Recovering Or Winding Up In Time Of Covid-19

The Darker Side Of Business Life

Almost all business literatures have given much focus on tips and techniques on how to drive business to exponential growth and financial success. Some business magazines and books have featured success stories about new entrepreneurs making headway with year-on-year dramatic surge of financial performance, generating big sales and transforming into giant conglomerates. But only seldom or not at all has been said about businesses in distress or in the brink of bankruptcy and how to come to their succor for survival or recovery and keep them in the game. For promising but losing entrepreneurs, their failures may be swept under the rug of silence or simply considered as a piece of business experience or lesson for future consumption in case of venturing anew.

Coming from the darker side, the players need to openly and honestly discuss what are the available remedies for entrepreneurs or corporations who are suffering from financial distress. With the corona pandemic crisis and its impact on local economy, an increasing number of corporation or business establishments are knocking before the courts or pleading with the creditors for rehabilitation or worse, insolvency for liquidation or suspension of payments is very much anticipated in the days to come signalling losses of jobs, seizing up of production and slowing down of supply chains. Thus, it is an opportune time to discuss the options generally available to entrepreneurs under financial distress.

In the past it was observed that with the magnitude of Asia’s financial turmoil, bankruptcy codes all over the region are being scrutinized not only by international agencies such as the IMF, but also but international creditors and investors. Other countries like Thailand and Indonesia have just recently overhauled their bankruptcy laws to be able to restore investors’ confidence. It has been reported that the main objective of bankruptcy reforms underway in Asia is to make company rehabilitation a viable alternative to liquidation proceedings where creditors are being encouraged “to take a pro-active and constructive role in salvaging debtors’ businesses.”

In the Philippines, a new law was passed on July 27, 2009 providing for “Rehabilitation or Liquidation of Financially Distressed Enterprises and Individuals”, presumably as a response not only to the dynamic transformation of competitive landscape in domestic marketplace but also to the ever-changing globalization in the areas of trade, travel and technology. By the passing of time, however, the local and global fluctuation of market dynamism have been randomly disturbed by the so-called VUCA (Volatility, Uncertainty, Complexity and Uncertainty) of our modern time, most recently exemplified by the influx of coronavirus. And now, this piece of legislation after a decade-long existence will be put to test with its efficacy if it is an opportune antidote to the most difficult viral malady after Spanish flu 100 years ago— Covid-19.

Currently, with the pandemic crisis plaguing the whole world including the Philippines registering more than 300,000 tested positive of Covid-19 (highest in Asia so far as of October 2020 and still counting), it leads to no other than a bleak forecast of huge losses of 2.2 trillion to Philippine economy “this year as firms shed profits while millions of workers lose their jobs and income”. Further, this pandemic crisis exacerbating to an unimaginable proportion bringing to a halt of 65.9% of businesses surveyed in the Philippines  it is widely feared that except for businesses which are temporarily shutdown and expected to bounce back during recovery period and under a ‘new normal’ (if there is such a thing), those which have been incurring huge losses looming into almost irreversible condition will have to face the fate of closing shop and in all probabilities be candidates for rehabilitation if not liquidation at its worst.

Definition and Thrust of Rehabilitation.

Corporate rehabilitation has been defined as a process “to try to conserve and administer the corporation’s assets in the hope that it may eventually be able to return from financial stress to solvency. It contemplates of the continuation of corporate life and activities so that it may be able to return to its former condition of successful operations and financial stability.”

In one recent case, the Supreme Court defined “rehabilitation” as contemplating a continuance of corporate life and activities in an effort to restore and reinstate the corporation to its former position of successful operation and solvency.

The primary purpose of rehabilitation proceedings is to give a petitioning corporation the breathing period for the deferment of the payments of its obligations, to come-up with a Rehabilitation Plan which shall refer to a plan by which the financial well-being and viability of an insolvent debtor can be restored using various means including, but not limited to, debt forgiveness, debt rescheduling, reorganization or quasi-reorganization, dacion en pago, debt-equity conversion and sale of the business (or parts of it) as a going concern, or setting-up of new business entity or other similar arrangements as may be approved by the court or creditors. (Par. ii, Sec. 4) It will provide the petitioning companies the opportunity to recover from financial distress, to achieve profitable operations to eventually be able to service its obligations, and perhaps even to accumulate once again retained earnings to be in a position to distribute dividends to its equity holders.

