In one of the first non-consensual rehabilitation petitions filed with Thailand’s newly established Central Bankruptcy Court, the court’s conclusion that Thai Petrochemical Industry Public Company Limited (“TPI”) was insolvent was seen by many, certainly in the international press, as an indication that the Thai courts had accepted the cash flow test of insolvency and that this test would be applied in future cases. This is, sadly, far from accurate.
TPI is Thailand’s largest corporate debtor, with over US$3.5 Billion (A$5 Billion) in debts owed to over 150 financial institutions and other creditors. It is the owner of a fully integrated petrochemical plant in Thailand and is one of Thailand’s corporate giants. TPI is run by its founder, a charismatic individual who has been often referred to in the Australia press as the “Thai Houdini” due to TPI’s success over the last few years in escaping its creditors.
TPI’s restructuring following the Asian economic crisis has been high profile and hotly contested. The case has been viewed as a test case for Thailand’s Central Bankruptcy Court. In addition to being viewed as test case on the question of insolvency, the TPI case has also been important to the dynamics of negotiations in numerous out-of-court workouts that are taking place. Investors have feared that rulings detrimental to creditors would encourage other corporate debtors to delay or seek to frustrate their own restructuring negotiations and therefore that Thailand’s economic recovery would be further delayed. The Thai stock market has fluctuated following events in the negotiations in the restructuring with panic selling of Thai stocks in general following creditors suffering set backs in the restructuring
Following the 1997 economic crisis, Thailand’s non-performing loans peaked at THB 2.7 Trillion (A$117 Billion) or 47% of all outstanding credit and have only recently dropped below 40%. In a country which does not provide creditors with effective tools such as private corporate receiverships to take control of a non-performing debtor’s assets and where civil remedies are often slow or ineffective, the threat of rehabilitation under Thailand’s Bankruptcy Act is often one of the only negotiating tools creditors can utilise to force a debtor into sensible conduct. Thailand does not have fixed and floating charges, interest must be outstanding for 5 years before a mortgage can foreclosed and mortgagee sales normally take at least 18 months and often do not proceed as the floor price is the historical pre-crisis land value and is therefore unrealistically high. In many respects, Thailand can be characterised as a debtor’s haven. The evolution in Thailand of the “strategic debtor” – a debtor who is able to pay but chooses not to – is evidence of the danger of inefficient creditor remedies. This situation has only recently begun to change.
In April 1998 Thailand introduced a rehabilitation procedure into its Bankruptcy Act. This procedure is loosely similar to the voluntary administration procedure in Australia although the court is far more entrenched in the process. Under the rehabilitation procedure, a planner (similar to a voluntary administrator) is appointed to manage the company and prepare a plan for approval by creditors to reorganise the business of the company. A formal petition to the court is necessary to place a company into rehabilitation. Insolvency and the possibility of a viable rehabilitation need to be proved. This exercise can be expensive and the result unpredictable. Despite the introduction of this procedure, only a small number of rehabilitation cases have been filed relative to the number of insolvent debtors. The reluctance to utilise the procedure has stemmed partly from a fear that the court would not assess the debtor to be insolvent, and therefore able to be placed into rehabilitation, based on evidence that the petitioning creditors could produce, particularly in cases where the debtor did not consent to the petition for rehabilitation and did not allow the petitioning creditors access to information.
It is clear that the relevant test of insolvency in Thailand is, and will remain so following the TPI judgment, the balance sheet test of insolvency (i.e. whether liabilities exceed assets).
Importantly, the TPI judgment does make it clear that the signing by a debtor of a Debtor Accession under the CDRAC process (an out of court restructuring process sponsored by the Bank of Thailand and the Corporate Debt Restructuring Advisory Committee for restructurings of debtors with multilateral creditor groups) and the issue by the debtor of terms sheet and proposed restructuring plans can be considered as amounting to a proposal by the debtor to compromise its debts with two or more of its creditors. This raises a presumption of insolvency under the Bankruptcy Act (other presumptions also exist). To rebut this presumption the debtor must introduce evidence to prove that it is in fact solvent by introducing evidence to show solvency. In the TPI case the court did not accept the debtor’s submission of accounts showing that its assets exceeded its liabilities as the accounts had not been audited by a public certified auditor and thus the court felt that they carried little weight and did not defeat the presumption of insolvency which had been raised.
The next portion of the judgment is the portion which has been misreported and its misunderstood by many. It has been suggested that the court then went on to apply a cash flow test of insolvency. It did not. It did not ask if TPI was able to pay its debts as they fall due – this is the cash flow test.
