Saturday, February 6, 2010

Corporate Recovery Act of the Philippines

Day 152/365 Corporations LawImage by jerine via Flickr
Corporate Recovery Act of the Philippines

For almost a century, the Philippines did not have a clear legislative base for insolvency, suspension of payments and corporate rehabilitation.
Our insolvency law last was passed way back last 1909(!) when the Philippines was still under American tutelage, while our suspension of payments and corporate rehabilitation are still of martial law vintage under Presidential Decree No. 902-A.
With the passage this week of the Corporate Recovery Act, our insolvency, suspension of payments and corporate rehabilitation laws are now updated, and hopefully to be at par with the realities of the global market and business conditions.
As explained by the authors --
"While SEC has recently adopted rules for governing petitions for suspension of payment and rehabilitation, it nevertheless has remained hampered by this inadequate legislative base.
"Further, and perhaps of most immediate concern, the recently passed Securities Regulation Code (Act 8799) will transfer SEC's quasi-judicial jurisdiction 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.
"In short, the Philippine has long needed to modernize and clarify its rules for rehabilitation and insolvency. This need has now become urgent with transfer of SEC's quasi-judicial jurisdiction over suspension payments and rehabilitation cases to the Regional Trial Courts.
According to the authors of the law, the Corporate Recovery Act, or the CRA, represents a comprehensive approach to the complex problems faced by enterprises when they, for whatever reason, can no longer pay their debts as they come due. It combines the creation substantive rights with relatively detailed procedural guidelines that move cases through court-supervised proceeding quickly. It emphasizes the survival of the enterprise while at the same time keeping paramount the rights of creditors with duly registered liens against the enterprise's assets.
The CRA clarifies the rights of debtors and creditors to initiate formal debt relief proceedings. A financially distressed enterprise may petition the court if it cannot pay its debts as they are coming due, regardless if it is insolvent. By contrast, P.D. 902-A allows SEC to take jurisdiction only when the distressed enterprise's assets exceed its liabilities. This has often led to time consuming litigation over whether the debtor is solvent or not at the onset of the proceedings. In the meantime, the debtor languishes. The CRA avoids this problem by allowing enterprises in the door regardless of their solvency or insolvency.
The authors of legislative measure said that once a case begins, the CRA offers four different means of relief: Pre-Negotiated Rehabilitation, Fast Track Rehabilitation, Court-Supervised Rehabilitation, and Dissolution-Liquidation.
Pre-Negotiated Rehabilitation
In the wake of the Asian crisis, banks have been diligently working with debtors to restructure loans whose payment terms are no longer practical. Numerous such agreements have been reached over the past several years. Two obstacles, however, stand in the way of a successful "work out". The first could be called the "maverick creditor problem" (where one creditor seeks to lay claim in the debtor's assets while others negotiate). The other is the "free-riding creditor problem" (where a creditor refuses to compromise knowing that the other creditors will). Both problems arise often. They undermine the trust patience needed to collectively restructure an enterprise's debts.
Pre-Negotiated Rehabilitation under CRA solves these problems. It allows a debtor that has worked out a rehabilitation plan with its creditors to go to court for official approval. While the plan awaits approval (expected time would be several weeks to hear technical objections, etc.), the claims and lawsuits of creditors, such as that of the maverick creditor mentioned above, are suspended. When the court approves that plan, all the creditors are bound by it, even the minority creditors who were trying to free ride on the good faith negotiations of the other creditors.
This remedy would be open to my enterprise that can develop a rehabilitation plan that is supported by a majority of its creditors. The experience of other countries, as well as some limited experience in the Philippines indicates that it is the most efficient and likely-to-succeed route to rehabilitation. It is thus one of the mainstays of the proposed legislation.
Fast-Track Rehabilitation
But what happens if the debtor cannot develop a pre-negotiated rehabilitation plan? The usual result has been for the debtor to petition SEC to initiate suspension of payments or rehabilitation proceedings. While various SEC cases involving large industrial companies are moving forward, few would deny that it has been a grueling experience and that success is not necessarily assured.
