

Kirkland & Ellis: Anyone who studied history knows that every jurisdiction in Southeast Asia has its own unique history and that’s reflected in the local legal and restructuring and insolvency regime. Effectively, the regime in each jurisdiction, be it Indonesia, the Philippines, Malaysia, Thailand, they’re fundamentally different. Indonesia is similar to, for example, Singapore, in the sense that you have essentially two key restructuring and insolvency regimes. You have a regime which is designed to rescue troubled businesses, and you have a regime which is designed to liquidate businesses that can’t be saved. But that’s pretty much where the similarity between Singapore and Indonesia ends. 

Indonesia is unique in many ways. From a legal perspective, it’s the only nation in Southeast Asia that was a Dutch colony and as a result, it has a legal system based on the Dutch civil code, which itself was based on the French civil code. And most of the other nations in Southeast Asia or a number of them have a common legal heritage because they were British colonies. The Philippines follows its Spanish roots and Thailand obviously was never a colony so it’s very different. Indonesia is unique, its restructuring and insolvency regime has two constituent parts: one is the suspension of payments or PKPU procedure — PKPU is an acronym which is taken from the Indonesian name for the process — and then there is a formal bankruptcy process.

Those two processes are effectively borrowed from the Dutch model and that makes them very different from anything else you can see in Southeast Asia. They also have Indonesian elements and have evolved over the years to reflect the Indonesian legal judicial system and also the Indonesian culture. So, they are fundamentally different from anything you would find elsewhere in Southeast Asia and the rest of the world.

CL: What are the challenges of rehabilitating a business in Indonesia?

K&E: Firstly, and this is common throughout Asia, there’s a real stigma surrounding insolvency in Indonesia. Indonesian companies find it very difficult to accept that they are suffering the consequences of financial distress. And that means they often face up to their problems too late in the day. Typically, as a restructuring advisor, you would tell your clients that at any sign of financial distress, they should think about contingency planning, they should think about talking to the stake holders in their business and figuring out how to deal with the problem as it develops. You would strongly advise them to do that as early as possible so they don’t come to a position where they start to run out of cash. Liquidity is tight, there’s a real value destruction through the inability to run the business correctly. In Indonesia, as in the rest of Asia, sponsors and the management of businesses are very bad at doing that. It typically means that you start dealing with a distressed Indonesian business which happens a year or so after it should have done, at a point where liquidity is tight, at a point where there is a real crisis and it’s difficult to slowly and rationally plan a solution for the business.

The second problem is that Indonesia has an unpredictable legal system and that means creditors have limited certainty regarding enforcement of their rights. They find it difficult to understand what the company’s financial and operational position is, largely because there’s often inadequate disclosure and the legal system doesn’t enforce adequate disclosure. In addition, you know that if you go through the Indonesian court sponsored restructuring process, which is called PKPU, there is a real uncertainty involved. The process itself has been tried and tested in recent years but there isn’t a long history of successful PKPUs that you can look to in determining what the outcome of your restructuring will be. Similarly, the Indonesian legal system has no concept of precedent, which exists in common law jurisdictions. Precedent is the concept of a previous decision handed down by the courts as binding on the courts moving forward, and that of course gives a degree of legal certainty. The Indonesian legal system doesn’t have that. As a result, if you are involved in an Indonesian court process, the particular outcome of a set of circumstances depends on the view taken by the judge based on all the facts and circumstances. That means as a creditor, or even a company going into a restructuring process, there is inherent uncertainty.

CL: Will the structure of a deal determine how investors file for a PKPU?

K&E: The short answer is yes. You have to be a creditor of the relevant company to file for PKPU and obviously, credit instruments issued by Indonesian companies are structured in different ways. The one fundamental difference that we encounter, and again this is a common difference throughout the world, is between syndicated loan debts or debt which is in loan form and debt which is issued in the form of bond or in notes. 

The key difference here is that in the syndicated loan, or even a bilateral loan, a creditor will typically be a direct creditor of the relevant company and have direct right against it. That means that if it’s filing for a PKPU, it simply stands up and says ‘I’m a creditor and the debt due to me is unpaid. And I like the company to be placed in to PKPU.’ 

The situation gets a lot more difficult when you deal with a bond. Bonds are issued and exist in many different ways, shapes and forms. One structure which is very commonly used is where you have a trustee who holds the benefit of the covenants under the bond documents and the benefit of the debt evidenced by the bonds on behalf of a group of underlying investors. Typically, those investors will hold their interests in the bonds themselves through a clearing system, that means there is another layer of complexity involved. One fundamental problem is that Indonesia has a civil law legal system. It doesn’t recognize the concept of a trust. In the context of PKPU, you have trustees standing up and saying that they are the creditor of the relevant company and that they would like to place that company in to PKPU. The Indonesian court and the Indonesian management will typically ask, well, what is a trustee? What does it do? Are you the real holder of the debt here or should I be speaking to somebody else? You say you act on behalf of a class of underlining bondholders, are they the people I should be speaking to? In the context of a bond, there is always a lot of confusion in Indonesia as to whether the trustee or underlining bondholders should file for PKPU. 

