ASIALAW - March 1998

THAILAND JAMES LAWDEN, SUPARB VONGKIATKACHORN AND EDWARD DEVER Freshfields, Bangkok

What went wrong? The reasons for current economic predicament of Thailand are best assessed by economists, rather than lawyers. From our perspective, it looks like an old-fashioned boom and bust, made worse by the boom being funded by a wave of cheap - but unhedged - foreign currency loans, and the bust being as bad as it is since, due to opaque reporting and a tendency towards concealment and crony capitalism, the boom may not have been quite as good as it appeared for some time. The blame for the end of the boom is now laid at the door of the devaluation of the renminbi in 1995, which rapidly had the effect of making Thai exports uncompetitive. That something was going wrong became apparent with the Bangkok Bank of Commerce debacle in 1996, when that bank was found to be missing around US$ 2 billion of its balance sheet. The stock market, which peaked in 1994 with the SET index at around 1800, was at around 1200 at the beginning of 1996 and 800 at its end. It continued to sink during 1997 to around 350 at the year end. The next sign of trouble was the announcement by Finance One PCL, the biggest Thai finance company, that it was in financial difficulties. During the spring of 1997 attempts were made to merge it with Thai Danu Bank PCL, under the aegis of the Bank of Thailand, but the transaction did not proceed. The Baht came under extensive attack during the spring and early summer of 1997, until at the beginning of July the Bank of Thailand had effectively used up its reserves and had to agree to a float. The currency then fell from around Baht 25 to the US dollar at the beginning of July to a low of Baht 57 to the US dollar in January 1998, from which it has since recovered to around Baht 43 to the US dollar at the time of writing. This has had devastating effects on the large number of Thai companies which had borrowed foreign currency unhedged, thinking that the peg of the Baht to the dollar would last. The loss of confidence has also led to a liquidity crisis, as new funding from abroad has dried up and the Thai banks and financial institutions have been struggling to cope with their own non-performing loans.

The financial sector The Financial Sector Restructuring Authority The Bank of Thailand suspended the operations of 16 of the finance companies in late June 1997, and a further 42 in August 1997, out of a total strength of 91. These finance companies were then given the opportunity to convince a body established for the purpose, the Finance Sector Restructuring Authority (the FRA) that they had a viable plan to recapitalise themselves, but at the beginning of December 1997 only two had done so and the remaining 56 were then taken over by Special Managers appointed by the FRA, with a view to the disposal of their assets and their subsequent liquidation. This process has just begun. Creditors of 40 of the closed finance companies have the option of converting the principal amount of their debt into Baht denominated negotiable certificates of deposit of Krung Thai Bank PCL. Interest at 2% per annum is payable on the NCDs, the maturity of which will vary depending upon the size of the original loan and its maturity. Creditors who do not convert their debts by the deadline of 31 March 1998 may participate in the liquidation of these companies. Creditors of the other 16 closed finance companies are not eligible to convert their debts into NCDs and can only participate in the liquidation process. Creditors are also expected to be entitled to convert part of their debt into equity in Radhanasin Bank, the commercial bank to be established by the government to purchase some of the finance companies assets. Assets of the finance companies will be sold by auction or tender process. Radhanasin Bank (and its finance and securities subsidiaries) as well as another specially established body, the Asset Management Corporation (AMC) are expected to bid for assets during the liquidation process: Radhanasin Bank focusing on better quality assets and the AMC acting as a buyer of last resort. The FRA expects to complete the liquidation process by the end of 1998. Distribution of the proceeds to creditors will commence in 1999. Other legislation 1997 also saw a range of new legislation introduced in an attempt to introduce liquidity into the financial sector and, to a limited extent, attract foreign investment. From the spring of 1997 onwards a series of measures was introduced by the Bank of Thailand, offering incentives to finance companies to merge by providing for a mini-bank or super finance company status. Foreigners were given the opportunity to acquire a stake in these businesses of more than the 25% to which they had previously been limited in the case of both banks and finance companies. As it has become increasingly clear that foreign capital will be