The terms of some of the rehabilitation plans have been discussed or made public in newspaper reports, and often the difficulties faced are the conflicting interests among the various creditors, some of whom have fully secured claims against other creditors who are not adequately secured or are entirely without collateral security, and even with the stockholders of the companies subject to rehabilitation proceedings.

The success of rehabilitation will largely depend on the feasibility of the rehabilitation plan. As outlined in the case of Bank of the Philippine Islands v. Sarabia Manor Hotel Corp. ( G.R. No. 175844, July 29, 2013), “in order to determine the feasibility of a proposed rehabilitation plan, it is imperative that a thorough examination and analysis of the distressed corporation’s financial data must be conducted. If the results of such examination and analysis show that there is a real opportunity to rehabilitate the corporation in view of the assumptions made and financial goals stated in the proposed rehabilitation plan, then it may be said that a rehabilitation is feasible. In this accord, the rehabilitation court should not hesitate to allow the corporation to operate as an on-going concern, albeit under the terms and conditions stated in the approved rehabilitation plan. On the other hand, if the results of the financial examination and analysis clearly indicate that there lies no reasonable probability that the distressed corporation could be revived and that liquidation would, in fact, better subserve the interests of its stakeholders, then it may be said that a rehabilitation would not be feasible. In such case, the rehabilitation court may convert the proceedings into one for liquidation.”

Available Remedies 

In general, it is said that the first option for a corporation in financial distress is, of course, to secure other sources of funding to cover the financial requirements and losses of the business. Being in a financial distress is not necessarily bad, as certain managers even adhere to the principle of operating under perpetual crisis. Successful and big corporations also have debts, which shows that the existence of debt is not necessarily a bad sign.

However should there be no other options and due to certain instances like the pandemic crisis when a business entity could not simply cope with its liabilities and must seek more drastic remedies, it may resort to available remedial measures under the “Financial Rehabilitation and Insolvency Act (FRIA) of 2010” which is predicated on four (4) State policy statements as follows:

• To encourage debtors, both juridical and natural persons, and their creditors to collectively and realistically resolve and adjust competing claims and property rights.
• To ensure a timely, fair, transparent, effective and efficient rehabilitation or liquidation of debtors.
• To ensure or maintain certainty and predictability in commercial affairs, preserve and maximize the value of the assets of these debtors, recognize creditor rights and respect priority of claims, and ensure equitable treatment of creditors who are similarly situated.
• to facilitate a speedy and orderly liquidation of these debtors’ assets and the settlement of their obligations, when rehabilitation is not feasible . (SEC. 2. Declaration of Policy. — It is the policy of the State to

Under the said law, debtors or even creditors, in some instances, may avail of the following remedies:

1. 1. Rehabilitation.

It is similar to Chapter 11 reorganization in the U.S., and is intended to enable a distressed corporation to gain a new lease on life, so to speak, and to continue its business as a going concern. Rehabilitation contemplates a continuance of corporate life and activities in an effort to restore and reinstate the corporation to its former position of successful operation and in the atmosphere of solvency. As defined, Rehabilitation shall refer to “the restoration of the debtor to a condition of successful operation and solvency, if it is shown that its continuance of operation is economically feasible and its creditors can recover by way of the present value of payments projected in the plan, more if the debtor continues as a going concern than if it is immediately liquidated” (Par. (gg) Sec. 4).

Rehabilitation proceedings may either be (a) court-supervised or by the parties in the form of (b) Out-of-Court or Informal Restructuring Agreements and Rehabilitation Plans.

On one hand, if it is in supervised by the court, it may be (i) voluntarily initiated by the debtor; (ii) involuntarily, thus, initiated by the creditor and; (iii) pre-negotiated rehabilitation. On the other hand, the rehabilitation can be done outside of the court by way of informal restructuring agreements and rehabilitation plans on the condition that the “the debtor must agree to it, however, it must be approved by creditors representing at least sixty-seven percent (67%) of the secured obligations or if unsecured at least seventy-five percent (75%) of obligations and if both secured and unsecured, at a least eighty-five percent (85%) of the total liabilities.

