Are the Interim Rules of Procedure on Corporate Rehabilitation (2000) Excessively Pro-Debtor?

An Examination of Corporate Reorganization in the Philippines and in the United States

By Atty. Juris Bernadette M. Tomboc

I. Introduction

Novel questions of interest to both bench and bar concern the correct interpretation and application of the Interim Rules of Procedure on Corporate Rehabilitation (2000; hereinafter “Interim Rules”) with respect to who must be given preference in the construction of the Interim Rules as between a distressed debtor and its creditors, as well as between secured and unsecured creditors of a distressed debtor.

The provisions of Chapter 11 of the United States Bankruptcy Code (Title 11) has been characterized as pro-debtor since they focus on the restructuring of debt obligations and rehabilitation of the debtor as compared for example to the German Insolvency Code which has been characterized as pro-creditor since the latter’s policy objective is to jointly satisfy creditors (Schwehr 2003).

Countries’ insolvency policies have likewise been classified by existing literature as to whether or not, and to what extent, priorities are given to specific creditors in case of insolvency by the debtor.

For example, the following countries have been characterized as adhering to the traditional approach of retaining wide preferential rights for certain creditors, i.e., pro-creditor: France, Spain, Ireland, Italy and South Africa; while the following countries have been characterized as having significantly reduced the level of priority by creditors, i.e., pro-debtor: the United States, New Zealand and the United Kingdom (Keay et al. 2001).

Off-hand the Interim Rules may be described as pro-debtor since their objective is the rehabilitation of a distressed debtor. However, are the Interim Rules also pro-debtor in the sense that they likewise reduce the level of security of claims by preferred creditors? If yes, to what extent do the Interim Rules diminish creditors’ security?

For a better understanding of the provisions of the Interim Rules, this study shall compare important aspects the reorganization process for insolvent or bankrupt creditors under Chapter 11 of the United States Bankruptcy Code with the equivalent provisions on rehabilitation proceedings under the Interim Rules. In the process, the study hopes to address the questions raised in the preceding paragraph concerning the proper interpretation of the Interim Rules and/or to recommend measures in order to assist in clarifying the latter.

II. History of Chapter 11 of the United States Bankruptcy Code

The Chapter 11 of the United States Code concerns corporate rehabilitation proceedings, including the restructuring of the obligations of a distressed debtor.

The United States government safeguards entrepreneurial liberty by providing a distressed debtor with a second chance at success by relieving it from the burden of its current obligations. The United States Supreme Court confirmed the role of bankruptcy procedure in its entrepreneurial system in Wetmore v. Markoe in 1904 (Schwehr 2003).

A. Equity receivership

The roots of the United States Bankruptcy Code can be traced back to the equity receivership proceedings in the late 19th century. Building of railroads across the United States entailed large capital expenditures that were much more than the material value of the rail tracks and trains. Thus, despite the railroads’ insolvency, it was more advantageous to creditors to keep or sell them as going concerns because it would have been difficult to liquidate their assets without destroying their usefulness (Schwehr 2003).

Under equity receivership, the court appoints a receiver to take charge of “selling” the business of the distressed debtor to a new corporation especially created for the purpose and composed by its creditors. The creditors participate in the new corporation in proportion to and in accordance with the nature of their claims against the debtor. The result of equity receivership was to transfer ownership of the business to its creditors (Schwehr 2003).

One of the major issues under equity receivership was that secured creditors preferred to negotiate with management for a low price for the sale so that they can take control of the business without necessarily making cash payments in addition to their claims. This may prejudice the interests of unsecured creditors since only secured creditors’ claims will be satisfied (Schwehr 2003).

Although courts may require a minimum price to protect the interests of unsecured creditors, they tended to keep the price low in order not to discourage secured creditors and other investors from pursuing the rehabilitation of the distressed debtor (Schwehr 2003).

The National Bankruptcy Act of 1898 replaced the receivership procedure with a reorganization procedure for bigger corporations and simpler debt arrangements for small businesses (Schwehr 2003).

