Emerging economies are home to approximately 85 percent of the world’s population – around 6 billion people. These markets are playing an increasingly significant role in the global economy, whether this is measured in terms of their gross domestic product, contribution to global growth, increasing role in global trade or the increasing inflow of investments. While emerging markets provide ample opportunities for investors, and offer potentially attractive rates of return on those investments, they also carry a significant amount of risk in an insolvency or bankruptcy scenario.
As emerging markets are being introduced to more sophisticated financial transactions and deal structures, their legal framework and judicial infrastructure are struggling to address the added complexities, particularly when insolvency occurs and companies are facing bankruptcy. This article will highlight some of the key issues and challenges encountered when advising clients that are involved in workouts, restructurings and insolvency proceedings in emerging markets.
Lack of Predicatability
The one single factor that presents the most difficult challenge in addressing workouts and insolvencies in emerging markets is the lack of predictability. The insolvency regimes found in the US, the UK and other developed countries, include a detailed statutory framework, established case law, and an experienced judiciary, which allows creditors to have some reasonable expectation of their rights, remedies and available legal options. This is not necessarily true in emerging markets. For instance, insolvency laws in an emerging market country may be antiquated, non-existent or only recently enacted and untested. The law is often not consistently applied for a variety of reasons. Moreover, the judiciary may lack the expertise or experience to undertake large and complex judicial restructurings. These challenges are often compounded when the situation involves high profile companies owned or controlled by a well-connected family or when the company is a major employer or taxpayer. Often in emerging economies, the law may look straightforward on its face, but it is either not uniformly enforced or is regularly ignored.
Brazil, for example, has implemented the Brazilian Bankruptcy Law of 2005 which borrowed heavily from the US Bankruptcy Code. As the Brazilian economy boomed, the new bankruptcy law was used infrequently. However, due to decreasing oil prices and the unfolding of widespread corruption scandals, it is only now that the law is being truly tested. The Brazilian courts and insolvency practitioners are starting to recognise the serious challenges presented by the Brazilian Bankruptcy Law when addressing complex corporate restructurings involving sophisticated financing agreements and cross-border issues.
To complicate matters, Brazilian bankruptcy law prioritises equity interests over secured and unsecured creditors. This is in sharp contrast to Chapter 11 in the US which places equity interests last in the priority scheme. Even when equity will likely not receive any distribution, under Brazilian law, equity holders still retain the ability to approve a restructuring plan. This can create significant delays and cause untold problems for secured and unsecured creditors, who did not take on the risks of ownership, are expecting payment and are frustrated with a process that impairs their rights to a reasonably prompt resolution.
India is another good example. In India, it takes an average of four years to wind up an insolvent corporation, according to the World Bank. In May 2016, India enacted the Insolvency and Bankruptcy Code which, in theory, could resolve insolvency cases in less than a year. The passing of the Indian Bankruptcy Code is a crucial first step in rehabilitating the otherwise unworkable insolvency regime that previously existed in India. However, the Indian government must now effectively implement an entirely new insolvency framework that will likely add to the challenges of advising clients involved in insolvency in India. While India is planning to begin implementing the new law in 2017, even under the best case scenario, it will likely take years for the system to become fully operational and develop an experienced judiciary and insolvency practitioners.
China, on the other hand, has a more established bankruptcy system, having enacted the Enterprise Bankruptcy Law in 2006. However, though China’s insolvency laws have been in effect for over a decade, the system has remained largely inactive until recently. Between 2008 and 2015, only approximately 20,000 cases were filed in China.
Apparently due to the Chinese government’s attempts to reduce industrial capacity, bankruptcies in China have been steadily increasing since 2016. However, China’s bankruptcy law remains relatively untested when it comes to larger companies or cross-border restructurings. Just how the Chinese government intends to intervene in the process remains unclear. Moreover, it is not just the national government that creates unique challenges in China, but also the lower levels of government bureaucracy that can present problems for an effective restructuring or bankruptcy.
Also, unforeseen problems may arise when addressing insolvency issues in China, due to the perception of bankruptcy, which is largely negative. While Americans tend to view bankruptcy as part of the risk of making entrepreneurial investments, the Chinese view bankruptcy as a personal failing and an embarrassment. Therefore, just getting the process started can be challenging. While these sentiments will largely defy quantitative analysis, it is something to consider when advising clients in insolvency proceedings in China.
Cross-Border Insolvency Proceedings and Protocols
To capitalise on a comprehensive solution involving insolvency there must be a means to address cross-border insolvency issues. The concept of cross-border insolvency is encapsulated in Chapter 15 of the US Bankruptcy Code. Chapter 15 allows a bankruptcy court, under certain conditions, to recognise the appointed estate fiduciaries handling foreign insolvencies and enforce the judgments and orders (and restructuring plans) of foreign jurisdictions that meet certain requirements. Unfortunately, not every country has a corollary to the US’ Chapter 15.
Brazil, for example, even after it updated and amended its insolvency laws, does not have a provision that would recognise a foreign bankruptcy proceeding. As such, if a US corporation built facilities or other structures in preparation for the Olympics in Rio de Janeiro, and then declared bankruptcy in the US, it may be exceedingly difficult to preserve or recover the assets of the US corporation located within Brazil.
The Chinese Bankruptcy Law, on the other hand, does allow a Chinese court to recognise and enforce foreign court orders and judgements to the extent such orders or judgments may be enforced or recognised by a Chinese court pursuant to existing treaties, international conventions or the principle of comity. Unfortunately, there is no such treaty for enforcing judgments between China and the US. It is unclear under what circumstances a Chinese court will be willing to enforce a US court order against assets located in China. This can seriously impair any attempt at a comprehensive financial restructuring.
In more developed countries, insolvency practitioners often take for granted the comprehensive statutory framework, experienced judiciary and established legal precedent, as well as the recognition of the rule of law, when undertaking a financial restructuring or insolvency. For the reasons outlined above, even the most basic assumptions can often be turned on their head when dealing with financial restructurings and insolvencies in emerging markets.
Joseph J. Wielebinski is a shareholder at Munsch Hardt. He can be contacted on +1 (214) 855 7561 or by email: firstname.lastname@example.org. The author wishes to thank his associate, Edward A. Clarkson, for his contributions to this article.