NYU Stern School of Business

Emerging Market Initiative

Corporate Restructuring in Southeast Asia

during the

Asian Financial Crisis of 1997

&

Compare and Contrast

it

with

Corporate Restructuring in Latin America

during its recent economic crises.

Initiated by

Chase Manhattan, Hong Kong SAR

Prepared by:

Steven Alexopoulos

Daniel Ang

Alex Kroner

Suhua Mi

Steven Wang

Date:

March 27, 2000

Introduction………….…………….………………………………………………………… 5

The Asia Crisis of 1997 – 1998…………………….………………………………….…..… 6

An Examination of Thailand’s Banking Sector before the Crisis……….…….…. 7

Thailand Collapses……………………………………………………………….….. 8

The Crisis Spreads to Malaysia & Indonesia………………………………..….…. 9

IN-DEPTH CASE STUDY: THAILAND

Cultural, Political & Legal Issues Affecting Debt Restructuring – Thailand…... 12

Out-dated bankruptcy law…………….…………………………………………….12 Government’s proposal of restructuring………………………………………………..… 12

New bankruptcy law…………………………………………………………….….. 13

Thailand Case Study I: Total Access Communications……………………….…. 15

Thailand Case Study II - Alphatech Electronics Public Company Limited.…… 19

Financial Stress – Hypergrowth or Mismanagement?…………………... 20

IN-DEPTH CASE STUDY: MALAYSIA

Cultural, Political & Legal Issues Affecting Debt Restructuring – Malaysia….. 25

Political-business axis:……………………………………………………………... 25

Economic structure………………………………………………………………… 26

Debt profile- why it allows a government-led restructuring….…………………. 27

Malaysia Case Study I: Debt Restructuring…………..………………………….. 27

Malaysia Case Study II: Renong Group…………………………………………….. 31

IN-DEPTH CASE STUDY: INDONESIA

Cultural, Political & Legal Issues Affecting Debt Restructuring – Indonesia...…. 41

Indonesia Case Study I – HM Sampoerna…………………………………..……… 42

Indonesia Case Study II – AriaWest International….…………………………….. 45

Indonesia Case Study III – Semen Sibinong ……….. …………………………….. 49

IN-DEPTH CASE STUDY: RESTRUCTURING IN LATIN AMERICA

Latin America Country Study I – Argentina………………………………………. 51

Latin America Country Study II – Mexico………………………………………… 61

Latin American Conclusions……………………………………………………….. 67

Assessment of Future Investment………………………………………………………….. 68

Debt Restructuring Matrix – Countries.……………………..………………….….…….. 71

Debt Restructuring Matrix – Companies…..……………………………………….…….. 72

References…………………………………………………………………………………… 73

• The Firm

• The Firm

Renong’s capital structure

Funding Source	1999	1998
Share Capital	1,116,472	1,115,005
Share Premium Account	1,805,409	1,794,848
Reserves	(1,724,955)	(318,073)
Shareholders' Equity BV(E)	1,196,926	2,591,780
Shareholders' Equity MV(E)	6,475,539	2,230,011
Short Term Borrowing	831,353	2,183,579
Convertible Bonds	-	1,805,251
Loan Stocks	240,420	252,447
5-Yr Bonds	-	1,062,227
Long Term Liabilities	8,936,357	4,359,425
Total Debt (D)	10,008,130	9,662,929
D + BV(E)	11,205,056	12,254,709
BV(D/E ratio) =	836.2%	372.8%
MV(D/E ratio) =	154.6%	433.3%
BV(D/(D+E) ratio) =	89.3%	78.9%
MV(D/(D+E) ratio) =	60.7%	81.2%

In December 1998, the Government referred the original restructuring plans for the Renong Group which required government financial support to CDRC. On March 8, 1999, CDRC unveiled its restructuring plans for Renong, UEM and PLUS. Both Renong and UEM have been unable to service debts since October 1998. As at June 30, 1999, the claims against Renong and UEM will amount to RM5.45 billion and RM2.96 billion respectively. Liquidation would be the likely scenario without a comprehensive debt restructuring exercise. Since PLUS is the strongest element in the Renong Group’s stable of companies, the restructuring exercise banks on PLUS’ future cash flow to address both Renong and UEM’s debt burden.

Renong’s Debt Profile – before restructuring

Facility	Amount (RM mil)	Accrued Interest	Total
SECURED Ringgit Loans :
Bank borrowings	397	36	433
RM500 million Bonds	442	-	442
RM390 million 1.75% bonds	390	8	398
RM200 million FRNs	200	20	220
Ringgit total	1,429	63	1,492
USD Loans:
USD118 million Bank Guarantee *	450	15	465
USD150 million TLC	559	26	585
USD total	1,009	41	1,050
TOTAL SECURED	2,437	105	2,542
UNSECURED : Ringgit Loans:
Bank borrowings	199	16	215
Renong ICULs	241	11	252
Ringgit total	440	27	467
USD Loans:
USD225 million ECB1	855	20	875
USD175 million ECB 2	808	13	821
USD 262 million TICL FRN	996	-	996
USD total	2,659	33	2,692
TOTAL UNSECURED	3,099	60	3,159
TOTAL LOANS	5,536	165	5,701
TOTAL LOANS- without ICULs	5,295	154	5,449

UEM’s Debt Profile – before restructuring

Facility	Amount (RM mil)	Accrued Interest	Total
SECURED Ringgit Loans:
Revolving credit	1,118	76	1,194
Term loan	8	1	9
Overdraf	15	1	16
RUNIF	200	11	211
Loans from subsidiaries	903	62	965
Ringgit total	2,245	149	2,394
USD Loans:
Bank Guarantee	152	7	159
USD TLC	384	24	408
USD total	536	31	567
TOTAL SECURED	2,780	181	2,961
UNSECURED Ringgit Loans:
UEM ICULs	169	10	179
Ringgit total	169	10	179
TOTAL UNSECURED	169	10	179
TOTAL LOANS	2,950	191	3,140
TOTAL LOANS- without ICULS	2,780	181	2,961

PLUS will issue RM8.41 billion (cash value) 7 year zero coupon bonds (PLUS Bonds) due in the year 2006 and carry a yield to maturity (YTM) of 9.4% per annum, compounded semi-annually, which will be used to settle all of UEM’s secured creditors and Renong’s secured creditors. As highlighted in the table below, Renong’s unsecured creditors amounting to RM2.907 billion will be part settled with the PLUS Bonds.