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required to recapitalise the Thai banking system, the Commercial Banking Act has now been amended to provide that the Bank of Thailand may approve foreign ownership of over 49%, and guidelines have been issued by the Bank of Thailand and the Ministry of Finance to the effect that the holding of over 49% may be maintained for 10 years, but after the 10 year period has passed the foreign shareholder may not subscribe to any further issues of capital until it has been diluted to a 49% interest. Other legislation in the financial sector has included the establishment of a secondary mortgage corporation, and a special purpose vehicle law, designed to assist securitisation. The special purpose vehicle law is designed to assist the securitisation process by removing some obstacles which were previously thought to stand in its way. These have included removing the requirement to give notice to debtors on transfers of their debts, clarifying the status of special purpose vehicle companies acquiring financial assets, removing the ceiling of 15% on interest charged by special purpose vehicles, eliminating the need to pay registration fees on the transfer of mortgages and eliminating the possibility of transfers to a special purpose vehicle subsequently being challenged under certain provisions of the Thai Bankruptcy Act. Certain issues were not dealt with - value added tax on the transfer of certain assets being one and facilitating the process of transferring mortgages at the land department (which might well hold up mortgage securitisations as a practical matter, even though the registration fees have been abolished) being another. The Thai Securities and Exchange Commission, which administers the Special Purpose Vehicle Law, is currently attempting to iron out these difficulties with the various government agencies and departments involved, but progress to date has been painfully slow. At the same time, there is work to be done on the accounting and regulatory treatment of securitisations. It remains to be seen when someone will be able to use the Special Purpose Vehicle Law. A number of securitisation transactions had in the past been done using offshore issuing vehicles, with monoline wrap around insurance to provide AAA rating, the transaction being structured as a loan to the originator secured by assignments of the relevant receivables. These transactions came to a halt with the suspension of the majority of the finance companies, and in the new year have been stopped again due to Thailands sovereign rating being reduced below investment grade level and the resulting inability of the monolines to participate. These transactions also required Baht/yen or Baht/dollar swaps, which have been difficult to achieve against the background of recent currency turmoil.

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Other foreign investment Some of the main impediments to foreign investment in Thailand have in the past been perceived to lie in the Alien Business Law and the Land Act. The Alien Business Law requires that entities engaging in certain businesses should have the majority of their capital owned by, and that a majority of the shareholders should be, Thais, unless promoted status is available under the Investment Promotion Act. The Alien Business Law, through covering service businesses, extends to most businesses except pure manufacturing enterprises. Under the Land Act, land must be owned by Thais. The effect of this is that a company must be majority Thai-owned to own land, and in practice the Land Department are difficult about registering transfers to a company more than 40 per cent. foreign-owned. Up to 40 per cent. of a condominium may be owned by foreigners. Foreigners are able to lease land, but the maximum lease term is 30 years. In the light of the requirement for more foreign investment in the current economic conditions, it has been hoped that restrictions on foreign ownership of certain businesses may be lifted. Proposals have been made to amend the Alien Business Law to permit 100% foreign ownership of approximately 32 currently restricted business categories. The government has also proposed liberalising the current restrictions on foreign ownership of land by permitting foreigners to own a small area of land and 100% of condominium buildings and by extending the maximum lease term from 30 to 99 years. However significant opposition to these measures is likely and reforms in this area are uncertain. Bankruptcy The speedy liquidation of assets of insolvent companies and quick realisation of collateral may be essential to enabling asset prices to reach more realistic levels, to assist the economy to move forward again. The limitations of Thai law in this area have become quite apparent in recent months. Thai bankruptcy law and procedures date from 50 years ago. There is currently no procedure for reconstructions: the only available procedure is bankruptcy, which involves the liquidation of the bankrupt company. A composition is possible during the bankruptcy proceedings with the approval of 75 per cent. of the creditors. But there is no procedure for reconstruction or reorganisation. While the Bankruptcy Act provides that bankruptcy proceedings must be handled expeditiously, the opposite is in fact the case. Bankruptcy proceedings follow the usual Thai court procedure of intervals between hearings, and in the face of a determined debtor can last for years.