In small businesses, the debtor must submit a plan for approval by the court with the consent by majority of the debts, i.e., pro capita, and of the total number of creditors. The court applied the best interest rule meaning that creditors in general should not be paid much less in reorganization than what they could reasonably expect to receive from the business in the normal course of the latter’s operations (Schwehr 2003).

B. The absolute priority rule

Equity receivership developed into the absolute priority rule defined as, viz.:

“The idea that creditors' claims take precedence over shareholders' claims in the event of a liquidation or reorganization. Shareholders are compensated only after debtors have been fully paid off” (investorwords.com).

“The absolute priority rule is the rule used in bankruptcy proceedings which states that creditors' claims take priority over shareholders' claims in the event of liquidation” (About.com).

The absolute priority rule generally means that a senior class must be paid or satisfied in full before a junior class, i.e., shareholders, may receive anything. It also requires the protection in both substantial and procedural law of claims by unsecured creditors (Schwehr 2003).

In North Pacific Railway Co. v. Boyd, the Supreme Court ruled that senior creditors are not allowed to unilaterally disregard claims by junior creditors. Likewise the “fair and equitable standard” prohibits senior creditors and management of the debtor corporation from negotiating on terms of sale of a business that would prejudice claims by junior creditors (Schwehr 2003).

III. Development of the Rules on Interim Corporate Rehabilitation in the Philippines

Section 5(d) of Presidential Decree No. 902-A (1976) vests in the Securities and Exchange Commission original and exclusive jurisdiction to hear and decide cases involving petitions for declaration in the state of suspension of payments, viz.:

“(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 sufficient property to cover all 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 of a Rehabilitation Receiver or Management Committee created pursuant to this Decree.”

Section 6(c) of Presidential Decree No. 902-A, as amended by Presidential Decree No. 1799 (1981) provides the Securities and Exchange Commission with the power to appoint a rehabilitation receiver, management committee, board or body, over the properties which are the subject of the action pending before the Commission in cases whenever necessary in order to preserve the rights of the parties-litigants and/or protect the interest of the investing public and creditors, viz.:

“In order to effectively exercise such jurisdiction, the Commission shall possess the following powers:

… c) To appoint one or more receivers of the property, real and personal, which is the subject of the action pending before the Commission in accordance with the pertinent provisions of the Rules of Court in such other cases whenever necessary in order to preserve the rights of the parties-litigants and/or protect the interest of the investing public and creditors: Provided, however, That the Commission may, in appropriate cases, appoint a rehabilitation receiver of corporations, partnerships or other associations not supervised or regulated by other government agencies who shall have, in addition to the powers of a regular receiver under the provisions of the Rules of Court, such functions and powers as are provided for in the succeeding paragraph d) hereof: Provided, further, That the Commission may appoint a rehabilitation receiver of corporations, partnerships or other associations supervised or regulated by other government agencies, such as banks and insurance companies, upon request of the government agency concerned: Provided, finally, That upon appointment of a management committee, rehabilitation receiver, board or body, pursuant to this Decree, all actions for claims against corporations, partnerships or associations under management or receivership pending before any court, tribunal, board or body shall be suspended accordingly.”

Further, Section 6(d) of Presidential Decree No. 902-A, as amended by Presidential Decree No. 1799 provides for the creation or appointment of a management committee, board or body, upon petition or motu propio, to undertake the management of corporations when there is imminent danger of dissipation, loss, wastage or destruction of assets or paralization of business operations which may be prejudicial to the interest of minority stockholders, parties-litigants or the general public, viz.:

“In order to effectively exercise such jurisdiction, the Commission shall possess the following powers:

… d) To create and appoint a management committee, board, or body upon petition or motu propio to undertake the management of corporations, partnerships or other associations not supervised or regulated by other government agencies in appropriate cases when there is imminent danger of dissipation, loss, wastage or destruction of assets or other properties of paralization of business operations of such corporations or entities which may be prejudicial to the interest of minority stockholders, parties-litigants or the general public: Provided, further, That the Commission may create or appoint a management committee, board or body to undertake the management of corporations, partnerships or other associations supervised or regulated by other government agencies, such as banks and insurance companies, upon request of the government agency concerned.

