The Restructuring Process In House Congress, Dubai February 10, 2010 By: Rindala Beydoun

Economic Landscape Many companies struggling to cope with effects of global financial crisis: reduced access to credit, flat or negative economic growth and over-leveraged balance sheets IMF and others predict region will enjoy modest growth this year, but numerous businesses, especially those in real estate and financial services sectors and some family-owned businesses, remain vulnerable Restructuring and reorganizations now a feature of regional economic scene

Restructurings in Gulf Region Until recently, very few public restructurings in Gulf region: economic activity dominated by Government and family-owned conglomerates tendency of region to avoid public failure of businesses (through Government support of businesses behind the scenes and reluctance of banks to take provisions) Restructurings expected to rise: many companies over-extended themselves, or used inappropriate credit facilities (e.g. short-term finance facilities for long-term projects) and now approaching zone of insolvency many companies considering restructurings as precautionary measure to improve balance sheets (e.g. reduce gearing levels) companies are reviewing operations and business plans, and focusing on core strengths Government bail-outs of distressed companies, including Government-related entities, can no longer be taken for granted increased willingness of local and regional banks to initiate insolvency proceedings

Insolvency: The Basics Insolvency regimes typically permit distressed companies to: - reorganize their debts and continue as going concerns (restructuring) or - sell their assets and wind up their operations (liquidation) Efficient insolvency system establishes predictable set of market exit rules that: - maximizes value of proceeds divided between stakeholders - includes rules regarding priority of claims - minimizes transaction costs - allows restructuring to take effect in a speedy manner Assuming company is viable, restructuring is preferable over liquidation to all stakeholders: - permits company to continue operating - provides creditors with steady payment stream without realization risk - avoid fire sales and destruction of values Insolvency regimes normally include prohibitions against unfair preferences – transactions with companies in “zone of insolvency” are at risk of being unwound

Regional Insolvency Regimes: Overview Region’s restructuring codes need improvement: designed many years ago when economic landscape was simpler contemplate traders having trouble, rather than complex, multi-national organizations lack detailed implementation regulations that would clarify scope and operation No “rescue culture”: focus on liquidations rather than promoting restructurings, which are feature of international models (US Chapter 11, UK company voluntary arrangements / schemes of arrangement)

Findings of Hawkamah Findings of 2009 Hawkamah/World Bank/OECD/INSOL International “Study on Insolvency Systems in the Middle Easy and North Africa”: MENA insolvency process take average 3.5 years (OECD average 1.7 years) MENA insolvency proceedings consume average 14.1% of company’s value (OECD average = 8.4%) creditors of MENA companies recover average of 29.9 cents in dollar (OECD average 68.6 cents)

Findings of World Bank-IFC Report World Bank-IFC “Doing Business 2009” report shows how MENA countries stack up against each other

Regional Insolvency Regimes: Key Features Largely untested: few precedents and none involving complex companies Few mechanisms allowing company to trade out of trouble Risk of criminal law applying in insolvency context Lengthy delays and unpredictability of process Default/enforcement provisions in Islamic finance instruments untested – causes confusion among stakeholders Lack of respect for rights of secured creditors

Regional Insolvency Regimes: Key Features (cont’d) Insolvency is defined as “cessation of payment” – i.e. the date on which debtor becomes unable to make payment to creditors During insolvency period, debtor may not engage in any “fraudulent conveyance” transactions: dispositions or acquisitions of assets settlement of debt of one creditor to the detriment of other creditors granting preferential treatment to one creditor even if such treatment is for purpose of obtaining an arrangement Criminal liability to directors and management (including imprisonment) for engaging in any “fraudulent conveyance” transactions

Preventive Arrangement Process Court process allowing debtor company to agree on restructuring plan with creditors to enable company to rehabilitate its business and avoid a declaration of bankruptcy Debtor company submits petition containing “proposals for arrangement” – if approved by court, Controller is appointed to prepare report and restructuring plan is fleshed out Creditors then approve or reject plan in a creditors’ meeting, which is held within 30 days of petition being accepted by court If approved by creditors, plan will be submitted to court for ratification. If court rejects, debtor may appeal within 10 days. If court approves, court will appoint one or more creditors to act as controllers to supervise the implementation of plan

