A 21st-century make-over of the 1909 Insolvency Law pt.1 by John M. Ryan (March 1, 2010)

Business World (03/01/2010)

(First of two parts)

After a century and a great deal of effort, a new insolvency law, the Financial Rehabilitation and Insolvency Act (FRIA) of 2010, is close to being enacted. As of writing, the consolidated version of House Bill 7090 and Senate Bill 61 has yet to be transmitted to Malacañang.

The draft of the House of Representatives carries significant changes from the Insolvency Law of 1909 (Act No. 1956) and from the Rules on Corporate Rehabilitation issued by the Supreme Court in 2001, as amended in 2008. Following are some of the more salient changes:

There will now be three ways that a debtor can be rehabilitated, namely: (1) a court-supervised rehabilitation; (2) a pre-negotiated rehabilitation; and (3) an out-of-court informal restructuring agreement. There are no significant changes to the administration of corporations in distress under a court-supervised and a pre-negotiated rehabilitation.

The inclusion of out-of-court settlements is a dramatic change. A standstill agreement among the parties and creditors holding more than 50% of debt can be achieved for up to 120 days in order to allow for negotiations. A notice is sent to all creditors inviting each to the negotiations. If at least 67% of secured creditors, 75% of unsecured creditors, and 85% of all creditors agree to the plan, then it is implemented among all creditors. The minimum required votes for all types of creditors must be obtained to impose the recovery plan despite opposition of other creditors and even stockholders. A creditor can, however, attempt to stay a plan’s implementation by getting a restraining order or injunctive relief. This form of rehabilitation also allows minimum disruption to the debtor’s business in order to provide better chances for rehabilitation.

A bank may accept an equity interest or investment in a debtor or its subsidiaries in satisfaction of debt. This equity ownership must not exceed the limits for universal banks under the General Banking Law and must be disposed of within five years. This gives more alternatives to reduce bank debt and its related carrying costs for the debtor, while providing the bank a potential upside from the rehabilitation of the debtor.

The debtor must now meet with its creditors making up three-fourths of its liabilities if the debtor is the petitioner; similarly the creditors must meet with the debtor if they are the petitioners. In his report to the Court, the rehabilitation receiver must state if both sides tried to reach a consensus. After the creditors’ meeting, the creditors may formally organize a committee by class, or as a body from each class, to serve as the primary liaison with creditors. The rehabilitation receiver will then be obligated to attend their meetings and provide assistance as later will be prescribed in procedural rules. This should open up communication with the rehabilitation receiver and help ensure that more trust is created with debtors and that more accurate, current information is relayed to creditors so they can make better-informed decisions.

The bill also provides that the debtor must make arrangements with a secured creditor to provide an alternate and equal level of security before selling assets subject to trust receipt or on consignment. Historically, these assets were sold by the debtor during the rehabilitation, with no funds going to the secured party or owner of the consigned goods. This provision will require debtors and creditors to plan a rehabilitation earlier to ensure that funds are available to continue operations, as parties holding trust receipts or goods on consignment will expect protection. This clause may cause banks who are term lenders to also provide the working capital borrowings through trust receipts. Such banks will then have a more controllable position in times of difficulty.

The debtor may elect to terminate or confirm existing contracts in rehabilitation. This provision will allow for the termination of onerous contracts that have likely been causing the corporation’s distress. The party whose contract is not confirmed by the debtor within 90 days following commencement of hearings will be allowed to include a claim for damages, which will be considered a demand against the debtor existing even prior to the petition for rehabilitation. Contracts confirmed by the debtor will continue to be in force, unless canceled or terminated for any ground provided by law. This provision may encourage parties holding onerous contracts with the debtor to renegotiate terms and avoid greater loss.
Any amount of indebtedness reduced or forgiven in connection with a plan shall not be subject to tax. This provision allows creditors to negotiate the reduction or forgiveness of debt, knowing there will be no tax on any amount reduced or forgiven.

Upon issuance of the Commencement Order by the Court, and during the period of rehabilitation, imposition of all taxes and fees, whether national or local, and the running of the period for penalties, interest and charges thereon shall be suspended, in furtherance of the objectives of rehabilitation.

(To be continued)

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.