The mechanics of the offer follows:

Step 1:

1. PLUS to raise RM8.41 billion using 7 year zero coupon bonds with a 9.4% YTM as follows:

• RM6.96 billion issued to new investors for cash
• RM1.07 billion for early redemption of 45 million of ‘A’ RCCPS owned by Renong
• RM0.38 billion issued to Renong SPV.

1. PLUS will lend RM2.96 billion cash to UEM with 7 year maturity, zero coupon and 9.4% YTM and UEM will pledge its assets in the form of listed shares to PLUS as security.
2. PLUS will redeem 45 million PLUS ‘A’ RCCPS (valued at RM1.07 billion) owned by Renong using the RM1.07 billion of PLUS Bonds.
3. PLUS to lend remaining proceeds to Renong SPV via the following:

• Renong SPV to issue to PLUS RM4.38 billion bonds (Renong SPV Bonds) for RM4 billion cash and RM0.38 billion PLUS Bonds. Renong SPV Bonds have a matching maturity profile to PLUS Bonds
• Renong SPV then uses the proceeds (RM4 billion cash and RM0.38 billion PLUS Bonds) to subscribe for the RM4.38 billion Renong SPV Bonds
• Renong guarantees all Renong SPV liabilities and pledges its assets to PLUS via a trustee

1. Renong uses its proceeds (RM4 billion cash and RM0.38 billion PLUS Bonds) to settle its creditors’ claims.

• Secured creditors to be settled in full with the RM2.54 billion in cash payment
• Unsecured creditors to be settled in full with RM1.45 billion cash and RM1.45 billion in PLUS Bonds

1. UEM to settle its creditors claim in full with RM2.96 billion cash payment.

To evaluate the restructuring exercise, we examine the economic efficiencies from the following perspectives:

1. Creditors: both Renong and UEM’s secured creditors were paid by cash, and Renong’s unsecured creditors were paid half cash and half PLUS bonds, BBB rated – all the creditors are getting paid without hair cut. Total debts of the Group as a whole remain the same as before the restructuring exercise. The parent company, Renong, simply leverages on its healthier subsidiary to finance its indebtedness. The creditors who originally lacked of doing due diligence and over-lent did not get penalized by any hair cut in the wake of financial crisis.
2. Shareholders: after the proposal of the restructuring exercise from CDRC, the stock price stood up from 0.6 ringgit, March 1999 to 2.96 ringgit, December 1999 and recently hit 3.2 ringgit back to the price level before crisis. The shareholders who frenziedly invested in did not take losses eventually.
3. Managers: Halim Saad, the CEO of Renong Group as well as the controlling shareholder, is widely assumed that his shares really still belonged to the ruling party, UMNO, or maybe to Daim Zainuddin, the Minister of Finance and treasurer of UMNO. Whatsoever, Halim Saad is a well-connected individual with UMNO and he continues to be the CEO of the Group. Unlike the market based restructuring exercise, which chooses to sell the less profit making assets or less specialized business, Renong did not dispose any of its assets and is still over-borrowing at a market value debt-to-equity ratio of 155%. All the management remains the same before the crisis hit.

Given the above observation, who foots the bill for the restructuring exercise? Renong explains how it is going be able to repay its creditors in the following chart. Instead of inflating the toll rates, they extend the concession period of the expressway from year 2018 to 2030. In other words, the road users of the generation to come will be paying the price of the restructuring.

Indonesia’s bankruptcy laws date back to 1906. For the most part, bankruptcy solutions in Indonesia have been worked out informally. According to the American Bankruptcy Institute, "there is no effective or predictable method for restructuring troubled loans in Indonesia." The bankruptcy laws are outdated and rarely used. In Indonesia, it is very difficult to force insolvency proceedings and attempted proceedings take years to commence. During which time assets are often hidden from creditors so to preserve the life of the company. The practice of hiding assets is common due to the lack of transparency in Indonesia. Currently, there is not a public system in which companies are required to file financial information.

The second issue in Indonesia relates to culture. It is not culturally acceptable for companies to be labeled as insolvent. The legal implications relating to this cultural issue are that even if a formal court-supervised system was in place, the system would go relatively unused. The IMF may place pressure on Indonesia to revise its bankruptcy laws; however, it may be a very long time before the laws actually change the informal workout methods practiced in Indonesia today. Currently, the most effective strategy by foreign creditors has been to establish relationships with the debtor that emphasize the creditors interest in assisting the debtor. Any IMF pressure may actually further alienate foreign creditors, which are usually advised by Indonesian debtors of an informal workout once it has been agreed upon locally.

Aside from culture, Indonesian people have been very reluctant to use the court system due to corruption. In Indonesia, litigation is considered not only expensive but also extremely unreliable. The government and high profile people are seen as controlling the outcome of litigation. The hesitance of people to rely on the court system, in conjunction with cultural beliefs, presents tremendous obstacles toward reorganizing the many bankrupt companies in Indonesia today.

HM Sampoerna, the second largest cigarette producer in Indonesia, is the producer of Dji Sam Soe, a premium hand-rolled brand of cigarette that accounted for 49% of all cigarette sales for the company in 1998. It is the oldest branded consumer-good and it is sold at a premium.

The cigarette sector is one of the most non-cyclical sectors due to the addictive nature of cigarettes. As such, Sampoerna can rely on brand loyalty from its smokers. As smokers are addicted to its cigarettes, Sampoerna can rely on them to continue to purchase it products. Occasionally, these smokers are known to splurge on premium cigarettes like Dji Sam Soe.

Almost all of Sampoerna’s debts were in foreign currencies. Despite its foreign debt level, in June 1996, Sampoerna issued a US$200 million 10-year Yankee bond to partly finance the acquisition of its 12.5% holding in Astra International, Indonesia’s leading auto producer, and to build its stake to 25%. This action compounded Sampoerna’s foreign debt standing.

