Five hedge funds are testing Indonesia’s legal protections for foreign investors after a local court barred them from Bakrie Telecom’s debt restructuring talks.

The funds and one other bondholder are asking a New York court to quash a ruling by a Jakarta district judge that they cannot vote on the workout arrangements because their defaulted notes were issued by an offshore special-purpose vehicle.

The investors, who own 28 percent of the $380 million May 2015 dollar-denominated securities, said in the suit they would recover less than 20 cents on the dollar under the plan.

Leading global asset managers are watching the dispute with interest because almost 90 percent of all Indonesian non-state corporate dollar notes have been issued via offshore entities similar to that used by the telephone company, which is part of the Bakrie conglomerate, a group with two other entities in restructuring.

President Joko Widodo can ill afford to irk foreign investors after outlining plans to build 25 dams in five years, 24 ports and six mass transport systems to spur an economy that grew at the slowest pace since 2009 last year.

“We want to know how bondholders are treated everywhere we invest so we watch closely key bankruptcy rulings,” said Benjamin Cryer, a Singapore-based portfolio manager for the Franklin Asia Credit Fund of Franklin Templeton Investments, a unit of Franklin Resources.

“Bondholders expect to be treated fairly in a restructuring and if they can just be excluded from the process, investors will at the very least require some additional safety in future issues.”

Less credit

Doubts over the ability to enforce the rights of foreign investors could reduce the availability of credit to smaller companies from Indonesia, Cryer said.

Bond issuers may have to start offering additional assurance in writing that foreign creditor rights will be respected, he said.

The dispute threatens to overshadow Indonesia’s position as the best performing country this year in JPMorgan Chase & Co.’s Asia Credit Index series. Returns total 5 percent.

“Indonesian bonds and mainly Indonesian high-yield bonds should trade wider than other similar rated emerging market bonds,” as a result of the recent ruling, Brigitte Posch, the London-based head of emerging market corporate debt at Babson Capital Management, which controls some $212 billion, said.

Bakrie Telecom hasn’t reported an annual profit since 2010, according to Bloomberg data, after focusing on a mobile phone technology that’s lost popularity.

“We are still reading the situation so we can’t give any official comment on this matter just yet,” Niko Margaronis, Bakrie Telecom’s head of investor relations, said.

Coffee, steel

Achmad Bakrie started what would become the Bakrie group in 1942, trading rubber and coffee, before expanding to steel, energy and property.

His son, Aburizal, struggled to repay $1.1 billion of debt when currencies plunged in the 1997 Asian financial crisis, and was forced to give away most of the family empire to creditors.

The group rebounded along with Indonesia’s economy until the companies accounted for 15 percent of the Jakarta stock exchange’s market value in June 2008.

The eight companies’ combined weighting has since shrunk to less than 1 percent.

Coal and palm oil have slid 48 percent and 38 percent respectively since the end of 2010, weighing on sales for miner Bumi Resources and Bakrie Sumatera Plantations.

Property sales for Bakrieland Development were hampered by 1.75 percentage points of increases in Indonesia’s benchmark interest rate in 2013.

All three companies are restructuring their debt, or have done in the past two years.

Bondholders sue

Bank of New York Mellon, the defaulted notes’ trustee, is representing bondholders in the restructuring, according to the notes’ contract.

Bank of New York Mellon as trustee was excluded from the process, and executives of a company subsidiary named Bakrie Telecom voted on the plan in its place, according to the Feb. 18 court document.

The five hedge funds are Universal Investment Advisory, Universal Absolute Return, Vaquero Master EM Credit Fund, Footbridge Capital and Growth Credit Fund, the document shows.

The bondholders suing in New York didn’t participate in the vote, according to Joel Hogarth, a partner at Ashurst, which represents Bakrie Telecom.

Even if they had, the dissenting votes amounted to about 18 percent of the company’s total debt, he said in an e-mail, suggesting they wouldn’t have had enough power to change the outcome of the workout anyway.

Mexican glassmaker

In 2012, Vitro, Mexico’s biggest glassmaker, explored a loophole in the local law to allow executives from its subsidiaries to steer its debt workout in a similar manner to Bakrie Telecom, leaving holders of $1.2 billion of bonds with losses of more than 40 percent.

The local ruling was challenged in the US by hedge funds including Paul Singer’s Elliot Management and a court decided the Mexican plan wasn’t worthy of enforcement.

While bondholders owned less of Vitro’s debt than its subsidiaries, and hence had less power in the restructuring, they were still allowed to vote in the process.

“I can’t think of any other case in which the special purpose vehicle investors were not allowed to vote in a restructuring,” as happened with Bakrie Telecom, James Harper, the head of research at BCP Securities in Connecticut, said.

“That puts Indonesia in a bad light.”

The government expects total investment in projects this year to reach 516.5 trillion rupiah ($40 billion), up 11.5 percent from 2014, with two thirds of that money coming from abroad.

Offshore cash

“It’s clear that the new government in Indonesia is trying to attract more offshore capital into the country and it will be very sensitive to perceptions of discriminatory treatment,” said Jim Jagger, a senior vice president and portfolio manager at Aviva Investors Global Services.

The Indonesian bankruptcy law was amended in 1998 to allow companies to remain operational while restructuring their debt, as part of an agreement with the International Monetary Fund, Gary Bell, an associate professor of law at the National University of Singapore said.

“While the law follows the framework of Chapter 11 in the US, local judges often have very different interpretations of it from what would be seen elsewhere in the world,” Bell said.

“When an Indonesian company goes into bankruptcy, the proceeding will happen in a local court, and there is nothing global investors can do about that.”

Bloomberg

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