The View from Taft: Insolvency and corporate recovery

BUSINESSWORLD (PHILIPPINES)

August 31, 2000

LENGTH: 1961 words

HEADLINE: The View from Taft: Insolvency and corporate recovery

BODY:

The Asian financial crisis of 1997, while it wreaked havoc on many economies, also served as an initiative for the undertaking of many reforms not just in the financial markets, but in the rest of the capital markets, spawned as well, by the encouragement of the multilateral development agencies through exchange of information among their member economies. In January 1999, the Asian Development Bank organized the Symposium on Insolvency Reforms, at which several developing member economies, the Philippines among them, participated.

The Asian crisis highlighted the need to review, and the symposium focused on insolvency laws and practice, because in the wake of the debris of the financial difficulties, it was important to provide order and process, and help rehabilitate or wind up affected businesses.

The symposium took note of the fact that while the decades of prosperity and transformation in Asia, and their economies and legal systems had evolved, insolvency laws changed very little. Many of the member countries depended on ante-diluvian laws inherited from their colonial masters - as in the case of Indonesia whose insolvency legislation dated to the Dutch colonial period, and in the case of the Philippines, when the Philippine Commonwealth legislature passed an insolvency law in 1909, a cut and paste law from California's liquidation statute and Spanish legislation on suspension of payments.

In the Philippines, insolvency is governed basically by: (1) the New Civil Code of the Philippines (which provides rules and procedures on preference of payments of debts); (2) the Philippine Bankruptcy Law or Act No. 1956, also better known as the Insolvency Law of 1909 (which deals with guidelines on the suspension of payments and insolvency procedures, and which is basically designed to equitably distribute the bankrupt's property among creditors, and to discharge an honest debtor from his liabilities and to help him resume business); and by some other special laws including (3) Title XV of PD 612 or the Insurance Code's Insolvency Proceedings (which mandates the Office of the Insurance Commission to handle distressed insurance companies with regard to their reorganization/rehabilitation and liquidation); (4) Republic Act 7630 or the new Central Bank Act which created a central monetary authority called the Bangko Sentral ng Pilipinas and which vested its Monetary Board with the power to regulate and supervise financial institutions and designated the Philippine Deposit Insurance Company to act as receiver and regulator of troubled banks referred to it by the BSP); and (5) PD No. 902-A (which provides the Securities and Exchange Commission exclusive jurisdiction over corporate disputes and petitions for suspension of debt payments, and gives the SEC the lead role in rehabilitating ailing companies by expanding its adjudicatory powers, including appointing a rehabilitation receiver, by authority of which the SEC issued its Rules of Procedure on Corporate Recovery).

This rehabilitation or "rescue" process, while part of the insolvency law, may be described as generally conservative in nature, and thus needs to be replaced or supplemented by more contemporary and efficient processes, as has been unfortunately found out when companies started tumbling, domino-fashion in the wake of the financial turmoil.

The ADB symposium provided a number of suggestions to the member countries as they sought to find solutions to problems and issues that arise from the competitive and globalizing environment when a crisis of the proportions of 1997 occur.

Last June, R.A. 8799 or the Securities Regulation Code, updating and rationalizing the Revised Securities Act, was signed into law. Among its provisions was the transfer of SEC's quasi-judicial power over suspension of payments cases to the regional trial courts. These courts, lacking a set of procedural rules to govern these cases, may have no choice but to apply the antiquated procedures of the Insolvency Law. This would radically change the rules of the game for companies that need the relief offered by rehabilitation and suspension of payments. With the passage of the SRC, the new scenario no longer affords rehabilitation remedies. The SEC, under the old regime had tried to do this, but was hampered by the inadequate legislative base.

In short, the Philippines needs to modernize and clarify the rules for rehabilitation and insolvency. This need is being addressed by the proposed draft House Bill 11867, entitled Corporate Recovery Act, authored by Congressman Pacifico M. Fajardo. In the introduction to the bill, it says that the CRA represents a comprehensive approach to the complex problems faced by enterprises which can no longer pay their debts when they become due. It combines the creation of substantive rights with relatively detailed procedural guidelines that move cases through court-supervised proceedings quickly, and emphasizes the survival of the firm while keeping the rights of creditors paramount. The CRA clarifies the rights of debtors as well as of creditors to initiate formal debt relief proceedings.

In contrast to PD 902-A which allowed the SEC jurisdiction only when the distressed enterprise's assets exceeds its liabilities, thus leading to time-consuming litigation over whether the debtor is solvent or not, the CRA avoids this problem by allowing enterprises in the door regardless of their solvency or insolvency. Once a case begins, the CRA offers four different means of relief: (1) Pre-Negotiated Rehabilitation, (2) Fast Track Rehabilitation, (3) Court Supervised Rehabilitation, and (4) Dissolution-Liquidation.