As discussed, the Indonesian legal system has no concept of the doctrine of precedent, and so previous decisions of the Indonesian court are not binding moving forward. That means you have a series of different decisions issued by the Indonesian courts over the years in relation to who should file an application for a PKPU and the context of a clear bond. In some part, PKPU filings have been made by the bondholders. In some parts, PKPU filings have been made by the trustee and in certain circumstances, proofs of claim in the same PKPU in respect to the same bond to be submitted by the trustee and bondholders and the Indonesian courts have partially accepted both. 

There’s huge confusion here and there is one fundamental problem which is that the issuance of a bond through a trust structure simply doesn’t make sense in Indonesia, it’s a concept which is alien to the legal system. It makes sense in the context of the western legal systems where the bonds are the financial instruments originated. It’s simply taken by the credit market and implanted into Indonesia where it doesn’t work. I often say to our clients that Indonesia has its own rupee bond market. You wouldn’t take a Texan company and ask that company to issue a rupee bond, because it doesn’t make any sense, so why take an Indonesian company and ask it to issue a New York law bond through a trustee structure? That doesn’t make sense. Whenever I do get the chance to work on new money deals, I always advise clients and colleagues that using trustee structures in the context of Indonesia is a fairly dangerous game and that bonds should be issued through alternative structures such as physical agency arrangements and the structure and the documents should be adapted so that it is very clear. What happens in the down-side scenario and if there is an insolvency process, either the underlying bondholder or the physical agent for the bond should have the ability to file.

CL: Can a foreign bondholder vote on a distressed company’s workout arrangements or participate in debt restructuring talks if its defaulted notes were issued by an offshore special-purpose vehicle?

K&E: Indonesia imposes 20% withholding tax on payments of interest fees and royalties from Indonesian residents to non-residents. The amount of holding, withholding tax payable can be reduced if there is a double taxation agreement between the entity in which the recipient is resident and Indonesia. As a result of the ability to reduce Indonesian withholding tax, Indonesian companies often issue bonds through offshore SPV structures. 
The structure that we most commonly see is that the Indonesian company incorporates a subsidiary in Netherlands or in Singapore because the Netherlands and Singapore have double taxation agreements with Indonesia. The bond is then issued by that subsidiary and the proceeds of the bond issuance are lent on to the Indonesian company. That means that the payments of interest on the intercompany loan of the bond proceeds by the Indonesian company to the Dutch or Singapore subsidiary only incur withholding tax at the lower rate under the applicable double taxation agreement. Under the Singapore-Indonesia agreement that’s 10%, under the Netherlands-Indonesia agreement it can even be pushed down to 0% so there is a real benefit for the company in terms of tax saving. You then have the bond issued by the SPV, on loan of the proceeds to the Indonesian company and the Indonesian company will then provide a guarantee for the bond. 

This structure again creates a lot of confusion in the context of an Indonesian insolvency proceeding and the confusion essentially arises because if there is an insolvency proceeding in respect of the Indonesian company, it’s possible to submit two proofs of claims in respect to the bond: one, in respect to the guarantee provided by the Indonesian company and two, in respect to the intercompany loan of the bond proceeds. Clearly, not both of those claims can be accepted because this would be double counting. The question is which one should be accepted. If the intercompany loan claim is accepted, then the creditor is actually the SPV that issued the bond and lent the proceeds on to the Indonesian company. If the guarantee claim is accepted, then the creditor is either the trustee or the underlying bondholder who has the benefit of the guarantee. The question of whether the trustee or the underlying bondholder should have the benefit of claims is a difficult one and something which is probably best discussed separately. 

What we’ve seen in recent PKPU is that Indonesian companies have manipulated this confusion to serve their own purposes. When they feel that they may not have enough votes in order to have the composition plan which they put forward in the PKPU approved, they will influence the outcome of the PKPU to ensure that the claim in respect of the intercompany loan of the bond proceeds, which is controlled and voted by their subsidiary, is the claim that gets accepted and voted in the PKPU. You will often hear international lawyers, and maybe Indonesian lawyers, talking about the clever strategies to prevent that from happening, but the reality is there is no single strategy that can prevent it. It’s a bit like a leaky dam, you put your finger into one hole and the water just comes out of another one. Essentially, what Indonesian companies do is work backwards. They figure out what result they want to achieve, what votes they need to achieve it and then they figure out a way to disenfranchise the bond guarantee claim and accept the intercompany loan claim. 

To give a shorter answer to the question, in theory, international creditors should be able to vote the guarantee claim, but in practice, given the difficulties associated with the Indonesian legal system and misunderstanding of the structures of which cleared bonds are issued, that is very tough to achieve in practice, unless the debtor is prepared to work collaboratively with you to allow it to happen.

See more at Conventus Law