The Philippines Establishes New Rehabilitation Rules Designates Insolvency Law Courts

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Apr 2001

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The Asian financial crisis spurred a host of efforts in various Southeast Asian
countries to re-engineer their bankruptcy law regimes. Thailand and Indonesia, for
instance, recently established specialized bankruptcy courts and updated their laws on
insolvency and rehabilitation.

However, as reported in this column in February 1999, the Philippines has
lagged behind its neighbors in reforming its bankruptcy laws. Observers have attributed
this to a combination of factors. Perhaps most importantly, the Philippines weathered
the early blows of the Asian crisis better than its neighbors. The Philippine banking
industry's level of non-performing loans has remained significantly below the levels in
Indonesia and Thailand.

Further, unlike its neighbors, the Philippines had an established bankruptcy court
operating under the Philippine Securities and Exchange Commission (SEC) and a legal
mechanism for resolving debt relief cases—the Insolvency Law (Republic Act No.
1956), enacted in 1909. The Insolvency Law set forth detailed procedural rules
for declaring individuals and companies in suspension of payments.<a href="#2" name="2a">2</a> It also allowed for
liquidations of companies under the guidance of an assignee following a voluntary or
involuntary declaration of insolvency.<a href="#3" name="3a">3</a>

But times have changed quickly. During the past year, new legislation intended to
improve the core regulatory functions of the SEC transferred the jurisdiction over
corporate debt relief cases from the Philippine SEC back to the trial courts. In
response, the Philippine Supreme Court designated specific courts to hear these cases
and established a set of procedures that are separate and apart from the suspension of
payment procedures found in the Insolvency Law.

These reforms are likely to be tested soon. Economic troubles connected to slowing
export markets, rising fiscal deficits and political uncertainty may prompt many
Philippine companies that weathered the Asian crisis to seek protection from creditors
under the new rules and the new forum in 2001.

This article will trace these developments and offer some opinions on the likely
direction of insolvency law reform in the Philippines over the upcoming months and
years.

<h3>The End of a 20-Year Experiment in Resolving Debt Relief Cases Under the SEC</h3>

Up through 1981, corporate debt relief cases in the Philippines were handled by
the trial courts. This changed with the issuance of Presidential Decree No.
902-A, as amended (PD 902-A). The decree vested in the SEC original
and exclusive jurisdiction to hear and decide on a petition of a corporation,
partnership or association that was seeking to be declared in a "state of suspension
of payments" where it had sufficient "property to cover all its debts, but foresees
the impossibility of meeting them when they fall due."<a href="#4" name="4a">4</a> PD 902-A also gave the
SEC jurisdiction over petitions for suspension of payments where a "corporation,
partnership or association has no sufficient assets to cover its liabilities, but is
under the Management Committee created pursuant to this decree."<a href="#5" name="5a">5</a> Apart from
debt-relief cases, the decree gave the SEC jurisdiction over cases involving
intra-corporate disputes.

In addition to transferring jurisdiction over these cases to the SEC, PD
902-A formally recognized the power of the SEC to appoint a rehabilitation
receiver or management committee "to restructure and rehabilitate" distressed companies "if
determined to be feasible by the Commission."<a href="#6" name="6a">6</a> For nearly the next 20 years, the
SEC accepted and heard evidence on approximately 100 debt-relief petitions, the
majority being filed in the past five years. The SEC's record for resolving petitions
for debt relief was mixed. A study sponsored by the Asian Development Bank noted
that only a small handful of companies have been successfully rehabilitated or
reorganized under the SEC.<a href="#7" name="7a">7</a>

Still, the specialization forum that the SEC offered, as well as its
less-formalized procedures, remained a somewhat appealing model. In a separate report,
the Asian Development Bank characterized the Philippine approach as a "model that
should not be dismissed or overlooked."<a href="#8" name="8a">8</a> Much hope was placed in a more detailed set
of procedural rules that the SEC adopted in December 1999, which provided for
greater participation by creditors regarding whether to approve a rehabilitation plan.<a href="#9" name="9a">9</a>
The SEC also reformed its internal procedures, clarifying the way its bankruptcy
hearing panels were formed and prohibiting ex parte contacts with SEC hearing
officers.<a href="#10" name="10a">10</a>

But while the SEC was attempting to reform its bankruptcy hearing unit, lawmakers
in the Philippine Congress were becoming increasingly concerned that the SEC's
bankruptcy functions were hampering its ability to regulate the securities markets
effectively. Thus, when the Philippine Congress passed comprehensive legislation
reforming securities market regulation in August 2000, it included a provision that
transferred the SEC's jurisdiction over debt-relief cases back to the regional trial
courts.<a href="#11" name="11a">11</a> Under the new Securities Regulation Code (Republic Act No. 8799),
corporate debt-relief cases filed after June 30, 2000, would be processed by
the regional trial courts.