This rehabilitation approach is subject to standstill period that may be agreed upon by the parties pending negotiation and finalization. Further, a restructuring/workout agreement or Rehabilitation Plan has a “Cram Down Effect” which means that it shall have the same legal effect as confirmed Rehabilitation plan which is binding upon the debtor and all persons who may be affected by it, including the creditors. (Sec 83, Sec 69)

The rehabilitation proceedings will then commence upon the issuance of the Commencement Order, which includes Stay or Suspension Order which have the effect of suspending all actions or proceedings, for the enforcement of claims against the debtor and all actions to enforce any judgment, attachment or other provisional remedies against the debtor, prohibiting the debtor from selling, encumbering, transferring or disposing in any manner any of its properties except in the ordinary course of business and from making any payment of its liabilities outstanding as of the commencement date (Sec. 16).

1. 2. Liquidation

The debtor doesn’t have enough assets to cover his liabilities in insolvency. The purpose of insolvency proceedings, is to bring together all debts and properties in a single proceeding, and determining the portion to which each creditor is entitled. Since insolvency presupposes that properties are lesser than the debts, not all creditors could receive the entire amount of the debt. In fact, it’s entirely possible that some creditors may be paid in full, while others will receive nothing, after applying the rules on concurrence and preference of credits. Another purpose of insolvency proceedings is to give the debtor a fresh start, to be discharged from his debts and to start his economic life anew.

Liquidation under the FRIA will not only apply to juridical but also to individual debtors. Either, it could either be voluntary (initiated by the debtor) or involuntary (initiated by the creditors). Voluntary Liquidation proceeds upon the filing of the petition by an insolvent debtor with the court which contains a schedule of the debtor’s debts and liabilities including a list of creditors with their addresses, amounts of claims and collaterals, or securities, if any; an inventory of all its assets including receivables and claims against third parties; and the names of at least three (3) nominees to the position of liquidator (Sec. 90)

Without any action by the debtor, Involuntary Liquidation is a remedy of at least three (3) creditors with aggregate claims of at least One million or 25% of the subscribed capital stock or partner’s contributions of the debtor, whichever is higher, may apply and seek the liquidation of an insolvent debtor showing that (a) there is no genuine issue of fact or law on the claim that the due and demandable payments have not been made for at least one hundred eighty (180) days or that the debtor has failed generally to meet its liabilities as they fall due; and (b) there is no substantial likelihood that the debtor may be rehabilitated (Sec. 91).

Liquidation proceedings, either voluntary in involuntary, may also be a remedy for conversion from court-supervised or pre-negotiated rehabilitation proceedings if, among others, rehabilitation of the debtor is not feasible. At any time during the pendency of court-supervised or pre-negotiated rehabilitation proceedings, the debtor or the creditor least three (3) creditors with aggregate claims of at least One million or 25% of the subscribed capital stock or partner’s contributions of the debtor, whichever is higher may also initiate liquidation proceedings to convert the rehabilitation proceedings into liquidation proceedings.

If liquidation proceedings used to be available to juridical persons, the new law paved the way for individual persons. For Voluntary Liquidation, an individual debtor whose properties are not sufficient to cover his liabilities, and owing debts exceeding Five hundred thousand pesos (Php500,000.00), may apply to be discharged from his debts and liabilities with the courtswinging a schedule of debts and liabilities and an inventory of assets (Sec. 103).

For Involuntary Liquidation, any creditor or group of creditors with a claim or claims aggregating P500,000 may file petition for liquidation if any acts of insolvency are present such as, among others such person is about to depart or has departed from the Republic of the Philippines, with intent to defraud his creditors, being absent from the Philippines and he remains absent with intent to defraud his creditors and he conceals himself to avoid the service of legal process for the purpose of hindering or delaying the liquidation or of defrauding his creditors and many other acts of insolvency ( Sec. 105).

1. 3. Suspension of payments.

This remedy is available to debtors who still possess sufficient property to cover all their debts but have reasonably anticipate the impossibility of paying them when they respectively fall due. The purpose of suspension of payments is to suspend or stop the payment of debts in order for the debtor to convert some of its properties to cash and pay the creditors.