Since almost all of its debt was in foreign currencies, Sampoerna was severely affected by the economic crisis of 1997. Despite its debt structure, it is one of the few companies dependent totally on domestic sales and having debt denominated in foreign currencies to emerge from the crisis without having to declare default. The non-cyclical nature of the cigarette business, Sampoerna’s innovative debt restructuring programs and the improved financial condition of the Indonesia economy contributed to the success of Sampoerna’s debt restructuring effort.

Although the cigarette industry was also hit by the economic crisis, the sales figures for 1998, as compared to 1997 figures, recorded increase for the three Indonesian Stock Exchange listed cigarette companies, Gudang Garam, HM Sampoerna and RAT Indonesia. This increase was attributable to a 100% rise in cigarette prices and an actual increase in sales despite the price doubling. Only Gudang Garam posted a profit.

HM Sampoerna realized a 49.5% increase in net sales for 1998, but it posted a net loss of Rp 122 billion for the year as against a net profit of Rp 20.3 billion for the previous year. This net loss was due to the tremendous increase in other costs in 1998, from Rp561.8 billion to Rp 1,234.8 billion, which was attributable mainly to losses in foreign exchange and swap costs.

With its strong brand name, Sampoerna was able to raise prices during the crisis without sacrificing demand. During the crisis, the Indonesian government imposed a 100% price increase on cigarettes. Sampoerna’s reaction to the price imposition was to raise the price of its cigarettes. This increase in cigarette price did not affect its sales. In fact, there was a general increase in cigarette sales despite two negative factors, the 100% price increase and the decreasing purchasing power of the consumers due to the economic crisis.

Despite the increase in cigarette sales, Sampoerna incurred tremendous losses in 1998. This could affect the liquidity and solvency of the company. These losses can be attributed to foreign exchanges and swap costs incurred by Sampoerna.

All values are in Billion of Indonesia Rupiah.

In order to weather the crisis, Sampoerna devised very innovative plans to restructure its debts.

First, it devised a plan that involved debt rescheduling and debt repurchase. Bond with a face value of US$60 million were issued and divided into two trenches:

• one worth US$20 million that was brought back at 55% face value in cash;

• the other worth US$40 million was swapped into equity of 28 million shares at US$0.75 a share, equivalent to 52.5% face value of the bond. There was a reversible option attached to this transaction. If in two years’ time the investors were not happy with their shares, they could swap the 28 million shares back to US$40 million face value bond and two year worth of interest. This debt-equity swap resulted in a dilution of 3.1% on Sampoerna stock price.

This plan was very attractive and well received. It was deemed a success at restructuring the US$60 million debt.

Second, for over a year, Sampoerna could not make payment on its USUS$150 million syndicated loan. It negotiated with its creditors for a debt-restructuring plan. In June 1999, the creditors accepted a debt-restructuring plan. This plan rescheduled the rest of the US$140 million with a single trench through 2002. Principal payments are amortized and paid at the commercial interest rates of Sibor+340 basis points and Sibor+370 basis points in 2002.

Third, it repurchased US$107.5 million of its outstanding US$200 million Yankee bond that matures in June 2006 with cash, forward contracts and debt for equity swap at an average of US$0.54 per dollar of the bond face value. It structured the complicated forward swap that gives higher interest payments combined with a sinking fund. This structure is a tax-effective way to set a side a pool of money to ensure its payments on its swap through to maturity.

The improved financial and political condition of Indonesia has stabilized the value of the Indonesian rupiah and contributed to an increase in purchasing power for its consumers. Because of good sales, Sampoerna now outperforms its sector. The sector grew by 7% per year while Sampoerna’s share of national retail sales improved to 14.2% in the year ending June 1999.

Although Sampoerna was burdened with almost entirely foreign currency denominated debt during the economic crisis, it has emerged from the crisis through innovative debt restructuring plans and a stable business model emphasizing a product that is non-cyclical and addictive.

PT AriaWest International is one of the five KSOs (Kerja SamaOperasi/joint operational scheme) linking a leading foreign telecom operators into a partnership with an Indonesia company holding major stakes. Its partnership structure was 35% MediaOne Group, formerly US West, 12.5% the Asian Infrastructure Fund and 52.5% Artimas Kencana Murni. Each KSO was given a specific area for telecommunication development. It was required to build and own telephone lines in this area and over a 15-year "modified-build-operate-transfer" arrangement with PT Telkom, the Indonesian national Telephone Company. PT Telkom receives a monthly royalty after handing over its lines to the KSO’s.

The lack of a transparent system of telephone tariffs and a better joint venture structure strongly affected PT AriaWest International’s ability to service its foreign debt during the economic crisis. It was able to effectively restructure its debt only after intense negotiations that resulted in changes to KSO agreements.

AriaWest received a chunk of West Java, with a population of 25 million, and only 1.4-telephone lines per 100 people. Under its mandate, which runs from 1996 through 2010, it was to build 500,000 telephone lines in the area. Given the population density and the penetration of telephone lines, it was a reasonable mandate. Because of the lack of capital in the Indonesian debt market to raise rupiah, the US$614.5 million project financing for the telephone line construction was raised in US dollars with the Indonesia government’s guaranty of adjusting telephone tariffs if the rupiah devalued more than ten percent. This adjustment would effectively hedge the rupiah against the dollar.

When the crisis hit, AriaWest was left paying US dollar loans with rupiah earnings. With the rapid decline of the exchange rate between rupiah to US dollar, AriaWest was unable to meet its debt commitments. AriaWest began to draw down its credit lines to satisfy its financial needs. At the same time, AriaWest’s shareholders also contributed another US$120 million of equity capital in order for AriaWest to continue to build telephone lines. This was needed in order for it to continue to make a profit. For AriaWest to survive the crisis, it needed to restructure its debt and its business. It engaged in all the traditional restructuring methods of reducing costs, like halting new constructions and sending home expensive expatriates. It continued to finish up constructions, that had already began, and service its customers in its maintenance capacity.

AriaWest encountered two major obstacles during its debt restructuring effort, which effectively delayed its ability to restructure its loan, and resulted in banks cutting off the company credit line in April 1998 after it had drawn down US$284 million in loans.