Preventive Arrangement Process (cont’d) Pro’s Provides interim moratorium on creditor claims Allows debtor to proceed with restructuring plan without approval of all creditors – only need approval of majority of creditors present at creditors’ meeting consisting of at least 2/3 of total debt (secured creditors will not count unless they have abdicated their security interest) Debtor can continue with ordinary business activities while process is ongoing Debtor can be given up to 5 years to pay its debts

Preventive Arrangement Process (cont’d) Con’s Lack of precedent casts doubt on efficiency and speed of process Need approval of general assembly of debtor before filing Difficult to withdraw from process once initiated Stay of proceedings will not apply to arbitrations and will not apply to proceedings in foreign jurisdictions even within GCC (Riyadh Agreement only applies to final judgments) During process, debtor cannot conclude a conciliation, mortgage or dispose of assets except after permission of court

Step-by-step guide to the restructuring process

Warning Signs It is important for companies to be on the lookout for warning signs of potential distress: reductions in working capital, customer defaults, significant fall in sales, upcoming debt maturities, etc. In order to be able to recognize such warning signs, management should understand their company’s overall debt position and be aware of its obligations to each of its creditors Is there a quick fix available? Likely only relevant where company is facing short-term difficulties - seek rescue financing - dispose of non-core assets - costs reduction - asking banks to extend debt maturities - asking for Government support

First Steps in a Restructuring If restructuring may be required, management should consult with financial and legal advisers and, when appropriate, begin dialogue with company’s creditors and other stakeholders Creditors may form creditors’ committee comprised of biggest creditors. Company should ensure that this committee is broadly representative of its creditors Directors should consider appointing separate advisers given personal liabilities they may face. Their duties are likely to change once company enters zone of insolvency, thus their interests may differ from company’s/shareholders’ interests Communication with all of the interested parties is essential to an orderly and transparent insolvency process, given that the support of creditors will be vital. Relevant procedures may need to be agreed with creditors’ committee

First Steps in a Restructuring Management should also consider different interests of different creditor classes. Banks/suppliers may be more prepared to assist than bondholders who have no other relationship with company Management will need to prepare for comprehensive due diligence exercise. This will require company to open up its books, and be more transparent about its activities. This is key issue for some, especially Government-related / family-owned entities Company will also need to consider how to retain their key management and staff, who will be important in any restructuring exercise. Management incentives may need to be offered If company is in zone of insolvency, it is likely to face variety of lawsuits / payment demands, enforcement of securities, etc.

Standstill Agreement Company may seek to negotiate Standstill Agreement with their creditors as soon as possible, to give it breathing space to consider its restructuring options and agree a restructuring plan with its creditors Standstill Agreement typically covers following: - standstill period of up to 6 months. In this period, creditors will not enforce their rights against company, provided company actively works on a restructuring with its creditors - may include outline of draft restructuring plan, e.g. deferral of debt in return for higher interest over default period - appointment of Chief Restructuring Officer (CRO) or directors representing interests of creditors

Standstill Agreement (cont’d) Standstill Agreement typically covers following (cont’d): - positive and negative covenants designed to ensure that company focuses on restructuring exercise, does not increase its debts, and does not dispose of its assets except with creditor approval - allow for payment of certain preferred expenses (restructuring expenses, employee costs, maintenance of essential services, etc) - company warranties/indemnity over information given to creditors - may be subject to minimum creditor approval - process for agreeing quantum, classification and ranking of claims against company

Restructuring Options During standstill period, company will consider a number of restructuring options, including following: - formal bankruptcy protection, either in home jurisdiction or abroad - consensual restructuring process - Government bail-out scheme - seeking new investors - merger with another company - liquidation - others? Option chosen will depend on circumstances of each company, its credit profile (size of debts, secured or unsecured, debt or equity), nature of its creditors (banks, bondholders or suppliers), where its assets are located (in home jurisdiction or across many jurisdictions) and long-term viability of its business Regardless of option chosen, company will need to keep Government and regulatory authorities on-side, given their wide powers over companies in financial distress

