Volume III, No.1

January 25, 1999

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Part III

Thailand

In communist countries, former communist countries and often in other emerging markets, political and economic power become centralized. In more mature economies, laws act as restraints on this process. Where legal traditions are not well rooted, the restraint is either weak or nonexistent. The economic effect is that the economy loses its diversity. Private or state monopolies and oligopolies tend to proliferate encouraged, protected and maintained by the ruling elite. With the loss of diversity, the economy loses its efficiency. Capital can no longer be allocated to the most efficient enterprise, because capital follows power and not the market.

Like the simple advances in hygiene, which created explosive population growth, the combination of sophisticated technology and cheap labor can create double digit economic growth. This rapid growth can conceal inefficiency. The problems are further exacerbated by the effects of corruption. Where the powerful attempt to ignore or control the market, the demands of the market are met by corruption. The inefficiency and lack of legal restraint of a cosseted market beget the inefficiency of a black market.

When the trend reverses, the deficiencies become painfully obvious. If the growth disappears, capital is repelled by the risk of an unregulated and unstable market. The result is the lack of liquidity. Capital can be attracted back if it is convinced that the markets will allocate it in ways that maximize benefits. In societies without sophisticated legal infrastructures parties acting in their own self interest will often select strategies that do not result in mutually beneficial transactions. The economy as a whole then suffers from this suboptimal micro economics. To regain investment capital, the society must reform its legal system to encourage a party to select strategies that result in the maximum benefits for all parties.

Thailand is undergoing the difficult process legal reform. Its people and government are looking for more expeditious legal procedures that both suit local traditions and satisfy international investors. Legal change involves a shift of economic power. Any shift of power is both extremely difficult and can be very slow.

The first reforms for Thailand occurred one hundred forty four years ago when western powers forced Siam to become a market economy. In 1855, the King signed the Bowring treaty which changed Thai Society.

The next great reforms were instigated by the visionary monarch Chulalongkorn, Rama V. He replaced the old legal system with a combination of civil and common law adopted from South Africa. By choosing a middle path he avoided pressure from Colonial powers France and England to adopt their respective systems.

The monarchy was not always so helpful. According to Professor Bovornsak Uwannoold Dean of Chulalongkorn University's Faculty of Law, Thailand has a heritage of dictatorial politics and the remnants of the old authoritarianism. This resulted in a legal system, which is deeply mired in power centralization, patron-client relationships and laws favoring those in power. With unchecked power in all levels of law enforcers, the result is widespread abuse and corruption. "Our system lacks the necessary ethics for fair distribution of resources. The quality of the legal system is seriously lacking," he said."Delayed justice is actually denial of justice. But in Thailand, we view such delays as normal," ⁽¹⁾

A good example of the present problem is the bankruptcy law. The prior law was originally promulgated in 1940. The present law was adopted under pressure from the IMF in April 1998. This law was based on a draft originally created nine years ago.

The main problem with the old law was that it gave creditors and debtors very limited and often drastic alternatives. If a bankruptcy suit was filed, there was no possibility of reorganization, only liquidation. There was also no legal protection for new financing. Foreclosure was and still is almost impossible.

As of April 10, 1998, some of these problems were remedied. Bankruptcy legislation was passed that included bankruptcy procedures and a plan for reorganization similar to the US Chapter 11. The legislation followed the US and UK on court jurisdiction practice very closely. The courts and the judges are given power to guide the process very closely to the end. It was estimated that any proposed reorganization plan would take between three to six months for court approval.

The new legislation was criticized by Sydney based Baker & Mackenzie expert Mark Chapple, ''In Hong Kong and Singapore, where there is similar legislation, reorganization is rarely used. Our partners say that the costs of court involvement make the process too costly''⁽²⁾ he said.

The new law also added provisions to protect creditors who advance new money to debtors in the process of reorganization. However, experts warn that this provision should be regarded with caution. According to Stephen Eno, a Baker & Mackenzie international partner practicing in Hong Kong, the provision was ambiguously worded. ''Unless the creditor obtains a specific court approval for the priority on each amount advanced, he will have no priority standing if the reorganization plan is subsequently abandoned,'' he said. ⁽³⁾

Mr. Eno also commented that the new legislation was weak in that it ignored creditors' committees until after the approval of the plan. This procedure runs contrary to the process in the U.S., Australia and the UK where the committees are seen as vital to the reorganization process.

