New FRIA Paper v1.6

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DIME & EVIOTA LAW FIRM

2010

Corporate Rescue and the

New Financial

Rehabilitation andInsolvency Act of 2010

[A DLDTE LAW CLIENT PAPER]Ronald B. Dime

2 / F M I D W A Y C O U R T B L D G . , 2 4 1 E D S A M A N D . C I T Y , P H I L S .


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Corporate Rescue and the New Financial Rehabilitation and InsolvencyAct of 2010

2010

I. INTRODUCTION: A BRIEF HISTORY

For a long time, a distressed corporation in the Philippines had no other

real recourse than to commit legal seppuku, whether or not its financial

condition was due to the fundamental unsoundness of its business or merely atemporary run in with bad luck.

This lack of any real corporate rescue vehicle characterized the legal

environment that prevailed under the regime of Act No. 1956 (otherwise known

as the Insolvency Law) from the time of its enactment on 20 May 1909 until the

early 1980s1.

Act 1956 by itself introduced major changes to corporate law and removed

the distinction in the Spanish system between insolvency

and bankruptcy. Nonetheless, the Insolvency Laws approach to corporate

rescue was simply to provide a solvent but illiquid debtor temporary relief from

payment of its debts while an insolvent corporation was forced to undertake a

gradual and organized liquidation process2.

1 The Insolvency Law of the Philippines is in fact a derivative of even

older laws from other jurisdictions, such as the California Insolvency

Law of 1895 and the American bankruptcy Act of 1867 [See Sun Life

Assurance Co. of Canada v. Frank B Ingersoll, et. al.; GR No. 164758

(November 1921)]

2The three main remedies under Act 1956 are:

a) Petitions for the suspension of payments by an individual, sociedad

or corporation under Section 2 of the Insolvency Law:

Section 2. The debtor who, possessing sufficient property

to cover all his debts, be it an individual person, be it a

sociedad or corporation, foresees the impossibility of

meeting them when they respectively fall due, may petition

that he be declared in the state of suspension of paymentsby the court, or the judge thereof in vacation, of the

province or of the city in which he has resided for six

months next preceding the filing of his petition.

b) Petitions for Voluntary dissolution under Section 14:

Section 14. An insolvent debtor, owing debts exceeding in

amount the sum of one thousand pesos, may apply to be

discharged from his debts and liabilities by petition to

the Court of First Instance of the province or city in


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In 1981, then President Marcos issued Presidential Decree (P.D.) No. 1758

which amended P.D. No. 902-A. For the first time, the concept of corporate

rehabilitation was introduced. This is contained in an addendum to the powers

formerly granted to the Securities and Exchange Commission (SEC)3 under

Section 5 of PD No. 902-A, to wit:

Section 5. In addition to the regulatory and adjudicativefunctions of the Securities and Exchange commission overcorporations, partnerships and other forms of associationregistered with it expressly granted under existing laws anddecrees, it shall have original and exclusive jurisdiction tohear and decide cases involving:

x x x

d) Petitions of corporations, partnerships or

associations to be declared in the state of suspension ofpayments in cases where the corporation, partnership orassociation possesses sufficient property to cover all itsdebts but foresees the impossibility of meeting them whenthey respectively fall due or in cases where the corporation,

which he has resided for six months next preceding the

filing of such petition. In his petition he shall set forth

his place of residence, the period of his residence therein

immediately prior to filing said petition, his inability to

pay all his debts in full, his willingness to surrender all

his property, estate, and effects not exempt from executionfor the benefit of his creditors, and an application to be

adjudged an insolvent. He shall annex to his petition a

schedule and inventory in the form hereinafter provided.

the filing of such petition shall be an act of insolvency.

c) Petitions for Involuntary Insolvency:

Section 20. An adjudication of insolvency may be made on

the petition of three or more creditors, residents of the

Philippine islands, whose credits or demands accrued in the

Philippine Islands, and the amount of which credits or

demands are in the aggregate of not less than one thousand

pesos; Provided, that none of said creditors has become a

creditor by assignment, however made, within thirty days

prior to the filing of said petition. Such petition must be

filed in the Court of first Instance of the province or

city in which the debtor resides or has his principal place

of business, and must be verified by at least three of the

petitioner. the following shall be considered acts of

insolvency, and the petition shall set forth one or more of

such acts: xxx

3 Jurisdiction has since been transferred to the Regional Trial Court.


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partnership or association has no sufficient assets to coverits liabilities, but is under the management of a

Rehabilitation Receiver or Management Committee createdpursuant to this Decree.

[as amended by P.D. 1758]

One of the innovations created by PD 1758 is that while an insolvent

corporation (i.e. one that does not have sufficient assets to cover its debts) was

limited to a Petition for Insolvency resulting in liquidation of assets under Act

1956; a corporation, which is technically insolvent, was given the authority to

prove that it can be rehabilitated with court supervision. As explained by the

Supreme Court:

Section 5, par. (d) should be construed as vestingupon the SEC original and exclusive jurisdiction only overpetitions to be declared in a state of suspension of payments,

which may either be: (a) a simple petition for suspension forpayments based on the provisions of the Insolvency Law, or(b) a similar petition accompanied by a prayer for thecreation/ appointment of a management committee and/ orrehabilitation receiver based on the provision of P.D. No.902-A. Said provision cannot be stretched to includepetitions for insolvency. The reason is that under saidSection 5, par. (d) above-quoted, the jurisdiction of the SECover cases where the corporation, partnership or associationhas no sufficient assets to cover its liabilities, and thereforeinsolvent, is qualified by the conjunctive phrase "but is underthe management of a Rehabilitation Receiver orManagement Committee created pursuant to this Decree."This qualification effectively circumscribes the jurisdiction ofthe SEC over insolvent corporations, partnerships andassociations and consequently, over proceedings or thedeclaration of insolvency. It demonstrates beyond doubt that

jurisdiction over insolvency proceedings pertains neither inthe first instance nor exclusively to the SEC, but only in

continuation of or as incident to the exercise of itsjurisdiction over petitions to be declared in a state ofsuspension of payments wherein the petitioning corporation,partnership or association had previously been placed undera rehabilitation receiver or management committee by theSEC itself.

