Supreme Court rules Indah Kiat bond invalid

Indonesia's Supreme Court puts the country's offshore borrowing prospects in doubt by ruling invalid the $500 million bond for APP subsidiary Indah Kiat Pulp & Paper.
When Indonesia's Supreme Court announced its decision to uphold the verdict of a lower court declaring the $500 million worth of bonds issued by Indah Kiat Pulp & Paper invalid, you could almost hear the collective groan from AsiaÆs debt capital markets.

In an appeal to the countryÆs highest court, Gramercy Advisors and Oaktree Capital Management û both US-based hedge funds û had hoped to overturn the 2004 ruling by the Central Jakarta Court, which had itself upheld a civil claim in Bangkalis District Court a year earlier, that annulled the bonds on the basis that their issuance via an offshore special purpose vehicle (SPV) structure was unlawful.

At the risk of overstating the obvious, what is particularly significant about the ruling is the precedent it establishes for other Indonesian borrowers. The structure that has now been deemed illegal in the eyes of the Indonesian judiciary is one of the most widely utilised structures employed for bringing domestic corporate borrowers to the international capital markets. The offshore SPV allows issuers access to foreign funds without having to issue a domestic public offering.

Indeed, national power producer Perusahaan Listrik (PLN) used a very similar overseas SPV for its $1 billion dual-trance bond deal that was completed in October.

Indah Kiat is a subsidiary of Asia Pulp & Paper (APP), which with almost $14 billion of debt in default, is one of the worldÆs largest defaulters, if not certainly AsiaÆs. The Widjaja family, the controllers of APP, have been struggling with their creditors since they ceased all payments on their debt in 2001.

Many in the market point out that this decision will certainly undermine investor confidence in Indonesia, as a corporate borrower, and the dependability of Indonesia's judicial practices. It certainly endangers IndonesiaÆs ability to raise money offshore.

Indonesia has enjoyed arguably its most prosperous year in the offshore capital markets in 2006. The country has struggled for years to find a level of legitimacy among international investors as corruption, unpredictable legal institutions, questionable creditor rights and an overall poor track record have consistently undermined confidence.

However, with an improvement in the political environment and subsequent strengthening of corporate credit profiles, Indonesia, both as a sovereign borrower and as a collection of corporates, has enjoyed marked success in 2006, with a record $3.7 billion worth of issuance so far this year.

Furthermore, the majority of those deals have performed strongly in secondary trading and were even rallying in the sessions preceding the Supreme Court ruling.

Now the country's funding prospects hang in the balance when funding requirements over the next few years for the development and construction will only increase.

So where exactly does this ruling put the prospects of Indonesian companies borrowing money from offshore investors?

For the time being, the market will await clarification on the decision, hoping that it will be reversed by the government, similar to that of the Manulife decision in 2002. The Indonesian subsidiary of Manulife Financial was declared bankrupt by a court, but that decision that was later overturned upon review. At the moment, however, market specialists are less than optimistic.

If the government allows the ruling to stand it will mean that companies looking to access the international capital markets will now be hamstrung by much more rigid structures. Structures that will overcompensate the need to protect the rights of investors, while undoubtedly increasing the cost of borrowing.

Additionally, it will now fall to the investment banks to conduct much deeper due diligence and bring only those borrowers to market with undoubted willingness, not simply the ability, to repay the debt. In a recent report, Fitch noted that it ôbelieves that this ruling could result in a more cautious approach to Indonesian bond issues by international investors, which is clearly not in the best interests of the market's development. Investors can be expected to examine the track record of the sponsors in future transactions to see how they may have treated creditors in the past, potentially leading to more selective investment decisionsö.
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