Focus: Thailand – November 2008
Guarantees by majority foreign-owned Thai companies
In brief:
Thailand's Ministry of Commerce recently issued an advice concerning
the ability of a majority foreign-owned Thai company to grant a guarantee. The
advice has important implications for all majority foreign-owned Thai companies
and their ability to grant guarantees and, by extension,
mortgages and other security for third-party debts. International Partner Marcus Clark
- Background
- Implications for the validity of guarantees
- Is the Ministry of Commerce correct?
- Why care?
- What can be done?
How does it affect you?
- If the Ministry of Commerce's advice is correct, guarantees and security for third-party debts given by majority foreign-owned Thai companies may be invalid.
- This may have adverse implications for the ability of any business with significant Thai operations to raise finance, particularly in the current environment.
- Lenders with existing exposure to such businesses may need to review the adequacy of any guarantees and third-party securities obtained from majority foreign-owned Thai companies.
- Borrowers with guaranteed credit facilities may need to determine whether the potential invalidity of such guarantees and securities constitutes an event of default for them.
Background
This issue arose in the context of a leveraged buy-out of a global electronics business with manufacturing operations in Thailand. The buyer negotiated a foreign credit facility to help fund the buy-out and future working capital requirements of the business. To avoid structural subordination of their exposures under the facility, lenders sought guarantees and other security from principal subsidiaries, including a Thai company. Without such security, the lenders would, at best, have only had rights as ordinary shareholders in these subsidiaries and been subordinated to the rights of all their trade and other creditors.
Counsel for the Thai subsidiary was concerned that the grant of a guarantee and other security by the subsidiary may breach the Foreign Business Act B.E. 2542 (1999) (the FBA) and advice was sought from the Ministry of Commerce on this point.
The operation by foreigners of businesses in Thailand is subject to the FBA under the administration of the Ministry of Commerce. The FBA restricts (and in some cases forbids) foreigners from engaging in a wide range of business activities. Majority foreign-owned Thai companies are classed as foreigners for the purposes of the FBA.
Most manufacturing businesses are not subject to restriction. In contrast, most service businesses are and the Ministry of Commerce now appears to have adopted a fairly unreasonable view as to what constitutes a service business.
One of the questions that was put to the Ministry (as a result of this case) was whether a majority foreign-owned Thai company would be conducting a service business if, as part of a one-off transaction, it guaranteed the obligations of its parent under a foreign credit facility for no consideration and where there was an expectation that some funds advanced through that facility would be on-lent to it. The Ministry's advice was that it would be.
Implications for the validity of guarantees
It is important to note that this advice is not law but merely the Ministry of Commerce's own view of what constitutes a service business for the purposes of the FBA. However, the Ministry is responsible for the enforcement of the FBA and its views may well be of some influence on a Thai court called upon to determine the validity of guarantees and third-party securities granted by a majority foreign-owned Thai company.
Section 150 of Thailand's Civil and Commercial Code declares an act to be void 'if its object is expressly prohibited by law...'. It is possible that a Thai court may declare a guarantee void under this section if it had been given by a majority foreign-owned Thai company in circumstances that constituted a service business not licensed under the FBA. By implication, it would also be open for a Thai court to declare void any securities, such as land or machinery mortgages or pledges of financial instruments, given in support of the guarantee.
Is the Ministry of Commerce correct?
In our view, no. Granted, there are circumstances where giving guarantees will constitute a service business (eg guarantee facilities offered by banks), but it rather strains the ordinary meaning of 'business' to suggest that a one-off guarantee for no consideration in connection with a parent company's group financing is an example.
The FBA defines business as 'engaging in trade enterprises in agriculture, industry, handicraft, commerce, services or other enterprises'. It does not go on to define 'enterprise' but, to our mind, engaging in an enterprise will involve performing thousands of individual tasks for a common purpose such as manufacturing electronics. Some tasks will be of direct relevance to the common purpose (eg actual manufacturing), while others will be merely supportive, such as procuring supplies or guaranteeing your parent company's credit facilities so that it can make some of those facilities available to you and otherwise support your operations.
The Ministry of Commerce appears to be singling out one discrete task (guaranteeing parent company debt) and saying that this is a separate business.
Why care?
The FBA imposes penalties for conducting restricted businesses without appropriate licences which include potential imprisonment for company directors.
We very much doubt that the authorities are going to start gaoling anyone for handing out one-off guarantees anytime soon. What is of concern is that a guarantor may challenge the validity of a guarantee or third-party security that lenders attempt to enforce against it. Of course, there is some risk for the guarantor in pursuing this tactic, because it would be admitting the commission of an offence under the FBA, but a guarantor may well take the view that the chance to escape its obligations is well worth the probably negligible risk of prosecution.
What can be done?
There are no easy solutions (if one concludes that the Ministry of Commerce's advice might prevail).
A service business that is subject to restriction under the FBA can operate if a foreign business licence or certificate1 is obtained from the Ministry of Commerce. That may be an option for companies that have existing licences, as they may be able to amend them to specifically authorise the guarantee of parent company debts. However, most manufacturing is not restricted by the FBA, and applying for a foreign business licence for the sole purpose of guaranteeing parent company debts is unlikely to be viable: the application procedures are geared towards substantive business activities (yes, there is an irony in that), the application process takes months and licence holders are subject to minimum capital, knowledge transfer and periodic reporting requirements.
Some lenders may require majority foreign-owned Thai companies to be actual borrowers under the facilities they are offering, rather than just guarantors of those facilities. While this approach has some merit – particularly in relation to funds that are to be ultimately made available to the Thai company – there is some danger that to the extent the Thai company will be agreeing to assume obligations for the repayment of funds that have not been lent to it, the Ministry of Commerce will consider that activity to be a form of service business.
What really needs to be done is for the Ministry of Commerce to take another look at this issue given the adverse affect it may potentially have on the ability of many businesses to obtain finance. Now is not the time for the Thai government to be doing anything that even remotely calls into question the validity of guarantees and other third-party securities that underpin many existing and future (perhaps desperately needed) finance facilities.
If you have any queries on this, or any other matter, please contact us.
Footnotes
- Foreign business certificates are available for businesses now restricted by the FBA that could previously be undertaken without restriction, businesses afforded benefits under some bilateral trade agreements between Thailand and other nations and businesses given investment promotion by Thailand's Board of Investment. Everyone else has to get a foreign business licence (and we say good luck with that).
For further information, please contact:
- Marcus ClarkPartner,
Bangkok
Ph: +66 2646 1888
Marcus.Clark@aar.com.au - Matthew BarnardPartner,
Hong Kong
Ph: +852 2903 6212
Matthew.Barnard@aar.com.au - Robert FishPartner,
Singapore
Ph: +65 6535 6622
Robert.Fish@aar.com.au - Thomas MillerPartner,
Ho Chi Minh City
Ph: +84 8 3822 1717
Thomas.Miller@aar.com.au - Diccon LoxtonPartner,
Sydney
Ph: +61 2 9230 4791
Diccon.Loxton@aar.com.au
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