Viewed differently, where the petition filed is one for


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declaration of a state of suspension of payments due to arecognition of the inability to pay one's debts and liabilities,and where the petitioning corporation either : (a) hassufficient property to cover all its debts but foresees theimpossibility of meeting them as they fall due (solvent but

illiquid) or (b) has no sufficient property (insolvent) but isunder the management of a rehabilitation receiver or amanagement committee, the applicable law is P.D. No. 902-

A pursuant to Sec. 5, par. (d) thereof. However, if thepetitioning corporation has no sufficient assets to cover itsliabilities and is not under a rehabilitation receiver or amanagement committee created under P.D. 902-A, and doesnot seek merely to have the payments of its debts suspended,

but seeks a declaration of insolvency, as in this case, theapplicable law is Act 1956 on voluntary insolvency,specifically section 14 therefor, which states:

x x x[Land Bank of the Philippines vs. Capistrano, et al.

G.R. No 73123, 2 September 1991]

It may be convenient to mention at this juncture that by the Law on

corporate rehabilitation, is meant that body of rules that govern: (i) formal and

substantive requirements of rehabilitation, (ii) effects of rehabilitation, (iii)

procedural rules as well as (iv) liquidation and disposition of assets. For the most

part, this body of rules was developed over time by the courts4. Thus, aside from

jurisprudence, the chief tomes of rehabilitation practice are Administrative

Matter (A.M.) No. 00-8-10-SC, otherwise known as the Rules of Procedure on

Corporate Rehabilitation5 of 2008 (hereinafter, the 2008 Rules) which took

the place of the 2000 Interim Rules on Corporate Rehabilitation (hereinafter,

the Interim Rules) as well as some related provisions of A.M. No. 01-2-04 SC or

the Interim Rules of Procedure for Intra-Corporate Controversies (circa

2001).

4 Thus, in a sense, mimicking Common Law.

5 Which amended the 2000 Interim Rules on Corporate Rehabilitation.


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While the current corporate rehabilitation rules are a marked

improvement over the antiquated Insolvency Law, certain gaps in the law have

prevented it from being a definitive corporate rescue vehicle.

II. THE FRIA

The Lower House approved House Bill (HB) 7090, its version of the

Financial Rehabilitation and Insolvency Act of 2010 (the FRIA), on 02

February 2010 or just before the end of its 14th Session6.

Off the bat, it would be accurate to conclude that the FRIA7 is not a simple

codification of the existing rules on corporate rehabilitation but a veritable

system overhaul. Broadly speaking, the FRIA integrates rehabilitation and

restructuring along with insolvency law. Furthermore, it moves from the debtor

controlled process of the older system to a framework where the creditors take

the fore in determining the future of the distressed corporation.

What follows below are some of the key features of the new FRIA

pertaining to rehabilitation of corporate debtors.

Meaning of insolvent

The old Insolvency Law of 1909 made a distinction between a debtor who

was insolvent and one which was solvent but illiquid. Given that prior to the

passage of the Securities Regulation Code (Republic Act 8799) the jurisdiction

over Petitions to Declare Suspension of Payments and/or for the appointment of

a Rehabilitation Receiver was given to the Securities and Exchange Commission

6 As of this writing, HB 7090 is to be consolidated with its counterpart

Senate Bill (SB) 61 and thereafter transmitted to the President for

approval.

7 The author uses FRIA and HB 2070 interchangeably as a practical

convention.


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(SEC) while Petitions for Insolvency had to be heard by the Regional Trial Court

(RTC), some confusion resulted which eventually required some clarification by

the Supreme Court8.

On the other hand, both the 2000 Interim Rules on Corporate

Rehabilitation as well as the 2008 Rules on Corporate Rehabilitation made

rehabilitation available to any debtor who foresees the impossibility of meeting

its debts when they respectively fall due.

The FRIA avoids the trap entirely by providing for a broad definition of the

term insolvent, as follows:

Section 4. Definition of Terms. As used in this Act,the term:

xxx

(p)Insolventshall refer to the financial condition of adebtor that is generally unable to pay its or his liabilities asthey fall due in the ordinary course of business or hasliabilities that are greater than its or his assets.

xxx

Three ways to rescue a corporation; Out-of-CourtRehabilitation

While the old rehabilitation regime did not expressly provide for

8 For instance, see Rubberworld v. NLRC, GR No. 126773.

See also: Union Bank v. Concepion, GR No. 160272 where the Supreme

Court declared that the SEC retained jurisdiction over a Petition for

the declaration of suspension of payments and rehabilitation even if

the debtor became insolvent during the course of the proceedings.

Finally, see Philippine National Bank v. CA [GR No. 165571, 20 January

2009] where one of the issues raised was whether or not a technically

insolvent corporation (i.e. one which foresees its inability to pay

its obligations for more than one year) can file a Petition for

Rehabilitation with the SEC despite not having filed a prior petition

for Suspension of Payments. The Supreme Court ruled that the SEC Rules

on Corporate Recovery allowed rehabilitation without [r]equiring a

previous filing of a petition for suspension of payments.


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rehabilitation without court intervention, it did not specifically disallow it either.

Thus, a rehabilitation plan entered into by the debtor and its creditors partakes of

the nature of a contract and should not be invalidated simply on the ground that

it was done without court approval. Following the general rule however, non-

parties cannot be bound by the terms of the negotiated rehabilitation plan.

The FRIA takes it a step further by expressly providing rules to govern

extrajudicial rehabilitation. More specifically, there are three (3) processes to

resuscitate a financially distressed corporation under the FRIA, namely: (i) court

supervised rehabilitation, (ii) pre-negotiated rehabilitation and/or (iii) out-of-

court restructuring agreements. The choice largely depends on whether or not

the initiating party can accumulate the necessary number of votes, to wit:

VoluntaryRehabilitation

(Debtor InitiatedCourt

Supervised)

Involuntary.Rehabilitation

(CreditorInitiated Court

Supervised)

Pre-NegotiatedRehabilitation

InformalRehabilitation

Provision Section 12 Section 13 Section 76 Section 83

Petitioner Debtor Creditors Debtor who may bejoined by any of its

creditors

None

GeneralConditions

- in case of acorporation, by a

majority vote of theboard of directors or

trustees andauthorized by a voteof the stockholders

representing at leasttwo-thirds (2/3) ofthe outstanding

capital stock, or incase of a non-stockcorporation, by the

vote of at least two-thirds (2/3) of the

members- in case of a

- creditors musthave an

aggregate claimof

PhP1,000,000.00 or at least25 % of the

subscribedcapital stock orpartner's

contributions,whichever is

higherprovided that:

(a) there is nogenuine issue of fact

- Pre-negotiatedRehabilitation Plan

which has beenendorsed orapproved by

creditors holding atleast two-thirds

(2/3) of the totalliabilities of thedebtor, includingsecured creditors

holding more thanfifty percent (50%)of the total securedclaims of the debtor

and unsecuredcreditors holding

- debtor must agreeto the out-of-court

or informalrestructuring/

workout agreementor Rehabilitation

Plan

- it must beapproved bycreditors

representing at leastsixty-seven percent

(67%) of the securedobligations of the

debtor- it must beapproved by


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partnership, theapproval of a

majority of thepartners

or law on theclaim/s and due and

demandablepayments have notbeen made for at

least 60 days or

debtor has generallydefaulted onobligations as they

fall due; or

(b) a creditor, otherthan petitioner/s,

has initiatedforeclosure

proceedings againstthe debtor that willprevent the debtor

from paying itsdebts as they fall

due.

more than fiftypercent (50%) of the

total unsecuredclaims of the debtor

creditorsrepresenting at leastseventy-five percent

(75%) of theunsecured

obligations of the

debtor- it must beapproved by

creditors holding atleast eighty-five

percent (85%) of thetotal liabilities,

secured andunsecured, of the

debtor.

Other than some salient points that will be touched on later, the rules on

voluntary and involuntary court supervised rehabilitation proceedings, as well as

pre-negotiated rehabilitation, remain essentially the same. Nonetheless, one of

the most significant developments under the new law is the recognition ofout-of-

court restructuring agreements and the establishment of the legal vehicle to

encourage informal rehabilitation of the debtor.

Procedure for Court Supervised Rehabilitation

A. Filing of Petition and Issuance of Commencement Order

In court supervised rehabilitation proceedings, the rehabilitation of the

debtor officially commences after the court makes the finding that the Petition

(whether voluntary or involuntary) is sufficient in form or substance. More

specifically, the rehabilitation proceedings are deemed to commence on the date

of the issuance of the Commencement Order, pursuant to Sections 15 and 16 of

the law, to wit:


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Section 15. Action on the Petition. If the Courtfinds the petition for rehabilitation to be sufficient in formand substance, it shall, within five (5) working days from thefiling of the petition, issue a Commencement Order. If within

the same period, the court finds the petition deficient in formand substance, the court may, in its discretion, give thepetitioner/s a reasonable time within which to amend orsupplement the petition, or to submit such documents asmay be necessary or proper to put the petition in properorder. In such case, the five (5) working days provided abovefor the issuance of the Commencement Order shall bereckoned from the date of the filing of the amended orsupplemental petition or the submission of such documents.

Section 16. Commencement of Proceedings andIssuance of a Commencement Order. The rehabilitationproceedings shall commence upon the issuance of theCommencement Order, which shall:

xxx

Under the same Section 16, the Commencement Order shall, among

others: (i) declare that the debtor is under rehabilitation9, (ii) direct publication

of the Order and notice to creditors10, (iii) appoint a rehabilitation receiver11, (iv)

set the date of the initial hearing for the determination of whether or not the

debtor can be rehabilitated12, (v) direct all creditors to file their claims at least

five (5) days from initial hearing13 and (vi) direct the government, through the

Bureau of Internal Revenue (BIR) to either file its Comment to the Petition for

Rehabilitation or present its claims against the debtor.

Suspension or Stay Order

9 Subparagraph (e)

10 Subparagraphs (f) and (g)

11 Subparagraph (h)

12 Subparagraph (m)

13 Subparagraph (i)


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In addition, the Commencement Order shall include a Suspension or Stay

Order prohibiting the sale or disposition of assets of the debtor and ordering the

suspension of all actions against the debtor and/or the debtors estate. The

scope and/or coverage of the stay order under the FRIA remain as broad as

before. However, certain cases are allowed to proceed until the execution stage14.

These and other exceptions are enumerated in Section 18 of the law, to wit:

Section 18. Exceptions to the Stay or SuspensionOrder. The Stay or Suspension Order shall not apply:

(a) to cases already pending appeal in the SupremeCourt as of commencement date: Provided, That any final

and executory judgment arising from such appeal shall bereferred to the court for appropriate action;

(b) subject to the discretion of the court, to casespending or filed at a specialized court or quasi-judicialagency which, upon determination by the court, is capable ofresolving the claim more quickly, fairly and efficiently thanthe court: Provided, That any final and executory judgmentof such court or agency shall be referred to the court andshall be treated as a non-disputed claim;

(c) to the enforcement of claims against sureties andother persons solidarily liable with the debtor, and thirdparty or accommodation mortgagors as well as issuers ofletters of credit, unless the property subject of the third partyor accommodation mortgage is necessary for therehabilitation of the debtor as determined by the court uponrecommendation by the rehabilitation receiver;

(d) to any form of action of customers or clients of asecurities market participant to recover or otherwise claimmoneys or securities entrusted to the latter in the ordinarycourse of the latters business as well as any action of suchsecurities market participant or the appropriate regulatory

agency or self-regulating organization to pay of settle suchclaims or liabilities;

(e) to the actions of a licensed broker or dealer to sellpledged securities of a debtor pursuant to a securities pledge

14 In Philippine Airlines v. Court of Appeals [GR No. 150592, 20 January

2009], it was held that the stay order suspends the proceedings and not

just the enforcement of the claim. However, the 2008 Rules allow the

commencement of actions to prevent prescription of actions.


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or margin agreement for the settlement of securitiestransactions in accordance with the provisions of theSecurities Regulation Code and its implementing rules andregulations;

(f) the clearing and settlement of financial

transactions through the facilities of a clearing agency orsimilar entities duly authorized, registered and/orrecognized by the appropriate regulatory agency like theBangko Sentral ng Pilipinas (BSP) and the SEC as well as anyform of actions of such agencies or entities to reimbursethemselves for any transactions settled for the debtor; and

(g) Any criminal action against the individual debtoror owner, partner, director or officer of a debtor shall not beaffected by any proceeding commenced under this Act.

Note that pursuant to sub-paragraph (c) above, the suspension order does

not cover the enforcement of claims against persons solidarily liable with the

debtor including issuers of letters of credit. This follows the rule in MWSS vs.

