The Amendment takes effect as an amendment to the Faillissements-Verordening or Regulations Concerning Bankruptcy of 1905 (commonly known as the Bankruptcy Code). The Bankruptcy Code was passed by the Dutch colonial authorities and has rarely been used in post-independence Indonesia. Usually, such legislation is amended by the National Assembly, rather than a Government Regulation signed by the President. However, the past few months have demonstrated that the amendment of the Bankruptcy Code was required as a matter of urgency.
Few, if any, proceedings were initiated under the Code even although recent press reports have estimated up to 80% of corporate Indonesia to be technically insolvent. Creditors who sought legal advice on the Code found that there was little track record of implementing the Code and inadequate provisions in the Code itself regarding fundamental procedural mechanics, such as time limits.
Furthermore, the recent agreement between the Republic of Indonesia and the International Monetary Fund (IMF) required amendment of the Bankruptcy Code by April 21, 1998, as a condition to further IMF funding.
This commentary considers some of the important areas of the Bankruptcy Code which are impacted by the Amendment.
Insolvency Not Required
The Amendment seeks to clarify the trigger for bankruptcy proceedings under the Bankruptcy Code. Previously, the Code stated that a company that had stopped paying its debts could be adjudicated bankrupt. There was no requirement that the company be "insolvent" in accordance with Western notions of insolvency, such as the common law concept of being unable to pay debts as and when they fell due.
The Amendment provides that "a debtor who has two or more creditors and has failed to pay at least one debt which is due and payable shall be declared bankrupt by decision of the competent Court...either upon its own petition or upon petition of one or more of its creditors."
The Amendment does not set out clear criteria for establishing whether a debt is due and payable. In the past, Indonesian courts have entertained various arguments by Indonesian debtors with varying degrees of merit as to why a debt is not due and payable. The law still requires further clarification regarding the defences which a debtor is entitled to for non-payment of debts.
The Amendment has still not introduced any concept of insolvency as a pre-requisite to bankruptcy proceedings. Unlike other jurisdictions, the creditor will not need to demonstrate that the debtor is insolvent, merely that the debtor has more than one creditor and has failed to pay at least one debt.
Moreover, the Amendment does not prevent minor creditors from commencing bankruptcy proceedings contrary to the wishes of more significant creditors, or even contrary to the wishes of a majority of creditors. Other creditors will have little choice but to become involved in bankruptcy proceedings, even if their preference would be to allow the debtor additional time for repayment or reorganization. Even secured creditors may be affected by the initiation of bankruptcy proceedings, as discussed below.
Insolvent Trading
Indonesian law still does not contain any provisions specifically making directors or commissioners of an Indonesian company liable to compensate creditors for liabilities incurred through such company's conduct of insolvent trading. However, there are certain criminal offences which may deter management of Indonesian companies from such conduct.
Directors and commissioners of Indonesian companies may be subject to criminal liability for ratifying the borrowing of money on very disadvantageous terms only for the sake of a postponement of a bankruptcy of the company, at least where the director or commissioner knows that the borrowing will only postpone an inevitable bankruptcy.
Directors and commissioners may also be criminally liable for any other illegal act which causes the company to lose money. It is unclear whether "illegal act" includes causing the company to enter into illegal transactions, such as transactions which jeopardize the rights of creditors through excessively high expenditures shortly before a bankruptcy (which is a corporate offence, at least for trading companies).
Protection for Banks
While the trigger mechanism for initiating a bankruptcy proceeding is unusually liberal for most companies, the trigger for banks is unusually restricted. The Amendment contains a new provision that a petition for a declaration of bankruptcy with respect to a debtor that is a bank may only be submitted by Bank Indonesia, the Indonesian central bank.
Creditors of Indonesian banks will therefore not be able to launch insolvency proceedings to recover loans and other liabilities of Indonesian banks. These creditors will evidently need to rely on Bank Indonesia and the new Indonesian Bank Restructuring Authority to protect their interests.
Timing Provisions
The Amendment introduces new timing provisions for the initiation of bankruptcy proceedings. Bankruptcy petitions will be dealt with by a new Commercial Court which is also established by the Amendment (see below). The Court is required to set a date for a bankruptcy hearing within 48 hours of the petition being registered, and the hearing must be within 20 days (or in special circumstances up to 25 days) after the petition is registered. Appeals must be filed within eight days and decided within 30 days. All hearings must be in a public session and reasons for the decision must be issued.
