Regulation establishes improved legal framework for acquisition of onshore Indonesian debt by foreign investors and may provide an opportunity to resolve a number of long-standing distressed situations
On 18 March 2010, the Indonesian Ministry of Finance released Regulation No. 64 of 2010 (the "Regulation") regarding settlement of non-performing loans ("NPLs") of State-owned enterprises engaged in banking business. The scope of the Regulation was initially unclear, but there is a developing view that it may provide an opportunity to resolve the deadlock on a number of long-standing distressed situations in Indonesia, as well as potentially creating a market for international investors looking to invest in Indonesian NPLs.

This client alert provides a summary of the Regulation and its potential impact.

The Regulation governs the "settlement" of NPLs by Indonesian State-owned enterprises (Badan Usaha Milik Negara) engaged in banking business. For purposes of the Regulation, NPLs include all loans categorized as such under prevailing Indonesian banking regulations. The term "settlement" is not clearly defined, but it is being interpreted as potentially including the sale of individual NPLs and NPL portfolios to both Indonesian and international investors.

The Regulation does not prescribe any specific procedure for the "settlement" of NPLs, but does specify that this should take place in accordance with applicable Indonesian laws and regulations. The only other requirement is for the relevant State-owned bank to notify the Indonesian Ministry of State-Owned Enterprises of all settlements of NPLs at the end of each semester.

Indonesian State-owned banks have a reputation for inflexibility and are bound by restrictions that prevent them from taking write-downs on their indebtedness. This has led to deadlocks in a number of high-profile distressed cases in Indonesia, some of which have been in distress since the Asian Financial Crisis of 1997-98. While a degree of 'strategic' inflexibility in their negotiating positions has led to some successful cases of recovery on the part of the government, this policy has often become an obstacle to implementation of a successful restructuring - particularly in cases where the debt burden is entirely unsustainable. A number of would-be 'white knight' investors into distressed businesses have been ultimately frustrated by the inability to resolve the State-owned bank debts in a commercial manner.

The Regulation may be welcomed by international investors for at least two reasons.

First, observers have noted that Indonesian State-owned banks have recently made some non-par NPL divestments (despite previous restrictions on this) in long-standing distressed situations, and one aim of the Regulation may be to legalise this existing practice. The Regulation provides a legitimate framework for the resolution of NPLs on distressed acquisitions, and is also notable in that it opens the door to the possibility of international investors acquiring interests in portfolios of NPLs held by Indonesian State-owned banks on a more certain basis than previously applied.

Second, the Regulation may have an interesting impact on the composition of creditor groups in Indonesian restructurings. Traditionally, major Indonesian companies have financed themselves with a mixture of onshore working capital debt from Indonesian lenders (including State-owned banks) and offshore US$ debt from international investors. The onshore debt is often secured over operating assets, whilst the offshore debt is commonly structurally subordinated and has a limited security package. The onshore debt has usually remained in the hands of the Indonesian banks, whilst the offshore debt is widely traded and often falls into the hands of international distressed funds.

There is a widespread perception that distressed Indonesian borrowers give priority to servicing their onshore debt. This may reflect the need to maintain working capital lines when cashflows are tight, and the fact that the onshore debt is usually secured by operating assets, but it has also created the impression that Indonesian borrowers give preference to Indonesian lenders over offshore creditors. The Regulation creates an increased possibility that Indonesian State-owned banks will look to offload their exposure to distressed credits and that the onshore debt will fall into the hands of a more diverse group of secondary market investors (both international and domestic). It also increases the possibility that international investors may, in developing a "total solution" strategy in restructurings, seek to take a holding in both the offshore and the onshore debt. This may have a notable impact on the dynamics of any restructuring and the interaction between different creditor groups.

The Regulation is effective until 31 December 2010. However, we understand that the Indonesian government intends to introduce a new law which will supersede the Regulation before the end of the year. Please stay tuned for a further update as and when this law comes into effect.

* O'Melveny & Myers LLP is not licensed to practice law in Indonesia, and this Client Alert should not be construed as providing advice concerning the laws of Indonesia or of any other country or jurisdiction. The foregoing should not be construed as an opinion on the laws of Indonesia. Readers should consult with Indonesian counsel for legal advice on the matters addressed herein.

O'Melveny & Myers LLP routinely provides advice to clients on complex transactions in which these issues may arise, including finance, mergers and acquisitions, and licensing arrangements. If you have any questions about the operation of the applicable statutory provisions or the case law interpreting these provisions, please contact any of the attorneys listed on this alert.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.