Restructuring Options: Formal Bankruptcy Protection In the Gulf, formal insolvency processes have not been used in complex restructurings, but this may change as Governments update their insolvency laws as a result of economic crisis Although generally inadequate for complex restructurings, may be useful for mid-market restructurings Has advantage of requiring less than 100% creditor approval. Once applicable threshold is reached, non-consenting creditors can be forced into the restructuring plan Orders only binding in home jurisdiction. Enforcement abroad normally requires petitions in those foreign jurisdictions, which may or may not be accepted depending on their view of home jurisdiction’s insolvency process Companies should consider whether they can use foreign regime (such as US Chapter 11 or UK company voluntary arrangements / schemes of arrangements) over all or part of their assets. Normally requires “sufficient nexus”

Restructuring Options: Consensual Restructuring In Middle East, this is preferred restructuring option, given inadequacy and unpredictability of formal insolvency processes. This can sometimes encourage companies to negotiate aggressively with their creditors, knowing that formal processes are not a realistic option Appropriate for complex restructurings or those involving many jurisdictions Creditors normally represented by creditors’ committee, which facilitates discussion between company and creditors Minimum approval threshold and the problem of non-consenting creditors

Restructuring Options: Consensual Restructuring (cont’d) Can be tailored according to circumstances of company and its creditors Although informal process, in practice Governments and regulators will play a strong role given their wide powers over companies in financial distress. They may appoint an observer or controller to monitor the consensual restructuring process Need to ensure restructuring plan complies with foreign investment restrictions. This may influence security structure available to creditors

Restructuring Options: Government Bail-Out Scheme Gulf region has history of providing support to key companies in distress (e.g. support from Dubai, Abu Dhabi Governments). This support has traditionally occurred behind the scenes, but can also be public Some countries have also introduced formal bail-out schemes (e.g. Kuwait). So far, these programs have not been greatly utilized given their conditions favor local creditors Governments can also provide soft support, e.g. asking their sovereign wealth funds to take a stake in companies in distress It is not clear what price companies pay in return for such support (either economically or politically)

Key Features of a Restructuring Plan A restructuring plan (whether pursued under a formal or informal restructuring process) will typically be tailored to meet needs of particular company in distress and its creditors However, restructuring plan will normally include many of following features: - new credit facilities or extension of existing debt maturities - debt for equity swaps - asset disposal program - rationalizing business of company, including folding under-performing business units - separation of “good” assets from “bad” - changes to company management and appointment of Chief Restructuring Officer - substantial security structure (including moving key assets offshore where legally possible) - stay of proceedings for duration of implementation period of restructuring plan - may involve “haircuts” for creditors

Implementing a Plan Once plan agreed, relevant approvals will need to be sought from company’s shareholders, creditors and regulators Company will need to devote substantial time in dealing with creditors’ committee, claims from individual creditors, Government and regulator representatives, shareholders and business partners Comprehensive due diligence process will need to be implemented, which can take up substantial management time Company will normally issue Information Memorandum or Explanatory Memorandum to send to creditors before obtaining final approval of plan Agreed Management Incentive Plan will need to be implemented Once plan is approved, contemplated restructuring will need to be implemented (e.g. assets disposed of, new finance facilities entered into, appointment of creditor representatives to Company board or management, etc)

Issues with Islamic Finance Default provisions in Islamic finance instruments untested Islamic financing tends to make finance providers partners with borrowers (or investors). So in theory finance providers rank as equity behind company’s debt holders. As this distinction is sometimes synthetic, it is not clear whether investors themselves will challenge this characterization, or whether such characterization will survive judicial scrutiny Shari’a compliant companies have added complexity of making sure that restructuring options are Shari’a compliant. This can sometimes reduce universe of potential restructuring options Need for Shari’a Board sign-offs (both of the company and its creditors/investors) can significantly delay restructuring process

Questions?