Under the new law, an individual debtor who, possessing sufficient property to cover all his debts but foreseeing the impossibility of meeting them when they respectively fall due, may be declared in the state of suspension of payments by the court provided he has to submit: (a) a schedule of debts and liabilities; (b) an inventory of assets; and (c) a proposed agreement with his creditors. (Sec. 94). Among the many consequences of filing the petition are forbidding the individual debtor from selling, transferring, encumbering or disposing in any manner of his property except those used in the ordinary operations of commerce or of industry and prohibiting the individual debtor from making any payment outside of the necessary or legitimate expenses of his business or industry ( Par. (e) and (f), Sec. 95). A meeting of listed creditors will be lated scheduled and held for the purpose of deliberating, formulating and voting upon the agreement.

Distinction between Rehabilitation and Liquidation

 In “rehabilitation,” the creditors are promised to be paid from the future earnings of the debtor, and not from the current properties of the debtor existing at the time the petition for rehabilitation is filed. On the other hand, “liquidation” essentially involves scheduling of the debtor’s debts and liabilities, listing of creditors with their addresses, amounts of claims and collaterals, or securities, making an inventory of all its assets including receivables and claims against third parties appointment of liquidator who collects the non-exempt properties of the insolvent debtor, converts the property to cash, and distributes the proceeds to the creditors in accordance with prevailing preference rights existing under the law, with also the end in view of obtaining a discharge for the debtor.

“The purpose of rehabilitation proceedings is precisely to enable the company to gain a new lease on life and thereby allow creditors to be paid their claims from its earnings. In liquidation proceedings, on the other hand, the company stops operating, and the claims of creditors are satisfied from the assets of the insolvent enterprises.”

Rehabilitation used to be available only to corporations, partnerships and associations but under the new law, similar to Liquidation proceedings, it is also available to individuals or natural persons.

Rehabilitation is rehabilitative being a debtor-friendly with the prime concern for the rehabilitation of distressed corporation while Liquidation arising from Insolvency is distributive: “ . . . the purpose of the filing of the petition was … to effect an equitable distribution of the bankrupt’s properties among his creditors and to benefit the debtor by discharging him to start afresh with the property set apart for him as exempt.” (In re: Estate of Mindanao Motor Line, Inc. [57 SCRA 103])

The Supreme Court in one case observes that “the rationale in corporate rehabilitation is to resuscitate businesses in financial distress because “assets . . . are often more valuable when so maintained than they would be when liquidated. Rehabilitation assumes that assets are still serviceable to meet the purposes of the business. The corporation receives assistance from the court and a disinterested rehabilitation receiver to balance the interest to recover and continue ordinary business, all the while attending to the interest of its creditors to be paid equitably. These interests are also referred to as the rehabilitative and the equitable purposes of corporate rehabilitation.”

Further, by finer comparison, it had the opportunity to observe that “Liquidation is diametrically opposed to rehabilitation. Both cannot be undertaken at the same time. In rehabilitation, corporations have to maintain their assets to continue business operations. In liquidation, on the other hand, corporations preserve their assets in order to sell them. Without these assets, business operations are effectively discontinued. The proceeds of the sale are distributed equitably among creditors, and surplus is divided or losses are re-allocated (Viva Shipping Lines vs. Keppel Philippines Mining, Inc. et. al., G.R. No. 177382, February 17, 2016).

Both liquidation and rehabilitation proceedings are embodied into the generic nomenclature of “bankruptcy,” and the trust of both proceedings is mainly to afford an equitable distribution of the properties of the debtor to allow the maximum means by which to cover the claims of the creditors.

Applicable Law And Jurisdiction

After a tediously riding for century on an outdated and obsolete Insolvency Law (Act No. 1956), which could be traced back to 1909, a revolutionary legislation providing for rehabilitation or liquidation of financially distressed enterprise and individuals was finally passed otherwise known as “Financial Rehabilitation and Insolvency Act (FRIA) of 2010”. Although in 1976, between the period of old and the new law , President Marcos using his legislative powers under martial law issued a Presidential Decree 902-A as an investment platform to attract and plow more investments into the Philippine economy, still the latter piece of presidential legislation did not cover all facets of rehabilitation and insolvency and was observed to be inadequate in rules for handling insolvency and rehabilitation. Thus, the passage of FRIA has expressly repealed Insolvency Law and superseded most, if not all, provisions of Presidential Decree 902-A.