The cashflow test of insolvency is used in many modern economies in the world. It has recently been suggested that Thailand should implement this test as the test of insolvency for bankruptcy cases and perhaps a lower threshold for rehabilitation cases such as a test requiring only an expectation of an inability to pay debts as they mature, as is the case in Indonesia, or the Singaporean test, which requires that a company is or will become unable to pay debts as they fall due. In Australia, a company which, in the opinion of its directors voting to place it into administration, is or is likely to become insolvent at some future time can be placed into administration. If the rehabilitation legislation requires that a company wait until it is, without doubt, insolvent before allowing it to enter rehabilitation, the company may be left waiting too long if the goal is to rehabilitate its business.
Whilst the cash flow test is clearly a more realistic test of day to day solvency from a commercial perspective, Thailand’s insolvency system can function without it. The test of insolvency is important because it is used as the door to determine which companies will be able to enter into or be placed into the bankruptcy and rehabilitation procedures. Once one accepts that Thailand has made a policy decision to apply a balance sheet test of insolvency (that is, it has decided to apply a high entry standard), the system can function adequately within its own limitations providing the test is properly and intelligently applied. However, this may be difficult to achieve. The balance sheet test can be distorted if inadequate accounting standards or misleading or manipulated valuations of assets mean that evidence before the court is not necessarily representative of the true fair market value of a company’s assets or an accurate statement of its liabilities. The balance sheet test can lead to delays in hearings, as detailed and often expensive evidence will need to be led about asset values with different expert valuers having different views. Without doubt Thailand’s Bankruptcy Court does not consider itself to be expert in the valuation of assets and therefore it must weigh expert valuation evidence before it – an unenviable task in the present economic circumstances. The balance sheet test also invites corruption and manipulated valuations. All of these factors make the balance sheet test a rather unpredictable test and a difficult test for the courts to apply in a transparent and fair manner.
In the TPI case the court applied a balance sheet test of insolvency, not a cash flow test. In applying the balance sheet test, it accepted that the assets in question could best be valued by applying the discounted cash flow method of valuing assets. That is, it accepted that the fair market value of assets in the petrochemical business could be assessed by utilizing the discounted cash flow method of valuation in comparison to a forced sale value of the assets, and utilizing net realizable values for other assets. The court was not concerned that the valuer had not visited the site or interviewed management as the valuation utilized cash flow projections prepared by the debtor’s management which, the court said, are normally prepared in an optimistic manner by the debtor. The court did not accept criticism of the valuation by the debtor’s witnesses because that evidence assumed that the serviceable life of the plant was very long in contrast to other evidence submitted by the debtor which indicated that the plant’s serviceable life was not more than 30 years. Thus, the court concluded that the debtor was insolvent as a presumption of insolvency was raised and the debtor could not introduce credible evidence to rebut the presumption and the valuation evidence produced by the five petitioning creditors.
In the TPI case the court’s assessment of the evidence before it was proper and intelligent. However, this is no guarantee of similar results in other cases and should not be viewed as an indication of a predictable approach to the application of the balance sheet test in future cases. The nature of the test means that it is difficult to apply in a predictable manner.
The TPI judgment appears to be an indication that the Central Bankruptcy Court will apply the balance sheet test sensibly by valuing assets on a discounted cash flow basis if credible valuation evidence is submitted to the court. However, the judgment is not an indication of a shift to a cash flow test of insolvency. It is possible for a company to be solvent on a balance sheet test (even if assets are valued on a discounted future cash flow basis) but insolvent on a cash flow test (i.e. it is unable to pay debts as they fall due from a liquidity perspective).
Despite support for the introduction of a cash flow test in Thailand (and possibly a lower test for entry into rehabilitation), it remains the writer’s opinion that neither the cash flow test or the balance sheet test are in themselves perfect tests of insolvency. In some countries, the courts apply both tests. In recent times Australian courts have moved to consider insolvency with an overarching sense of commercial reality. The ideal approach, in a world where transparency, independence and integrity could be assured, is to apply both tests of insolvency as appropriate with an overarching sense of commercial reality in assessing the company’s true position as the Australian courts have begun to do.
However, in Thailand today, predictability is what is really needed. Whilst the number of cooperative rehabilitations have increased, aggressive creditor driven rehabilitations against totally uncooperative debtors remain rare. If creditors and debtors are able to accurately predict how the court will assess the question of solvency this will have a significant impact on the progress and quality of restructurings, as parties will understand with greater certainty their bargaining positions. Predictability can be an illusion in a civil law country where courts are not bound by earlier decisions; however, significant comfort should now be able to be drawn from the existence of a specialized bankruptcy court to consider bankruptcy and rehabilitation cases and it is hoped that there will a consistency of approach from the court in similar cases.
Following the court’s assessment that TPI was insolvent and should be placed into rehabilitation, creditors voted to select a planner. A subsidiary of Ferrier Hodgson was appointed as planner and is presently preparing a rehabilitation plan for creditors to vote on later this year.