CORPORATION LAW AND CORPORATE REHABILITATION

Grandfather rule

Basically, there two acknowledged tests in determining the nationality of a corporation: the
control test and the grandfather rule. Paragraph 7 of DOJ Opinion No. 020, series of 2005,
adopting the 1967 SEC Rules which implemented the requirement of the Constitution and other
Laws pertaining to the controlling interests in enterprises engaged in the exploitation of natural
resources owned by Filipino citizens, provides:

“Shares belonging to corporations or partnerships at least 60% of the capital of which is

owned by Filipino citizens shall be considered as of Philippine nationality, but if the
nationality of Filipino ownership in the corporation or partnership is less than 60%, only the
number of shares corresponding to such percentage shall be counted as a Philippine
nationality.” This pertains to the stricter, more stringent grandfather rule.

Under the Liberal Control Test, there is no need to further trace the ownership of the 60% (or
more) Filipino stockholdings of the investing Corporation since a corporation which is at least
60% Filipino-owned is considered as Filipino.

Under the Strict Rule or Grandfather rule proper, the combined totals in the investing
corporation and the investee corporation must be traced (i.e., “grandfathered”) to determine
the total percentage of Filipino ownership. Moreover, the ultimate Filipino ownership of the
shares must be first traced to the level of the Investing Corporation and added to the shares
directly owned in the Investee Corporation.

Which of the two (2) tests must be applied?

A perusal of the deliberations in the Records of 1986 Constitutional Commission reveals that
the Grandfather rule must be applied in cases where corporate layering, as in the case, is
present. When the 60-40 Filipino-foreign equity ownership is in doubt, the grandfather rule
must be applied.

Note: Please read: Narra Nickel Mining and Development Corp. vs. Redmont Consolidated
Mines Corp., 722 SCRA 382, April 21, 2014.

Rules on Merger

Merger is a re-organization of two or more corporations that results in their consolidating into a
single corporation, which is one of the constituent corporations, one disappearing or dissolving
and the other surviving. To put it another way, merger is the absorption of one or more
corporations by another corporation, which retains its identity and takes over the rights,
privileges, franchises, properties, claims, liabilities and obligations of the absorbed
corporation(s). The absorbing corporation continues its existence while the life or lives of the
other corporation(s) is or are terminated.

The Corporation Code requires the following steps for merger or consolidation:
1. The board of each corporation draws up a plan of merger or consolidation. Such plan
must include any amendment, if necessary, to the articles of incorporation of the
surviving corporation, or in case of consolidation, all the statements required in the
articles of incorporation of a corporation.
2. Submission of plan to stockholders or members of each corporation for approval. A
meeting must be called and at least two (2) weeks’ notice must be sent to all
stockholders or members personally or by registered mail. A summary of the plan must
be attached to the notice. Vote of two-third of the members or of stockholders
representing two-thirds of the outstanding capital stock will be needed. Appraisal rights,
when proper, must be respected.
3. Execution of the formal agreement, referred to as the articles of merger or
consolidation, by the corporate officers of each constituent corporation. These take the
place of the articles of incorporation of the consolidated corporation, or amend the
articles of incorporation of the surviving corporation.
4. Submission of said articles of merger or consolidation to the SEC for approval.
5. If necessary, the SEC shall set a hearing, notifying all corporations concerned at least
two weeks before.
6. Issuance of certificate of merger or consolidation.

A merger does not become effective upon the mere agreement of the constituent corporations.
All the requirements specified in the laws must be complied with in order for merger to take
effect.

Note: Please read: Bank of Commerce vs. Radio Philippine Network, Inc., 722 SCRA 520, April
21, 2014.

De facto merger

A de facto merger can be pursued by one corporation acquiring all or substantially all of the
properties of another corporation in exchange of shares of stock of the acquiring corporation.
The acquiring corporation would end up with thebusines enterprise of the target corporation;
whereas, the target corporation would end up with basically its only reaming assets being the
shares of stock of the acquiring corporation.

Winding up period: three years from corporation dissolution

Corporate liquidation – Every corporation whose charter expires but its own limitation or is
annulled by forfeiture or otherwise, or whose corporate existence for other purposes is
terminated in any other manner, shall nevertheless be continued as a body corporate for three
years after the time when it would have been so dissolved, for the purpose of prosecuting, and
defending suits by or against it and enabling it to settle and close its affairs, to dispose of and
convey its property and to distribute its assets, but not for the purpose of continuing the
business for which it was established.

At any time during said three (3) years, said corporation is authorized and empowered to
convey all of its property to trustees for the benefit of stockholders, members, creditors, and
other persons in interest. From and after any such conveyance by the corporation of its
property in trust for the benefit of its stockholders, members, creditors and others in interest,
all interest which the corporation had in the property terminates, the legal interest vests in the
trustees, and the beneficial interest in the stockholders, members, creditors or other persons in
interest.