No significant changes have been made to the timing of the existing procedure whereby the bankrupt's estate is administered by a Court-appointed receiver pending the bankrupt presenting a compromise proposal to a meeting of creditors.
The compromise proposal now requires the approval of a special majority of more than one-half (previously at least two-thirds) in number and at least two-thirds (previously three-quarters) in value of recognized unsecured creditors, as well as approval of the Court, in which case it becomes binding on all creditors. If the proposal is not accepted, the receiver will be required to liquidate the bankrupt's estate.
Receivers
Previously, the Bankruptcy Code provided for a government body, the Official Receiver (or Weeskamer) to administer bankrupt estates. The Amendment now enables the appointment of private receivers. Creditors are even entitled to nominate their preferred private receiver to the Court.
Eligible as private receivers are individuals or partnerships domiciled in Indonesia who (i) possess the special expertise which is required for managing and settling the bankrupt's estate and (ii) are registered with the Department of Justice. The Amendment does not set out any objective criteria for registration with the Department of Justice.
Professionals considering taking on the role of receiver may be concerned that the Amendment also provides that the receiver can be held responsible for any errors or negligence in performing managerial duties and/or settlement which causes any damage to the bankrupt's estate. This standard is comparable to the level of responsibility of company directors under the Indonesian Company Code. Moreover, the level of service fees which private receivers may charge will be determined on the basis of guidelines set by the Minister of Justice.
In other jurisdictions, professional receivers only accept responsibility for wilful default and gross negligence. If the level of fees is not set high enough to offset the increased risk which professionals will need to accept to act as private receivers, there may be significant restrictions on the number of skilled private receivers available in Indonesian bankruptcies.
Indonesian law still contains no provisions allowing a secured creditor to appoint a private receiver to take possession of secured property, as is usual in common law jurisdictions.
Powers of Receivers
The receiver of a bankrupt estate is given broad powers to manage the estate without needing the bankrupt's consent. In particular, the receiver is entitled to obtain new loans from third parties, in the framework of increasing the value of the bankrupt estate. The receiver is only entitled to grant security in respect of such loans over assets which have not yet been used as security for any other debts. The receiver is therefore not able to grant junior security interests over assets in the bankrupt estate to obtain third party finance.
The Amendment clarifies the powers of receivers in two important areas. First, the Amendment makes clear that the receiver may disclaim an existing contract of the bankrupt which has not yet been fully performed, leaving the other contract party with an unsecured claim for damages against the bankrupt. There are no express restrictions on this power, except that it does not apply to contracts which require personal performance by the bankrupt.
Second, the Amendment sets forth the circumstances in which a receiver will be entitled to retrospectively invalidate certain transactions of the bankrupt completed prior to the initiation of the bankruptcy.
Previously, the Bankruptcy Code permitted the receiver to invalidate gifts made by the company within 40 days of the declaration of bankruptcy, or where the company was aware that the rights of its creditors would be diminished.
"Irresponsible" transactions entered into by the company for valuable consideration where both the company and the other parties to the transaction were aware that the rights of creditors of the company would be diminished could also be invalidated.
The Amendment now provides for the invalidation of all prior transactions which the relevant parties knew or should have known would cause damage to the company's creditors. Similar to the existing law, this provision is likely to be of limited use because of the difficulties in establishing what the knowledge of the parties to each transaction was or should have been.
However, the Amendment now deems knowledge in relation to certain classes of transactions within the 12 month period prior to the Court declaration of bankruptcy. Any transactions with related parties fall within the proscribed class. For this purpose, "related parties" of a company include directors and their families and majority-owned companies, majority shareholders and their families, group companies, and other companies with shared directors and managers.
In addition, the proscribed class of transactions includes payments for, or giving of security for, debts which are not yet due and payable and also contracts "in which the obligations of the debtor considerably exceed the obligations of the party with whom the contract is made".
The existing exception for transactions which the company was legally obliged to enter into has been retained. However, there is no exception for assignments to third parties acting in good faith for valuable consideration, and these transactions may be invalidated if they fall within the proscribed class.
Foreign investors seeking to take advantage of low asset values in Indonesia need to be aware of these provisions. It is unclear whether a sale of assets by a company facing insolvency on otherwise arm's length terms, but at a price which is well below the replacement value of the assets, could be considered to "considerably exceed" the obligations of the vendor. It may even be necessary for purchasers to consider requiring the vendor to obtain consents from its creditors in these circumstances.
