“The insolvency of individuals” by John M. Ryan (Jul 19, 2010)

Business World (07/19/2010)

Back in the 1800s, American philosopher Ralph Waldo Emerson remarked, “It is said that the world is in a state of bankruptcy, that the world owes the world more than the world can pay.” This simply says that the inability of individuals to repay debts is as old as humanity itself. Debtors have been legally dealt with at least in the past 500 years, so much so that the amount of debts incurred in history may, in fact, surpass the resources of the world. Nonetheless, creditors will always want to recoup some, if not all, their losses.

In the Philippines, the century-old Insolvency Law has been updated in the Financial Rehabilitation and Insolvency Act (FRIA) of 2010. The latest version of FRIA was endorsed on July 7 to President Benigno Aquino III for signature. Unless approved sooner, the bill will lapse into law on Aug. 6.

In a previous article in this column, I commented on the FRIA’s provisions on the rehabilitation and liquidation of corporations. In this article, I will comment on the sections that pertain to insolvency of individuals.

The issues involving individuals in a bankruptcy process are not complicated and, instead of overburdening the courts with individuals going bankrupt, I believe that consideration should be given to allow for the processes to be delegated to persons such as a bankruptcy administrator.

Suspension of payments

The FRIA provides that individuals who have sufficient assets to cover liabilities may file for suspension of payments. This should help those individuals who cannot meet their liabilities as they fall due and allow them to put their financial lives back in order.

When the individual files for suspension of payments, he must present listings of assets and liabilities and a proposed agreement with his creditors. The stay provided by the court is automatically lifted when the proposed agreement is rejected or when no agreement is reached with the creditors within three months.

Under the FRIA, properties held by a secured creditor will not be subject to the suspension order. This provision will make it difficult for a debtor who owns a small business from carrying on. I recommend that consideration be made for a stay of a secured creditor where the asset secured is needed to continue the operation of the business.

A meeting of creditors must be held not less than 15 days but not more than 40 days from the date of the suspension order and be attended by creditors holding more than 3/5 of the liabilities of the individual. At the meeting, 2/3 of the creditors representing at least 3/5 of total liabilities must approve the proposed agreement. If the required number of creditors does not attend or if the required majority of creditors does not vote in favor of the proposed agreement, it is deemed rejected.

No creditor who incurred his credit within 90 days prior to filing is entitled to vote. I cannot rationalize this provision. Creditors who continually supply credit to individuals would likely be most affected. These same creditors would likely know the individual best for purposes of assessing the capability of the debtor to pay under the proposed agreement.

The FRIA provides that failure by the debtor to perform on the agreement causes all rights that the creditors had at the pre-filing of the petition to revest in them.

Voluntary liquidation

An individual with debts exceeding P500,000 may apply for discharge of his obligations, provided that his assets are not sufficient to cover his liabilities. On filing, the individual must provide a schedule of assets and liabilities and an inventory of assets. These assets will be liquidated by a liquidator as in corporate liquidation and the proceeds used to pay creditors. There appear to be no provisions at this time to prevent abuses by debtors going bankrupt more than once. Credit card companies may need to address their aggressive issuance of credit cards due to the ease by which a person can build up credit and quickly go bankrupt to wipe out debts. Some consideration should be given in specific circumstances to provide for a discharge which is conditional on payment of a specific amount to creditors depending on the income level of the individual going bankrupt.

Involuntary liquidation

Any creditor or group of creditors with a claim or aggregate claim of at least P500,000 on an individual may file a petition for liquidation in the province or city where the debtor resides. The petitioning creditor must post a bond the court will set. If the petition is dismissed or withdrawn by the petitioner, the creditor will pay the costs and damages incurred by the debtor including his legal costs.

Upon filing the petition, the court will issue an order requiring the debtor to show cause why he should not be judged insolvent. Upon showing good cause, the court will issue a further order forbidding the debtor to pay liabilities and transferring assets. If, after trial, the court finds in favor of the creditors, it will issue the liquidation order.

The FRIA provides that when the liquidation order is issued, the sheriff must take control of the assets of the bankrupt individual. It would more efficient if in the petition there are nominated parties to act as liquidator to take possession of the assets for administration. In practice, these could be professionals who could be identified to carry out this type of service and potentially be licensed to perform such services

The purpose of the FRIA is to allow an honest person — but unfortunate debtor — to obtain a discharge from his debts in order to reintegrate himself into the business life of the country as a useful citizen. The FRIA provides for the orderly and fair distribution of the property of the debtor on a pari passu (equally and with no preference) basis. Hopefully, there will be a continued review of FRIA in the 15th Congress to allow for these processes to run efficiently and to prevent abuses.

(John M. Ryan is a managing director of Ernst & Young Transaction Advisory Services, Inc.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.