Daway [GR No. 160732, 21 June 2004] which held that a letter of credit is

excluded from the jurisdiction of the rehabilitation court, thus:

Secondly, Sec. 6 (b) of Rule 4 of the Interim Rules

does not enjoin the enforcement of all claims againstguarantors and sureties, but only those claims againstguarantors and sureties who are not solidarily liable

with the debtor. Respondent Maynilads claim that thebanks are not solidarily liable with the debtor does not findsupport in jurisprudence.

We held inFeati Bank & Trust Company v. Court ofAppeals that the concept of guarantee vis--vis the conceptof an irrevocable letter of credit are inconsistent with eachother. The guarantee theory destroys the independence of

the banks responsibility from the contract upon which it wasopened and the nature of both contracts is mutually inconflict with each other. In contracts of guarantee, theguarantors obligation is merely collateral and it arises onlyupon the default of the person primarily liable. On the otherhand, in an irrevocable letter of credit, the bank undertakes aprimary obligation. We have also defined a letter of credit asan engagement by a bank or other person made at the


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request of a customer that the issuer shall honor drafts orother demands of payment upon compliance with theconditions specified in the credit.

Letters of credit were developed for the purpose of

insuring to a seller payment of a definite amount upon thepresentation of documents and is thus a commitment by theissuer that the party in whose favor it is issued and who cancollect upon it will have his credit against the applicant of theletter, duly paid in the amount specified in the letter. Theyare in effect absolute undertakings to pay the moneyadvanced or the amount for which credit is given on the faithof the instrument. They are primary obligations and notaccessory contracts and while they are securityarrangements, they are not converted thereby into contractsof guaranty. What distinguishes letters of credit from otheraccessory contracts, is the engagement of the issuing bank topay the seller once the draft and other required shippingdocuments are presented to it. They are definiteundertakings to pay at sight once the documents stipulatedtherein are presented.

Letters of Credits have long been and are stillgoverned by the provisions of the Uniform Customs andPractice for Documentary Credits of the InternationalChamber of Commerce. In the 1993 Revision it provides in

Art. 2 that the expressions Documentary Credit(s) andStandby Letter(s) of Credit mean any arrangement, however

made or described, whereby a bank acting at the request andon instructions of a customer or on its own behalf is to makepayment against stipulated document(s) and Art. 9 thereofdefines the liability of the issuing banks on an irrevocableletter of credit as a definite undertaking of the issuing bank,provided that the stipulated documents are presented to thenominated bank or the issuing bank and the terms andconditions of the Credit are complied with, to pay at sight ifthe Credit provides for sight payment.

We have accepted, in Feati Bank and Trust

Company v. Court of Appeals and Bank of America NT & SAv. Court of Appeals, to the extent that they are pertinent, theapplication in our jurisdiction of the international creditregulatory set of rules known as the Uniform Customs andPractice for Documentary Credits (U.C.P) issued by theInternational Chamber of Commerce, which we said inBankof the Philippine Islands v. Nery was justified under Art. 2 ofthe Code of Commerce, which states:


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`Acts of commerce, whether those who execute thembe merchants or not, and whether specified in thisCode or not should be governed by the provisionscontained in it; in their absence, by the usages ofcommerce generally observed in each place; and in

the absence of both rules, by those of the civil law.

The prohibition under Sec 6 (b) of Rule 4 of theInterim Rules does not apply to herein petitioner as theprohibition is on the enforcement of claims againstguarantors or sureties of the debtors whose obligations arenot solidary with the debtor. The participating banksobligation are solidary with respondent Maynilad in that it isa primary, direct, definite and an absolute undertaking topay and is not conditioned on the prior exhaustion of thedebtors assets. These are the same characteristics of a suretyor solidary obligor.

Being solidary, the claims against them can bepursued separately from and independently of therehabilitation case, as held in Traders Royal Bank v. Courtof Appeals and reiterated inPhilippine Blooming Mills, Inc.v. Court of Appeals, where we said that property of thesurety cannot be taken into custody by the rehabilitationreceiver (SEC) and said surety can be sued separately toenforce his liability as surety for the debts or obligations ofthe debtor. The debts or obligations for which a surety may

be liable include future debts, an amount which may not be

known at the time the surety is given.

The terms of the Irrevocable Standby Letter of Creditdo not show that the obligations of the banks are not solidary

with those of respondent Maynilad. On the contrary, it isissued at the request of and for the account of Maynilad

Water Services, Inc., in favor of the MetropolitanWaterworks and Sewerage System, as a bond for the full andprompt performance of the obligations by the concessionaireunder the Concession Agreement and herein petitioner isauthorized by the banks to draw on it by the simple act of

delivering to the agent a written certification substantially inthe form Annex B of the Letter of Credit. It providesfurther in Sec. 6, that for as long as the Standby Letter ofCredit is valid and subsisting, the Banks shall honor any

written Certification made by MWSS in accordance with Sec.2, of the Standby Letter of Credit regardless of the date on

which the event giving rise to such Written Certificationarose.


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Taking into consideration our own rulings on thenature of letters of credit and the customs and usagedeveloped over the years in the banking and commercialpractice of letters of credit, we hold that except when a letterof credit specifically stipulates otherwise, the obligation of

the banks issuing letters of credit are solidary with that of theperson or entity requesting for its issuance, the same being adirect, primary, absolute and definite undertaking to pay the

beneficiary upon the presentation of the set of documentsrequired therein.

The public respondent, therefore, exceeded hisjurisdiction, in holding that he was competent to act on theobligation of the banks under the Letter of Credit under theargument that this was not a solidary obligation with that ofthe debtor. Being a solidary obligation, the letter of credit isexcluded from the jurisdiction of the rehabilitation court andtherefore in enjoining petitioner from proceeding against theStandby Letters of Credit to which it had a clear right underthe law and the terms of said Standby Letter of Credit, publicrespondent acted in excess of his jurisdiction.

