Out of Court Workouts (OCWs) Mahesh Uttamchandani Law Justice and Development Week 2011 November 16, 2011

NPLs in many countries are high and rising 2 Non-Performing Loans/Total Loans in percent Source: IMF Global Financial Stability Report

Benefits of an Effective Insolvency and Restructuring Regime Key Findings from a recent World Bank/IFC study: Reforms that improve insolvency regimes have a real effect on credit More timely repayment Reduce the cost of debt and interest rates Increase aggregate level of credit In Brazil, 2005 bankruptcy reform followed by 22% reduction in cost of debt and 39% increase in aggregate level of credit New mechanisms for debt restructuring or reorganization 1) reduce the failure rate of insolvent firms and 2) decrease the duration and cost of bankruptcy proceedings Belgium’s 1997 bankruptcy reform allowing reorganization reduced liquidation of SMES by 8.4% In Thailand a legal framework for rehabilitation lowered NPLs and insolvency costs Leora Klapper, joint World Bank/IFC study, funded by USAID,

What is an OCW? Out of court workout allows collective negotiation among creditors and the debtor, during a standstill period that allows all the parties to reach the best restructuring solution for a distressed company Unlike formal bankruptcy/reorganization proceedings, OCWs: Do not change legal entitlements; Are consensual Do not impair debtors and creditors legal rights; Are appropriate only for viable company debtors; Are flexible In many countries, they offer distressed firms financing which would be unavailable during formal bankruptcy proceedings 4 1 Jostarndt, Philipp and Zacharias Sautner. “Out-ou-Court Restructuring verus Formal Bankrutpcy in a Non- Interventionist Bankruptcy Setting.” Review of Finance (2009), 1-46.

Why develop a system for OCWs? Formal insolvency proceedings in client countries are often slow and offer very low recovery Cheaper than formal insolvency proceedings More distressed-but-viable companies are rehabilitated Bankruptcy filings prevented – avoid court case overload Creditors benefit by shared information and negotiating together Collective action benefits creditors, maximizes recovery when enforcing individual claims will lead the debtor to formal insolvency and low recovery for all If bankruptcy filed, improved outcomes due to intensive prior negotiations Viable debtors have access financing for working capital 5

Goals of debt resolution: for viable companies, OCWs help all parties reach these goals more effectively 6 Preserve business value of debtor enterprises Minimize creditors’ risk, improving access to finance Reduce time and cost for restructuring Increase stakeholder returns

Examples of Out of Court Workout Systems London Approach—well-known, model for many other systems, informal, established practice East Asia—systems developed in response to financial crisis, JITF in Indonesia, CDRAC in Thailand, CPRA in Korea, others. Mandataire Ad Hoc in France, expert appointed on a case by case basis to assist debtor in negotiations with creditors Corporate Debt Restructuring system in India—non- statutory but institutional, RBI encourages participation, the CDR system involves several bodies that work with creditors and debtors during negotiations 7

Spectrum of Out of Court Workouts--Examples French Mandataire Ad Hoc: Assisted negotiations, with a trained mediator, creditors gathered on a case-by-case basis—pre- insolvency London Approach: Major creditors, (banks and financial institution) agree to negotiate collectively with common debtors according to certain rules; voluntary; central bank available for assistance but does not control process. Corporate Debt Restructuring in India (CDR): Banks agree in advance to negotiate restructurings for common debtors; voluntary and non-statutory but written agreement to use elaborate institutional mechanisms banks have agreed to use when a distressed debtor is common to several of them Korean Approach: Law mandated a lead bank convene creditors for restructuring when corporate clients fail and that debtors submit; but private parties implement. Government provides arbitration at parties’ request if no agreement 8 Formality: Least formal  More Formal  Most Formal Procedure: Flexible  Defined  Institutional

French Mandataire Ad Hoc—simple negotiation assistance pre-insolvency Court appoints a mandataire ad hoc, usually a receiver, for three months (renewable) to assist the company in negotiating with its creditors No standstill statutorily, though in practice creditors refrain from recovery action Confidential Mandataire has no power over any of the parties—purely advisory Agreement to restructuring/reschduling plan must be unanimous Conciliation, next level pre-insolvency Court appoints a conciliateur who has more power, he can demand financial information and hire experts, recommend a plan, and can negotiate with tax authorities. Conciliation can lead to a Sauvegard Express, a prepackaged plan that is implemented through the Sauvegard (reorganization) procedure in the French law Both Mandataire Ad Hoc and Conciliation are used 9

London Approach Developed in the 1970s with Bank of England’s support; Rules of procedure are known and accepted but not codified; central bank will assist but leaves development of plans to private parties Voluntary Instrumental in recession of 1990s No statutory guidelines, but recognized procedures Standstill among creditors New financing available to debtors Has earned the trust of the market over decades of use Model for many systems which developed later—INSOL principles for out of court workouts based on London Approach 10

Korean Approach Response to Asian Financial Crisis Corporate Restructuring Promotion Act (CPRA) of 2001 mandated that banks work together when corporate clients are financially distressed Standstill for one to three months, extendable for one month Creditor council develops plan 75 percent threshold for creditor approval of workout agreements A seven-person Corporate Restructuring Coordination Committee (“CRCC”) to provide workout guidelines and arbitrate inter-creditor differences after three rounds of voting fail to bring agreement Creditors can ask to be bought out--CRCC can establish the price of the debt to be bought out by other creditors Law was to expire but was resurrected; system still in use; has earned the trust of the market 11

CDR in India Reserve Bank of India (RBI), the central bank, promoted CDR Voluntary, non-statutory Banks/financial institutions are standing signatories (CDR members) to the Inter Creditor Agreement, which sets forth procedures and obligations; non-members can join on a case-by-case basis Debtor’s lead bank (or a consortium) holding 20%+ of debtor’s debt can initiate proceedings Institutional: one CDR body does case intake, another viability assessment, another formulates plan with creditors, another monitors implementation, etc. 75% creditor approval required for plan approval Successful, has earned the trust of the market 12

Lessons An out-of-court workout framework can be useful for the financial stabilization of distressed companies Tax debts can be a huge obstacle to restructuring A credible threat of total loss – from foreclosure, liquidation, and/or receivership – encourages debtor cooperation with court-supervised rehabilitations or out-of-court workouts An effective out-of-court workout scheme benefits from a reliable mechanism for resolving inter-creditor differences Mako. William P. “Uses and Limitations of Out-of-Court Workouts.” Global Forum on Insolvency Risk Management