Some Problem Areas in Philippine Corporate Rehabilitation and Insolvency Proceedings

By Atty. Rogelio F. Vista

I. Introduction

Corporate rehabilitation is a recent phenomenon in the Philippine legal landscape. Before the enactment of Presidential Decree No. 902-A, now complemented by the Interim Rules on Corporate Rehabilitation promulgated by the Supreme Court, the law that would apply to a financially distressed entity was Republic Act No. 1956, otherwise known as the Insolvency Law of 1909 governing the liquidation of an insolvent debtor.

Corporate rehabilitation provides an alternative to liquidation under which a debtor company or individual can enter into compromise with its creditors to keep the business as a going concern with the view of maximizing returns to both creditors and the debtor. It gives enterprises in serious financial difficulty an opportunity of resolving their problems and continuing in business rather than going into liquidation for the benefit of all company stakeholders including creditors, suppliers, employees, customers, shareholders, and society in general.

However, corporate rehabilitation should not be expected to apply to each company that is in financial distress. It may be more prudent to wind up enterprises that are irreversibly insolvent or those whose principal activities are no longer economically efficient or viable, rather than initiate a rehabilitation attempt that will merely postpone the inevitable outcome while in the process dissipating any remaining company assets. Nei-ther should rehabilitation be resorted by the debtor simply to take advantage of a holiday from debt-service.

There are many potential benefits that may be cited in favor of allowing a distressed debtor to avail of rehabilitation proceedings. It preserves the economic value of the business as a going concern and may aid in minimizing financial loss to creditors in general that may be occasioned by the debtor’s insolvency. It may also provide for a more balanced distribution of company assets should the attempt at corporate rehabilitation eventually fail.

However, it should be stressed that there are likewise potential costs that are inherent in rehabilitation proceedings. For one, the cost of credit may increase for a debtor that has undergone rehabilitation due to its creditors’ experience of helplessness in enforcing contractual rights during the enforcement of a stay order. Thus, the cost of allowing the company to continue in business may simply lead to a further erosion of its value. Further, the administration of rehabilitation proceeding may entail additional financial cost and stress to an already distressed debtor. All these factors should be taken into consideration in deciding whether to opt for rehabilitation or outright liquidation. (Rehabilitating Large and Complex Enterprises in Financial Difficulties [2003]. Discussion Paper. Australian Government. Corporations and Markets Advisory Committee. p.v.)

II. Rationale Behind Insolvency and Rehabilitation Proceedings

Corporate insolvency should be viewed as an integral part of governing business concerns in any economy. Financial distress is a possible outcome of any enterprise -– it is virtually impossible to think of a business concern that is completely insulated from possible insolvency. This is because engaging in an enterprise necessarily involves risk-taking while risk taken may overwhelm the capacity of an enterprise and push it to bankruptcy.

Insolvency, therefore, should not be viewed with indignation, because, unless wrongful trading or misfeasance is established on the part of those running the business, corporate distress might really be a result of a genuine business failure. In such case, the question that must be asked is: Would it be in the larger interest to reorganize and restruc-ture the business to make it work or would it better to simply liquidate it? Corporate bankruptcies today affect far more than creditors’ claims. Many financially distressed corporations are substantially powerhouses in the sense that their exit from business may affect many individuals, including workers and consumers as well as the country’s economic system in general. As corporations have become more concentric and dominant in the financial and economic system of a given milieu, corporate bankruptcy has likewise become no longer a purely commercial issue but has assumed a social dimension. This form of corporate rescue has its origin in the American practice that is in sharp contrast with the British approach (Franks, J. and Sussman, O. [Aug. 24, 1999]. Financial Inno-vations and Corporate Insolvency).

England and the United States adopt substantially different legal procedures in dealing with insolvency. Under the English procedure, control rights in case of insolvency by a debtor are concentrated in the senior lender (termed in the British system as the floating charge holder). Lenders and borrowers who were exercising their right to contract freely developed this procedure. It was left to the parties themselves to design their own insolvency procedure as part of their contract. Eventually, those contracts were standardized into law. The State’s role in the process remained relatively limited. It was largely confined to enforcing the contract, under the principle that while no one is obliged to impose an obligation upon oneself, the State will enforce the obligations that the par-ties have voluntarily imposed upon themselves.

