FRIA Law (R.A. 10142)

HBN 7090 (Substitute bill Accepted by Senate)

FRIA Articles

PSE lauds new rules for financially distressed companies

THE PHILIPPINE STOCK EXCHANGE (PSE) welcomes the approval by the Supreme Court of the 2008 Rules of Procedure on Corporate Rehabilitation which replaces the Interim Rules of Procedure on Corporate Rehabilitation approved by the Supreme Court way back in 2000.

The new rules will take effect January 16, 2009. The new rules seek to improve and expedite the court procedures for petitions for rehabilitation or re-organizations of corporations, partnerships and associations in order to help debtors recover from financial difficulties while at the same time attempting to ensure fair treatment of creditors.

Mr. Francis Lim, PSE president and chief executive officer, expressed elation over this development. “The passage of the new rules is perfectly timed as some of our companies may encounter financial difficulties as a result of the ongoing global recession. It is therefore important that our bankruptcy system is ready to help our companies get back on their feet if they find themselves in such a situation,” Mr. Lim said.

“The new rules will be the counterpart of Chapter 11 proceedings in the United States pending passage by Congress of a more comprehensive bankruptcy law to replace our 1909 Insolvency Act,” Mr. Lim said further. Congress has been working on the Corporate Recovery and Insolvency Act or CRIA, which is one of the capital market-related laws being advocated by the PSE.

“One major change being introduced by the Supreme Court is a new rule governing pre-negotiated rehabilitation plans. Under the rule, if the plan is approved by creditors holding at least two-thirds of the total liabilities of the debtor, including secured creditors holding more than 50% of the total secured claims and unsecured creditors holding more than 50% of the unsecured claims, both parties can go to court for approval of the plan. The court is then given a maximum of 120 calendar days from the date of filing of the petition to make a decision on the petition. If the court fails to do so within the period, the rehabilitation plan shall be deemed approved,” Mr. Lim explained.

As far as ordinary petitions for rehabilitation are concerned, the new rules give the court a maximum period of one year to approve or disapprove the petition. The new deadline is intended to avoid delay in the disposition of rehabilitation cases, which has proven detrimental to the interest of both the debtor and its creditors.

Another major improvement is the recognition of foreign re-organization or rehabilitation proceedings which covers cases whereby assistance is sought in a Philippine court by a foreign court or representative, or assistance is sought in a foreign state in connection with a domestic proceeding, or a foreign proceeding and domestic proceedings are concurrently taking place.

“The new rule on foreign proceedings elevates our rehabilitation rules to global standards as it is almost a verbatim copy of the UNCITRAL model rules on recognition of foreign insolvency proceedings. This rule is intended to make our country attractive to foreign investors. A modern set of bankruptcy law is a big factor being considered by foreign investors when making investment decisions. This was amply demonstrated by our CaLPERS experience where the Philippines was almost delisted as an investment-grade country partly because of our archaic and outmoded bankruptcy law, which was enacted way back in 1909,” pointed out Mr. Lim.

“The new rule on foreign proceedings may play a critical role amidst the present financial meltdown in which we see foreign companies undergoing re-organization proceedings (like Chapter 11) in foreign countries. These companies may have assets in the Philippines. Conversely, there may be domestic companies undergoing rehabilitation proceedings in the Philippines with assets located abroad. The new rule, which is based on international best practices, is envisioned to cover such situations,” Mr. Lim noted further.

The rules were drafted by a committee of the Supreme Court with the assistance of private sector representatives which includes the Philippine Stock Exchange.  

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The Proposed Corporate Recovery & Insolvency Act

The strength of financial markets depends not only on the performance and soundness of financial institutions and that of the regulatory agencies, but also in having an effective rehabilitation and insolvency system which recognizes creditor rights and provides an orderly procedure in pursuing rehabilitation and liquidation of distressed enterprises. Aside from market discipline and governance, a market-based economy that thrives on commercial credits must ensure that contractual rights are enforceable and that the enforcement mechanism is clear to all. Further, without orderly procedures, the rights of debtors and their employees may not be adequately protected and different creditors may not be treated equitably. There must be a predictable and transparent manner by which both secured and unsecured creditors can enforce their claims. Uncertainty always exacts a price—by way of higher credit cost. Hence, it is crucial to define and set the rules for the resolution of corporate failures either through rehabilitation or liquidation. A quick resolution will also mitigate further asset deterioration and allow the assets tied up in the process to go back into the economic mainstream.