Although the new law passed in April was a welcome addition, it soon became clear that additional reforms were needed. These included some of the basic foundations of commercial law concerning collateral. There are three aspects to this process. First, the lender must establish a security interest or some sort of legal claim to the collateral. Second, the lender must establish its priority against other lenders in the same collateral. Third, the lender must be able to quickly foreclose on the collateral in case the borrower defaults.

The government has proposed legislation to cure some of these problems. The proposed legislation will expand the types of assets, subject to non-possessory security interests, and will cover inventories, raw materials, accounts receivables, equipment, and commercial vehicles. The new foreclosure laws are designed to speed up the foreclosure process. Under the present process, a case can drag on for 10 years. A court judgement does not automatically result in possession or payment.

Amendments to the bankruptcy law would include a reform of the bankruptcy proceedings and the creation of a specialized bankruptcy court. The new amendments also attempt to clarify problems of new loans to companies in the process of reorganization. The law passed in April does allow lenders preferential treatment for extending funds to reorganizing corporations, it does not extend the same preferences to creditors of corporations, who cannot agree on a reorganization plan.

Some of these proposals have been made as a result of several recent cases. The first case involves the Hotel Nikkon Mahanakorn. In that case, the Hotel's owner, Bangkok Thani Hotel Co. was in default on its loan from its creditors, several Thai banks. In an attempt to force Bangkok Thani to restructure its debt, the creditors brought an action under the new law. The court held that even though the corporation was in default on its loans, it could not be forced into reorganization because its assets exceeded its liabilities. Bangkok Thani did not want to restructure because it wanted to avoid a takeover by its creditors, who would convert its debts into equity.

The second case is far more serious. It represents not only the weaknesses in the new law, but also a wide spread problem in Asia and in other emerging markets, lending by state owned banks to favored industries.

Alphatec Electronics Plc. (Atec) was once the star of Thailand's strategy to move into high tech manufacturing. Prior to the economic crisis, Atec hoped to become a world leader in the semiconductor industry. Its bid was supported by the Krung Thai Bank (KTB). KTB, a state-majority owned bank was run by the Ministry of Finance through the appointments of the board and its chairman. Since KTB is a state enterprise it was subject to periodic political interference.

Atec was able to borrow 4.2 billion baht from KTB. KTB became Atec's largest creditor with about 32 percent of Atec's total loans. The Asian crises and the downturn in the semiconductor industry, caused the Atec company to seek court protection under current bankruptcy laws. Its CEO, Charn Uswachoke, once billed as the country's pioneer in the development of the high-end electronics industry, is the subject of fraud charges.

After Atec filed for bankruptcy, its court appointed planner was able to put together a restructuring plan with new capital from American International Group (AIG) and a Swiss investor group, Investor AB. The plan called for lenders to accept a loss of up to 90% of the value of their loans in exchange for an equity stake in a restructured entity. KTB together with another state owned creditor bank, Union Bank, were to use the new law to block the plan despite the fact that the deal had been approved by an overwhelming majority of the 75 creditors.

KTB's objection was two fold. First there was the potential political problem of a state-owned bank using taxpayer money to bail out an allegedly fraudulent bankrupt operations. The second objection was that unlike private banks, KTB may not have provided adequate reserves against losses. Finally, KBT once recapitalized is due to be privatized and after absorbing two other banks, it will become Thailand's largest bank.

Another issue is that lack of judicial expertise in this and other bankruptcy proceedings. Kitipong Urapeepatanapong, an attorney at Baker & Mckenzie, "the issues such as the viability of proposed reorganization plans require specific expertise which judges do not have. ''Which one of our judges would know if the Alpha Tec plan was viable?'' he asked."⁽⁴⁾

The third case involved the bankruptcy of Thai-Chrysler. Like Nikkon Hotel and Atec, the Thai-Chrysler case exposes the limited alternatives offered by the new law when there is a disagreement among the creditors. Unlike the Nikkon Hotel case, Thai-Chrysler was insolvent. There are two main problems. First, the law provides only one remedy when the debtor and the creditors cannot agree on a restructuring plan. The only remedy available is liquidation. Second, if there is no agreement on a plan, any new money extended to the debtor will not be entitled to preferential treatment.