On the other hand, the Stay or Suspension Order applies with equal force

to the enforcement of both secured and unsecured claims except that under

Section 60 of the FRIA, the issuance of the Stay or Suspension Order shall not

be deemed in any way to diminish or impair the security or lien of a secured

creditor, or the value of his lien or security, except that his right to enforce said

security or lien may be suspended during the term of the Stay Order. Again,

this paraphrases the equality in equity principle the effects of which were

explained in the case of Tsuneishi Heavy Industries (Cebu), Inc. v. Negros

Navigation Co., Inc. et. al. [GR 166845, 10 December 2008], thus:

PD 902-A mandates that upon appointment of amanagement committee, rehabilitation receiver, board or

body, all actions for claims against corporations,partnerships or associations under management orreceivership pending before any court, tribunal, board or

body shall be suspended. PD 902-A does not make anydistinction as to what claims are covered by the suspensionof actions for claims against corporations under


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rehabilitation. No exception is made therein in favor ofmaritime claims. Thus, since the law does not make anyexemptions or distinctions, neither should we. Ubi lex nondistinguit nec nos distinguere debemos.

The justification for the suspension of actions orclaims, without distinction, pending rehabilitationproceedings is to enable the management committee orrehabilitation receiver to effectively exercise its/his powersfree from any judicial or extra-judicial interference thatmight unduly hinder or prevent the "rescue" of the debtorcompany. To allow such other actions to continue would onlyadd to the burden of the management committee orrehabilitation receiver, whose time, effort and resources

would be wasted in defending claims against the corporationinstead of being directed toward its restructuring andrehabilitation.

It is undisputed that THI holds a preferred maritimelien over NNCs assets by virtue of THIs unpaid services.The issuance of the stay order by the rehabilitation courtdoes not impair or in any way diminish THIs preferredstatus as a creditor of NNC. The enforcement of its claimthrough court action was merely suspended to give way tothe speedy and effective rehabilitation of the distressedshipping company. Upon termination of the rehabilitationproceedings or in the event of the bankruptcy andconsequent dissolution of the company, THI can still enforce

its preferred claim upon NNC.

PD 902-A was designed not only to salvage an ailingcorporation but also to protect the interest of investors,creditors and the general public. Section 6 (d) of PD 902-Aprovides: "the management committee or rehabilitationreceiver, board or body shall have the power to take custodyof, and control over, all the existing assets and property ofsuch entities under management; to evaluate the existingassets and liabilities, earnings and operations of suchcorporations, partnerships or other associations; to

determine the best way to salvage and protect the interest ofthe investors and creditors; to study, review and evaluate thefeasibility of continuing operations and restructure andrehabilitate such entities if determined to be feasible by the[court]. It shall report and be responsible to the [court] untildissolved by order of the [court]: Provided, however, Thatthe [court] may, on the basis of the findings andrecommendation of the management committee, or


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rehabilitation receiver, board or body, or on its own findings,determine that the continuance in business of suchcorporation or entity would not be feasible or profitable nor

work to the best interest of the stockholders, parties-litigants, creditors, or the general public, order the

dissolution of such corporation entity and its remainingassets liquidated accordingly. The management committeeor rehabilitation receiver, board or body may overrule orrevoke the actions of the previous management and board ofdirectors of the entity or entities under managementnotwithstanding any provision of law, articles ofincorporation or by-laws to the contrary."

When a distressed company is placed underrehabilitation, the appointment of a management committeefollows to avoid collusion between the previous managementand creditors it might favor, to the prejudice of the othercreditors. The stay order is effective on all creditors of thecorporation without distinction, whether secured orunsecured. All assets of a corporation under rehabilitationreceivership are held in trust for the equal benefit of allcreditors to preclude one from obtaining an advantage orpreference over another by the expediency of attachment,execution or otherwise. As between the creditors, the keyphrase is equality in equity. Once the corporation threatened

by bankruptcy is taken over by a receiver, all the creditorsought to stand on equal footing. Not any one of them should

be paid ahead of the others. This is precisely the reason for

suspending all pending claims against the corporation underreceivership.

Rizal Commercial Banking Corporation v.Intermediate Appellate Court [GR No. 74851, 9 December1999], promulgated by the Court en banc before theeffectivity of the Interim Rules on Corporate Rehabilitation,is still valid case law up to the present. It enumerates theguidelines in the treatment of claims involving corporationsundergoing rehabilitation, viz.:

1. All claims against corporations, partnerships, orassociations that are pending before any court,tribunal, or board, without distinction as to whetheror not a creditor is secured or unsecured, shall besuspended effective upon the appointment of amanagement committee, rehabilitation receiver,board, or body in accordance with the provisions ofPresidential Decree No. 902-A.


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2. Secured creditors retain their preference overunsecured creditors, but enforcement of suchpreference is equally suspended upon theappointment of a management committee,

rehabilitation receiver, board, or body.

In the event that the assets of the corporation,partnership, or association are finally liquidated, however,secured and preferred credits under the applicableprovisions of the Civil Code will definitely have preferenceover unsecured ones.

B. Other effects of Commencement

Continuous Supply of Goods and Services

To ensure continuous delivery of goods and services necessary for the

debtors business, the FRIA adopts the provision under the 2008 Rules granting

the rehabilitation court authority to include in the Commencement Order a

prohibition enjoining the debtors suppliers from withholding supply of essential

goods and services15, to wit:

Section 16. Commencement of Proceedings andIssuance of a Commencement Order. The rehabilitationproceedings shall commence upon the issuance of theCommencement Order, which shall:

xxx

(k) prohibit the debtors suppliers of goods orservices from withholding the supply of goods and services

15 Presumably, the authority of the court under this section appliesonly to valid and subsisting contracts for continuous supply of goods

or services, as opposed to supply contracts on a per order basis. In

other words, it would be one thing to require the supplier to fulfill

the terms of an existing supply contract by continuing to supply the

debtor. It would be a different matter to compel the supplier to

continue supplying the debtor where each order is covered by a separate

contract as this would be tantamount to requiring the supplier to

contract with the debtor.


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in the ordinary course of business for as long as the debtormakes payments for the services or goods supplied after theissuance of the commencement order;

xxx

[Italics ours]

Waiver of Taxes

Section 19 of the law provides that from the time of the issuance of the

Commencement Order until the approval of the Rehabilitation Plan or dismissal

of the petition, the imposition of all taxes shall be waived, thus:Section 19. Waiver of Taxes and Fees Due to the

National Government and to Local Government Units. Upon issuance of the Commencement Order by the court,and until the approval of the Rehabilitation Plan or dismissalof the Petition, which is earlier, the imposition of all taxesand fees, including penalties interests and charges thereof,due to the national government or to LGUs shall beconsidered waived, in furtherance of the objectives ofrehabilitation.