It bears to note that provisions of the New Civil Code (Republic Act 386) on concurrence and preference of credits have interlocking effect with the FRIA as legal references for settlement of liabilities with secured or unsecured creditors. Further, the recent passage in February 2019 of “Revised Corporation Code” (RCC Republic Act No 11232) stressing a new feature of “one-person corporation”, requires reexamination in the light of who will represent (juridical or natural persons) in either rehabilitation or liquidation proceedings.

As regards rules on jurisdictions and proceedings, Presidential Decree No. 902-A originally bestowed the power to hear and decide with the Securities and Exchange Commission (SEC). In 2000, however, the jurisdiction of SEC over these cases was transferred to the Regional Trial Court under Securities Regulation Code (Republic Act 8799) coupled with the issuance of the Interim Rules of Procedure on Corporate Rehabilitation which provides a summary and non-adversarial proceeding to expedite the resolution of cases for the benefit of the corporation in need of rehabilitation, its creditors, and the public in general.

However, all have been made codified with simplified procedures by the passage of FRIA Financial Rehabilitation and Insolvency Act of 2010 (FRIA) and subsequent promulgation of the Financial Rehabilitation Rules of Procedure on August 27, 2013. Two years later, it was followed by the issuance of A.M. No. 15-04-06-SC which provides for the Financial Liquidation And Suspension of Payment Rules Of Procedures For Insolvent Debtors (2015).

Meanwhile, if it involves a foreign entity that is subject of the foreign proceeding, it requires the adoption of Uncitral Model Law on Cross-Border Insolvency of the United Nations Center for International Trade and Development. In that instance, the court shall set a hearing in connection with an insolvency or rehabilitation proceeding taking place in a foreign jurisdiction upon the submission of a petition by the representative of the foreign entity subject of the foreign proceeding (Sec. 140).

Receivership: A New Career Path For Financial Managers

Rehabilitation receiver refer to the person or persons, natural or juridical, appointed as such by the court pursuant to FRIA which shall be entrusted with powers and duties (Par. (hh), Sec. 4).

1. 1. The Powers, Duties and Responsibilities of the Rehabilitation Receiver

            The rehabilitation receiver shall be deemed an officer of the court with the principal duty of preserving and maximizing the value of the assets of the debtor during the rehabilitation proceedings, determining the viability of the rehabilitation of the debtor, preparing and recommending a Rehabilitation Plan to the court, and implementing the approved Rehabilitation Plan.

The rehabilitation receiver shall have the following powers, duties and responsibilities:

(a) To verify the accuracy of the factual allegations in the petition and its annexes;

(b) To verify and correct, if necessary, the inventory of all of the assets of the debtor, and their valuation;

(c) To verify and correct, if necessary, the schedule of debts and liabilities of the debtor;

(d) To evaluate the validity, genuineness and true amount of all the claims against the debtor;

(e) To take possession, custody and control, and to preserve the value of all the property of the debtor;

(f) To sue and recover, with the approval of the court, all amounts owed to, and all properties pertaining to the debtor;

(g) To have access to all information necessary, proper or relevant to the operations and business of the debtor and for its rehabilitation;

(h) To sue and recover, with the approval of the court, all property or money of the debtor paid, transferred or disbursed in fraud of the debtor or its creditors, or which constitute undue preference of creditor/s;

(i) To monitor the operations and the business of the debtor to ensure that no payments or transfers of property are made other than in the ordinary course of business;

(j) With the court’s approval, to engage the services of or to employ persons or entities to assist him in the discharge of his functions;

(k) To determine the manner by which the debtor may be best rehabilitated, to review, revise and/or recommend action on the Rehabilitation Plan and submit the same or a new one to the court for approval;

(l) To implement the Rehabilitation Plan as approved by the court, if so provided under the Rehabilitation Plan;

(m) To assume and exercise the powers of management of the debtor, if directed by the court;

(n) To exercise such other powers as may, from time to time, be conferred upon him by the court; and