The management committee or rehabilitation receiver, board or body shall have the power to take custody of, and control over, all the existing assets and property of such entities under management; to evaluate the existing assets and liabilities, earnings and operations of such corporations, partnerships or other associations; to determine the best way to salvage and protect the interest of the investors and creditors; to study, review and evaluate the feasibility of continuing operations and restructure and rehabilitate such entities if determined to be feasible by the Commission. It shall report and be responsible to the Commission until dissolved by order of the Commission: Provided, however, That the Commission may, on the basis of the findings and recommendation of the management committee, or rehabilitation receiver, board or body, or on its own findings, determine that the continuance in business of such corporation or entity would not be feasible or profitable nor work to the best interest of the stockholders, parties-litigants, creditors, or the general public, order the dissolution of such corporation entity and its remaining assets liquidated accordingly. The management committee or rehabilitation receiver, board or body may overrule or revoke the actions of the previous management and board of directors of the entity or entities under management notwithstanding any provision of law, articles of incorporation or by-laws to the contrary.

The management committee, or rehabilitation receiver, board or body shall not be subject to any action, claim or demand for, or in connection with, any act done or omitted to be done by it in good faith in the exercise of its functions, or in connection with the exercise of its power herein conferred.”

Pursuant to the provisions of Presidential Decree No. 902-A, as amended by Presidential Decree No. 1799, the Securities and Exchange Commission approved the Rules of Procedure on Corporate Recovery which took effect on January 15, 2000.

However, on July 19, 2000, the Congress enacted the Securities Regulation Code, which transferred jurisdiction over cases enumerated under Section 5 of Presidential Decree No. 902-A from the SEC to regular courts and gave the Supreme Court the authority to designate appropriate Regional Trial Court branches for the said purpose.

Pursuant thereto, the Supreme Court promulgated in November 2000 the Interim Rules setting forth the procedures governing corporate rehabilitation. It also designated sixty-five regional trial courts as commercial courts to handle cases of this nature. The Interim Rules took effect on December 15, 2000.

It is interesting to note that Section 2, Rule 2 of the Interim Rules provides for a liberal construction thereof, viz.:

“Sec. 2. Construction. – These Rules shall be liberally construed to carry out the objectives of sections 5(d), 6(c) and 6(d) of Presidential Decree No. 902-A, as amended, and to assist the parties in obtaining a just, expeditious, and inexpensive determination of cases. Where applicable, the Rules of Court shall apply suppletorily to proceedings under these Rules.”

As mentioned in the Introduction, a question that may arise from a reading of Section concerns the extent of liberality in the construction of the Interim Rules in the context that the said Rules are may be construed as pro-debtor in general.

IV. Discussion of the provisions of the United States Bankruptcy Code and the Interim Rules of Procedure on Corporate Rehabilitation

A. Who may petition

1. Under Chapter 11 of the United States Code

A case under Chapter 11 of the United States Bankruptcy Code commences upon the filing of a petition, which may be voluntary, filed by the debtor, or involuntary, filed by creditors. The debtor usually initiates the reorganization proceedings under the through the filing of a voluntary petition (Schwehr 2003).

2. Under the Interim Rules

Section 1, Rule 4 of the Interim Rules provides that the rehabilitation petition may be filed by any debtor who foresees the impossibility of meeting its debts when they fall due or by any creditor or creditors holding at least twenty-five percent (25%) of the debtor’s total liabilities. Section 1 provides viz.:

“Section 1. Who May Petition. - Any debtor who foresees the impossibility of meeting its debts when they respectively fall due, or any creditor or creditors holding at least twenty-five percent (25%) of the debtor's total liabilities, may petition the proper Regional Trial Court to have the debtor placed under rehabilitation.”

B. Parties to the proceeding

1. Under Chapter 11 the United States Bankruptcy Code

Under Chapter 11 of the United States Bankruptcy Code, judges are provided flexibility and space for interpretation in naming parties aside from the debtor, trustee, all committees, all creditors and equity security holders who should participate in the procedure (Schwehr 2003).

