Close Enough for Comity Philippine Rehabilitation Law and Philippine Airlines 304 Proceeding

Close Enough for Comity Philippine Rehabilitation Law and Philippine Airlines 304 Proceeding

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The Asian financial crisis has affected all of the countries in Asia and is imposing tremendous financial pressure on many companies located throughout the region. Due to the dire financial condition of many of these companies and the continuing negative impact that their collapse would have on the economy, many Asian countries such as Thailand and Indonesia have already enacted or are in the process of enacting new bankruptcy laws to allow for the rehabilitation of financially troubled companies, and are encouraging unstable companies to utilize these debt-restructuring laws.

By way of contrast, the Philippines has not needed to enact new bankruptcy legislation to assist rehabilitating troubled companies. Since 1909, Philippine law has provided the legal mechanism for their rehabilitation.2

This article provides a general overview of Philippine rehabilitation law and discusses an October 1998 decision in the §304 ancillary proceeding of Philippine Airlines (PAL) in which Bankruptcy Judge Thomas Carlson (N.D. Calif.) ruled that Philippine rehabilitation law is worthy of comity.

To date, the vast majority of §304 cases have dealt with liquidations because other countries have only recently adopted models similar to chapter 11. Now that more countries, including those within Asia, are allowing distressed corporations the opportunity to rehabilitate and restructure their indebtedness under court supervision, more foreign debtors with U.S. assets and operations will take advantage of the protections offered by §304 of the Code and commence an ancillary proceeding to assist in their restructuring efforts. PAL is one of the first such cases.

Historical Origins of Philippine Insolvency/Rehabilitation Laws

In 1909, the Philippine legislature enacted the Insolvency Law, Act No. 1956.3 In its current form, the law contains 13 chapters. They include Suspension of Payments (Chapter II), Voluntary and Involuntary Insolvency and Assignees (Chapters III, IV, V), Classification and Preference of Creditors (Chapter VI), Partnerships and Corporations (Chapter VII), Proof of Debts (Chapter VIII), Compositions (Chapter IX), Discharge (Chapter X), Fraudulent Preferences and Transfers (Chapter XI), Penal Provisions (Chapter XII) and Miscellaneous Provisions (Chapter XIII). The chapter of the Insolvency Law dealing with suspension of payments was modeled after similar provisions in the then-existing Spanish Code of Commerce. The remaining chapters of the Insolvency Law were modeled after similar provisions in the U.S. Bankruptcy Act of 1898 and the Insolvency Act of California of 1895. Supplementing the Insolvency Law are the Concurrence and Preference of Credits provisions of the Philippine Civil Code.4 Those provisions, in part, set forth the priority scheme of claims.

Role of the Philippine SEC

Prior to 1981, all petitions under the Insolvency Law, including petitions for the suspension of payments and corporate rehabilitation, were handled by Philippine trial courts. In 1981, then-Philippine president Marcos issued amended Presidential Decree 902-A (PD 902-A). Pursuant to that decree, the Philippine Securities and Exchange Commission (SEC) was vested with "original and exclusive jurisdiction to hear and decide cases involving...(d) petitions of corporations, partnerships or associations to be declared in the state of suspension of payments in cases where the corporation, partnership or association possesses property to cover all of its debts but foresees the impossibility of meeting them when they respectively fall due, or in cases where the corporation, partnership or association has no sufficient assets to cover its liabilities, but is under the Management Committee created pursuant to this decree."5

While PD 902-A did not expressly incorporate the Insolvency Law, the Philippine SEC and courts in some instances have expressly adopted sections of the Insolvency Law and in other instances have used the Insolvency Law for guidance in reaching decisions. The Philippine SEC has adopted Policies and Procedures for Suspension of Payment Proceedings. Practice before the Philippine SEC is governed by the Amended Rules of Procedures of the Philippine SEC.6

Key Features of Philippine Corporate Rehabilitation Law

• Eligibility to File and Required Supporting Documents

Any corporation, partnership or association that "possesses sufficient property to cover all [its] debts" may commence a suspension of payment and corporate rehabilitation proceeding by filing a petition with the Philippine SEC.7 The petition must be accompanied by certain financial statements, a list of creditors, the amount of the claims, and whether the claims are admitted, contingent, unliquidated or disputed; a list of equity holders; and a list of assets stating the specific nature of each asset, as well as its book value, market value and location.

The petitions filed with the Philippine SEC and its annexes are served on all creditors. Creditors then have 20 days from receipt of the petition to submit "comments" to the petition.

• Hearing Panel and Appellate Review

When corporate rehabilitation cases commence, they are assigned to a three-person hearing panel. Final decisions, orders or rulings of a hearing panel are appealable to the Philippine SEC en banc, then to the Philippine Court of Appeal and finally to the Philippine Supreme Court.