Understandably there is resistence to change both from politicians and judges. Senators Prachai Leopairatana of the Thai Petrochemical Industry Group (TPI), Senator Sawad Horrungrueng of the NTS Steel Group and Senator Pairote Piempongsan of the real estate firm Ban Chang Group have a combined debt of more than US$13.8 billion. Senators Prachai and Sawad have voiced opposition to the amendments to the bankruptcy law and to the new foreclosure bill.

The main concern of some of the senators was that the new laws would speed up collection of personal guarantees. As of January 18^th, 1999, the Finance Minister Tarrin Nimmanahaeminda "agreed to demands by some senators that the new version of the bankruptcy bill should eliminate legal obligations on personal guarantees once the failed businesses have been taken over by creditors." ⁽⁵⁾

In addition to the senators, the judiciary has become sensitive to criticism. Judge Sri-amporn Salikupt, an Appeals Court Region 3 judge, stated that judicial training requested by the World Bank was an unjustified interference in the Thai Courts. ''If we allow the World Bank to dictate to the courts by pressuring the government, the country will face worst humiliation than the loss of extraterritorial jurisdiction,'' he said. Surasak said the courts already have an ongoing training program for judges and legal officials on bankruptcy proceedings." ⁽⁶⁾

Thailand's economy, the star pupil of the IMF recovery program has made great improvements. The Baht has recovered from a low of 57 to the dollar to a present level of 37. The trade balance and current account are in very healthy positive territory. It appears that Thailand has weathered the crisis and is ready to resume momentous growth.

The main drag to growth is the lack of infrastructure. Anyone, who has been subject to Bangkok's traffic, can attest to the need for a better transportation infrastructure. Telecommunications, information technology, energy and potable water are all areas that require investment.

But perhaps the greatest need for Thailand is the need for a legal infrastructure. It may even be possible to provide a quantitative measure of the effect. On December 15th the Financial Sector Restructuring Authority, the Thai government agency responsible for restructuring banks, attempted to auction off bad loans it received from banks. Since the possibility of legal recovery was so small, in some cases investors were willing to pay no more than 25% of an assets nominal value.

Besides commercial law, reform of land use law, securities, banking, and environmental regulation, all are required to give Thailand the society it deserves. Yet, the process is extremely slow. An infrastructure that can be created at the stroke of a pen would seem easier to create than structures that take thousands of tons of concrete or miles of cable. Unfortunately the reverse is true.

By: William Gamble, J.D., LL.M.

Emerging Market Strategies Company

1990 Pawtucket Avenues, Suite 1D
East Providence Rhode Island, United States 02914

Tel. 401-272-8906
Fax 401-272-8139
EMail:william@emergingmarketstrategies.com

This article also appears on the University of Virginia Darden Graduate School of Business Administration Alumni Forum (http://www.Darden.Virginia.edu/), the New York University Stern Graduate School of Business Administration Asia Crises Home page (http://www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html) and the EMS home page (http://www.Xensei.Com/users/gamblet) Articles are also translated into Korean at www.seri-samsung.orgl. Other articles are also published in the Providence Journal.

Emerging market strategies is a specialized consulting company. We serve clients by providing unique solutions for companies entering the frontiers of the global marketplace. We focus on particular strategies to help clients make accurate forecasts and reduce risk in these volatile areas. By rigorous analysis of the economic and legal situations we can clarify potential problems and propose distinctive solutions. Our advice is based on twenty years of extensive research and hard won experience from the trenches.

1. Ekachai, Sanitsuda Justice in the Balance: Legal Reform, The Bangkok Post, August 28, 1998.

2. K. I. Woo, Businesses Urged to Push for Changes, The Nation, March 30, 1998.

3. Ibid.

4. K. I. Woo, Thai Chrysler Exposes a Need for More Reform, The Nation, December 14, 1998.

5. Sorrayuth Suthassanachinda, Tarrin Retreats Over Personal Guarantees, The Nation, January 18^th, 1999.

6. Opas Boonlom, Judges attack WB, IMF, The Nation, December 22, 1998

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