While the English approach’s advantage was that of preserving the parties’ “ex ante” outlook, its inherent weakness is that parties would likely fail to take into account values for subsequent parties and thus ignore the long-term effects of their decisions. In other words, since their focus is parochial limited as it is to the immediate benefits that they desire they would tend to innovate much less than what is socially desirable.

Control rights are more dispersed under the American procedure. Congress had power to legislate bankruptcy laws. Some railroad companies began defaulting in the payment of their obligations by the late 19th century thereby necessitating the courts’ in-tervention given the necessity for the continued operation of the railroads. It was felt that lenders’ liquidation rights stood in conflict with public interest.

This American approach pursuing and protecting public interest may be seen as an attempt to remedy the weakness of the English approach. However, legislation necessarily implies that the government, rather than the contracting parties themselves, takes in control of the process. A sort of “political bias” was therefore injected into the process, away, and far different, from the terms, conditions and stipulations that the parties have agreed upon and which they relied on in committing themselves in the contract. In the case of railroad companies, the bias was in favor of preserving the going concern rather than satisfying creditors’ claims. This political bias has been standardized and continues as the justifying principle behind corporate rescue up to the present day.

The Philippine insolvency regime is patterned after the American approach. The parties had to follow the path laid down in Republic Act No. 1956 in insolvency cases and innovations that may be undertaken by debtors and creditors may not deviate from the path predetermined by statutory fiat. Presidential Decree No. 902-A made even clearer the political bias by Philippine insolvency law in favor of public interest and farther away from the creditors’ interests. Thus, while creditors’ approval was needed for suspension of payments under Republic Act No. 1956, this is no longer the case under Presidential Decree No. 902-A, although it was possible for the creditors to overrule the SEC-controlled process. However, under the Interim Rules promulgated by the Supreme Court, creditor’s approval is no longer needed altogether. The consolation given to creditors is that they may file their comments or opposition to the petition for rehabilitation, but the final decision on whether or not to approve the petition for rehabilitation rests with the courts, which may decide to give due course to a petition for rehabilitation for reasons of public interest, whether or not creditors’ opposition thereto is/are meritorious.

It may be observed, in this regard, that the criticism hurled against the Philippine rehabilitation scheme that it is debtor-friendly is not accurate. As a matter of fact, several effective and efficient options are available to creditors to satisfy their claims against debtors. In so many instances, the Supreme Court has struck down as unfair and unconscionable the practice by creditors of exhausting these legal remedies because it resulted into hemorrhaging of debtors’ already bleeding state of affairs. The point is not that there is no adequate protection of creditors’ rights but rather that the exercise of these rights should bend a little backward to promote the overriding consideration of public interest. After all, society has its own interests that are distinct and separate from the interests of those comprising it.

III. Some Problem Areas

The above notwithstanding, there is yet much to be desired in the entire rehabilita-tion scheme. Despite the passage of some relevant legislation, the Philippines has yet to pass a major legal bankruptcy law. The enactment of Republic Act No. 8799 [July 19, 2000], otherwise known as the Securities Regulation Code, transferring jurisdiction over rehabilitation cases from the Securities and Exchange Commission to regular courts and Republic Act No. 9182 [December 23, 2002], otherwise known as the Special Purpose Vehicle Act, are on the whole not substantial improvements of the process. On the contrary, they have even contributed to the piece-meal approach in rehabilitation cases, as relevant statutory provisions may be found, but only with much effort exerted, in several laws here and there. The Interim Rules, on the other hand, may be open to constitutional challenge because it has not limited itself to rules and procedures in rehabilitation proceedings but has rather encroached into forbidden areas through the creation of substantive rights that is properly within the realm of legislation.

As it is now, in the absence of a comprehensive and integrated rehabilitation and insolvency law, the Interim Rules govern. But if the petition for rehabilitation is dismissed the next step is liquidation. The Interim Rules do not contain proceedings in the event of insolvency. In fact it is silent with respect to liquidation if and when the petition for rehabilitation is dismissed. The implication is that the parties concerned will have to file liquidation proceedings under Republic Act No. 1956 which is already an antiquated approach. The main defect of the law is that it was primarily intended as a process for liquidating the assets of individual debtors hence it would be completely inadequate should it be applied to more complex and sophisticated proceedings involving corporate entities.