AriaWest was unable to extend the term of its loans for more than ten years because of the restrictive operating agreements attached to the KSOs. These agreements grant the Indonesian partners the exclusive rights to buy out their foreign investors in year ten of the fifteen-year duration of the partnership. The banks were unwilling to rely on such a contract where there was a possibility that AriaWest would be bought out in the tenth year.

Since the formation of KSOs, PT Telkom had become 24% owned by foreign investors after an IPO. The new Telkom could not afford to be charitable and therefore was not able to "share the pain" experienced by the KSOs.

Finally, the government had not delivered on its guarantee of raising the tariffs after the tremendous drop in the value of the rupiah from 2,400 to 18,000 rupiah per U.S. dollar.

AriaWest successfully negotiated with Telkom and the Indonesian government to drop the ten-year buyout option, allow the KSOs to retain 20% more profits for two years, ease the requirements to build new telephone lines, and raise tariffs by 24 percents. These tariffs were later lowered to 15% without notification or explanation.

This revised deal came as a relief to stakeholders of AriaWest. Banks and vendors began to negotiate with AriaWest. It was to their best interest to have AriaWest as a going concern instead of liquidating it. AriaWest is providing telephone service to a country that is seriously in need of such service. The upside for AriaWest is therefore very attractive.

An agreement with thirty-eight banks, six vendors and three shareholders was reached after six months of complex negotiations. AriaWest’s was able to generate cash to repay the US$57 million in vendor-obligations and a US$212 million funded facility. This deal enabled AriaWest to continue building telephone lines. As of August 1999, it has built almost 300,000 new lines and even offers enhanced services like those available in developed countries.

Further restructuring of the telephone tariffs and the joint venture (KSO) structure would significantly improve the health of and the viability of the joint venture in the telecommunication industry in Indonesia during this difficult period. Due to its superior negotiation skills, AriaWest was able to navigate through the system searching for a way to change its business environment and find a way that ultimately saved the company.

Semen Cibinong is the third largest cement maker in Indonesia. It is the cement company part of the Tirtamas Group. The Tirtamas group is headed by tycoon Hashim Djojohadikusumo, a relative of President of Suharto. Because of the relationship between Mr. Djojohadikusumo and President Suharto, Semen Cibinong was able to secure government contracts and raise tremendous funds for its projects.

Due to the financial crisis and the devaluation of Indonesian rupiah, Semen Cibinong was unable to service its US$1.3 billion of debts.

On March 27, 1998, the cement maker had deferred the payment of interest and principal of its loan. It was able the resume its monthly partial interest payment at 25% of original interest rate by November 30, 1998 through cost cutting efforts and the increasing its exports.

The company also entered into debt restructuring talks with the help of the Jakarta Initiatives with its creditors. After eighteenth months of negotiations with sixty banks, including Deutsche Bank, Chase Manhattan, the U.S. Export-import Bank, ABN Amro Bank, and the Indonesian government, these creditors agreed to restructure up to US$1.3 billion in accrued interest and principal payments. This agreement was based on the company assurance that it had US$234 million in cash available for debt buy-backs.

Before the final settlement of the restructuring plan, these creditors was informed by Mr. Djojohadikusumo that about US$200 to US$250 million was no longer available for debt buy-backs. This news abruptly halted the debt restructuring talks.

Mr. Djojohadikusumo insisted that the fund was not missing instead it was deposited into other banks but he was not at liberty to disclose the banks in order to prevent the creditors from freezing the fund.

This practice of hiding assets from creditors is very common in Indonesia. Because of the multi-layer ownership structure inherent in the corporate structure in Indonesia, it is very easy for one corporate entity to transfer assets to another corporate entity under the same-umbrella corporation. Without transparent transaction between these corporate entities, it is very difficult for creditors to determine the actual assets of these entities.

Indonesia like its neighbors emerged from the crisis with a better understanding of debt restructuring and reforms. There were no specific restructuring pattern found in these case studies.

With the help of IMF, it has established a better system to handle corporate restructuring. Through the Frankfurt agreement between creditors, it has established three elements: a framework to reduce real exchange risk on payments following restructuring of external debts, a scheme to restructure interbank debts and an arrangement to maintain trade finance facilities. Bankruptcy law was revised and a Special Commercial Court was established to handle bankruptcy proceedings.

Unlike its neighbor, Indonesia is also going through political and social reforms. A majority of its crony capitalists from the Suharto regime were severely "cripple" by the crisis with sizable losses. With the help and directions of IMF, Indonesia could emerge to become a country with more transparency in its business dealings and be more attractive to foreign investors if it could maintain its political and social stability.

This part of our analysis reviews the legal framework for restructuring distressed companies in Latin America and reviews several completed restructuring cases. In addition to analyzing the terms of the settlement, we examine the role of the government of the borrower’s nation in the workout process.

We have selected restructuring cases in two of the three largest economies in the Latin American region: Argentina and Mexico. In selecting the representative cases, we tried to avoid examining the insolvency of banks because these assets are viewed as more strategic to the government than an ordinary corporation. Therefore, the treatment of the banking corporations may not be indicative of how a non-banking restructuring is done in these countries. In addition, banks are inherently more regulated than other corporations.

In August 1995, the Argentine government has introduced a significantly more progressive legislation governing bankruptcy to replace the existing legislation, Statute 19,551.

The main objectives of the law are:

• to make insolvency proceedings more flexible in order to allow the creation of as many ways as possible to keep debtors in business;
• This objective, to some extent mirrors the mechanisms that exist in the US

• to assign a more important role to creditors;

• to limit the powers of the bankruptcy judge;

• to simplify the process so as to enable a faster sale of the assets of the debtor in the event of bankruptcy / forced liquidation;

• to reformulate the receivership function;

• to bring in specialists and other professionals (accountants, financial analysts, and so on) during the insolvency and bankruptcy process.

• Finally, this new law accelerates the bankruptcy process in several ways, discussed below. Such acceleration allows the future owners of the business (creditors or shareholders) to preserve some value and create certainty around the operations of the debtor.

One important departure from the old regime is that the law now provides that corporations partly or wholly owned by the federal government or by state or municipal governments may be declared in bankruptcy. This part of the new law is very important because it reduces the bias toward government-owned corporations.

