INSOLVENCY IN THE PHILIPPINES

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1 Quisumbing Torres XV. INSOLVENCY IN THE PHILIPPINES 1. Overview and Introduction to the Jurisdiction / Applicable Legislation There are three types of remedies available to a financially distressed individual or juridical person, to wit, suspension of payments, corporate rehabilitation, and insolvency. The applicable laws are the Civil Code of the Philippines ( Civil Code ), the Insolvency Law, Presidential Decree No. 902-A ( P.D. 902-A ), and the Rules of Procedure on Corporate Rehabilitation. The type of proceeding that applies to a debtor depends on the particular relief sought. If what is sought is merely a little financial breathing space, then the remedy is a suspension of payments, which provides for the deferment of payments and temporary protection against actions/executions by unsecured creditors. If, on the other hand, the rehabilitation of a company entails more radical measures such as changes in organization, management, and/or strategy, and requires temporary protection against both secured and unsecured creditors, then the remedy is to seek corporate rehabilitation. Finally, if the debtor company is no longer capable of or interested in maintaining its business, it may apply for insolvency and have its assets distributed accordingly among its various creditors. Each of these remedies is discussed in more detail below. 2. Proceedings for Solvent Debtors (Individuals or Corporations) 2.1 Suspension of Payments An individual debtor who possesses sufficient property to cover all of his/its debts but foresees the impossibility of meeting them when they respectively fall due, may file a petition with a Philippine Regional Trial Court (the Court ) to be declared in a state of suspension of payments. The petition must be filed with the Court of the place where the debtor has his/its residence within six months prior to the filing of the petition. a. Effects of a Petition for Suspension of Payments The filing by a debtor of a petition for suspension of payments: i. Suspends all pending executions against the debtor s properties, except executions against properties specially mortgaged; ii. iii. Bars ordinary creditors from instituting proceedings in any Philippine court against the debtor; and Prohibits the debtor from disposing of his property or making payments, except in the ordinary course of the business in which the debtor is engaged. b. Court Proceedings The petition for suspension of payments must include a Schedule of Creditors, a statement of the debtor s assets and liabilities, and the debtor s proposed agreement for the suspension of payments. The proposed agreement must be approved by two thirds (2/3) of the creditors representing at least three fifths (3/5) of the debtor s total liabilities. If the required vote is not achieved, the proceeding is terminated and the creditors may enforce their respective credits. If the required vote is achieved without any objection from the creditors, the Court will issue an order that the proposed agreement be carried out, and such 38

2 Doing Business in Philippines 2009 agreement shall be binding on all creditors that have been properly summoned and included in the Schedule of Creditors. If the required vote is achieved but there is an objection from any of the creditors, the Court will conduct a hearing on the objection. If the objection is found to be meritorious, the proceeding will terminate. If the objection is found to be unmeritorious, the Court will proceed as though no objection had been made. The amount of the debts of the debtor is not affected by a suspension of payments. However, the payment for such debts is delayed. c. Objections to the debtor s proposed agreement The possible grounds for objecting to the proposed agreement are as follows: i. defects in the call for the meeting of the creditors, in the holding thereof, and in the deliberations thereat, which prejudice the rights of the creditors; ii. fraudulent connivance between one or more creditors and the debtor to vote in favor of the proposed agreement; iii. fraudulent conveyance of claims for the purpose of obtaining the required majority. If the debtor fails wholly or in part to perform the Court-approved agreement, the rights which the creditors had against the debtor before the agreement shall re-vest in them. 2.2 Corporate Rehabilitation A debtor, which is a corporation, partnership, or association, that foresees the impossibility of meeting its debts when they respectively fall due, or any creditor or creditors holding at least 25 percent of such debtor s total liabilities, may petition the proper Court to have the debtor placed under rehabilitation. The petition for rehabilitation must be filed with the Court of the place where the debtor s principal office is located. The petition for rehabilitation must be accompanied by, among others, a rehabilitation plan. a. Effects of a Petition for Rehabilitation If the Court finds the petition to be sufficient in form and substance, it will, not later than five days from the filing of the petition, issue a Stay Order which, among others: (a) appoints a Rehabilitation Receiver; (b) stays the enforcement of all claims, whether for money or otherwise and whether such enforcement is by court action or otherwise, against the debtor, its guarantors and sureties not solidarily liable with the debtor; (c) prohibits the debtor from selling, encumbering, transferring, or disposing in any manner any of its properties except in the ordinary course of business; (d) prohibits the debtor from making any payment of its liabilities outstanding as at the date of filing of the petition; (e) prohibits the debtor s suppliers of goods or services from withholding supply of goods and services in the ordinary course of business for as long as the debtor makes payments for the services and goods supplied after the issuance of the stay order; (f) directs the payment in full of all administrative expenses incurred after the issuance of the Stay Order; and (g) sets an initial hearing on the petition, and directs all creditors and interested parties to file their verified comments on or oppositions to the petition before the said initial hearing. The Stay Order applies to both secured and unsecured creditors. The Stay Order is effective from the date of its issuance until the dismissal of the petition or the termination of the rehabilitation proceeding. 39

