Setting up of games servers is ‘doing business’

The Securities and Exchange Commission has ruled that the setting up of game servers in the Philippines by a foreign corporation constitutes “doing business,” which requires the foreign corporation to secure a license from the SEC.

The legal consequence of doing business in the Philippines without a license consists of criminal liability for violating the Corporation Code or, at least, depriving the foreign corporation from suing in the Philippines, although it can be sued before our courts or administrative tribunals.

Characterization test

There is no hard and fast rule in determining whether a certain foreign corporation is doing, transacting or engaging in business in the Philippines. The determination is done on a case-to-case basis.

The Supreme Court has, however, adopted the so-called “Twin Characterization Test” as to when a foreign corporation is considered to be “doing business” in the Philippines, to wit:

a.) The foreign corporation is maintaining or continuing in the Philippines the body or substance of the business or enterprise for which it was organized or whether it has substantially retired from it and turned it over to another; and

b.) The foreign corporation is engaged in activities which necessarily imply a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incidental to, and in progressive prosecution of, the purpose and object of its organization. (Mentholatum Co., Inc. v. Anacleto Mangaliman, G.R. No. 47701, 27 June 1941; B. Van Zuiden Bros., Ltd., v. GTVL Manufacturing Industries, Inc. (G.R. No. 147905, 28 May 2007).

The Foreign Investments Act has adopted, albeit in a more detailed manner, the foregoing standards (Section 3 (d), Republic Act No. 7042).

Setting up of game servers

The Office of the General Counsel of the SEC, in its Opinion No. 22-10, recently applied the Twin Characterization Test in ruling that the setting up of game servers in the Philippines by a foreign corporation is considered doing business.

Genibrain Co. Ltd., a Korean corporation based in Seoul, was licensed to offer various interactive games accessible through the Internet to players anywhere in the world. In pursuit of its business, Genibrain was planning to set up game servers physically located at the Philippines.

The servers would be connected to the Internet through the facilities provided by ePLDT Inc., a provider of co-location spaces and other manpower and technical services for the proper functioning of servers.

With respect to the first requisite of the Twin Characterization Test, the SEC found that the setting up of game servers may be considered as maintaining or continuing in the Philippines the body or substance of the business.

The SEC stated that “[a]lthough the setting up of servers does not involve the physical acts or transactions beyond the mere leasing of a specific portion of space in the Philippines to accommodate these servers, these servers shall act as memory storage where the e-game software and related data are stored. In effect, Genibrain will use the servers to store various data relative to the games that it will advertise online, making it a vital component of Genibrain’s online business.”

With regard to the second requisite, the SEC stated that these servers will be in continuous operation while being physically present in the Philippines. The continued presence of these servers in the Philippines was construed by the SEC to mean that Genibrain is engaged in activities which necessarily imply a continuity of commercial dealings.

The SEC stated that “while there are no physical activities because the transactions appear to be processed and consummated in a virtual plane, the physical presence of these servers in the Philippines is essential in the perfection of these online transactions.”

The SEC also observed that the purchase of games online creates earnings and direct profits for Genibrain, which games are then accessed using the game servers located at the Philippines.

Consequently, the SEC opined that Genibrain, by setting up servers that will have continuous presence and operation in the Philippines, is considered as doing business. Genibrain, therefore, must first obtain a license from the SEC.

Need to revisit the concept?

Without going into the issue of whether the opinion is correct, the SEC has effectively restricted the capability of our local companies to do business with foreign companies. A clear example is the case of our telecommunications companies and similar entities which, under the opinion, may not provide co-location services to foreign companies that do online business, unless these entities secure a license from the SEC. Of course, rather than going through the rigors of obtaining a license from our SEC, these foreign companies will just shy away from the Philippines and give their business to competing countries. Our local companies are thereby deprived of business opportunities from foreign countries and, in the process, the Philippine economy will lose millions (if not billions) of dollars of foreign remittances from this huge and increasing global business.

Another potential victim of the new opinion is the business process outsourcing (BPO) industry. Foreign companies outsource a portion of their operations to Philippine-based companies. Invariably, these operations are part of the “body or substance” of their business or at least normally incidental to, and in progressive prosecution of, their business. Given the way our BPO companies are normally set up, the foreign principals of our BPO companies should not be considered as doing business in the Philippines. However, there is no stopping our local plaintiffs from taking them to our local courts and other regulatory agencies for allegedly doing business in the Philippines without a license, especially with the propensity of some lawyers to file harassment suits in the name of protecting their clients. If such happens (God forbid!), the Philippines will be a less attractive investment destination for the BPO business.

In short, given modern-day developments in global business, the set of standards for determining doing business in the Philippines, a 1941 vintage, has become archaic.

Thus, there is a need to revisit them since an overly strict view will adversely affect the competitiveness of the Philippines as a business destination.

(The author, former president and CEO of the Philippine Stock Exchange, is now the Co-Managing Partner and head of the Corporate and Special Projects Department of Accralaw. He may be contacted through [email protected].)