In addition, insolvency proceedings may now be commenced at the instance of the debtor even after the bankruptcy has been declared. In such cases, if the bankruptcy is declared by the judge at the request of a creditor, the debtor (and not a creditor) may ask for the conversion of the bankruptcy into an insolvency proceeding. The role of the court system is crucial in the process.

At the time of court presentation, most of the requirements are directed towards the creation of a clear picture of the financial condition of the debtor. The law requires, as did the previous law that the debtor is in cesacion de pagos in order to file for an insolvency proceeding. The cesacion de pagos has been construed by legal scholars and from judicial precedents as a general and permanent state in which the debtor is incapable of complying with its due financial obligations by normal means. Thus, the law has adopted the criterion that the debtor's state of insolvency may be revealed by a number of indicia (inability to pay a debt, closure of place of business, sale of assets at below market prices, and so on). In the event of such insolvency, the debtor is entitled to file an insolvency proceeding. The drawback of the system is that at the time of presentation the debtor is already immersed in a financial crisis.

• The law gives creditors a more significant role, authorizing the setting up of creditors' committee, to be composed of representatives of each of the different categories of creditors. Once the insolvency proceeding has been initiated, the debtor presents a payment proposal for approval by the creditors. On their approval, the judge then confirms it.

• Following the trend in other countries, the law allows the presentation of a different proposal for each category of creditor and the offering of several choices within each category.

• A creditor may choose between a reduction of the payable amount, longer terms, a fixed interest rate of debt bonds, issuance of bonds convertible into shares, or assignment of credits to other companies.

One very innovative approach involves the chance the law gives to a creditor or a third party to rescue the troubled corporation. This approach is, in some ways superior, than the one in the US, Pursuant to this mechanism, if the term for presentation and approval of the scheme has expired before the debtor has been able to obtain approval by the creditors, third parties or any creditor of the debtor may present a payment proposal. If such proposals are approved, the creditor or third party may acquire the aggregate equity interests held by shareholders of the debtor.

This rescue mechanism works as follows: within 48 hours of the expiration of the term for the approval of the debtor's proposal, the court opens a registry in which the creditors and third parties interested in rescuing the debtor register. Those registered will be entitled to present payment proposals within a 10-day period. The proposal must be approved by a majority of creditors representing at least two-thirds of the capital within each category of creditors. The first to obtain the approval of the proposal has the right to request the transfer of the aggregate interest held by the shareholders or partners of the debtor. The amount paid must not be less than the total net worth of the debtor minus the value of all the credits against the debtor admitted by the court. It is expected that this mechanism will attract foreign investors (with available funds and technology or know-how) with the prospect of acquiring companies in financial difficulties cheaply.

However, a serious problem is that the rescue of the corporation by third parties can be carried out only if the debtor has failed to get the creditors' approval of its proposal. At that point the company is likely to be in even greater difficulties than at the time of filing for insolvency.

Another important amendment to the former bankruptcy law is that labor suits, which usually arise during the financial difficulties of a company, are suspended if the debtor files for bankruptcy or insolvency. Workers will have to demonstrate the existence of their credits at the bankruptcy court. The accumulation of all labor suits at the court where the bankruptcy has been filed will save time, reduce the receiver's workload and benefit the labor creditor. Previously, it was necessary for workers to obtain a favorable verdict from the labor court and afterwards request verification of the amount of the judgement in the bankruptcy courts. Furthermore, under the new law, the debtor is allowed to renegotiate the employment terms with the workforce (formerly prohibited because of public order considerations and collective bargaining agreements), limiting the days and hours of work and cutting salaries.

Since in the present economic system corporate groups are significant players, the law incorporates a special chapter enabling entities that form part of an economic group to jointly request in court the opening of an insolvency proceeding. Under the law, the whole group of companies may file the preventive proceeding. Article 66 of the law provides that in the case of companies that make up a single economic group, it is sufficient that one of the companies be in a state of insolvency in order to be able to file the preventive proceeding, provided that such state may affect the rest of the companies of the group. The court having jurisdiction over the company with the most significant assets handles the suit. Only one receiver is appointed for the whole group. However, the court may decide to appoint more than one. There is one proceeding for each company but the receiver will prepare only one report. Finally, as to credits among the companies in the group, the new regime establishes that credits in the two years prior to the filing shall have no voting rights in the proceedings to verify claims.

The law also regulates out-of-court agreements executed between creditors and debtors. If the agreement is signed by a majority of the creditors, representing at least two-thirds of the liabilities of the debtor (excluding the creditors indicated in Section 45 of the law), the agreement may be filed in court for the judge's approval. All creditors not party to the agreement may oppose its approval. If approved by the judge, the agreement will be held valid against those creditors who were not parties to it, and against any other third party even if the debtor is subsequently declared bankrupt.

Like the previous law, the new law establishes that certain acts of the debtor performed while insolvent, but prior to the declaration of bankruptcy, or to the filing for insolvency proceedings, may be held to lack legal effect because they are performed during the so-called periodo de sospecha (period of suspicion). Such period may not extend for more than two years prior to the declaration of bankruptcy or filing for insolvency proceedings. The acts that may be declared ineffective are:

• gratuitous acts;

• advance payments of debts which otherwise would have matured after the date of bankruptcy;

• acts that granted a security interest or mortgage regarding debts which originally lacked such preference or security interest; and,

• any other act which has been detrimental to the creditors and which was entered into with a party that knew at the time of execution that the debtor was insolvent. The party to the contract with the debtor must prove that the act was not detrimental.

The requirement that the act has to be detrimental to the creditor is one of the law's innovations and seems reasonable as creditors would otherwise be entitled to demand the invalidity of acts that do not affect their position.

However, the law has shifted the obligation to demonstrate that the action of the debtor has not been detrimental to the creditors from the receiver (as provided before) to a third party. It is likely that third parties will have no relationship with the debtor or with the creditors and will,

in all probability, have problems showing that the actions of the debtor are not detrimental to the position of the creditors.

Finally, another important feature of the law is the creation of the National Registry of Insolvency Proceedings and Bankruptcies, in which all parties subject to any proceeding will appear. With the creation of this registry it is expected that more transparency and certainty will be given to future business activities. The law applies to all insolvency proceedings filed and bankruptcies declared after the date on which the law enters into effect.