Suspension of Debt Repayment
Before many creditors have the opportunity to initiate bankruptcy proceedings, Indonesian companies may take advantage of the re-vamped provisions in the Amendment to seek a suspension of its obligations for payment of debt.
It is common knowledge that most Indonesian companies are not currently servicing their outstanding debt obligations. In fact, the existing Bankruptcy Code permitted Indonesian companies to seek a court order approving a debt repayment suspension, although few, if any, Indonesian companies have sought such an order.
The Amendment clarifies the procedure in respect of debt repayment suspensions. Like a bankruptcy, the debtor is required to present a compromise proposal for the approval of creditors and the court. Like a bankruptcy, a private administrator is appointed to the debtor and has powers to disclaim contracts.
Unlike a bankruptcy, the debtor is entitled to continue to manage its affairs, but may not take any actions in relation to such management or transfer any assets without the prior consent of the administrator. In particular, unauthorized liabilities incurred during this period may be disclaimed unless they benefit the debtor's estate.
The suspension may be terminated if the debtor does not abide by its obligations under the Code or fails to comply with directions by the Court or administrator in the interests of the debtor's estate, or the creditors or the court do not approve the debtor's compromise proposal. In this event, the debtor will be automatically declared bankrupt.
Secured creditors
Perhaps the most controversial aspect of the Amendment will be its treatment of secured creditors. Under the existing Code, secured creditors are entitled to enforce their rights regardless of the bankruptcy proceedings. This right has been significantly qualified by the Amendment.
The Amendment provides that, for a period of up to 90 days from the Court's declaration of bankruptcy, secured creditors will generally not be entitled to enforce their security rights. The standstill does not apply to cash deposit security interests or set-off rights (which are often important security interests for retail banks). The 90-day standstill period will cease upon earlier termination of the bankruptcy (by approval of the debtor's compromise proposal) or upon commencement of the liquidation of the bankrupt's estate.
During the standstill period, the receiver is entitled to sell secured property in the ordinary course of the bankrupt's business provided that "adequate protection has been provided" for the secured creditors.
In the event that the liquidation of the bankrupt's estate is commenced, the secured creditor will then be required to exercise its security within two months of such commencement. After the two month period, the receiver is entitled to sell the assets (although the secured creditor is still entitled to receive the proceeds of sale in satisfaction of its debt).
Moreover, the Amendment permits the receiver, at any time, to release secured property by payment to the secured creditor of "the smaller of the market price of the encumbered asset and the amount of debt secured by said encumbered asset". There are no clear provisions on valuation of assets to determine market value. There is also no restriction on the receiver choosing to pay out the secured creditor at the bottom of the asset value cycle.
The difficulty with the new provisions is that they deprive secured creditors of control over the enforcement of their security interests. Secured creditors usually want maximum flexibility to choose the time at which they enforce their security interests, depending on the state of the market.
Given the level of asset values in Indonesia presently, many secured creditors may have preferred to wait for some level of recovery before enforcing their mortgages and other security interests. Combined with the liberal trigger mechanism, the Amendment creates the potential for the priorities of unsecured creditors to severely restrict the flexibility of secured lenders in this regard.
Secured creditors already face significant areas of uncertainty and difficulty in effectively enforcing their security interests, which are not addressed by the Amendment. It is said that no major foreign lender has yet successfully enforced a real property mortgage against an Indonesian debtor. It seems that the Amendment may serve to increase the complexities facing secured creditors in Indonesia.
Commercial Courts
One of the most important aspects of the Amendment is also the most difficult aspect to assess at this stage. The establishment of Commercial Courts to be staffed by specially trained judges could herald the commencement of a new system of efficient enforcement of legal rights in Indonesia which sees a return of credibility and confidence to the market - or it could create even further disillusionment and disappointment.
This all depends upon the judges of the new Commercial Court. The criteria for selection of judges includes prior judicial experience and knowledge regarding bankruptcy and other matters falling within the Court's jurisdiction. A Commercial Court judge is required to successfully complete a special training program. Most importantly, the judge must "have authority, be honest, just and always of upright moral behaviour".
The success of the Commercial Court will be crucial to the success of the new Bankruptcy Code. Moreover, since the Amendment contains provisions for the extension of the Court's jurisdiction, other matters, such as the enforcement of security rights, could also be dealt with by the Court. However, if the Court fails to provide an effective and consistent basis for enforcement of creditors' rights in Indonesia, all the amendments in the world will not save the Bankruptcy Code.