Even within the Interim Rules itself, there are problems that need to be met. In the Philippines, very few are competent and qualified to act as rehabilitation administrators. While there are efforts to solve this inadequacy, it is submitted that a pool of administrators, duly qualified, trained and accredited by an administrative body, for example, the Supreme Court itself, is desirable. In a paper prepared by the Asian Development Bank, it stated, thus:

“The absence of a modern insolvency law makes debt relief proceedings in the country inefficient. The current Philippine insolvency regime is still a cacophony of laws, jurisprudence and rules of procedures. The first basic law is the 96-year-old Insolvency Act, which vested the courts with jurisdiction over peti-tions for insolvency and suspension of payment. Presidential Decree No. 902-A was then issued in 1976 (and amended in 1981). It vested SEC with jurisdiction over corporate rehabilitation petitions, and transferred to SEC’s jurisdiction petitions for suspension of payments, In August 2000, a code for regulating securities transaction transferred corporate rehabilitations and returned suspension of payments to the regular courts. Interim rules on corporate rehabilitation, which attempt to hew closely to international standards, have been issued by the Supreme Court to govern these debt relief proceedings. However, because of the absence of a comprehensive legislative framework, some gaps cannot and have not been addressed by the interim rules.”

“Tedious and protracted court proceedings have proved to be major deterrents to effective rehabilitation and insolvency proceedings. While certain branches of the regional trial court were designated as commercial courts to hear debt relief cases, their heavy caseloads from other types of cases, and the piece-meal trial system in the country make it difficult for the rehabilitation court to grant speedy remedies. This imperils the preservation of value, of both the enterprise and stakeholder claims. Commercial court judges likewise did not initially have the requisite expertise or “feel” for the complexities of the various hierarchical, proprietary and valuation claims of the various stakeholders.”

Indeed, this lack of expertise or “feel” resulted in several judges deciding or re-solving similar issues differently. As pointed out by Santo, P. (An Assessment of the Application of the Interim Rules of Procedure on Corporate Rehabilitation, Benchbook on Corporate Rehabilitation. Part 5 pp.135-137):

“It is interesting to note that different judges decide or resolve the same or similar issues differently. In SP No. 02-445 involving East Asia (AEA) Capital Corp. pending before the Makati RTC, Branch 138, Judge Sixto C. Marella, Jr. overruled the objection of the BSP that it has primary jurisdiction over the petitioner which is a financial institution and gave due course to the petition. On the other hand, Judge Estela P. Bernabe of the Makati RTC, Branch 142, dismissed the petition for failure of the petitioner to submit a request of the BSP for the appointment of a rehabilitation receiver. Judge Jose F. Caiobes, Jr. of the Las Piñas RTC, Branch 253, decreed as premature the report filed by the rehabilitation receiver before the petition was given due course. On the other hand, Judge Bernabe of the Makati RTC, Branch 142, directed the interim rehabilitation receiver to submit his recommendation on the issue of whether or not the petition shall be given due course. The different courts have different approaches on how to treat the insufficiencies in the form and substance of the petition. The commercial courts of Quezon City and Makati were liberal and gave the petitioners an opportunity to correct the defects. The Pasig City commercial courts, however, was strict and dismissed two petitions outright.”

The commercial courts also differ as to the amount of bond required to be posted by the rehabilitation receiver:

“The bond required was not uniform and ranged from a high of P5 Million Pesos, P2 Million Pesos, P1 Million Pesos to P500 Thousand Pesos and a low of P100 Thousand Pesos. In one case where an interim rehabilitation receiver was appointed for failure of the petitioner’s nominee to qualify, the filing of the bond was waived. In fixing the bond of the rehabilitation receiver, some judges gave paramount consideration to the expertise, track record and reputation of the rehabilitation receiver.”

IV. Conclusion

The Supreme Court, through the PHILJA has been continuously conducting lectures and seminars for commercial court judges, which the latter find very helpful. However, the Supreme Court can only do so much within its defined power and authority. There is need for a comprehensive legal framework that can be supplied only by legislation. The proposed corporate recovery bill initiated in the House of Representatives and the one introduced by Senator Osmeña in the Senate are steps in upgrading Philippine laws on insolvency to conform to international standards. The House bill centers on corporate rehabilitation and insolvency while the Senate bill proposes measures to prevent companies from becoming bankrupt. The results of the legislative debate and the consolidation of these points into a comprehensive law are much awaited not only by domestic players but by foreign investors as well.