In 1994, the petrochemical industry was in a downturn due to overcapacity and falling prices. In addition, as a result of Mercosur, an economic treaty between several nations in Latin America, which include Brazil and Argentina, Argentine petrochemical producers were loosing market share to their Brazilian competitors.

Indupa, once the largest petrochemical company in Argentina, unified its subsidiaries into a single concern and filed for Chapter 11, seeking protection for its debts of more than US$500 million--US$350 million of which resided with the government. The government rescue plan for Indupa included swapping debt for assets. As a consequence of the bankruptcy and the restructuring of Indupa, there has been a change in its ownership; the government took over 51% of Indupa's voting stake in exchange for debts. The government has also appointed a new management team headed by the chairman Oscar Saggese, a highly experienced and talented executive. Previous shareholders in Indupa, which include YPF S.A. experienced a 50% dilution as a result of the debt restructuring. Post restructuring, Indupa had US$780 Million of assets and was on target to post US$200 million in sales for 1994, despite the cyclical downturn in the chemical industry.

The Argentine government has since privatized some of its stake in Indupa S.A. and PBB, a sister company by selling a 24% stake to Solvay Group, a Belgian-based multinational chemical concern. The Solvay group also purchased a 27% stake in Indupa from YPF-Repsol (former state-owned Argentine monopoly. These two purchases gave the Solvay Group a controlling 51% interest in Indupa. Indupa has since added a highly profitable PVC chemical to its operations and expanded its capacity in the region.

The case of Ipako, the other large petrochemical company in Argentina is drastically different because the government did not actively participate in the restructuring. In the midst of the financial distress, the Company announced restructuring effort and sold one of its crown jewels, Petroken, a joint venture in Polypropylene to its partner YPF, a former state monopoly. This sale resulted in proceeds of US$42.5 million and allowed the company to reduce its debt load from US$194 million to US$139 million. In addition, Ipako eliminated over 600 jobs and was able to post a profit of US$11.7 million in the quarter following the restructuring compared to a loss of US$12 million during the same period in the prior year.

The case of Buenos Aires Embotelladora SA is by far one of the most interesting in the history of bankruptcies in the region. BAESA is an independent bottling company that holds exclusive rights to market PepsiCo’s soft drinks in the Latin American region.

Baesa was started by an American citizen, Charles Beach, a 35-year veteran of the soft drink industry. In 1987, Mr. Beach acquired PepsiCo’s bottling operation in Puerto-Rico and Costa Rica. By 1989, Mr. Beach signed a license agreement with PepsiCo for the area of Buenos Aires, where PepsiCo’s competitive position had been completely wiped out by Coca-Cola and the existing PepsiCo bottler went bankrupt. A unique feature of Baesa is that it was financed by private investors, not the government.

By 1992, the company had revenues of US$204 million and a net income of US$28 million. In three years, Baesa secured a 23 percent share of the cola market and 39 percent of the soft drink market compared to the former licensee of PepsiCo, Inc, whose cola market share was a mere 5.3%. Baesa went public in 1993 selling $156 million worth of common stock, one half of which by Charles Beach. Wall Street was enamored with the story and Baesa received multiple awards for outstanding performance. In 1993, Baesa’s ADRs were listed on the New York Stock Exchange.

After this initial success and recognition, Baesa secured its relationship with PepsiCo, Inc. in a complex merger. PepsiCo’s operations from Chile and Uruguay would be merged into Baesa; PepsiCo also invested US$26 million into Baesa in exchange for 26% of the company. PepsiCo has also publicly committed to begin purchasing controlling interest in Baesa in 2001. Subsequently, in December of 1994, Baesa has also received a franchise license in Brazil, the largest market in Latin America. Wall Street continued to applaud the Company that has increased sales by 800% in just over four years. Baesa was expanding to five major markets without a middle management structure in place.

Brazil turned out to be a major roadblock for Baesa, where Coke continued to dominate. By the middle of 1996, the Company had amassed $800 Million of debt and in light of unsuccessful penetration of the market in Brazil, posted a loss of $251million, which included loss from operations and restructuring charges. PepsiCo assumed a management control and began restructuring efforts. Baesa announced a 100-day restructuring plan and a potential sale of its Costa Rican operations. The Company began to close a manufacturing plant and three distribution sites in Brazil. It also announced layoffs of 1,500 workers. While Baesa was hit the hardest in Brazil, the company suffered in all of its markets. The Company’s equity market value in August 1996 dropped to $180 million from $1.5 Billion in 1994.

In October 1996, PepsiCo committed an additional US$40 million to Baesa (US$25 million as a loan and US$15 million as marketing support). The Company has also managed to delay the principal payment on a US$520 million of its US$700 million debt until March 1997. In December of 1996, the Company took a US$40 million charge for accounting irregularities. Similar accounting problems have also been found at the Puerto Rican franchise, also controlled by Charles Beach.

In February 1997, the Company announced that it completed its restructuring efforts and announced a loss for the quarter of US$16.7 million. The Company’s debt reached US$765 million and its market capitalization further declined to US$80 million. The Company defaulted on a US$505 million of its US$765 million debt in April of 1997 and posted a loss of US$30 million for the first quarter. In June, the Company missed an interest payment on the rest of its debt obligations. In July of 1997, the Company completed its restructuring in a form of debt for equity swap. The unsecured creditors agreed to exchange their obligations for 98% of the Company’s equity and US$300 million in new notes.

Mexico's Bankruptcy and Suspension of Payments Law (Bankruptcy Law, for short) dates back to 1943 and has never been amended. Moreover, it is often inconsistent and subject to different interpretations. With these provisos, following are some of the basics.

In Mexico, as in Canada, bankruptcy proceedings can be initiated voluntarily by the debtor or involuntarily by one or more creditors alleging that the debtor has ceased to pay its obligation. Either way, the court examines the evidence and determines whether to accept the bankruptcy. When a debtor is declared bankrupt, the court appoints a trustee (sindico) and an inspector (interventor). Sindico: The sindico's powers (in the case of bankruptcy) are similar to that of a trustee in Canada. They include:

• taking possession and managing the bankrupt's assets;
• preparing financial statements and approving them;
• examining the bankrupt's books and documents;
• collecting and depositing monies;
• preparing a list of creditors.

