DEBT is critical to the functioning of an economy. Companies can use it to finance investments. There are times, however, when companies’ investments have excessively low (or negative) yields.
It is well understood that in this case, a strong and effective regime for restructuring debts can unlock better performance, build stakeholder confidence and benefit the economy.
With the second round effects (bounce-on effects) of the 2008 global financial crisis that Tanzania has been experiencing, the escalating banks’ nonperforming loans (NPLs) as well as ongoing tight margins and liquidity challenges, the question whether bold new reforms to the country’s debt restructuring regime are needed has been cast into the limelight.
Recent consultations between the World Bank and UNCITRAL and many governments of other countries have focused on this question.
This article is intended to advance and ignite dialogue and debate among Tanzanian policymakers, bankers, lawyers, business executives and academics on the need for Tanzania to bring its corporate debt restructuring regime up to speed with the latest trends in order to ensure that it encompasses the essential legislative tools to rescue viable but financially distressed companies from insolvency and to protect much-needed jobs.
As at December 2016, the global speculative-grade default rate rose to 4.2 percent from 2.8 percent at the end of 2015, according to S&P Global Rating’s 2016 Annual Global Corporate Default Study and Rating Transactions report issued on April 13, 2017.
“The energy and natural resources sector accounted for 51 percent of all defaults in 2016, a historical record and far outpacing the consumer and service sector,” the report’s authors say, adding that “This pushed the corporate default count up to $239.8bn in debt, which is more than double the $110.3bn total for 2015”.
Tanzania—a country endowed with natural resources—already provides a variety of debt restructuring tools, including (a) scheme of arrangement (b) company voluntary arrangement and (c) administration, as provided for under the Companies Act, 2002.
However, when used as a separate tool for debt restructuring, none of these mechanisms provides all the features necessary for a strong and effective restructuring regime.
Inspired by Chapter 11 of the United States’ Bankruptcy Code, which has fruitfully resuscitated companies like American Airlines and Chrysler after accumulating very high debt burdens, the UK government’s Insolvency Service has been exploring new approaches to restructuring.
Specifically, just last year, in 2016, the Insolvency Service issued a consultation paper proposing a raft of sweeping reforms aimed at encouraging business rescue and ensuring that the UK debt restructuring regime delivers the best outcomes to all stakeholders.
Other European jurisdictions that have recently adopted significant new approaches to debt restructuring include Germany, France, Spain, The Netherlands and Italy. These countries’ adoption of new approaches came hard on the heels of a set of European Commission rules on business insolvency proposed in 2016.
In Singapore too, parliament recently enacted The Singapore Companies (Amendment) Act, 2017, which has introduced bold new approaches to rescue financially distressed companies.
This Act has expressively enhanced Singapore’s schemes of arrangement and judicial management processes and also brought into Singaporean law the UNCITRAL Model Law on Cross Border Insolvency, which facilitates the recognition of cross border insolvency processes in Singapore. Such recognition does not exist in Tanzania at present.
But, what is the importance of these initiatives for Tanzania? The initiatives mirror the need to adapt to, and take advantage of, developments in the world economy.
Tanzania’s economy is not invulnerable against the impact of global economic trends, including the increasing global default rate activity reported by S&P Global Ratings.
Non-performing loans (NPLs) in the Tanzanian banking sector hit 9.53 percent in December 2016. According to the latest Tanzania Financial Stability Report (March 2017), NPLs are on the rise and this is coupled by a sharp decline in credit to the private sector thus undermining growth.
Agriculture—the mainstay of the Tanzanian economy—transport and communications, and hotels and restaurant are the activities with the highest proportion of loans being classified as NPLs.
If more debtor-friendly restructuring tools are introduced in Tanzania to suit new demands in line with present-day economic realities, it can be expected that Tanzanian companies on the verge of insolvency will be rescued and jobs protected.
The main tools of US-style debt restructuring which have inspired reforms in Germany, France, Spain, The Netherlands, and Italy and the recommendations of the UK Insolvency Service’s July 2016 reform proposals include:
This restructuring plan binds all classes of creditors using a single restructuring device even if secured creditors vote against the plan, provided that certain conditions such as (a) the creditors will not be worse off than in liquidation or (b) the plan be fair, equitable for the dissenting classes of creditors are met.
Rescue financing creates an enabling situation for creditors to advance new secured loans or loans entitled to super-priority status and the extension of existing loans, which may save the debtor company from insolvency, loss of crucial employees and damage to vital business relationships.
Another restructuring plan is the automatic imposition of a restructuring moratorium once a petition for reorganization is filed in court. This prohibits any legal or enforcement action by the participating creditors and all the debtor company’s related parties. The moratorium, lasting 90 days with possible extension for a maximum of 180 days, also prohibits creditors with “essential contracts” from axing the contracts on the basis of insolvency alone.
Often viewed as the most beneficial aspect of US-style debt restructuring, debtor-in-possession (“DIP”) financing is a special type of credit provided to insolvent companies operating under Court-supervised creditor protection. A DIP loan permits the distressed company to carry on business as a going concern. Major incentives for DIP lenders include, among others, a Court-supervised super-priority charge over other creditors and the ability to charge interest rates that are higher than normal non-distressed lending rates.
Need for reform?
The above restructuring tools are laudable, but are glaringly absent from Tanzania’s debt restructuring regime.
Tanzania should not rest on its laurels. It is argued that Tanzania should consider and weigh the restructuring options available and reform its existing regime with the latest trends, if the country is to encourage business rescue, protect jobs and remain competitive in today’s increasingly changing global economy.
In particular, the introduction of a restructuring moratorium and cram-down would be beneficial. Skill and care will, however, need to be exercised so that the potential benefit of the reforms to financially distressed companies is balanced aptly with the limitations the reforms impose on existing creditors’ rights.