Negotiating Emerging Market Debt Restructurings: Recognizing the Warning Signs of a Non-Cooperative Debtor STEVEN T. KARGMAN STEVEN T. K ARGMAN The views expressed in this article are solely the per- In addition, restructurings can involve is counsel with the sonal views of the author and do not necessarily rep- very significant transaction costs for the cred- Export-Import Bank of resent the views of the Export-Import Bank or the itor institutions involved in the process. First, the United States in Washington, DC. U.S. Government. restructurings may require a substantial invest- [email protected] ment of staff time for the respective creditor n recent years, the emerging markets in institutions. These transactions can be very Asia, Latin America, and elsewhere have labor-intensive given, among other factors, witnessed a number of high-profile defaults their complexity and the array of legal and and restructurings. Some of these defaults business/financial issues raised by such trans- Ihave involved outstanding indebtedness on the actions, the difficulties of negotiating with part of the debtor companies of hundreds of mil- debtors, and, if and when a deal appears to lions of dollars, and in some cases well over a have been reached, the often voluminous deal billion dollars. In many cases, for various rea- documentation involved. Second, restructur- sons, including particularly the possible weak- ings can require the creditors to incur sub- nesses of the relevant local insolvency system, stantial fees and expenses for professional legal the creditors involved in such defaults have and financial advisers for those fees and attempted to negotiate an out-of-court, “con- expenses that are not otherwise covered by the sensual” restructuring with the debtor to resolve debtor.2 the debtor’s financial difficulties. Foreign creditors in particular—even cer- Nonetheless, emerging market out-of-court tain creditor institutions that would generally restructurings can pose unique and daunting chal- be considered to have extensive and sophisti- lenges for creditors, especially foreign creditors. cated international experience—may not be Among other difficulties, it has not been unusual fully prepared for some of the obstacles that for a number of these restructurings to drag on they may encounter in some emerging market for several years without a definitive conclusion.1 debt restructurings. Such creditors may well From the creditors’ standpoint, a protracted understand in the abstract that such restruc- restructuring process can be particularly costly turings may not proceed in the same manner since there is often a debt service moratorium in (or with the same results) as restructurings in place during this process, which may have been their domestic markets in the developed unilaterally imposed by the debtor following the economies. However, even so, they may not original defaults. Therefore, under such circum- fully appreciate in concrete terms many of the stances, the majority of the creditors during the handicaps that they may face as they attempt period of the restructuring may not be receiving to negotiate certain restructurings in the any debt service payments. emerging markets. SUMMER 2004 THE JOURNAL OF PRIVATE EQUITY 77 This article is reprinted with permission from Instititional Investor, Inc. For more information please visit www.iijpe.com. © International Insolvency Institute - www.iiiglobal.org FUNDAMENTAL STRUCTURAL CHALLENGES have significant concerns with respect to the indepen- IN EMERGING MARKET RESTRUCTURINGS dence, integrity, and/or fairness of the local courts.7 There- fore, to the extent that creditors attempt to exercise In the first place, creditors in general and foreign remedies in the local courts in certain jurisdictions or creditors in particular may be seriously disadvantaged by even to defend themselves against legal actions by the the nature of the local laws of the debtor’s home juris- debtor in such courts, they may find themselves at a sig- diction, particularly the local insolvency system, as well nificant disadvantage. as the functioning of the local courts. Although the cred- Creditors may not receive a fair or impartial hearing itors and the debtor may be negotiating an out-of-court that they might hope for or expect. Creditors may as a restructuring, the local insolvency system can play a crit- consequence find themselves in certain situations facing ical role in determining whether the creditors and debtor judicial rulings that they find difficult to fathom. Such rul- are negotiating on anything resembling a level playing ings may not comport with the creditors’ understanding of field. The World Bank addressed this matter in a 2000 normal commercial law principles or may otherwise appear draft consultation report on insolvency law. This report in the creditors’ view (as well as the in view of certain out- stated in relevant part as follows: “With little or no cred- side observers) to be somewhat arbitrary and capricious itor protections and weak enforcement rights, manage- and/or not necessarily well grounded in the applicable law.8 ment for financially distressed or willfully defaulting In some emerging market jurisdictions, it is not just enterprises have no credible threat to compel them to the foreign creditors that may be concerned by the nature negotiate on commercially reasonable terms.”3 and functioning of the local insolvency system and the As is sometimes observed, out-of-court restructur- local judicial system. Rather, in certain emerging market ings essentially take place in the so-called “shadow of the jurisdictions, some of the domestic creditors may have insolvency law.” This means that, as counterintuitive as it similar concerns. For example, it is possible that in cer- may seem at first blush, the likelihood of success of an tain large-scale restructurings, some of the leading domestic out-of court restructuring may depend heavily on the commercial banks may also find the local insolvency system framework and substance of the local insolvency law, and the local court system to be highly frustrating for including not unimportantly how the local insolvency pursuing creditor rights and remedies and/or otherwise law is applied in practice.4 If the local insolvency law is achieving acceptable restructuring results. In such cases, not well developed or is otherwise disadvantageous to it is possible, but certainly not guaranteed, that these local creditors, the incentives for the debtor to negotiate a fair, creditors may be inclined or willing to work with some reasonable, and timely out-of-court restructuring may be of the foreign creditors in seeking a solution. minimal at best. As the International Monetary Fund Nonetheless, in some emerging market restructur- (IMF) has observed more generally, “. out-of-court ings, it is not unheard of for some of the local creditors negotiations are likely to be limited or even nonexistent to end up receiving preferential treatment from the debtor. if there is no clear and predictable in-court insolvency Notwithstanding any debt service moratorium or debt system to provide a backdrop for these negotiations.”5 standstill that may generally be in place, certain local cred- (It should be noted that, in light of the deficiencies itors may continue to receive some or all of their debt of insolvency laws in many jurisdictions, there are major service payments in the wake of a debtor’s default on its and important international efforts currently underway to outstanding debt. Yet, at the same time, other creditors, improve domestic insolvency systems around the world. including foreign creditors, may be subject to a debt ser- These efforts are led by, among others, the United Nations vice moratorium or debt standstill and therefore may not Commission on International Trade Law (UNCITRAL), be receiving any debt service payments during the course which through one of its working groups has been devel- of the restructuring process. oping a draft legislative guide in the area of insolvency law In addition to the potential substantial handicaps for possible use by individual countries, and the World imposed on creditors by the local insolvency systems and Bank, which has been developing a set of core principles the local legal systems, the creditors involved in an for domestic insolvency systems.)6 emerging market restructuring may also face difficulties The weaknesses of the relevant local insolvency posed by the role of the so-called “controlling share- system may be compounded in certain jurisdictions by holders” of the relevant debtor company. The control- the functioning of the local courts. Specifically, foreign ling shareholders consist of the individuals who hold a creditors may encounter certain jurisdictions where they controlling equity stake in the debtor company. They may 78 NEGOTIATING EMERGING MARKET DEBT RESTRUCTURINGS: RECOGNIZING THE WARNING SIGNS OF A NON-COOPERATIVE DEBTOR SUMMER 2004 This article is reprinted with permission from Instititional Investor, Inc. For more information please visit www.iijpe.com. © International Insolvency Institute - www.iiiglobal.org also control the board of directors of the debtor company sonable expectations concerning the possible and/or likely and/or of any holding company of the debtor company. procedural and substantive aspects and outcomes of the In addition, such controlling shareholder’s individual family restructuring process. members may also occupy some of the key management Unfortunately and