Bottom Shekel / Judge's Creativity on Africa Israel May Cost Us Dearly

Nobody wants to see a tycoon fall. Certainly nobody wants to be responsible for a tycoon's fall. Therefore, everyone went out of their way this week to prevent the fall of Lev Leviev, owner of the huge Africa Israel Investments company.

Everyone, including the court: Tel Aviv District Court Judge Varda Alshech, Israel's high priestess of suspending legal proceedings, did everything possible and impossible in order to save Africa Israel. Alshech thought out of the box and was creative in her treatment of the law - all in order to reach a compromise both among the holders of Africa Israel's 13 different series of bonds, and between the bondholders and the company.

Alshech decided that the rules for suspending proceedings did not apply to the case of Africa Israel, for the simple reason that no bondholder bothered to request a suspension of proceedings. And since the rules spelled out in the law for suspending proceedings were not activated, Alshech felt free to decide on innovative rules for the Africa Israel deal, such as the rule that the deciding factor would not be the size of the debt, but the date of maturity. In other words, bond series that were supposed to come to maturity in the coming year (the maturity date of one, Series 9, has already passed) are more important than bond series with later maturity dates.

As a result, three small, short-term bond series were preferred to the other Africa Israel bonds series. And almost all the cash allocated via the debt restructuring flowed into the pockets of these three series' bondholders.

A very convenient choice

For Alshech, this choice was very convenient. The three short-term series, and especially Series, whose maturity date had already passed, would have caused the main problems in the restructuring. These are series in which private investors - two of whom hired separate attorneys for themselves - have relatively large holdings, and these investors were the ones most likely to demand Africa Israel's liquidation if they were not paid in full. Bondholders of two of these short-term series had been responsible for most of the liquidation threats, and they were also the ones most serious about carrying them out.

Therefore, these were the bondholders that Alshech took most seriously, trying to placate their demands in an attempt to reach a deal. That is why she invented the innovative rule that the series' maturity date, rather than its size, is what determines what portion of the debt restructuring each series will receive. This rule greatly benefited the short-term series.

Alshech in effect changed the rules governing which creditors get priority: The criteria is no longer the size of the debt, but the maturity date. What reason did the judge give for turning the usual arrangement upside down? Practicality. It was simply the shortest and most convenient way to reach a deal on Africa Israel. And to secure such a deal, the court was ready to go as far as inventing new rules for creditor priority.

But in her desire to reach a deal at any cost, Alshech sacrificed three crucial interests. One is the public's interest. Most of the public's money is in the long-term bond series, which account for some 90 percent of Africa Israel's debt. But it was the short-term series, which account for only 10 percent of the debt, that received all the cash offered in the arrangement. Instead of cash, most of the public received shares and new, very long-term bonds - which is like getting three birds in the bush instead of one in the hand.

The second interest that was undermined was legal certainty. Instead of certainty about how a debt restructuring will be handled, there is now chaos - a situation in which a creative court can reinvent the rules. That will certainly not help the capital market conduct future debt restructurings.

Short-term debt is now worth more

The third interest that was sacrificed is the rule laid down by law with regard to suspending proceedings, and that is the equality of all the creditors. From now on, in any debt restructuring not governed by the legal framework of suspending proceedings, a short-term debt will be worth more than a long-term one. That is what Alshech ruled.

This means that anyone who holds long-term bonds must start fearing for the value of his bond. It also means that if someone hold long-term bonds in a company that is exhibiting signs of distress, he should not go the route of debt restructuring, as his debt will be considered inferior. Instead, he would be better off making an immediate request for a legal suspension of proceedings. Thus the worst consequence of Alshech's decision is that it reduces the advisability of requesting debt restructuring. From now on, we will probably see more and more suspensions of proceedings.

It is doubtful whether Alshech thought about this consequence of her decision. Yet complaints should not be directed at her. The judge tried to be creative and promote a debt restructuring at almost any price. Those who gave her the opportunity to do so were the institutional investors - those who hold the long-term bonds, who saw and remained silent.

Alshech's creativity would have ended the moment any institutional bondholder bothered to return the court to the rules determined by law - in other words, the rules of suspending proceedings. For that reason alone, they should have requested a suspension of proceedings. But none of the institutional bondholders bothered to do so, because none of them wanted to be the bad guy who sent a huge concern like Africa Israel into suspension.

Everyone tried to be nice - both the institutional investors and the court. And the result is a problematic legal precedent, a threat to the future of debt restructurings and a sacrifice of the interests of the public, which holds mainly long-term bonds. Perhaps the time has come to make niceness illegal?