• Rehabilitation Receiver or Management Committee

The Philippine SEC has the power to appoint a rehabilitation receiver or a management committee.8 The rehabilitation receiver may (a) "take custody of and control over all existing assets and properties" of the debtor; (b) "evaluate the [debtor's] existing assets and liabilities, earnings and operations;" (c) "determine the best way to salvage and protect the interest of the investors and creditors;" (d) review and evaluate the feasibility of continuing operations and rehabilitation; (e) report and be responsible to the Philippine SEC until the rehabilitation receiver is removed by the Philippine SEC; and (f) "overrule and revoke the actions of the corporation's previous management and board of directors notwithstanding any provision of law, articles of incorporation or bylaws to the contrary."9

• Stay of Actions and Motions for Relief from Stay

There is no automatic stay upon the commencement of the proceedings. A stay against actions on claims against a debtor is imposed only when a rehabilitation receiver or management committee is appointed.10 That stay applies to both secured and unsecured creditors.11 Creditors are entitled to seek relief from the stay by filing motions with the hearing panel of the Philippine SEC.12

• Right of Creditors to File Claims and Revocation of Executory Contracts

Creditors who disagree with the amount of their claims, as listed in the petition, are entitled to file claims with the rehabilitation receiver.13 Once such claims are filed, the rehabilitation receiver is obligated to review and consider such claims. The rehabilitation receiver then has the ability to challenge any claims for which there are disputes. Such disputes may then be resolved by the Philippine SEC. Section 55 of the Insolvency Law allows for the estimation of contingent or unliquidated claims.

The rehabilitation receiver has the right to revoke executory contracts.14 Any such revocation may be requested by way of a motion made to the hearing panel of the Philippine SEC or may be contained in the rehabilitation plan.

• Concurrence and Preference of Credits

The Concurrence and Preference of Credits, in part, sets forth the priority scheme of various types of claims. For example, Articles 2241 and 2242 of the Philippine Civil Code address which claims are entitled to preference with respect to "movable" and "immovable" property, respectively.15

• Rehabilitation Plans, Classification and Treatment of Claims and Voting

Generally it is the debtor that proposes the rehabilitation plan (which may accompany the petition but also may be filed later with Philippine SEC consent).16 The creditors and rehabilitation receiver are then entitled to comment on the plan either before or at the creditors' meeting. Voting on the plan takes place at the creditors' meeting.

In most cases, secured creditors are classified and treated separately from unsecured creditors (unless a secured creditor consents to joint classification and treatment). Likewise, secured creditors retain their liens to the extent they are secured. There is some debate in the Philippines whether secured creditors can opt out of rehabilitation plans. That issue has not yet been decided in any reported decision.

PD 902-A does not contain guidelines for voting on plans or the requisite number of votes to confirm a plan. Nevertheless, a review of the few cases in which confirmation was contested demonstrates that the Philippine SEC does require at least a majority of the creditors to accept the plan before it will be approved and, in at least one case, referenced the required voting amounts set forth in the Insolvency Law.17

• Preferences and Fraudulent Transfers

Section 70 of the Insolvency Law provides for the recovery of preferential transfers to creditors made within 30 days before the filing of the petition. It also allows for the recovery of fraudulent transfers. The Philippine SEC has ruled that this section applies to suspension of payment and corporate rehabilitation cases.

PAL's §304 Proceeding

PAL is the national airline of the Philippines. On June 19, 1998, it commenced a suspension of payments and corporate rehabilitation proceeding, and a rehabilitation receiver was appointed several days thereafter.

PAL's rehabilitation proceeding is the largest bankruptcy case ever filed in the Philippines. At the time of filing its bankruptcy case, PAL had more than 10,000 employees, more than 60 planes, and assets and liabilities each in excess of U.S. $2 billion.

In addition to its filing in the Philippines, on June 22, 1998, PAL filed a §304 ancillary petition (the first ever involving a Philippine debtor) in the Northern District of California. PAL's §304 petition was challenged by three of its U.S. creditors, including Boeing and General Electric. In their oppositions, these creditors contended that the Philippine SEC does not provide the creditors with the protections necessary for a U.S. bankruptcy court to grant comity and that the Philippine SEC is not bound by the Insolvency Law since PD 902-A does not expressly incorporate the Insolvency Law.

On October 30, 1998, following a two-day trial, Judge Carlson issued an unpublished memorandum decision in which he overruled the objections, granted the §304 petition and ruled that Philippine rehabilitation and insolvency law are worthy of comity.18 Judge Carlson found that "Philippine insolvency law provides creditors protections similar to those found under U.S. bankruptcy law and satisfies the criteria of §304(c)."19 After summarizing the salient features of Philippine rehabilitation law and analyzing the objections leveled at PAL's petition and the request for injunctive relief, Judge Carlson made the following observations:

No published decision states that the Philippine SEC is not bound by the Insolvency Act or Civil Code. Furthermore, having read every Philippine SEC and Philippine court decision submitted by the parties, I conclude that the Philippine SEC applies the Insolvency Act and the Civil Code with reasonable reliability and is not at all the lawless agency objecting creditors portray it to be.20

Import of the PAL Decision

The standards to determine whether comity under §304 should be accorded to a foreign proceeding, as set forth in the statute itself and in the reported decisions, are geared towards liquidations.21 No court has yet set forth any standards to be used in determining whether comity should be afforded to a foreign rehabilitation proceeding.