It is important for a developing economy such as the Philippines to ensure that there are appropriate rules and procedures governing commercial relationships. In the Philippines, capital is raised mostly through debt financing in contrast to equity financing. The proposed Corporate Recovery and Insolvency Act provides for an effective rehabilitation and insolvency system that will function as an important pillar of support for the domestic banking system by enabling banks to curtail the deterioration of the quality of their claims, whether through a court-approved restructuring or, where necessary, through an efficient liquidation. The procedures will also induce greater caution in the incurrence of liabilities by debtors and greater confidence in creditors when extending credit or rescheduling their claims, thereby encouraging a healthy credit culture and discipline.  

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History of Insolvency Procedures

The Report of the Committee on Banks, Financial Institutions & Currency provides the following historical summary of insolvency procedures in the country.

The country’s insolvency procedures were developed gradually in a span of almost a century through various legislations, presidential decrees, court-issued rules and decisions and administrative regulations. This piece-meal evolution led to the now fragmented and unclear insolvency proceedings, the substantive and procedural basis of which are scattered in different issuances.  

Insolvency Law

The Philippine insolvency law was enacted by the Philippine Legislature under the authority of the United States on May 20, 1909 as Act No. 1956. The Philippine Insolvency Law deals with three remedies: suspension of payments, voluntary insolvency, and involuntary insolvency.

The Insolvency Law is now antiquated. It does not provide for corporate rehabilitation and its provisions on stay order do not effectively cover actions on enforcement by creditors. As a consequence, it is seldom invoked and virtually fell into disuse.  

PD 902-A and its amendments

In 1976, Pres. Ferdinand Marcos issued PD 902-A which re-organized the SEC and placed the Agency under the administrative supervision of the Office of the President. Various amendments thereof expanded SEC’s jurisdiction which led to the expansion of remedies allowable to an ailing corporation, namely, (1) suspension of payments, (2) rehabilitation, and (3) dissolution.  

SEC Rules

With the existence of the Insolvency law, which is clearly obsolete, and PD 902-A, which is merely skeletal, the SEC promulgated rules to cover and govern petitions of suspension of payment and rehabilitation. On December 30, 1999, the SEC adopted formal rules of procedure on corporate recovery, which Rules took effect in January 15, 2000.  

Republic Act 8799 (the Securities Regulation Code)

In 2000, Republic Act 8799, otherwise known as the Securities Regulation Code (SRC), was enacted. Under this law, the quasi-judicial functions of the SEC over corporate recovery cases were transferred to the Regional Trial Courts (RTC). The enactment of the SRC gave rise to even more pressing need for a piece of legislation that will address the resolution of corporate recovery and insolvency cases now pending in the regular courts.  

Interim Rules of Procedure issued by the Supreme Court

In the interim period that the much-needed law is yet to be enacted, the Supreme Court took the initiative in issuing the Interim Rules of Procedure on Corporate Rehabilitation to address the need for a more structured set of rules. While the Interim Rules made significant changes to rehabilitation proceedings, the underlying substantive law, P.D. 902-A, provides limited remedies and may prove to be inadequate in dealing with the requirements of a modern and complex business environment.

At present, distressed corporations are limited to a court-supervised rehabilitation process, which could be too costly for companies with small capitalization. The Insolvency Law, on the other hand, does not provide for corporate rehabilitation and its provisions on stay order do not effectively cover actions on enforcement by creditors. There is therefore a pressing need for legislative reform in the areas of insolvency and rehabilitation.

The proposed Corporate Recovery and Insolvency Act was consolidated from Senate Bill Nos. 208 (by Senator Sergio Osmeña III) and 1847 (by Senator Edgardo J. Angara) which were filed during the Thirteenth Congress and referred to the Committee on Banks, Financial Institutions and Currencies.

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Salient Points of the Proposed Bill

The following provides the salient points embodied in the proposed bill.

An insolvent juridical debtor and its creditors must collectively resolve and adjust competing claims and property rights. Through theCorporate Recovery and Insolvency Act (CRIA), the State hopes that it will assist in ensuring a timely, fair, transparent, effective and efficient rehabilitation or liquidation of an insolvent juridical debtor.  

1. Nature of Proceedings

The proceedings under CRIA shall be in rem in nature and shall be conducted in a summary and non-adversarial matter.

2. Coverage

The CRIA does not include within its coverage banks, insurance companies, pre-need companies, cooperatives, and national and local government units. The CRIA is applicable to government financial institutions (other than banks) and government owned or controlled corporations, unless their charters provide otherwise.

3. Procedural Rules and Designated Courts

The Supreme Court is responsible for the formulation of the procedural rules to implement the CRIA. The Supreme Court is also vested with the power to designate courts to hear and determine cases brought under the CRIA.

4. Who is an Insolvent under CRIA?

A debtor is considered insolvent if it is generally unable to pay its liabilities as they fall due in the ordinary course of business or has liabilities that are greater than its assets.