(o) To submit a status report on the rehabilitation proceedings every quarter or as may be required by the court motu proprio, or upon motion of any creditor, or as may be Provided, in the Rehabilitation Plan. ( Sec. 31)

1. 2. Who May Qualify for Receivership or Management Committee

Any qualified natural or juridical person may serve as a rehabilitation receiver and   if the rehabilitation receiver is a juridical entity, it must designate a natural person/s who possess/es all the qualifications and none of the disqualifications as its representative (Sec. 28) The rehabilitation receiver shall have the following minimum qualifications:

(a) A citizen of the Philippines or a resident of the Philippines in the six (6) months immediately preceding his nomination;

(b) Of good moral character and with acknowledged integrity, impartiality and independence;

(c) Has the requisite knowledge of insolvency and other relevant commercial laws, rules and procedures, as well as the relevant training and/or experience that may be necessary to enable him to properly discharge the duties and obligations of a rehabilitation receiver; and

(d) Has no conflict of interest which may be waived, expressly or impliedly by a party who may be prejudiced (Sec. 29).

1. 3. How Rehabilitation Receiver Is Compensated

In comparison to prior compensation package under SEC Memorandum Circular No.14, Series of 2001 where the compensation or fees of the receivers and liquidators will be determined by the agreement between the parties and the Management Committee members, receiver or liquidator, under the new law, the rehabilitation receiver and his direct employees or independent contractors shall be entitled to compensation for reasonable fees and expenses from the debtor according to the terms approved by the court after notice and hearing. Prior to such hearing, the rehabilitation receiver and his direct employees shall be entitled to reasonable compensation based on quantum meruit. Such costs shall be considered administrative expenses (Sec. 33).

In fixing the compensation or fees, the following may be considered, among others, the amount of liabilities settled;   amount of cash and other assets coming into the possession and control of the receiver or liquidator; practical benefits derived from the receiver or liquidator’s efforts;  attention, time, labor and skill needed or expended in the discharge of duties measurable in terms of common business standards; complications involved, the degree of activity, integrity and dispatch with which the work of the receiver or liquidator are conducted; and  difficulties of conserving and administering the estate and the care and fidelity with those difficulties have been met and surmounted.

1. 4. A Mutual Pact Between Entrepreneurs In Financial Distress And Financial Managers

Corporation in financial distress and financial managers who are specializing in corporate rehabilitation are mutually cooperating with each other for mutual and greater benefits. While corporation in financial distress on one hand, would ask relief for rehabilitation for their troubled business, receiver or management committee, on the other, would perform their functions as such through their expertise, among others, preparing a rehabilitation plan with the end in view of being able to pay off existing liabilities and give a new breath of life to the corporation.

The success or failure of rehabilitation effort to restore and reinstate the corporation to its former position of solvency rests in the hands of a good receiver who in turn deserves reasonable fees and compensation services rendered. For corporation in distress, it is to his advantage if his business is resurrected to its new life due to effective management of a receiver. For receiver, it is a lucrative professional undertaking with touch of social responsibility

Thus, the enactment of laws for corporate rehabilitation and insolvency is for the best interest not only for distressed corporation but also for financial managers who have chosen a new path of receivership career. The law in effect gives financial managers a new ground for career opportunity in the area of rehabilitation and liquidation for insolvent debtor both for natural and juridical person vying for a new lease of corporate existence.

References:

1. www.pinoy-business.com
2. Cesar L. Villanueva, B.S.C., L.L.B, LL.M, Revisiting Laws on Corporate Bankruptcy
3. Ruby Industrial Corp. v Court of Appeals G.R. No. 124185-87, 20 January 1998.
4. Rubberworld (Phils.), Inc. v. NLRC, G.R. No. 126773, 14 April 1999.
5. Balgos, Corporate Rehabilitation: Should Secured Creditors Queue?, 8 Phil. L. Gaz. 1 6.
6. Viva Shipping Lines vs. Keppel Philippines Mining, Inc. et. al., G.R. No. 177382, February 17, 2016.
7. Bank of the Philippine Islands v. Sarabia Manor Hotel Corp. ( G.R. No. 175844, July 29, 2013)
8. “P2.2 trillion in losses: Cost of COVID-19 impact on PH economy”, Ben O. de Vera, Philippine Daily Inquirer, May 28, 2020