A capital market-friendly insolvency law

On Oct.  22, 2013, the Financial Rehabilitation (FR) rules of procedure went into effect.

The FR rules were promulgated by the Supreme Court to implement the Financial Rehabilitation and Insolvency Act of 2010 (Fria).

Fria replaced our more than century-old Insolvency Act of 1909.

Not known to many, the Fria and FR rules contain several provisions that are envisioned to help develop our capital markets.

Faster rehabilitation proceedings

The Fria and FR rules mandate a faster rehabilitation proceeding for debtors including listed companies and market participants such as clearing and settlement companies, stockbrokers, underwriters, stock transfer agents and similar entities.

For the traditional court-supervised rehabilitation, the rehabilitation court is mandated to decide on the matter not later than one year from the filing of the rehabilitation case.

For pre-negotiated rehabilitation, the maximum period is 120 days from the filing of the petition. If the court fails to approve the rehabilitation plan within the said period, the plan is deemed approved.  This mode of rehabilitation can be utilized if the debtor can secure the consent of its creditors representing two-thirds of its total liabilities.

Most importantly, the Fria and FR rules authorize out-of-court rehabilitation if the debtor is able to obtain the approval or consent of its creditors representing 85 percent of its total liabilities. The restructuring or rehabilitation plan does not need court approval to be effective. It is binding on all creditors of the debtor under rehabilitation, including non-participating and objecting creditors.  Court intervention is necessary only if it is needed to enforce the terms of the plan.

Exemptions from the suspension order

The suspension order is an essential part of the commencement order that is issued by the court to signal the start of the rehabilitation proceedings. It suspends the enforcement of all claims, in court or otherwise, against the debtor under rehabilitation.

Fria specifically exempts from the coverage of the stay order the clearing and settlement of financial transactions through clearing agencies duly authorized by the regulatory agencies. For example, if a debtor sells listed stocks through the Philippine Stock Exchange (PSE) and a suspension order is issued in its favor during the 3-day clearing period for the trade, the transaction will still be cleared and must be settled despite the issuance of the stay order. The same holds true for listed bonds sold by the company through the fixed income exchange.

This means that the debtor company will still be obliged to deliver the shares and bonds it sold through the exchanges, which ordinarily cannot be enforced by the buyers against the debtor during the rehabilitation proceeding were it not for the exemption specifically provided for by the Fria and FR rules.

Similarly exempted from the stay order are cases filed by clients or customers to recover securities or money entrusted to market participants (e.g., a stock transfer agent) in the event of rehabilitation proceedings filed in respect of the latter. This is an express recognition that the clients’ money or securities in the possession of the market participants are not part of the assets and, therefore, immediately recoverable by the clients despite the fact that the market participant is under rehabilitation.

Also exempted from the suspension order are criminal cases filed against the directors and officers of listed companies and market participants for fraud committed against the investing public. For example, if a company commits insider trading or manipulation to the prejudice of the investing public, and a criminal case is filed against the responsible directors and officers of the company, the case will continue its natural course despite the issuance of the suspension order in favor of the company.

Likewise, if a director of a stock brokerage company runs away with the securities or money of its clients, a criminal case for estafa filed against the responsible directors and officers of the company will not be suspended despite the suspension order issued in favor of the company.

The suspension order also does not apply to the action of a licensed broker or dealer to sell pledged securities of a debtor pursuant to a securities pledge or margin agreement for the settlement of securities transactions.

Fria also exempts from the suspension order any form of action of market participants to reimburse themselves for any transactions settled for the debtor. For example, a broker may sometimes advance payments for clients in order to preserve the integrity and stability of financial transactions executed through the exchanges. If the broker does that and its client company goes under rehabilitation proceeding, any case filed by the broker against the client company to recover what it had paid on the company’s behalf will not be suspended despite the stay order issued in favor of the client company.

There are instances where a self-regulatory organization like the Philippine Stock Exchange (PSE) or the Philippine Dealing and Exchange Corp. (PDEx) will have to pay or settle the claims of clients of a market participant. A good example is the case of a stockbroker where the PSE can sell its seat or trading right in order to pay for its liabilities to its clients. The PSE has done this on several occasions in the past.  Such course of action, which is intended to protect the clients of the broker, is not suspended even if the broker files for a rehabilitation proceeding and secures a suspension order in its favor.

Priority of claims

Fria and FR rules also give absolute priority to claims of clients on trade-related assets of market participants in the event a liquidation proceeding is filed in respect of the latter. For example, if a stock transfer agent goes under liquidation in insolvency, its clients have priority over its assets that are used in the ordinary course of its business even vis-à-vis the mortgage creditors of the stock transfer agent.

Conclusion

The foregoing are a few examples how Fria can help develop our capital markets.

Hopefully, Fria—together with the other capital market-related laws such as the Real Estate Investment Trust Act, Personal Equity Retirement Account Act, Credit Information System Act and the documentary stamp tax exemption for the secondary trading of listed stocks that the PSE helped enact during my term as PSE president—will achieve this salutary objective.

(The author is a senior partner of the Angara Abello Concepcion Regala & Cruz Law Offices (Accralaw). The views in this column are, however, purely his own and should no way be attributed to Accralaw. He may be contacted through [email protected].)