5. Remedies under the CRIA

There are three remedies under the CRIA: court-supervised rehabilitation, pre-negotiated rehabilitation, and out-of-court or informal restructuring agreements or rehabilitation plans. A debtor may also choose to directly undergo, or convert any of the aforementioned relief into, liquidation.

6. Court Supervised Rehabilitation

Initiation of Proceedings

Court supervised rehabilitation (CSR) may be initiated by either the insolvent debtor or creditor/s.

An insolvent debtor may file a verified petition for CSR with the court. The petition shall establish the insolvency of the debtor and include the schedule of debts, inventory of assets, rehabilitation plan and names of the nominees for rehabilitation receiver.

A creditor or group of creditors with claims of at least P1.0 million or 25% of the subscribed capital stock or partners’ contributions of the debtor may file a verified petition for CSR. The petition shall include the rehabilitation plan and names of the nominees for rehabilitation receiver.  

Administration of the Proceedings

If the court finds the petition sufficient in form and substance, it will issue a commencement order within 5 working days from the filing of the petition. The issuance of the commencement order signals the start of the rehabilitation proceedings. The commencement order shall, among others (a) appoint a rehabilitation receiver, (b) prohibit the debtor’s suppliers from withholding supply of goods and services, (c) direct all creditors to file their claims, and (d) set the case for initial hearing.

The commencement order shall also include a suspension or stay ordersuspending all actions or proceedings for the enforcement of claims or judgments against the debtor and prohibiting debtor from selling, encumbering or disposing of any of its properties and from making any payment of its liabilities. The suspension order, however shall not apply to cases on appeal in the Supreme Court at the time of the issuance of the commencement order;the enforcement of claims against sureties and other persons solidarily liable with the debtor and third party mortgagors; and the sale by licensed brokers or dealers of pledged securities pursuant to a securities pledge or margin agreement.

The stay order shall be effective for a period of 3 months from the date of the filing of the petition, extendible for 3 months a time, with the total extension not to exceed 15 months.

Unless canceled by the court, all contracts of the debtor shall remain in force. The issuance of the commencement order or stay order shall not diminish or impair the security of the secured creditors, except that the stay order may suspend their rights to enforce their security. The court, however, may allow the secured creditor to enforce his security or foreclose on the property of the debtor constituting the security if said security or property is not necessary for rehabilitation.

The court may modify or terminate the stay order if it is proven that a creditor does not have adequate protection over the property constituting its security or that the value of the claim secured by the debtor’s property (which is not necessary for rehabilitation) exceeds the fair market value of the said property.

At the initial hearing, the court shall determine which creditors timely filed their claims and hear any objection to the appointed rehabilitation receiver or to the rehabilitation plan. A creditor who failed to file its claim shall not be entitled to participate in the rehabilitation proceedings, but shall be entitled to receive distributions therefrom.

After the initial hearing, the rehabilitation receiver shall submit to the court his report on whether or not to give due course to the petition. The rehabilitation receiver may likewise recommend the liquidation of the debtor.

The rehabilitation receiver shall establish a preliminary registry of claims. Interested parties may challenge or oppose any claim therein. The confirmation of the rehabilitation plan shall bind the debtor and persons who may be affected by it, including the creditors, whether or not such persons have participated in the proceedings or opposed the Rehabilitation Plan or whether or not their claims have been scheduled.  

The Rehabilitation Receiver

A rehabilitation receiver must be a resident citizen, knowledgeable of insolvency, possess good moral character and have no conflict of interest. His role is to preserve the value of the assets of the debtor and implement the rehabilitation plan. He may be removed for cause by the court, motu proprio or upon motion of creditors holding 50% of the total liabilities of the debtor.

Post-Commencement Date Actions

The court may, upon the recommendation of the rehabilitation receiver, authorize the sale of the debtor’s assets if the assets are perishable, susceptible to devaluation or are otherwise in jeopardy.

The court may rescind or declare null and void (a) any sale or disposal of debtor’s property which is not made in the ordinary course of business or (b) any transaction of the debtor occurring prior to the issuance of the commencement order which was executed with intent to defraud creditor/s or gives undue preference to any creditor.

Liability of Directors and Officers

Directors and officers of the debtor shall be liable up to double the value of the property sold, embezzled or otherwise disposed of if they knowingly dispose of debtor’s property other than in the ordinary course of business, approve fraudulent or grossly disadvantageous transactions, or conceal, embezzle or misappropriate debtor’s property.