The sindico may propose arrangements to the creditors, such as the continuation of the enterprise as a going concern or the liquidation of the bankrupt's assets. Interventor: Though he represents the creditors the interventor is initially appointed by the court. Later, however, the appointment must be confirmed by the creditors.

This procedure, similar to reorganizations in Canada, is designed to give a debtor time to solve its financial problems before resorting to bankruptcy. A judge authorizes the debtor to stop paying its obligations during a given period of time while it attempts to reach agreement with

its creditors for a restructuring of its debt.

Though the court appoints a sindico, suspension of payments differs from bankruptcy in that the debtor continues to operate the enterprise. The sindico's role is that of an inspector rather than a manager. But in practice, suspension of payments seldom results in successful reorganization. By the time all fees, taxes and wages have been paid, there is usually little or nothing left to continue the business. In most cases, the end result is liquidation.

In the beginning of 1993, AeroMexico and Mexicana the two largest Mexican airlines combined after a fierce competition against one another and in anticipation of fierce competition from the US carriers. AeroMexico acquired a 55% interest in Mexicana. This combination was in part orchestrated by the Mexican government, which owned one third of the combined entity. The government publicly announced its intention to "protect national sovereignty and keep our operational wits about us" a few weeks prior to the combination.

From 1990, after an investment by a prominent aviation executive Gerardo de Prevoisin, who became the Chairman of the Board, the Company was transformed in an effort to build a southern hub. The two companies were run by the same management and had an 80% market share in the domestic market and a controlling share of AeroPeru. Mr. Gerardo de Prevoisin was highly praised by its colleagues for a successful turnaround and enjoyed great publicity in the US as well. The combination with Mexicana was the largest transaction undertaken by any Mexican airline. His popularity increased after Mr. de Prevoisin was honored as the Houston Aviation Executive of the Year.

Six months after such a prestigious award the banks forced Mr. de Prevoisin out of the Company due to his inability to raise capital for the money loosing airlines. In the first half of 1994, Aeromexico posted a loss of US$139 million on sales of US$975 million, while Mexicana lost US$117 million on sales of US$427 million. Together, the companies had approximately US$1 billion of debt. The company appointed a new management team headed by one of the investors to negotiate with creditors and restructure the money-loosing airline.

In September 1994, the Company discovered a liability of US$50 million previously undisclosed. The former Chairman Mr. Gerardo de Prevoisin fled the country. Both companies had trouble meeting its aircraft lease obligations to Airbus Industrie. By November of 1994, the two companies were placed in a single transitional entity and Aeromexico negotiated a capital infusion from the creditors of 527 million pesos (US$152 million).

The Tequila crisis of 1994 exacerbated the airline’s problems as 70% of the total debt was denominated in U.S. dollars while the predominant portion of the Company’s revenues was in pesos. In June 1995, when it became clear that Aeromexico would fail to make interest payments, the company had US$400 million of non-bank debt, US$100 million of a Eurobond issue, between US$250 and US$300 million in bank debt, partially dominated in pesos, a US$37.5 million in Euro commercial paper and a liability of US$50 million or US$70 by some estimates created by the fraudulent activities of Gerardo de Prevoisin. In addition, the Company had other liabilities including lease payments to Airbus Industrie.

• Euronotes: US$137.5 million in bonds due June1995 were exchanged for a five-year note at 9.75% beginning amortization in 1998.

• $1 billion of bonds and notes were converted to 70% equity ownership. The government approved a full-scale merger between Mexicana and Aeromexico, creating Cintra S.A., which will dominate the Mexican market.

• Subsequent to the merger a public offering of the combined entity was priced at US$1.25 per share or three times earnings. The ownership continued to be concentrated with the banks and Mexican government.

• By combining these two entities, the government essentially created a monopoly, driving smaller carriers such as Taesa out of business.

In the late 1980s - early 1990s, Grupo Sidek was one of Mexico's top 25 companies. The company was a conglomerate with interests in steel, tourism, and the retail sector. Sidek's shares have been quoted on the Mexican stock market since 1979 and through American Depositary Receipts (ADRs) on the New York Stock Exchange since 1989. Tourism and related real-estate business represent 68 percent of Sidek, rapidly overtaking the company's former emphasis on steel.

Having anticipated a rise in tourism by Mexico due to great economic conditions, Sidek's tourism arm, Grupo Situr, began work on the first private sector megadevelopment in the history of Mexican tourism. This development, Marina Vallarta, primarily marketed directly to foreigners and affluent Mexicans, was designed so that tourists who fly into the resort can be on board their yacht or on the golf course within ten minutes after arrival. The idea was to create a destination that offers hardworking people the chance for a "cocooned adventure" free from the tedium of arranging reservations, day tours, and ground transportation. In addition, the Company built a shopping mall and invited other resort development companies such as Marriott to build properties there as well. The venture was highly successful. Many properties were purchased for US$250,000 - US$300,000.

Following the success and Marina Vallarta, Grupo Situr continued its expansion and built similar resorts along the Carribean coast and other parts of the country. In some developments the houses were sold for as much as US$500K - US$1 million.

The company’s unique expertise of building megaresorts as well as the perceived profit potential attracted European investors. Two Irish companies, Irish Life Assurance and G.P.A. Group Ltd., each purchased a percent of Situr. Europeans also began to purchase leisure properties in Situr’s resorts.

In 1991, the company’s tourism subsidiary earned US$44 million on revenues of US$399 million. In addition to heavy expenditures in the tourism sector, the Company committed to invest US$200 million to upgrade its steel arm and penetrate the U.S. steel market taking advantage of NAFTA.

By 1991, the company’s debt to assets ratio was 50%. To sell its developments to investors, the company had to operate a mortgage bank, which experienced a 6% default rate and had loans outstanding of US$150 million. In 1993, the company completed an equity offering in the U.S. and in 1994, was listed on the New York Stock Exchange.

The Tequila Crisis of 1994 put the entire tourism industry in distress. In February 1995, Grupo Sidek missed a scheduled debt payment of US$19.5 million. The Company had US$1 billion of dollar-denominated debt, US$100 million in commercial paper and US$60 million of cash. As the peso value fell by over 40%, many Mexican companies including Sidek experienced a credit squeeze. Sidek chose to use the existing cash balance to finance continuing operations.