<h3>Back to Bankruptcy for the Philippine Regional Trial Courts</h3>

The transfer of jurisdiction of debt relief cases from the SEC was a somewhat
sudden and unexpected development. The clause that transferred the jurisdiction was found
in neither the original House or Senate bills that formed the basis for the final
legislation. Although the Philippine Congress had been considering separate legislation
that called for a transfer of the jurisdiction back to the courts, most observers did
not expect that legislation to be passed before the end of 2001.

The Philippine Supreme Court, which oversees the administration of the regional trial
courts in the Philippines, had to react quickly to this development. To facilitate
training and specialization of judges to hear these cases, it designated courts in
Manila and several other larger Philippine cities as "special commercial courts"<a href="#12" name="12a">12</a> and
began efforts to provide these judges with a "crash course" in legal principles
regarding the laws of bankruptcy and corporations.<a href="#13" name="13a">13</a> It also created a committee of
jurists and practitioners to establish procedural rules pertaining to "suspension of
payments, rehabilitation, constitution of management committees, and dissolution and
liquidation of corporations."<a href="#14" name="14a">14</a>

The committee developed the "Interim Rules of Procedure on Corporate Rehabilitation"
by mid-November 2000. With slight modification, the Supreme Court voted en banc
to adopt them on Nov. 21. The rules came into legal effect on Dec. 15.

<h3>The Philippine Interim Rules of Procedure on Corporate Rehabilitation</h3>

Due to the abbreviated schedule under which the rules committee and the Supreme
Court labored, the Interim Rules of Procedure on Corporate Rehabilitation (Interim
Rules) are narrowly focused. They do not address issues regarding suspension of
payments procedures under the Insolvency Law, nor do they address how to treat
companies that are slated for liquidation. Rather, the Interim Rules provide a
framework for treating companies that request "rehabilitation." A summary of the major
aspects of the Interim Rules is provided below:

Availability: The proceedings established under the Interim Rules are available
to any corporation, partnership or association that "foresees the impossibility of meeting
its debts when they respectively fall due." They are also available to creditors of
such entities, where the creditor, either singularly or jointly with other creditors,
holds at least 25 percent of the debtor's liabilities.<a href="#15" name="15a">15</a> The Interim Rules
establish a checklist of required information and attachments to initiate the
proceedings.<a href="#16" name="16a">16</a> One of these documents is a rehabilitation plan that has been
formulated according to the minimal requirements of the Interim Rules.<a href="#17" name="17a">17</a>

Issuance of a Stay Order: The court is required to act on the petition no later
than five days from the date of its filing. If it finds the petition on its face
to be legally sufficient, the court issues a stay order that, among other things,
fixes a date for an initial hearing no later than 60 days from the date the
petition was filed. The petitioner is required to publish the order in a newspaper
of general circulation.

Scope of a Stay Order: The stay order suspends all legal actions against the
debtor, including foreclosure actions by secured creditors. This is a deviation from
the Philippine Insolvency Law, which exempted secured creditors and other preferred
creditors from the stay. Concurrently, the order initiating the case is required to
enjoin the debtor from disposing of assets outside the ordinary course of business and
making any payments on liabilities outstanding as of the date when the petition was
filed.<a href="#18" name="18a">18</a>

Appointment and Role of the Rehabilitation Receiver: The Interim Rules require the
court to appoint a rehabilitation receiver as part of its stay order. The receiver
is required to meet the standards of competence and expertise set forth in the Interim
Rules and should be free of any conflicts of interest.<a href="#19" name="19a">19</a> Considered to be an
officer of the court, the receiver is "tasked to study the best way to rehabilitate
the debtor and to ensure that the value of the debtor's property is reasonably
maintained pending the determination of whether or not the debtor should be
rehabilitated."<a href="#20" name="20a">20</a> But rather than replacing the management of the debtor, the
Interim Rules call on the receiver to oversee and monitor the debtor's operations.
To this end, the Interim Rules endow the receiver with unfettered access to the
debtor's "employees, premises, books, records and financial documents..."<a href="#21" name="21a">21</a>

