Capital Increase Without Pre-Emptive Rights

As you can see, I have mixed up chemical tanker news and the corporate finance news recently. Basically shipping is capital intensive and therefore the capability to raise financing is really critical for certain shipping company and therefore the role of raising funds is paramount for the success of the organisation. So from now and then please dont be surprised of this mix news. Please tell me if you want me to stop from writing about financing news.

So this time, I am going to discuss about Capital Addition or Increase without Pre-emptive Rights.

In general, issuance of securities to a particular party from Indonesian point of view must all be offered to the existing shareholders first (Rule IX.D.1). So the existing shareholders have the first option to subscribe to such securities. Offering such securities to all shareholders require a tedious process and normally will require shareholders approval among other things.

Do we have exemption on such requirement, some corporates ask?

The good news is yes we do. The bad news is there is only a limited option companies can do it. Based on the existing Corporate Law, exemption applies to such offering but limited only on the following circumstances i.e.

1. If the issuance of securities is in relation to a debt to equity conversion (in cases where a company cannot pay its obligors).

2. If the issuance of securities is in relation to an ESOP or MSOP

3. If the issuance of securities is in relation to or part of a restructuring process

The process of offering securities without first offering to the existing shareholders is called a PMTHMETD process (what a complicated abbreviation, huh!) basically that means a process of issuance of securities for capital increase or addition without pre-emptive rights). However the amount of shares issued is capped at 10% and must be exercised within 2 years after its announcement based on the existing regulation (Rule IX.D.4). Such plan must also be published to the market as required by the capital market authority so corporates must have known the use of proceeds of such understaking prior to doing the transaction.

Having regard to several corporate cases on the debt to equity conversion such Lippo Karawaci, Argo Pantes, Kedaung Setia, Teijin Indonesia Fiber, Surabaya Agung, Suparma, etc lets focus more on the debt to equity conversion as it seems more frequently performed by domesstic corporates than any other exemptions above.

One thing to note on debt to equity conversion is the criteria who can actually do this. First thing to check is as to whether such conversion is already stated and permitted under the ariticle of association of the company. If no such provision provided, then there is no way a company can do so. If the article of association allows for capital addition under a certain restructuring process to improve the company's financial position, then the company can use this basis for the conversion.

The criteria of companies eligible to apply for the debt to equity conversion is as follows:

1. It borrows from the Central bank or other government linked financial institutions and such borrowing is 100% more than its current share capital (basically this clause is pertained to domestic banks that are under restructuring process which happenned a lot during the Asian Financial Crisis)

2. Companies other than banks which have negative working capital AND with total liability 80% more than its assets value at the time the EGM is conducted (this is kind of difficult to fulfill because even if a company is declared bankrupt, it may have assets more than its liability. Probably because of this condition, there is the 3rd item below which helps companies which are really in need of debt reduction and equity infusion to continue operating.)

3. Companies that fails to fulfill its debt obligation and the debt is from a third party (non affiliated party) and such third party agree to that debt to equity conversion.

Basically the third point above doesnt require the company to provide certain financial reviews and ratios from any third party to fulfill the requirement for such debt to equity conversion and therefore have been the most widely used criteria by corporates. One thing to note that such debt should not be from any affiliated parties. This is to avoid cases in the past whereby the debt to equity conversion have been used by the existing shareholders to increase its shareholding without the need to offer its securities to the other shareholders and therefore cornering and diluting the the shareholding amount of the existing shareholders.

The other criteria to be noted is the type of debt which is allowed for equity conversion. As you can see, not all type of debt can be converted. We need to refer to the existing corporate law on the meaning of Rights to Collect (Hak Tagih).

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Cheers
PC