The challenge of the traditional rehabilitation approach is that it tries to do two things at the same time: (1) to figure out how to fix the debtor's business, and (2) to determine who gets what out of the proceedings. This one-two combination is the reason why many rehabilitations fail. The parties to the proceeding, seeking to minimize their losses, have move than the long-term interest of the enterprise in mind. The result is strategic bargaining, strategic lawsuits, and endless proceedings. And time, unfortunately, is the number one enemy of a successful outcome.
Fast-Track Rehabilitation under the proposed legislation stems from the assumption that the persons with the best incentives to fix an enterprise are owners with long-term outlook. These individuals will gain or lose depending on the ultimate outcome of the rehabilitation. To get to this point, Fast-Track Rehabilitation:
* 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 toward maximizing revenues from the sale;
* gives shareholders and creditors of the debtor various preferred rights in bidding for the shares of the new enterprise if they so choose;
* allocates the proceeds from the shares sales to creditors and shareholders of the debtor according to pre-established 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. While there are no guarantees of success, the enterprise, under new corporate trappings and management, has a far better chance of rehabilitating itself under these circumstances rather than trying to do it through endless rehabilitation proceedings. Workers benefit from this. So do the high priority creditors.
The legislation essentially makes Fast-Track Rehabilitation mandatory if the enterprise has not already petitioned for Pre-Negotiated Rehabilitation.
Court-Supervised Rehabilitation
As experienced in the Philippines and elsewhere teaches, traditional rehabilitation, even under the most progressive legislation, is drawn out process with few guarantees of success. Nonetheless, the CRA does provide it as a form of relief. It is only available, however, to non-stock corporations, or in instances where the secured creditors submit a motion to the court to convert the proceedings from Fast-Track Rehabilitation.
The CRA allows for the drafting of a rehabilitation plan while claims of creditors are suspended. The creditors then decide to support the plan or not. If the majority of a particular class of creditors opposes the plan, the case is converted to liquidation.
Court-Supervised Rehabilitation under CRA differs from current practice in several respects. The CRA puts the onus on the shareholders (through the debtor's board of directors) in drafting and selling a rehabilitation plan. The shareholders have the most to win or lose depending on whether a plan is approved. They should be the ones to take the first crack at the plan. Further, while the shareholders can hire experts to help in formulating the plan, the cost of hiring such experts are borne by the shareholders rather than the creditors.
This is contrast with current practice where the interim rehabilitation negotiates and balances the competing demands of the creditors and the shareholders. While some individuals have been able to rise to this challenge, even they concede it is very difficult to wear several hats at once. It is better to split the job into two roles: the court-appointed administrator (called the "conservator") conserves the assets (for the general benefit of all creditors) while the shareholders and their rehabilitation planner make their pitch for adjusting creditor's claims, minimizing shareholder dilution, and saving the enterprise.
The proposed legislation makes Dissolution-Liquidation the relief of last resort. It will most often be used when other forms of relief fail or when a debtor seeks to liquidate itself when it has insufficient assets to cover its debts.
The liquidation proceedings under the CRA are rather straightforward. They closely resemble the approach currently adopted by SEC. The major change is the modification of the ranking and prioritization of creditors currently found in the Civil Code. Several practitioners and commentators have argued that the Civil Code rankings massively complicate both liquidations and rehabilitations.
The CRA presents several options to a distressed enterprise. First, it gives it the chance to negotiate a rehabilitation plan agreed to by the majority of its creditors. Upon court approval, the plan would bind all creditors, even the dissenting ones.
If this effort fails, 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 improving the enterprise's operations falls upon the new owners.
Traditional Court-Supervised Rehabilitation is available under the CRA, but only under limited circumstances, due to its inherent delay, cost, and risk. Finally, traditional dissolution and liquidation available, but only when a debtor voluntarily consents to it or when other rehabilitation approaches fail.
The CRA thus is both an evolution and an innovation in terms of current practice. It emphasizes workable solutions and de-emphasizes court-led approaches. Above all, it emphasizes the preservation of an enterprise while allowing its ownership to be restructured and its creditors to be treated fairly. In this sense, the CRA is pro-worker, pro-market, and pro-creditor at the same time.
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