C. Duration of the Commencement Order and Modification of theSuspension Order

The Commencement Order shall be effective for the entire duration of the

rehabilitation proceedings and for as long as there is a substantial likelihood

that the debtor will be successfully rehabilitated16. The determination of this

fact will be based primarily on a report (by the Rehabilitation Receiver] either

that the Rehabilitation Plan is realistic, feasible and reasonable or even if the

Rehabilitation Plan is not feasible, there still exists a substantial likelihood for

the debtor to be rehabilitated.

16 Section 21


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As in the old Rules, the FRIA allows the court to modify the terms of the

suspension order or relieve a claim from its coverage if a creditor does not have

adequate protection over the security, thus:

Section 61.Lack of Adequate Protection. The court,on motion or motu proprio, may terminate, modify or setconditions for the continuance of suspension of payment, orrelieve a claim from the coverage thereof, upon showing that:(a) a creditor does not have adequate protection overproperty securing its claim; or (b) the value of a claimsecured by a lien on property which is not necessary for therehabilitation of the debtor exceeds the fair market value ofthe said property.

For purposes of this section, a creditor shall be

deemed to lack adequate protection if it can be shown that:(a) the debtor fails or refuses to honor a pre-existing

agreement with the creditor to keep the property insured;

(b) the debtor fails or refuses to take commerciallyreasonable steps to maintain the property;

(c) the property has depreciated to an extent that thecreditor is under secured.

Upon showing of lack of protection, the court shallorder the debtor or rehabilitation receiver to makearrangements to provide for the insurance or maintenance ofthe property; or to make payments or otherwise provideadditional or replacement security such that the obligation isfully secured. If such arrangements are not feasible, the courtmay modify the Stay Order to allow the secured creditorlacking adequate protection to enforce its security claimagainst the debtor: Provided, however, That the court maydeny the creditor the remedies in this paragraph if theproperty subject of the enforcement is required for therehabilitation of the debtor.

D. Use, Treatment and Disposition of Assets

As a general rule, funds or property of the debtor cannot be used except in

the ordinary course of business or unless necessary to pay off the administrative


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expenses during the rehabilitation proceedings17. These include court-approved

pre-commencement loans, as discussed above18 and compensation of employees

necessary to carry on the debtors business19.

Nonetheless, the court may, upon application by the rehabilitation

receiver, allow the disposition of the debtors encumbered property subject to the

general requirement that the disposition is necessary for the continued operation

of the business. However, the debtor must make an arrangement with the

secured creditor for a substitute lien20. This applies to the sale of property

covered by a trust receipt or consignment agreement, in which case the law

provides that the disposition shall not give rise to any criminal liability under

applicable laws.

E. Treatment of Contracts

Confirmation of Cancellation of Existing Contracts

Likewise, the issuance of the Commencement Order marks the start of a

cleanup period which requires the debtor and the rehabilitation receiver to chop

out those contractual commitments which are not necessary for the continued

existence of the business and/or the rehabilitation of the debtor.

Section 57 of the law grants the debtor the power to confirm or cancel

pre-existing contracts within ninety (90) days from the issuance of the

Commencement Order in order to weed out extremely onerous contracts that

may have been the cause of the debtors predicament. Those not confirmed

17 Section 48

18 Section 55

19 Section 56

20 Section 50.


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expressly by the debtor shall be deemed terminated but the party whose contract

is not confirmed will be allowed to pursue a claim for damages on account of the

debtors election, which claim shall be considered a demand existing prior to the

filing of the Petition for Rehabilitation, to wit:

Section 57. Treatment of Contracts. Unlesscancelled by virtue of a final judgment of a court ofcompetent jurisdiction issued prior to the issuance of theCommencement Order, or at anytime thereafter by the court

before which the rehabilitation proceedings are pending, allvalid and subsisting contracts of the debtor with creditorsand other third parties as at the commencement date shallcontinue in force: Provided, That within ninety (90) daysfollowing the commencement of proceedings, the debtor,

with the consent of the rehabilitation receiver, shall notifyeach contractual counterparty of whether it is confirming theparticular contract. Contractual obligations arising orperformed during this period, and afterwards for confirmedcontracts, shall be considered administrative expenses.Contracts not confirmed within the required deadline shall

be considered terminated. Claims for actual damages, if any,arising as a result of the election to terminate a contract shall

be considered a pre-commencement claim against thedebtor. Nothing contained herein shall prevent thecancellation or termination of any contract of the debtor for

any ground provided by law.

New Money

Stay Order notwithstanding, the FRIA allows the debtor to incur post-

commencement loans and/or other obligations subject to the approval of the

court21. This has a similar import as the New Money clause under the 2008

Rules. Debt payments falling under this provision will be considered as

administrative expenses during the pendency of the proceedings.

F. The Rehabilitation Receiver

21 Section 55


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The initial appointment of the Rehabilitation Receiver (as one of the

elements of the Commencement Order under Section 16) is subject to the

discretion of the court, which may retain the original appointee or choose another

from the petitioners nominees. However, this discretion is limited in the

following circumstances:

(a) In case the debtor is a securities market participant, in which case the

court shall give priority to the nominee of the appropriate securities or

investor protection fund; or

(b) If the qualified natural or juridical person is nominated by more than50% of secured creditors and general unsecured creditors, in which case

the court shall appoint the creditors nominee22.

As a rule, the Rehabilitation Receiver will not supplant the existing

management of the debtor corporation unless otherwise ordered by the court on

motion ofany interested party, thus:

Section 36. Displacement of Existing Managementby the Rehabilitation Receiver or Management Committee. -- Upon motion of any interested party, the court may appointand direct the rehabilitation receiver to assume the powers ofmanagement of the debtor, or appoint a managementcommittee that will undertake the management of thedebtor, upon clear and convincing evidence of any of thefollowing circumstances:

(a) Actual or imminent danger of dissipation, loss,wastage or destruction of the debtors assets or otherproperties;

(b) Paralyzation of the business operations of thedebtor; or

22 Section 30


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(c) Gross mismanagement of the debtor, or fraud orother wrongful conduct on the part of, or gross or willful

violation of this Act by, existing management of the debtor orthe owner, partner, director, officer or representative/s inmanagement of the debtor.

In case the court appoints the rehabilitation receiverto assume the powers of management of the debtor, thecourt may:

(1) require the rehabilitation receiver to post anadditional bond;

(2) authorize him to engage the services or employpersons or entities to assist him in the discharge of hismanagerial functions; and

(3) authorize a commensurate increase in hiscompensation.