Initial Hearing: The first opportunity for creditors and interested parties to
formally participate in the proceeding is at the initial hearing. The rules contemplate
the initial hearing as an opportunity for creditors and other interested parties to have
the petition dismissed for failure to comply with the rules. Such right is dependent
on the interested party filing a written opposition with the court no later than 10
days before the date of the initial hearing.<a href="#22" name="22a">22</a> If the petition survives the initial
hearing, the court is required to submit the petition and proposed rehabilitation plan
to the rehabilitation receiver.

Administrative Expenses and Post-Petition Financing: The Interim Rules specifically
require the debtor to make payments for administrative expenses,<a href="#23" name="23a">23</a> which are defined
as "expenses incurred in the ordinary course of business after the issuance of the stay
order, excluding interest payable to creditors."<a href="#24" name="24a">24</a> The Interim Rules, however, do
not provide for any super-priority for creditors offering post-petition financing.
Further, a prohibition against encumbering assets outside the ordinary course of business
in the Interim Rules would appear to preclude new financing secured by collateral of
the debtor.

Voidability of Fraudulent Transfers and Preferences: The Interim Rules specifically
allow the court to unwind transactions or preferences made by the debtor in violation
of the stay order.<a href="#25" name="25a">25</a> However, the rules are silent as to the right of the court
to unwind transactions or preferences made before the imposition of the stay.

Adequate Protection for Secured Creditors: The Interim Rules provide a secured
creditor with specific remedies should depreciation or neglect threaten the value of its
collateral. In such instances, the rehabilitation receiver is required to intervene in
order to protect the collateral—for instance, making insurance payments current or
providing for property's maintenance or safekeeping. Alternatively, the receiver may be
ordered to "make payments or otherwise provide additional or replacement security such
that the obligation is fully secured."<a href="#26" name="26a">26</a> If such arrangements are not feasible, the
court is required to lift the stay against the secured creditor.

Exception to Adequate Protection when it Jeopardizes a Rehabilitation: Although the
Interim Rules establish a coherent framework for providing secured creditors with adequate
protection, they nonetheless deny the remedies set forth in the Rules when "such
remedies would prevent the continuation of the debtor as a going concern or otherwise
prevent the approval and implementation of a rehabilitation plan."<a href="#27" name="27a">27</a> The Rules are
silent as to the alternative remedies that would be available to a secured creditor
under such circumstances.

Contents of the Rehabilitation Plan: The Interim Rules provide an outline of what
a plan should entail. The plan should provide "desired business targets...and the
duration and coverage of the rehabilitation." It should also disclose how the plan
will be implemented "giving due regard to the interests of secured creditors." For
purposes of assisting creditors in deciding to support the plan, the Interim Rules
require that the plan contain a liquidation analysis that would estimate the dividend
"creditors and shareholders would receive if the debtor's properties were liquidated" and
other "relevant information to enable a reasonable investor to make an informed decision"
on the plan's feasibility.<a href="#28" name="28a">28</a>

Creditor and Shareholder Participation in Plan Formulation: The Interim Rules allow
interested parties to provide input on the plan both through court filings and
discussions with the debtor and rehabilitation receiver. Interested parties may file
a comment or opposition with the court within 120 days from the date of the initial
hearing. Further, the Rules specifically contemplate the rehabilitation receiver meeting
with creditors to discuss the plan.

Submission of the Rehabilitation Plan for Court Approval: Upon expiration of the
comment period by the receiver and interested parties, the debtor has the choice of
moving for court approval of the plan or to submit a modified or substitute plan for
final approval. The deadline for submission of a substitute plan is one year from the
date of the initial hearing.<a href="#29" name="29a">29</a>

Creditor Objection and Possibility of Cram Down: If creditors holding a majority
of the total liabilities of the debtor oppose the plan, the Interim Rules implicitly
suggest that the court has the right and duty to disapprove the plan, lift the stay
order and dismiss the proceedings. Nonetheless, the Interim Rules allow the court to
approve the plan despite the objections of a majority of creditors if it deems that
the opposition is "manifestly unreasonable." For guidance in this determination, the
Interim Rules provide the courts with the following criteria. A plan may be crammed
down if:

<ol>
<li>it provides the creditors with compensation greater than they would have received
if the debtor were liquidated;

</li><li>the shareholders or owners of the debtor lose at least their controlling
interest as a result of the plan; and

</li><li>the rehabilitation receiver has recommended approval.

