Corporate Restructuring: International Best Practices

Washington, D.C.March 22-24, 2004

 KEYNOTE ADDRESS:

Are More Restructuring Regimes Becoming Like the U.S. Chapter 11 System? 

James H. Zukin, Co-Founder & Senior Managing DirectorHoulihan Lokey Howard & Zukin

 Alan Fragen, Managing Director & Dorian Lowell, Senior Vice President

Houlihan Lokey Howard & Zukin Assisted in preparation of this outline

THE WORLD BANKTHE WORLD BANK

2

Preface

This presentation will cover the state of the global market for corporate and sovereign restructurings. The first part includes a discussion of the basic principles of reorganizations, the required enabling infrastructure and a few observations regarding the use of a Chapter 11-style reorganization system.

Next, I will present a brief overview of new restructuring paradigms in several Western European countries that support the apparent trend towards Chapter 11-style reorganizations vs. traditional liquidations. I will then comment on such trends in emerging market countries followed by discussion of how a Chapter 11-style system could be applied in cases of systemic crisis as part of a recovery plan utilizing a process of rapid sequencing.

Finally, I will conclude with a brief comment on the current state of sovereign debt restructuring techniques utilizing the principles of a Chapter 11 system.

3

Bankruptcy – Historical Vignettes

The penalty for declaring bankruptcy in Ancient Rome was slavery or being cut to pieces. The choice was left to the creditor. By the Middle Ages, the treatment of insolvent debtors had softened considerably. In Northern Italy, bankrupt debtors hit their naked backsides against a rock three times before a jeering crowd and cried out, “I declare bankruptcy.” In French medieval cities, bankrupts were required to wear a green cap at all times, and anyone could throw stones at them.

- Source: World Bank, Doing Business in 2004

4

Introduction

Economies are Darwinian. They compete with each other, adopt best practices and evolve. Just as capitalism overtook communism as the better system for maximizing wealth, procedures for rescuing distressed companies should overtake systems that focus on receiverships and liquidations at the expense of lower recoveries and the disenfranchisement of creditors. The prevalence of bankruptcy systems focusing on receiverships and liquidations reflect the historical emphasis on tangible property rights, the rights of secured creditors and the realization of assets to discharge debts. But in modern economies we talk of cash flows and enterprise values, values that invariably exceed tangible asset values. Maximizing these values when companies are in distress demands more flexible solutions than those provided by receiverships and liquidations.

In a modern capitalist economy, the primary role of a bankruptcy regime should be to differentiate between balance sheet distress and operational distress. Viable entities should be encouraged to reorganize via a balance sheet restructuring and non-viable enterprises should be liquated and the assets and capital redeployed to more productive uses. The preferred outcome is that which maximizes economic recovery and which seeks to minimize (but not avoid) negative externalities. To promote effectiveness and efficiency, the bankruptcy regime should strive to create a collective process with active participation by the economically affected parties. Examples of restructuring techniques can be found in the accompanying paper by Alan Fragen, “Financial Restructuring – Techniques and Negotiating Dynamics”.

5

What Is Chapter 11?

Chapter 11 is the chapter under Title 11 of the United States Bankruptcy Code providing for the reorganization of a company; other chapters deal with case administration, liquidation and other related procedures. Reorganizing under Chapter 11 means allowing a company to survive as a going-concern, maximizing enterprise and recovery values for creditors and discharging the old debts. It allows the company to survive and have a second chance. It is not a liquidation or a receivership for the benefit of secured creditors.

6

The Seven Basic Objectives of Chapter 11

1. Stabilizing business operations

2. Financing the business after the commencement of insolvency

3. Maximizing the value of the business operations

4. Providing for the representation of unsecured creditors

5. Providing a central forum for creditors to exercise remedies

6. Allowing a plan of reorganization to be proposed based on an objective valuation of the post-reorganized enterprise

7. Providing a framework for formulating and approving a plan of reorganization

7

The Eight Principles of Corporate Restructuring

1. Creditors should cooperate with each other and give a debtor time to resolve its financial difficulties during a standstill period

2. During the standstill period creditors should refrain from taking action against the debtor

3. During the standstill period the debtor should not take any action prejudicial to the creditors

4. Creditors should coordinate with the debtor, typically through a committee, and through the appointment of professional advisors to assist the committee

5. During the standstill period, the debtor should provide the creditors and their professional advisors all relevant information to evaluate its financial condition and any restructuring proposals

6. Any proposal for resolving the debtor’s financial difficulties should reflect applicable law and the creditors’ relative positions

7. All information should be made to all relevant creditors and, unless public, be treated as confidential

8. Any necessary additional funding should be accorded priority status for repayment

-Source: INSOL 2000

8

The Four Requirements of Chapter 11-style Bankruptcy Laws

1. Stay against individual creditors

2. Mechanism to force responsible debtor behavior

3. Prioritization of new money (to provide liquidity)

4. Bind holdouts

9

Chapter 11 Refinements

1. The system has become routinized and much legal work is boilerplate. Efficiency increases with use and professional fees actually fall as timeframes shorten.