F. Actions by the Rehabilitation Receiver

As part of its functions, the Rehabilitation Receiver retains the authority to

file an action to annul certain pre-commencement transactions intended to

defraud the creditors. Indeed, this power can be traced back to the basic

authority of the receiver to undertake measures to preserve property underreceivership under the Rules of Court23.

Should the receiver refuse to institute proceedings, any creditor may take

up the cudgels of the corporation with leave of court. If successful, Section 59 of

the law provides that the fruits of the case will redound to the pro-active creditor

to the extent of the value of its credit plus costs, thus:

Section 59. Actions for Rescission or Nullity. (a)The rehabilitation receiver or, with his conformity, anycreditor may initiate and prosecute any action to rescind, ordeclare null and void any transaction described in Section 58hereof. If the rehabilitation receiver does not consent to the

23 Salientes v. IAC [GR 66211, 4 July 1995]


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filing or the prosecution of such action, any creditor mayseek leave of the court to commence said action.

(b) If leave of court is granted under subsection (a),the rehabilitation receiver shall assign and transfer to thecreditor all rights, title and interest in the chose in action or

subject matter of the proceeding, including any document insupport thereof;

(c) Any benefit derived from a proceeding takenpursuant to subsection (a), to the extent of his claim and thecosts, belongs exclusively to the creditor instituting theproceeding, and the surplus, if any, belongs to the estate.

(d) Where before an order is made under subsection(a), the rehabilitation receiver (or liquidator) signifies to thecourt his readiness to institute the proceeding for the benefitof the creditors, the order shall fix the time within which he

shall do so and, in that case, the benefit derived from theproceeding, if instituted within the time limits so fixed,belongs to the estate.

H. Administration of Proceedings

Within forty (40) days from the issuance of the Commencement Order, the

court shall set the case for Initial Hearing to determine whether or not there is

substantial likelihood that the debtor can be rehabilitated and undertake the

following:

(a) determine the creditors who have made timely and proper filing

of their notice of claims;

(b) hear and determine any objection to the qualifications or the

appointment of the rehabilitation receiver and if necessary, appoint a new

one;

(c) direct the creditor to comment on the petition and the

Rehabilitation Plan, and to submit the same to the court and to the

rehabilitation receiver within a period not exceeding twenty (20) days;

(d) direct the rehabilitation receiver to evaluate the financial

condition of the debtor and to prepare and submit his report to the court24.

24 Section 22


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Within forty (40) days from the Initial Hearing, the Rehabilitation

Receiver is required to submit his written Report to the court, which will include

a determination of (a) whether or not there is substantial likelihood for the

debtor to be successfully rehabilitated or in the alternative (b) whether the

debtor should be dissolved or liquidated25. After submission of report, the Court

shall act on the petition by: (i) giving due course to the petition, (ii) dismissing

the petition or (iii) converting the proceedings into one for liquidation26.

In the event the court gives due course to the petition, the court will

require the Rehabilitation Receiver to review the Rehabilitation Plan, taking into

consideration the views of the debtor and all creditor classes. While theconsultation is a necessary procedure, the Receiver is not bound by the objections

of the parties27.

Among others, Section 62 of the FRIA provides that Rehabilitation Plan

must include provisions establishing classes and subclasses of voting creditors28.

After identifying the appropriate creditor classes and sub-classes, the Plan must

specify the treatment of each class or subclass29 and provide for equal

treatment for all claims within the same class30. Similar to the 2008 Rules,

Section 62 grants additional protection to secured creditors by requiring the Plan

to maintain the security interest of secured creditors and preserve the

liquidation value of the security.

25 Section 24

26 Section 25

27 Section 63

28 Sub-paragraph (d) and (e)

29 Sub-paragraph (g)

30 Sub-paragraph (h)


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Once satisfied with the version of the Rehabilitation Plan, the receiver

must convene the creditors and present the plan to them for approval. Unlike the

old procedure however31, the vote of the debtor is not required for the approval of

the plan, thus:

Section 64. Creditor Approval of the RehabilitationPlan. The rehabilitation receiver shall notify the creditorsand stakeholders that the Plan is ready for their examination.

Within twenty (20) days from the said notification, therehabilitation receiver shall convene the creditors, either as a

whole or per class, for purposes of voting on the approval ofthe Plan. The Plan shall be deemed rejected unless approved

by all classes of creditors whose rights are adversely modifiedor affected by the Plan. For purposes of this section, the Planis deemed to have been approved by a class of creditors ifmembers of the said class holding more than fifty per cent(50%) of the total claims of the said class vote in favor of thePlan. The votes of the creditors shall be based solely on theamount of their respective claims based on the registry ofclaims submitted by the rehabilitation receiver pursuant toSection 44 hereof.

Notwithstanding the rejection of the RehabilitationPlan, the court may confirm the Rehabilitation Plan if all of

the following circumstances are present:(a) the Rehabilitation Plan complies with all the

requirements specified in this Act;

(b) the rehabilitation receiver recommends theconfirmation of the Rehabilitation Plan;

(c) The shareholders, owners or partners of thejuridical debtor lose at least their controlling interest as aresult of the Rehabilitation Plan; and

(d) The Rehabilitation Plan would likely provide theobjecting class of creditors with compensation which has a

net present value greater than that which they would havereceived if the debtor were under liquidation.

31 See Section 8 of the Rules of Procedure on Corporate Rehabilitation

(2008)


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Note that under the foregoing provision, separate arrangements can be

made with different classes of creditors subject to approval of 50% of the affected

creditors or 80% of all creditors. This grants flexibility in dealing with varying

needs of each class32.

Even if the Rehabilitation Plan is not approved by the creditors, the court

may still confirm the Plan if it can be shown that objecting class of creditors shall

receive a net present value greater than that they would have received if the

debtor were under liquidation. Under the Interim Rules, the debtor can force

court approval of a Rehabilitation Plan over the objection of creditors by merely

showing that [t]he plan would likely provide the objecting class of creditors with

compensation greater than that which they would have received if the assets ofthe debtor were sold by a liquidator within a three-month period. The 2008

Rules33 changed the basis to present value projected in the plan. Requiring

that the computation be based on net present value is intended to prevent

debtors from railroading a rehabilitation plan disadvantageous to the creditors by

the simple expedient of stretching the repayment schedule without regard to the

costs of borrowing.