3 Quisumbing Torres b. Court proceedings If, after the initial hearing on the petition for rehabilitation, the Court is satisfied that there is merit in the petition, it will give due course to the petition and refer the same to the Rehabilitation Receiver. The Rehabilitation Receiver will evaluate the rehabilitation plan and submit his recommendations to the Court not later than 120 days from the date of the initial hearing. The petition will be dismissed if no rehabilitation plan is approved by the Court upon the lapse of 180 days from the date of the initial hearing. The Court may extend this period only if it appears by compelling evidence that the debtor may successfully be rehabilitated. However, the period for approving or disapproving a rehabilitation plan may not exceed 18 months from the date of filing of the petition. The Court may approve a rehabilitation plan even over the opposition of creditors holding a majority of the total liabilities of the debtor if, in its judgment, the rehabilitation of the debtor is feasible and the opposition of the creditors is manifestly unreasonable. The Court may impose such terms, conditions, or restrictions as the effective implementation and monitoring of the rehabilitation plan may reasonably require, or for the protection and preservation of the interests of the creditors should the plan fail. On motion by a party or on its own, within 90 days from the approval of the rehabilitation plan, the Court may revoke the approval thereof on the ground that the same was secured through fraud. c. Clawback provisions Upon motion by a party or on its own, the Court may declare void any transfer of property or any other conveyance, sale, payment, or agreement made in violation of the Court s Stay Order or in violation of the Rules on Corporate Rehabilitation. d. Effects of an approved rehabilitation plan on prior agreements between the debtor and creditor(s) Contracts and other arrangements between the debtor and its creditors will continue to be effective to the extent that these contracts and other arrangements do not conflict with the approved rehabilitation plan. In a recent decision involving a creditor s security agreement with a debtor under rehabilitation, the Supreme Court of the Philippines ruled that a Stay Order and an approved rehabilitation plan merely suspend the enforcement of the security, and do not prejudice the status of the secured creditor vis-à-vis the unsecured creditors. 3. Insolvency Proceedings (Individuals or Corporations) In insolvency proceedings, the basic premise is that the debtor does not have enough assets/properties to cover his obligations. Insolvency proceedings may be voluntary or involuntary. 40

4 Doing Business in Philippines Voluntary Insolvency A debtor owing debts exceeding Ph P1,000 (approx. US $25) may seek a declaration of insolvency. a. Court Proceedings The petition for voluntary insolvency must be filed in the Court of the place where the debtor has resided (in case of an individual) or has had its principal office (in case of a corporation, partnership or association) for six months preceding the filing of the petition. The petition must allege, among others, the debtor s inability to pay all his/its debts in full; his/its willingness to surrender all his/its property, estate, and effects not exempt from execution for the benefit of the creditors; and an application to be adjudged insolvent. The debtor must also include in the petition a schedule of debts and of creditors, and an inventory of all his/its assets. The filing of the petition is deemed an act of insolvency. If the debtor is a corporation, the petition may be filed by any officer of the corporation, duly authorized by the board of directors. Upon the filing of the petition, the court will issue an order declaring the debtor insolvent. 3.2 Involuntary Insolvency Three or more creditors whose total credits exceed Ph P1,000 (approx. US $25) may seek a declaration of insolvency against a debtor. The creditors must be Philippine residents whose credits accrued in the Philippines, and did not become creditors by assignment within 30 days prior to the filing of the petition. a. Court Proceedings The petition for involuntary insolvency must be filed in the Court of the place where the debtor resides or has his/its principal place of business, and must be verified by at least three of the petitioners. The petition must also allege one or more acts of insolvency. The petition must be accompanied by a bond, in such sum as the Court will direct, conditioned upon the payment to the debtor of all costs and damages occasioned by the proceedings in insolvency if the petition is dismissed by the Court, or withdrawn by the petitioners, or if the debtor is not declared insolvent. The Court may, upon motion, direct the filing of an additional bond when deemed necessary. The Court will require the debtor to show cause why he/it should not be declared insolvent. If the Court finds the petition meritorious, the Court will issue an order declaring the debtor insolvent. 3.3 Provisions applicable to both voluntary or involuntary insolvency proceedings a. Effect of Order of Insolvency An Order of Insolvency generally suspends all civil proceedings pending against the debtor. 41