Pre-Negotiated Rehabilitation allows a debtor that has worked out a rehabilitation plan with its creditors to go to court to get the plan officially approved (and solves the problem of so called "maverick creditors" by temporarily suspending their claims and of "free-riding creditors") whereby all creditors are equally bound by the plan. This method is open to any enterprise that can come up with a rehabilitation plan that is supported by the majority of its creditors. The experience of other countries and some limited Philippine experience indicates that it is the most efficient and likely to succeed route to rehabilitation, and is one of the mainstays of the proposed legislation.

Fast Track Rehabilitation stems from the assumption that the persons with the best incentives to fix an enterprise are owners with a long-term outlook, who will gain or lose depending on the outcome of the rehabilitation. This method creates a new, debt-free enterprise based on the assets of the debtor; transfers the shares of the new enterprise to the debtor in exchange for the debtor's assets; allows for the auctioning of the shares of the new enterprise with an eye to maximizing the sales revenues; gives shareholders and creditors of the debtor various preferred rights in bidding for the shares of the new enterprise if they so choose; and allocates the proceeds from the share sales to creditors and shareholders of the debtor according to preestablished priorities. Fast Track Rehabilitation keeps the enterprise together, albeit under a new corporate entity, while significantly reducing its debt in a very short period of time - everyone benefits, the enterprise, the priority creditors, and the workers. The CRA essentially makes Fast Track Rehabilitation mandatory if the enterprise has not already petitioned for Pre-Negotiated Rehabilitation.

Court-Supervised Rehabilitation differs from current practice by putting the onus on the shareholders (through the debtors' board of directors) rather than the conservator in drafting and selling a rehabilitation plan. Since the shareholders have the most to win or lose, depending on whether a plan is approved or not, they should be the first to take a crack at the plan. They can hire experts to help them formulate the plan, and the costs of hiring such experts are borne by them rather than by the creditors. This method differs from the current practice where an interim rehabilitation receiver negotiates and balances the competing demands of the creditors and shareholders - rather, the conservator conserves the assets (for the benefit of the creditors) and the shareholders and their rehabilitation advisers try to adjust creditor claims and save the enterprise.

Another change in the CRA is the elimination of the discretionary practice of the SEC to override an objection to the plan by the creditors. There is also a provision which confirms the right of the court to bind dissenting, minority creditors to the terms of a rehabilitation plan.

Some caution, however, is noted in this "forced novation," which has to be resolved by the Supreme Court, and so this method may be used in rather limited circumstances.

The fourth method is Dissolution-Liquidation, which is resorted to if all else fails. The proceedings here are rather straightforward and closely resemble the approach adopted by the SEC prior to the passage of the SRC. A revision however is that the CRA modifies the ranking and prioritization of creditors as currently found in the Civil Code, which have been found to undermine the priority of registered lien holders.

Under the CRA, there are fewer classes of creditor, who are ranked as follows: (1) administrative expenses, and creditors with registered liens on collateral; (2) wage arrears and corresponding withholding taxes; (3) claims of government for unpaid taxes that have not been secured by a registered tax lien; (4) general unsecured creditors; (5) claims that represent penalties, punitive damages, or other claims not based on compensation for financial loss; (6) claims that are subordinated by law or by agreement; and lastly, (7) claims of shareholders. This ranking would also determine payments under Fast Track Rehabilitation, and form the basis for establishing classes of creditors for Pre-Negotiated Rehabilitation and Court-Supervised Rehabilitation.

This proposed draft bill provides several options to a distressed enterprise. As the CRA's explanatory note further states, it gives the enterprise the chance to negotiate a rehabilitation plan agreed to by the majority of its creditors, which would be binding to all, even dissenting ones, once approved by the court. Otherwise, if this doesn't work, and an enterprise goes into formal rehabilitation proceedings, the CRA focuses on restructuring the claims against the enterprise, while getting it out of debt quickly.

The task of fixing the enterprise falls on the new owners. On the other hand, court-supervised rehabilitation is still provided for, although under limited circumstances, due to inherent delay, costs, and risks. Finally, traditional liquidation is possible, but only when the debtor voluntarily consents to it or when all else fails.

The CRA is seen to be evolutionary and innovative in terms of current practices, emphasizing workable solutions rather than court-led approaches. Most importantly, it emphasizes the preservation of the enterprise, while allowing its ownership to be restructured and its creditors to be treated fairly. The explanatory note concludes that the Corporate Recovery Act is "pro-worker, pro-market, and pro-creditor at the same time."

The Capital Market Development Council, the private/public sector policy-recommending body led by FINEX and the Department of Finance agreed, in its last Council meeting, to endorse the bill to the President as urgent.

The author is a faculty member of the De La Salle University Graduate School of Business, the Executive Director of the Capital Market Development Center, Inc., and a Director of FINEX.

LANGUAGE: English

LOAD-DATE: August 31, 2000