</li></ol>

The rules appear to require the court to make such a finding as part of any order
to approve the plan over the objections of the creditors.

Effect of Plan Approval: The Interim Rules resolve a contentious issue that has
plagued efforts to rehabilitate companies in the Philippines for the past several years:
the power of a court to unilaterally alter the contractual rights of the debtor with
its creditors. Under the Rules, the terms of an approved plan "shall be binding upon
the debtor and all persons who may be affected by it, including the creditors,
whether or not such persons have participated in the proceedings or opposed the plan,
or whether or not their claims have been scheduled."<a href="#30" name="30a">30</a> Further, these alterations
are irreversible, even if the plan fails: "Any compromises on amounts or rescheduling
of timing of payments by the debtor shall be binding on creditors regardless of whether
or not the plan is successfully implemented."<a href="#31" name="31a">31</a>

<h3>The Impact of the Interim Rules on Philippine Bankruptcy Practice</h3>

Although intended as a temporary measure, the Interim Rules will have a
long-lasting effect on the way Philippine companies are rehabilitated. The Rules lay
to rest the controversy over the application of the procedures under the Insolvency
Law to rehabilitation cases. Although the SEC had been reluctant to apply the
Insolvency Law to cases before it, this was a controversial policy that had yet to
be affirmed by the Supreme Court. This long-standing dispute was the key issue in
the §304 proceeding regarding Philippine Airlines (see The International Scene,
February 1999). With the Interim Rules, the Supreme Court has unequivocally
established that the Insolvency Law does not apply to petitions for rehabilitation.

With the establishment of an alternative set of rules for rehabilitation, few, if
any, companies are likely to file petitions for suspension of payments under the
Insolvency Law, as the latter provides procedures that are far less debtor-friendly.
For instance, the approval of a debt restructuring plan under the Insolvency Law
requires the approval of two thirds of the creditors holding three fifths of the debtor's
liabilities.<a href="#32" name="32a">32</a> Secured creditors that choose not to participate in the proceedings under
the Insolvency Law are free to enforce their claims against the debtor notwithstanding
the stay order.<a href="#33" name="33a">33</a> By contrast, under the Interim Rules, a stay order applies to
all creditors, and a plan may be approved so long as a majority of creditors do not
object to it.

The Interim Rules also establish that a duly approved rehabilitation plan may alter
the creditors' contractual rights against the debtor regardless of their consent to the
plan. Previously, provisions in the Philippine Civil Code on the sanctity of contract,
and the non-impairment clause in the Philippine Constitution, had given dissenting
creditors much fodder for arguing that their contractual rights against the debtor withstood
the approval of a rehabilitation plan. This in turn lead the SEC to use its power
to issue stay orders indefinitely—until the creditors voluntarily consented to the plan,
or payments were made in full, or until the debtor no longer had assets worth
pursuing.

The authority of a court under the Interim Rules to amend contracts thus resembles,
in effect, the discharge provisions in chapter 11 proceedings in the United States.
By permanently altering contracts in accordance with a plan, the Rules provide the
debtor with a genuine fresh start free from claims other than those defined in the
rehabilitation plan.

<h3>Future Directions for Philippine Bankruptcy Law</h3>

As their name suggests, the Interim Rules were written with the notion that they
would serve as a stopgap measure until new legislation takes the place of the
Insolvency Law. One such bill, the Corporate Recovery Act (House Bill No.
11867), was filed in Congress soon after the Securities Regulation Code
transferred jurisdiction over debt relief cases to the regional trial courts. The
Corporate Recovery Act, which establishes a comprehensive framework for rehabilitation
and, when applicable, liquidation of financially distressed corporations, is currently
under review by various public- and private-sector groups. Although the congressional
elections in the first half of 2001 make passage of the Corporate Recovery Act
extremely unlikely in the current session, the measure is likely to be taken up again
when Congress reconvenes in July.

In the meantime, the regional trial courts that have been slated to hear petitions
for corporate rehabilitation have a challenge before them in addressing the concerns of
critics of the decision to transfer these cases out of the SEC. Although not
perfect, the Interim Rules give the courts a chance to prove these critics wrong.