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There are other disincentives to commencing bankruptcy proceedings, including that the petitioning creditor is responsible for the costs of the bankruptcy, although these are paid first out of the proceeds realised. In the face of this, it is not surprising that no bankruptcy proceedings have been commenced against any of the large Thai companies which have defaulted or are obviously insolvent. To make matters worse, there is a serious disincentive to providing liquidity to companies in trouble. This lies in Section 94(2) of the Bankruptcy Act, which provides that a creditor may not file a claim in the bankruptcy of the debtor in respect of a debt which the creditor allowed the debtor to create knowing that the debtor was insolvent at the time. At the time of writing there is some amending legislation in the latter part of its parliamentary journey. It is to be hoped that it will be enacted during March. The amendment, in brief, introduces the concept of a reorganisation. A petition for a reorganisation can be presented by a debtor (currently a debtor cannot file a bankruptcy position) or creditors owed a minimum of Baht 10 million. The procedure involves the appointment of a planner, who is responsible for preparing a reorganisation plan, and while doing this takes over the powers and duties of management and shareholders. The plan must be submitted to the official receiver within three months of the planners appointment, although two extensions of one month are possible. After the plan has been prepared, a meeting of creditors will be held to consider approving it. Under the current draft legislation, the plan requires the approval of creditors holding 75 per cent. of the total claims of the creditors present at the meeting and voting on the resolution. Failure by the creditors to approve the plan may result in the court revoking the order to reorganise the business or ordering the bankruptcy of the debtor. Following court approval of the plan, a new figure, the plan administrator, assumes the powers and duties of the planner. The plan must be implemented within five years, but there are possibilities of extensions for two periods of one year, and further extension if implementation of the plan has almost been completed. The amendment provides for a stay of proceedings against the debtor, and provides restrictions on the enforcement of security and similar matters, on a planner being appointed. It also provides an exception to Section 94(2) of the Bankruptcy Act for creditors providing funds to the planner, plan administrator or the official receiver for the purposes of reorganising the debtors business, and creditors extending loans to these persons under the debt restructuring plan receive priority in the distribution of the debtors assets in any bankruptcy proceedings.

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The critical element of the amendment is that it gives creditors the ability to take over the management of debtor companies comparatively quickly. This changes the balance of power between debtors and creditors, and finally gives debtors something to be worried about in the weaponry available to creditors. As a result, the amendment has been subject to a rearguard action by interested business concerns, who have attempted to slant it to make it more debtor-friendly. We will have to wait to see the final form, and also see if the judiciary is able effectively to operate a piece of legislation which requires far more energetic and interventionist behaviour on its part than has been displayed in the past. We also understand that the amendment may provide some help, at least in the context of reorganisations, on debt-equity conversions. The Thai Civil and Commercial Code and Public Limited Company Act are currently interpreted to prevent shares being paid up by the release of debts: it is necessary for payment to be made to the company for the new shares, and the funds then to be repaid to the creditor. Such a procedure is clearly very cumbersome, and is probably impractical on large debt-equity conversions. It also raises worrying possibilities of other creditors being able to attach funds during the split second they are in the companys bank account before paying out the converting creditor, and of possible preference concerns if the company became bankrupt shortly thereafter. One area which is not being addressed by the amendment relates to the remedies available for the enforcement of security. The enforcement of a mortgage requires a court order followed by sale at a public auction. This can take a number of years. Foreclosure is only available when the debtor has defaulted on interest for five years. The enforcement of pledges does not require a court order, but reasonable notice must be given to the debtor and the pledged property must then be sold at a public auction. The creditor can bid at the auction in either case. However, the lengthy period for enforcement of pledges makes taking pledges over listed securities unattractive: the creditor wants to be able to close out the position fast and does not want to have to wait for a number of weeks. The future Most commercial law firms in Thailand will have seen their work change over the past year to eighteen months. Share offerings and Euroconvertible bonds will have tailed off, and big new project financings may also have reduced sharply in volume. At the same time, mergers and acquisitions activity, as foreign investors have come looking for cheaper assets, has increased. To date this activity has generally focused on due diligence activities: it is now all too common to be called at short notice to put a team into a data room which is available for five days or so. Also much work has been done advising creditors on remedies against defaulting debtors under a wide variety of instruments, and possibilities in restructuring debts against the

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background of Section 94(2) of the Bankruptcy Act referred to above and the need to avoid a novation of the debt so as to preserve rights to security and against guarantors. A number of firms have extensive roles representing steering committees of creditors on the big restructurings which are being attempted to be put in place. What are likely to be the expanding areas of business in the future? Future business will depend on how quickly a recovery emerges, and what form it takes. A quick recovery will make Thai owners less inclined to sell their assets to foreigners, and probably reduce merger and acquisitions activity. On the other hand, with a return of confidence, there should be more fund raising and a resumption of some project activity. A slower, or no, recovery would have the opposite effect. But it will be necessary for some deals to be done to provide pricing benchmarks. To date there has been much activity, but few completed transactions. We hope that Thailand, having encountered problems first, will be the first to emerge from them. Even some recovery will probably not be enough to rescue a number of companies in their current form. Those lawyers acquiring expertise in the first few reconstructions under the amendment to the Bankruptcy Act will therefore be in a strong position. Even though litigation is very much a measure of last resort in Thailand, some litigation capacity may also be desirable for the cases where matters cannot be worked out between debtors and creditors. Lawyers in Thailand, we suspect, are generally taking things from day to day. While they may be frantically busy at the moment, there is no saying what the future may bring.

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