5 Quisumbing Torres All property of the insolvent not exempt by law from execution will be conveyed to an assignee-in-insolvency elected by the creditors. By way of exception, the debtor s property that is subject of a pledge or mortgage is not included in the debtor s assets that are assigned to the assignee-in-insolvency for the satisfaction of the debtor s general creditors. No discharge is granted to a corporation that is declared insolvent. b. Rights of secured creditors A creditor whose credit is secured by a mortgage or pledge is allowed, at its option, either (i) to foreclose the property subject of such security arrangement (notwithstanding the stay effected by the Order of Insolvency), or (ii) to pursue his/its claim in the insolvency proceeding together with other creditors, by releasing or surrendering to the assignee-in-insolvency the properties subject of the pledge or mortgage. If the secured creditor opts for foreclosure, such creditor cannot participate in the election of the assignee-in-insolvency. But the creditor may be admitted in the insolvency proceeding to recover the balance of the debt, after deducting the value of the property foreclosed. The creditor recovers the balance by participating in the pro-rata distribution of the debtor s estate. If the creditor pursues his claim in the insolvency proceeding, he may recover his credit by participating in the pro-rata distribution of the debtor s estate, but will have to relinquish his security and surrender the properties subject of the security to the assignee-in-insolvency. c. Preference of Credits In an insolvency proceeding, certain types of credits enjoy preference with respect to specific movable or immovable properties ( Special Preferred Credits ). Among the Special Preferred Credits, taxes and assessments due upon the property to which the claims relate enjoy absolute preference. All the remaining classes of Special Preferred Credits with respect to specific movable or immovable property (e.g., credits secured by a pledge or mortgage) do not enjoy priority among themselves, but must be paid concurrently and pro rata, i.e., in proportion to the amount of the respective credits. Credits that do not enjoy any preference with respect to specific property are satisfied in the order established in Article 2244 of the Civil Code. Article 2244 provides for the preference of certain claims and credits which, without special privilege, appear in (i) a public instrument (i.e., the instrument is notarized) or (ii) a final judgment. These credits have preference among themselves in the order of priority of the dates of the instruments and of the judgments, respectively. 42

6 Doing Business in Philippines 2009 d. Clawback provisions The assignee-in-insolvency may recover property given as security, or the value thereof, if the debtor, being insolvent, or in contemplation of insolvency, within 30 days before the filing of a petition to be declared insolvent by or against him, procures any of his property to be attached, sequestered, or seized on execution, or makes any pledge, mortgage, assignment, transfer, sale, or conveyance thereof to anyone with a view to: (i) giving a preference to any creditor or person having a claim against him; or (ii) preventing the property from being distributed ratably among his creditors; or (iii) defeating the object of, or in any way hindering, impeding, or delaying the operation of the provisions of the Insolvency Law. In such a case, the attachment, sequestration, seizure, pledge, mortgage, transfer, sale, assignment, or conveyance is considered void. Under the Insolvency Law, if the pledge, mortgage, conveyance, sale, assignment, or transfer of the property is not made in the usual and ordinary course of business of the debtor, or if such seizure is made under a judgment which the debtor has confessed or offered to allow, that fact is deemed as prima facie evidence of fraud. Furthermore, any pledge, mortgage, conveyance, sale, assignment, or transfer of property made by the insolvent within one month before the filing of a petition in insolvency by or against him, except for a valuable pecuniary consideration made in good faith, is considered void. 43