Judge Carlson's decision is quite important from the standpoint of international bankruptcy jurisprudence. It is the first time that a U.S. bankruptcy judge has granted comity in a §304 proceeding to the Philippine bankruptcy system. Beyond that important facet, Judge Carlson's decision is one of the first decisions under §304 to address comity in the context of a foreign corporate reorganization. Judge Carlson ruled that comity should be granted to a Philippine rehabilitation proceeding even though there may not be exact similarity between the U.S. system for reorganizing companies and the system within the Philippines. In Judge Carlson's view, as long as the foreign country's system for rehabilitating distressed companies is codified, provides fundamental fairness to creditors, does not discriminate on the basis of nationality and includes the basic concepts involved in all U.S. bankruptcy cases—such as a meeting of creditors, a stay against creditor actions, the right to be heard, the ability to file claims, a priority system for classifying and treating claims, and the ability to recover preferences and fraudulent transfers—that system should be afforded comity. It has yet to be seen whether other courts will follow Judge Carlson's analytical framework or create a new set of standards to determine whether comity should be accorded to a foreign proceeding involving the rehabilitation of a foreign corporation.


1 The views expressed herein are solely those of the author and are based, in part, upon a comprehensive review and study of Philippine bankruptcy law and consultation with Philippine lawyers and accountants. The views expressed herein may not be attributed to Brobeck, Phleger & Harrison LLP or any client of the firm. Return to article

2 There are several different groups within the Philippines studying possible bankruptcy reform legislation, including a group supported by the International Monetary Fund. However, as of press time, no such legislation has been proposed. Return to article

3 In 1898, the United States acquired the Philippines by treaty at the close of the Spanish-American War. From that point until 1946 (when the Philippines regained their independence), the United States exercised complete sovereignty over the Philippines. As required by then-existing U.S. law, the Insolvency Law was reported to the U.S. Congress, which took no action to amend or nullify the Insolvency Law. Return to article

4 Philippine Civil Code §§2236-2251. Return to article

5 PD 902-A, §5(d). Return to article

6 The Philippine SEC is currently drafting revised rules for suspension of payment and corporate rehabilitation cases. Return to article

7 See Insolvency Laws, §2. Return to article

8 PD 902-A, §§6(c), 6(d). Return to article

9 PD 902-A, §6(d). Return to article

10 See Alemar's Sibal & Sons Inc. v. Elbinias, 186 S.C.R.A. 94, 100 (1990). S.C.R.A. is the recognized abbreviation for "Supreme Court Reports Annotated," the leading reporter for decisions of the Philippine Supreme Court. Return to article

11 See Rizal Commercial Banking Corp. v. Intermediate Appellate Court, 213 S.C.R.A. 830, 838 (1992), and Bank of the Philippine Islands v. Court of Appeals, 229 S.C.R.A. 221, 228 (1994). Return to article

12 See Amended Rules of Procedure, Rule X, §3. Return to article

13 See, e.g., Alemar's Sibal & Sons Inc. v. Elbinias, 186 S.C.R.A., at 99-100. Return to article

14 See PD 902-A, §5(d); Figueroa v. Securities and Exchange Commission, 162 S.C.R.A. 689 (1988). Return to article

15 See State Investment House Inc. v. Court of Appeals, 277 S.C.R.A. 209, 211 (1997). In that case, the Philippine Supreme Court ruled that the Concurrence and Preference of Credits provisions apply to corporate rehabilitation cases under PD 902-A. Return to article

16 There are no exclusivity periods and, as a result, any party-in-interest could submit a competing plan at any time. The filing of competing plans has occurred in several cases. Return to article

17 There have been very few corporate rehabilitation cases in the Philippines since 1981 (when the Philippine SEC was vested with exclusive jurisdiction). There have been even fewer cases in which there was a true dispute over whether the requisite number of votes had been obtained and whether a plan should be confirmed. As a result, the case law on voting and confirmation of plans is almost non-existent. Return to article

18 Judge Carlson's decision may be obtained from the web page of the Northern District of California Bankruptcy Court at Return to article

19 Memorandum Decision, p. 5. Return to article

20 Memorandum Decision, p. 12. Return to article

21 See, e.g., Allstate life Ins. Co. v. Linter Group Ltd., 994 F.2d 996, 999 (2nd Cir. 1993). In Allstate, the Second Circuit set forth the standards to determine whether a foreign proceeding provides "fundamental fairness." Of the eight factors listed by the Second Circuit, two specifically reference "liquidators" and one refers to the distribution of assets. Return to article

Journal Date: 
Monday, February 1, 1999