Upon winding up of the corporate affairs, any asset distributable to any creditor or stockholder
or member who is unknown or cannot be found shall be escheated to the city or municipality
where such assets are located.

Except by decrease of capital stock and as otherwise allowed by the Code, no corporation shall
distribute any of its assets or property except upon lawful dissolution and after payment of all
its debt and liabilities.

Note: Please read: Alabang Development Corp. vs. Alabang Hill Village Association, 724 SCRA,
June 2, 2014.

Approval of a corporation’s rehabilitation plan: substantive considerations.

Recognizing the volatile nature of every business, the rules on corporate rehabilitation have
been crafted in order to give companies sufficient leeway to deal with debilitating financial
predicaments in the hope of restoring or reaching a sustainable operating form if only to best
accommodate the various interests of all its stakeholders, may it be the corporation’s
stockholders, its creditors and even the general public. In this light, case law has defined
corporate rehabilitation as an attempt to conserve and administer the assets of an insolvent
corporation in the hope of its eventual return from financial stress to solvency. It contemplates
the continuance of corporate life and activities in an effort to restore and reinstate the
corporation to its former position of successful operation and liquidity. Verily, the purpose of
rehabilitation proceedings is to enable the company to gain a new lease on life and thereby
allow creditors to be paid their claims from earnings. Thus rehabilitation shall be undertaken
when it is shown that the continued operation of the corporation is economically more feasible
and its creditors can recover, by way of the present value of payments projected in the plan,
more, if the corporation continues as a going concern than if it is immediately liquidated.

Note: Please read:

1) Express Investments III Private Ltd. vs. Bayan Telecommunications, Inc., G.R. Nos.
174457-59, Dec. 5, 2012, 687 SCRA 50, 86-87.
2) BPI vs. Sarabia Manor Hotel Corp., G.R. No. 175844, July 29, 2013.
Feasibility of rehabilitation

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 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 the stakeholders, then it may be said
that rehabilitation would not be feasible. In such case, the rehabilitation court may convert the
proceedings into one for liquidation.

Note: Please read: Wonder Book Corporation vs. Philippine Bank of Communications, G.R. No.
187316, July 16, 2012, 676 SCRA 489.

Rehabilitation is available to a corporation (which), while illiquid, has assets that can generate
more case if used in its daily operations than sold. Its liquidity issues can be addressed by a
practicable business plan that will generate enough cash to sustain daily operations, has a
definite source of financing for its proper and full implementation, and anchored on realistic
assumptions and goals.

This remedy should be denied to corporations whose insolvency appears to be irreversible and
whose sole purpose is to delay the enforcement of any of the rights of the creditors, which is
rendered obvious by the following:

a. The absence of a sound and workable business plan;

b. Baseless and unexplained assumptions, targets and goals;
c. Speculative capital infusion or complete lack thereof for the execution of the
business plan;
d. Cash flow cannot sustain daily operations; and
e. Negative net worth and the assets are near full depreciation or fully depreciated.

Tests in determining whether a controversy is intra-corporate

Initially, the main consideration in determining whether a dispute constitutes an intra-

corporate controversy as limited to a consideration of the intra-corporate relationship existing
between or among the parties.
The types relationships embraced under Section 5(b) were as follows:

a. Between the corporation, partnership or association and the public;

b. Between the corporation, partnership, or association and its stockholders, partners,
members, or officers;
c. Between the corporation, partnership, or association and the State as far as its
franchise, permit or license to operate is concerned; and
d. Among the stockholders, partners or associates themselves.

The existence of any of the above intra-corporate relations was sufficient to confer jurisdiction
to the SEC (now the RTC), regardless of the subject matter of the dispute. This came to be
known as the “relationship test”.

Note: Please read: Reyes vs. RTC of Makati, Branch 142, G.R. No. 165744, Aug. 11, 2008, 361
SCRA 593.

However, in the 1984 case of DMRC Enterprises vs. Esta del Sol Mountain Reserve, Inc., the
court introduced the nature of the “controversy test. We declared in this case that it is not the
mere existence of an intra-corporate relationship that gives rise to an intra-corporate
controversy, to rely on the relationship test alone will divest the regular courts of their
jurisdiction for the sole reason that the dispute involves a corporation, its directors, officers, or
stockholders. We saw that there is no legal sense in disregarding or minimizing the value of the
nature of the transactions which gives rise to the dispute.

Under the nature of controversy test, the incidents of that relationship must also be considered
for the purpose of ascertaining whether the controversy itself is intra-corporate. The
controversy must not only be rooted in the existence of an intra-corporate relationship, but
must as well pertain to the enforcement of the parties’ correlative rights and obligations under
the Corporation Code and the internal and intra corporate regulatory rules of the corporation.
If the relationship and its incidents are merely incidental to the controversy or if there will still
be conflict even if the relationship does not exist then no intra-corporate controversy exists.