Rehabilitation Plan

The CRIA provides for the minimum contents of a rehabilitation plan. As a rule, the rehabilitation plan is submitted upon filing of the petition for CSR. The rehabilitation receiver may propose changes thereto, considering the views and comments of the debtor and creditors. The rehabilitation plan is approved by a majority of each class of creditors, the majority being based on the value of claims held by the creditors in each class. If no such majority is obtained, the rehabilitation plan is considered rejected. The court, however, exercise its cram-down power and approve the rehabilitation plan over the objection of any class of creditors under the following circumstances: (a) the rehabilitation receiver recommended the confirmation of the rehabilitation plan; (b) the rehabilitation plan would give the objecting class of creditors greater compensation (computed at net present value) than at liquidation; or (c) the shareholders of debtor loses their controlling interest in the debtor as a result of the rehabilitation plan. A breach of the rehabilitation plan may result in the liquidation of the debtor.

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Pre-Negotiated Rehabilitation

An insolvent debtor may choose to initially negotiate a rehabilitation plan with its creditors out-of-court. If creditors holding two-thirds of the total liabilities of the debtor, including those holding 50% each of the secured and unsecured claims, approve or endorse the rehabilitation plan, the debtor may file a verified petition with the court for the approval of such pre-negotiated rehabilitation plan (PNR).

If the court determines that the petition is sufficient in form and substance, it shall issue an order allowing any creditor to oppose the petition and a suspension or stay order (similar to the one discussed under CSR). If there are no objections, the court will approve the rehabilitation plan. If there are objections, the court will hear them. The court has a maximum of 60 days from the time of the filing of petition to approve the rehabilitation plan. The rehabilitation plan shall be deemed approved if the court fails to act within the 60-day period.

The approval of the rehabilitation plan shall discharge the debtor from all obligations with respect to the claims and shall bind all creditors.

Out-of-court or Informal Restructuring Agreements or Rehabilitation Plans

The CRIA sets the minimum requirements for out-of-court or informal restructuring agreements or rehabilitation plans such as debtor’s consent thereto and approval of creditors holding 67% of the secured claims, 75% of the unsecured claims and 80% of the total obligations, secured or undecured. There shall be a standstill period pending the negotiation and finalization of the out-of-court or informal restructuring agreements or rehabilitation plans which shall not exceed 120 days. The standstill period shall be approved by creditors holding 75% of the total liabilities of the debtor.

The approval of the restructuring agreement or rehabilitation plan shall discharge the debtor from all obligations with respect to the claims and shall bind all creditors.

Liquidation in Insolvency

There are two kinds of liquidation proceedings – voluntary and involuntary. In voluntary liquidation, the insolvent debtor may directly file a verified petition for liquidation with the court attaching a schedule of its debts, inventory of assets and names of nominees for liquidator. The insolvent debtor may also convert proceedings for CSR or PNR into liquidation by filing a motion with the court. In involuntary liquidation, three or more creditors with claims of at least P1 million or holding 25% of the total paid-up capital or partners’ contributions of the debtor may directly file a verified petition for the liquidation of the debtor. Such creditors may also convert proceedings for CSR or PNR into liquidation by filing a motion with the court.

If the court finds the petition sufficient in form and substance, it shall issue a liquidation order declaring the debtor insolvent which shall have the following effects: the debtor shall be deemed dissolved, the legal title to the assets of the debtor shall be deemed vested in the liquidator, and all contracts of the debtor are deemed terminated. The liquidation order shall not affect the rights of the secured creditors to enforce his security, although he may waive his security.

The Liquidator is elected by creditors who filed their claims within the period set by the court. A secured creditor cannot vote unless he waives his security. The liquidator has the power to recover all the assets belonging to the debtor, take possession thereof, and sell the same. The liquidator also has the duty to prepare the registry of claims which, after entertaining any opposition or challenge, shall be submitted to the court for final approval.

The liquidator shall submit a liquidation plan which shall govern the manner of disposition of the assets of the debtor. In the disposition of the assets, the Civil Code provisions on concurrence and preference of credits shall be observed.

Cross-Border Insolvency

The occurrence of cross-border insolvency is anticipated by giving the Court the authority to hear petitions in connection with an insolvency or rehabilitation proceeding taking place in a foreign jurisdiction. In this connection, the Court may issue orders suspending any actions to enforce claims against the entity or otherwise seize or foreclose on property of the foreign entity located in the Philippines, requiring the surrender of property of the foreign entity to the foreign representative, or providing other necessary relief.

In drafting the proposedbill, international best practices or standards were taken into consideration although such approach was balanced with the need to consider the existing legal and regulatory framework.

Once an enterprise is no longer financially and operationally viable it must undergo liquidation in a quick and efficient manner. This will prevent further dissipation in the value of the assets and maximize their recovery for the creditors welfare. On the other hand, if there is likelihood that the enterprise can be rehabilitated and that its value is greater as a going concern rather than putting the assets into liquidation, the law must provide for the means to enable stakeholders to pursue such a process. Rehabilitation will allow the different parties to participate in the preparation of the rehabilitation plan; protect their rights; and enable a majority of the creditors in favor of the plan to bind other creditors.

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