2. Pre-arranged or pre-negotiated bankruptcies are emerging – solicited through the court.

3. SEC solicitation of a pre-packaged plan of bankruptcy is also a key new technique.

4. 363 sales of assets before resolution of inter-creditor bankruptcy issues is a key system refinement.

5. A two-tier system has developed as WorldCom is different from the insolvent corner grocery store and so is the process to restructure them.

10

Developed Countries Restructuring Regimes

In many jurisdictions the emphasis of insolvency proceedings is receivership, liquidation, or proceedings dominated by politics or courts. This suggests business rescue is not the prevailing culture. For many countries, corporate insolvency is stigmatized by failure and deserving of liquidation. It takes a fundamental change in thinking to see insolvency instead as an opportunity to fix a bad balance sheet of a good business.

Agents of change are the private investors in the international capital markets. The distressed debt and hedge funds of today have proliferated in number and size, see themselves as the catalysts of corporate renewal and have become highly sophisticated in using Chapter 11 to reallocate assets and capital.

A system that saves everything, such as one in which every insolvent company is recapitalized or restructured, is as problematic for an economy as one that liquidates everything. A good system quickly chooses between reorganization and liquidation and then provides an efficient process to execute the result.

11

Selected Countries

1. France

2. Germany

3. Italy

4. United Kingdom

12

Examples of Foreign Companies Filing for Chapter 11Under the U.S. Bankruptcy Laws

1. Edelnor SAA – Chilean power generation company

2. Chivor SA – Colombian power generation company

3. FLAG Telecom – Bermuda-registered telecom company

4. Global Ocean Carriers Ltd. – Greece-headquartered shipping company

5. Cenargo International PLC – English freight and passenger ferry company

6. Petroleum Geo-Services ASA – Norwegian oil field services company

13

Developing Countries Restructuring Regimes

1. Argentina

2. Dominican Republic

3. Indonesia

4. Iraq

5. Korea

6. Mexico

7. Russia

14

Requirements of a Rapid Sequencing Process

1. A trained independent judiciary for financial claims and bankruptcy

2. A working private property system for perfecting creditors’ rights in default

3. Proper credit information systems

4. Lending based on credit worthiness and a solvency monitoring system

5. A working simplified Chapter 11-type system

6. Functioning professionally managed CRVs for each distressed asset class

7. The ability to attract foreign direct investment

To promote recovery in a crisis-affected economy, it is essential to link together a restructuring of the financial and the corporate sectors, a so-called rapid sequencing restructuring of the economy.

15

State of Sovereign Debt-Restructuring Regimes

THE MERITS OF A CHAPTER 11 SYSTEM FOR COUNTRIES

Techniques perfected in complex corporate restructuring may be transferable to sovereign debt situations. In particular, a successful process should seek to resolve all classes of creditor claims simultaneously, and the process should be transparent. Any sovereign debt-restructuring plan needs to be feasible from a commercial point of view and consider existing cash-generation capabilities and internal and external factors that may impact future cash flows. Such an approach works in the business world and is considerably different from the piecemeal approach typically employed to restructure sovereign obligations. The Paris and London Club procedures may provide the basis for such a process if it becomes more routine.

The most practical and broadly acceptable reform to facilitate future sovereign debt restructurings would be a commitment by sovereign borrowers to put a package of new clauses (“Collective Action Clauses”) into all future debt contracts. The clauses are intended to create a more orderly and predictable workout process and should describe as precisely as possible what happens when a country decides it has to restructure its debt.

16

State of Sovereign Debt-Restructuring Regimes

THE MERITS OF A CHAPTER 11 SYSTEM FOR COUNTRIES (continued)

Recently, the IMF put forth a detailed sovereign bankruptcy scheme (SDRM) that includes many admirable features, including a majority rule for sovereign debt holders. But, the IMF would limit the scheme to dealings with “private” creditors. This approach doesn’t recognize the fact that, in a sovereign restructuring, all pre-existing debt is similarly situated (with the same legal entitlements). Unless a restructuring plan applies to all similarly situated creditors, it will be difficult to achieve consensus among the private creditors.

In this environment, the role of the Paris Club is particularly important. This unique organization of sovereigns that seeks to restructure the debts of sovereigns facing financial distress is a likely candidate for the role of “lead creditor.” In particular, the Paris Club members have the opportunity to create incentives for global investors to abide by consensual plans that garner support by an appropriate majority. In the future, a mediation forum could develop in Paris, which would seek to resolve all classes of creditor claims simultaneously.

17

Conclusion

1. Chapter 11-type restructuring concepts are important and spreading

2. Chapter 11-type restructuring concepts are critical to affect turn-arounds instead of liquidation and this is important to the company and economy as a whole

3. Chapter 11-type restructurings are critical to attracting new capital, which is a required element of an effective restructuring

4. The trend toward Chapter 11 around the world is accelerating and maturing. Capacity building will be critical to the success of these new systems

5. The basic principles of Chapter 11 restructurings can and should be made applicable to sovereign debt restructurings