Finally, creditors who take a haircut under the plan will not be taxed for

any amount of debt which is reduced or forgiven under Section 71 of the law.

H. Termination

After creditor approval of the Rehabilitation Plan as provided above, it

must be submitted to the court for confirmation. Creditors shall have the right to

make an Objection but on limited grounds, to wit:

(a)The creditors support was induced by fraud;

32 See also Section 42 on the formation of Creditors Committee.

33 Specifically, Rule IV, Section 11


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(b)The documents or data relied upon in the Rehabilitation Plan are

materially false or misleading; or

(c)The Rehabilitation Plan is in fact not supported by the voting

creditors34

If, upon due hearing, the court finds merit in the objection, it may order

the receiver or the debtor to cure the defect whenever possible. On the other

hand, it shall order the proceedings to be turned into liquidation if the debtor

acted in bad faith or if the defect is incurable35.

However, in case (a) there are no objections to the Rehabilitation Plan, (b)

the objections are found to be without merit or (c) any defect in theRehabilitation Plan has been cured; the court shall issue an order confirming the

plan even over and above the objections of the owners, partners or stockholders

of the insolvent debtor36

To prevent the debtor (or any interested party) from dragging out the

proceedings in the hopes of obtaining a settlement on the basis of attrition, the

law fixes a maximum period of one year (from the time of the filing of the

petition) within which the plan must be confirmed. Otherwise, the proceedings

will turn into one of liquidation. This should force the parties to negotiate in

earnest.

Pre-Negotiated Rehabilitation

The concept of a pre-negotiated rehabilitation was introduced and is

currently available under the 2008 Rules, which the FRIA adopts without

substantial modification. Thus, the debtor, by itself or jointly with the creditors,

34 Section 66

35 Section 67

36 Section 68


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may file a petition for the approval of a pre-negotiated rehabilitation plan

provided that it has been endorsed by creditors holding at least 2/3 of the total

liabilities of the debtor, including secured creditors holding more than 50 percent

of the total secured claims and unsecured creditors holding more than 50 percent

of the total unsecured claims. However, while the 2008 Rules mandated the

appointment of a Rehabilitation Receiver either by election of the parties or by

order of the court, the FRIA gives the parties the freedom to undertake the

proceedings without a receiver.

The Order under Section 77 of the law which directs interested parties to

file their objections to the Pre-Negotiated Rehabilitation Plan also requires

publication and personal delivery of a copy of the Petition to each creditor who is

not a petitioner but who holds at least 10%37 of the total liabilities of the debtor.

The FRIA enumerates grounds to object to the Rehabilitation Plan in

addition to those originally provided under the 2008 Rules. Thus, under Section

79:

Section 79. Objection to the Petition or

Rehabilitation Plan. Any creditor or other interested partymay submit to the court a verified objection to the petition orthe Rehabilitation Plan not later than eight (8) days from thedate of the second publication of the Order mentioned inSection 77 hereof. The objection shall be limited to thefollowing:

(a) The allegations in the petition or theRehabilitation Plan, or the attachments thereto arematerially false or misleading;

(b) The majority of any class of the creditors do notin fact support the Rehabilitation Plan;

(c) The Rehabilitation Plan fails to accurately accountfor a claim against the debtor and the claim is notcategorically declared as a contested claim; or

(d) The support of the creditors, or any of them, was

37 5% under the 2008 Rules.


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induced by fraud.

Copies of the objection to the petition or theRehabilitation Plan shall be served on the debtor, therehabilitation receiver (if applicable), the secured creditor

with the largest claim and who supports the Rehabilitation

Plan, and the unsecured creditor with the largest claim andwho supports the Rehabilitation Plan.

If, after due hearing, the courts finds merit to the objection, it will order

the debtor to cure the defect. On the other hand, if it finds that the petitioners

acted in bad faith or that the defect is incurable, it may order the conversion of

proceedings into one for liquidation38. As in the 2008 Rules, the Rehabilitation

Plan will be deemed approved if the court fails to act within a period of 120

days39.

Informal Rehabilitation

As mentioned previously, one of the most important and potentially far

reaching innovations under the FRIA is the recognition of out-of-court

restructuring/workout agreements. Pursuant to Section 89 of the Act, [t]he

insolvent debtor and creditor may seek court assistance for the execution orimplementation of the Rehabilitation Plan, provided that it meets the minimum

requirements of the law. Ultimately, this type of cooperative endeavor may offer

the best chances of rehabilitation as it theoretically provides the least amount of

disruption to the operations of an already beleaguered company.

Furthermore, to allow the parties to negotiate a feasible workout plan, the

debtor and creditors holding more than 50% of the debt may agree on a standstill

period pending the completion of the plan for up to 120 days40, provided in

38 Section 80.

39 Section 81.

40 Section 85


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Corporate Rescue and the New Financial Rehabilitation and Insolvency

Act of 20102010

addition that notice to all creditors is published in a newspaper of general

circulation once a week for two consecutive weeks. The said notice must invite

the creditors to participate in the negotiation of the plan and inform them that

the plan will be binding on all creditors if the required votes are obtained41.

An out-of-court Rehabilitation Plan approved by at least 67% of secured

creditors, 75% of unsecured creditors, and 85% of all creditors42 will be

crammed down all creditors pursuant to Section 86 of the law, to wit:

Section 86. Cram Down Effect. Arestructuring/workout agreement or Rehabilitation Plan thatis approved pursuant to an informal workout framework

referred to in this chapter shall have the same legal effect asconfirmation of a Plan under Section 69 hereof. The notice ofthe Rehabilitation Plan or restructuring agreement orPlan shall be published once a week for at least three (3)consecutive weeks in a newspaper of general circulation inthe Philippines. The Rehabilitation Plan or restructuringagreement shall take effect upon the lapse of fifteen (15) daysfrom the date of the last publication of the notice thereof.

Quick Notes on Insolvency and Liquidation: Cross Border

Insolvency

By virtue of Section 139 of the FRIA, the Philippines is now deemed to

adopt the provisions of the UNCITRAL Model Law on Cross Border Insolvency

(1997) subject to procedural rules to be promulgated by the Supreme Court.

Essentially, the law provides a framework for the recognition of foreign

insolvency proceedings and grants certain parties in such proceedings access to

Philippine courts for purposes of obtaining some form of affirmative or other

relief.

41 Ibid.

42 Section 84

New FRIA Paper v1.6

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