Two days after default, the company was pressured to release US$29.5 million to its short-term creditors, following the commitment by the Mexican government and a group of local banks to arrange US$107 million in additional credit lines. The Company was experiencing a severe decline in financial performance with sales dropping by 25% in the first half of 1995 and a drop in net income by 38% from 133 million pesos to 82.4 million pesos.

In December 1995, as Sidek’s financial performance deteriorated, the company arranged a six-month extension on its short-term credit line. As of February 1995, the company’s debt reached US$2.12 billion, 70% of which the creditors agreed to restructure. The company also defaulted on a US$20 million of internationally placed note and unlike other companies in distress, did not receive a capital injection from the government. In April 1996, the Company was sued by the US investors. The corporate restructuring of the US$2.12 billion of Sidek’s debt was the largest corporate default in Mexico. Banamex, one of the largest Mexican banks, with exposure to over 40% of the group’s debt was leading the restructuring effort. The Company’s assets were valued at US$700 million.

The final restructuring turned out to be quite contentious. Although the foreign investors, primarily US hedge funds, initially refused to accept the terms of the settlement, they, however, were forced to comply by the company and large Mexican banks. The restructuring, which reduced the group’s debt from US$2.1 billion to US$1 billion was also designed to shield the company’s assets from the foreign investors. The company was essentially placed in the liquidation mode. Its assets were placed in a new entity called Sidek Creditor Trust, which had been given five years to sell the assets. While no specific information had been given about the restructuring, the foreign investors that held US$150 million of unsecured bonds stated that the settlement was favoring the large Mexican Banks. The Mexican banks, in turn, sold their exposure in exchange for zero-coupon bonds to Fobaproa, a government agency set up to rescue Mexican corporations with theUS$56 Billion loan aid from the US. Six months later, the Mexican authorities arrested the chairman of Sidek based on tax-evasion charges.

The Mexican government has again acted in a protectionist fashion without allowing free-market forces or the established legal system to fulfill its role. This behavior as well as favoritism to the Mexican banks, has undermined the promises of a free market reform.

The Mexican government has been acting in a protectionist fashion during the crisis. In addition to the cases described above, the government has also blocked many vulture investors that were flooding Mexico in 1995 in hopes of purchasing distressed assets. Throughout the crisis, the government stepped in as a buyer of last resort, again acting against the laws of financial markets. As a result, Mexican banks also did not feel the need for quick restructuring in an open market because the government was not only absorbing defaulted banks but also buying bad loans from the balance sheets of healthier banks.

The Argentine government, however, acted as a powerful participant in financial markets as a shareholder when implementing and overseeing restructuring in Argentina. Such behavior has been welcomed by the Western financial community and illustrates the Argentine government’s commitment to a free market economy.

As capitalism moves into the twenty-first century, the trend towards a truly global economy will result in an increased level of foreign portfolio and direct investment. Some of the most interesting stories are likely to be found in what have come to be called "emerging markets", countries such as China and Mexico. Recent trends help to illustrate the deterioration of barriers to foreign investment going forward into the new millennium.

In China, a landmark agreement was reached with the United States in an accord that is the first step to opening China’s markets for the first time in history. With 1.3 billion potential customers, China’s market is perhaps the largest marketplace in the world. The 250 page document laid out the plan which would result in Beijing becoming a member of the World Trade Organization. According to the report released by the White House, in addition to eliminating many quotas and slashing tariffs, China’s major commitments include:

• China will permit a 50 percent foreign equity share for value-added and paging services two years after accession, a 49 percent foreign equity share for mobile voice and data services five years after accession, and for domestic and international services six years after accession.

• China agreed to allow 50 percent ownership for life insurance. Life insurers may also choose their own joint venture partners. For nonlife, China will allow branching or 51 percent ownership on accession and wholly owned subsidiaries in two years. Reinsurance is completely open on accession.
• China has committed to full market access in five years for U.S. banks. Foreign banks will be able to conduct local currency business with Chinese enterprises starting two years after accession. Foreign banks will be able to conduct local currency business with Chinese individuals from five years after accession.
• China will permit minority, foreign-owned joint ventures to engage in fund management on the same terms as Chinese firms. By three years after accession, foreign ownership of those joint ventures will be allowed to rise to 49 percent.
• Beijing will allow U.S. businesses to have their own distribution networks in China, rather than being forced to set up factories there to sell products through Chinese partners.

All of the stated commitments will result in an increased level of foreign portfolio and direct investment in China.

Perhaps the greatest push to reduce barriers to foreign investment is coming from the European Union (EU). In Mexico, an accord was recently signed that will provide European companies with greater access to markets in Latin America. According to Mexican President Ernesto Zedillo, "It is the first free trade accord between Europe and a country on the American continent." The agreement will also give Mexican producers access to 375 million customers in Europe. EU’s agreement was largely in response to North American Free Trade Agreement between Mexico and America and Canada in 1992. European Union is also aggressively pursuing open trade agreements with Chile, Argentina, Brazil, Paraguay, Uruguay and 71 African, Caribbean and Pacific countries. Portuguese Prime Minister Antonio Guterres has stated that "..(EU)..does not want to be fortress Europe….(EU) was open to the world."

As more developed countries push for free-market reforms in order to attain access to untapped markets, the long-term result will be an increased level of both portfolio and direct investment, but not without social costs. Three major currency crises have been witnessed over the last decade, the European crisis of 1992-1993, the Latin American crisis of 1994-1995 and the Asian Crisis of 1997-1998. These crises did not arise without real economic consequences as the capital flight out of emerging economies has catapulted numerous companies in the affected countries into bankruptcy. Napoleon had recommended to "let China sleep, for when it wakes, it will shake the world." As of the completion of this report it appears that the United States has taken the first step in awakening China.

On the pages that follow is a table that compares and contrasts the countries and companies under analysis in this report. It is our hope that the lessons learned from reports such as this one be utilized by all countries, such as China, that have reduced or eliminated historic barriers to foreign investment. While there are tremendous benefits to open markets, this report has demonstrated that the benefits are not attained without a cost.