Author's Note: Copies of the documents referred to in this article may be
obtained from Daniel Fitzpatrick at fitzdj@aol.com.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Mr. Fitzpatrick served as the Resident Advisor on Insolvency Law at the Philippine Securities and Exchange Commission from March
1999 to December 2000 through a program funded by the U.S. Agency for International Development (USAID). Mr. Lim is a member
of the committee that drafted the Interim Rules of Procedure on Corporate Rehabilitation. The views expressed in this article should not be
attributed to USAID or Angara Abella Concepcion Regala and Cruz. <a href="#1a">Return to article</a>

<a name="2">2</a> Insolvency Law, Chapter II. <a href="#2a">Return to article</a>

<a name="3">3</a> Id., Chapters III and IV. <a href="#3a">Return to article</a>

<a name="4">4</a> PD 902-A, §5(d). <a href="#4a">Return to article</a>

<a name="5">5</a> Id. <a href="#5a">Return to article</a>

<a name="6">6</a> Id., §6(d). <a href="#6a">Return to article</a>

<a name="7">7</a> T. Regala, Report on the Philippines (Part 2), at 3. Another report, this time by the International Monetary Fund, cited
a case in which the claims of secured creditor had been stayed for more than 14 years "as a result of, among other things, a dispute
between the majority shareholder group and the minority group over whose rehabilitation plan should be approved." International Monetary Fund,
Managing Corporate Distress in the Philippines: Some Policy Recommendations (1998), at 20. <a href="#7a">Return to article</a>

<a name="8">8</a> Asian Development Bank, Insolvency and Law Reforms in the Asian and Pacific Region, in Law and Policy Reform at the Asian
Development Bank (2000 ed., Vol. 1) at 78. <a href="#8a">Return to article</a>

<a name="9">9</a> SEC Rules of Procedure on Corporate Recovery (December 1999). <a href="#9a">Return to article</a>

<a name="10">10</a> See SEC Revised Rules of Procedure (June 2000). <a href="#10a">Return to article</a>

<a name="11">11</a> The Securities Regulation Code (Republican Act No. 8799), §5.2 (2000). <a href="#11a">Return to article</a>

<a name="12">12</a> Resolution Designating Certain Branches of Regional Trial Courts to Try and Decide Cases Formerly Cognizable by the Securities
and Exchange Commission, Supreme Court Administrative Memorandum No. 00-11-03-SC (Nov. 21, 2000). <a href="#12a">Return to article</a>

<a name="13">13</a> "Supreme Court Prepares to Create New Special Court," Philippine Business World (Sept. 14, 2000). <a href="#13a">Return to article</a>

<a name="14">14</a> Resolution Regarding the Transfer of Cases from the Securities and Exchange Commission to the Regional Trial Courts, Supreme Court
Administrative Memorandum No. 00-8-10-SC (Sept. 12, 2000). <a href="#14a">Return to article</a>

<a name="15">15</a> Interim Rules, Rule IV, §1. Although not made explicit in the rules, a petitioning creditor would likely have to allege and
prove that the debtor was not able to meet its obligations as they came due in order to initiate a case. <a href="#15a">Return to article</a>

<a name="16">16</a> Id., Rule IV, §2. <a href="#16a">Return to article</a>

<a name="17">17</a> Id., Rule IV, §2(e). <a href="#17a">Return to article</a>

<a name="18">18</a> Id., Rule IV, §6. <a href="#18a">Return to article</a>

<a name="19">19</a> Id., Rule IV, §13. <a href="#19a">Return to article</a>

<a name="20">20</a> Id., Rule IV, §14. <a href="#20a">Return to article</a>

<a name="21">21</a> Id., Rule IV, §14(p). <a href="#21a">Return to article</a>

<a name="22">22</a> Id., Rule IV, §10. <a href="#22a">Return to article</a>

<a name="23">23</a> Id., Rule IV, §6. <a href="#23a">Return to article</a>

<a name="24">24</a> Id., Rule II, §1(a). <a href="#24a">Return to article</a>

<a name="25">25</a> Id., Rule IV, §8. <a href="#25a">Return to article</a>

<a name="26">26</a> Id., Rule IV, §12. <a href="#26a">Return to article</a>

<a name="27">27</a> Id. <a href="#27a">Return to article</a>