The debtor remains in possession of his property and is allowed to operate the bankrupt business during the bankruptcy proceedings, unless and until the court orders the appointment of a trustee (Schwehr 2003).

Chapter 11 of the Bankruptcy Code provides for the appointment of a U.S. trustee. The U.S. trustee supervises the administration of bankruptcy cases with the purpose of relieving the bankruptcy court from certain administrative duties, especially oversight functions (Schwehr 2003).

Aside from the U.S. trustee, a trustee may be appointed by the court to run the business (Schwehr 2003).

In addition, a party in interest or a U.S. trustee may request for the appointment of an examiner. The examiner does not replace the debtor in possession but simply investigates cases of fraud, dishonesty, incompetence, mismanagement or irregularity in the debtor’s office (Schwehr 2003).

Participating creditors under the United States Bankruptcy Code are divided into roughly three different categories: (a) secured creditors, who have a granted security interest in the assets of the debtor collateralizing the obligation amounting to the value of the claim; (b) unsecured creditors who have claims without collateral security; and (c) equity holders, e.g., shareholders (Schwehr 2003).

2. Under the Interim Rules

The debtor remains in possession during the rehabilitation proceedings. The court may appoint a rehabilitation receiver whose functions are similar to those of the U.S. trustee. There is no express provision for the appointment of an examiner under the Interim Rules.

There is no requirement for the approval of a rehabilitation plan by creditors under the Interim Rules. As such, there is likewise no requirement for the classification of creditors.

C. The Rehabilitation Plan

1. Under Chapter 11 of the United States Bankruptcy Code

All participants have some margin of negotiation. The provisions of Chapter 11 of the United States Bankruptcy Code are liberal rather than restrictive in favor of participation by the creditors (Schwehr 2003).

The plan is required to designate the classes of claims and classes of interests and expressly differentiate between impaired and unimpaired claims or interests and must state how the former will satisfy the impaired classes. The plan must also contain a list of the measures to achieve the reorganization (Schwehr 2003).

The debtor may exercise its judgment in the selection of the classes, in the determination of the contracts to be accepted or rejected and in the selection of proposed measures. The only requirement is that the proposed reorganization scheme for realization of the plan must be feasible (Schwehr 2003).

However, the classification of creditors by the debtor has been criticized because of the danger of manipulation in the classification of similar claims. The United States Bankruptcy Code only provides that claims that are substantially similar be placed in one class but it does not mean that all substantially similar claims must be placed in one class.

Therefore, the debtor may groups claims by creditors in such a way that it can be more or less assured that at least one class of impaired creditors will accept the plan, by classifying together all creditors who are likely to disapprove of the plan, and thereby make the plan qualified for cram down consideration by the court (Schwehr 2003).

Article 1123 of the Bankruptcy Code specifies the following contents of a reorganization plan, viz.:

(a) Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall—

(1) designate, subject to section 1122 of this title, classes of claims, other than claims of a kind specified in section 507 (a)(1), 507 (a)(2), or 507 (a)(8) of this title, and classes of interests;

(2) specify any class of claims or interests that is not impaired under the plan;

(3) specify the treatment of any class of claims or interests that is impaired under the plan;

(4) provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment of such particular claim or interest;

(5) provide adequate means for the plan’s implementation, such as—

(A) retention by the debtor of all or any part of the property of the estate;

(B) transfer of all or any part of the property of the estate to one or more entities, whether organized before or after the confirmation of such plan;

(C) merger or consolidation of the debtor with one or more persons;

(D) sale of all or any part of the property of the estate, either subject to or free of any lien, or the distribution of all or any part of the property of the estate among those having an interest in such property of the estate;

(E) satisfaction or modification of any lien;

(F) cancellation or modification of any indenture or similar instrument;

(G) curing or waiving of any default;

(H) extension of a maturity date or a change in an interest rate or other term of outstanding securities;

(I) amendment of the debtor’s charter; or

(J) issuance of securities of the debtor, or of any entity referred to in subparagraph (B) or (C) of this paragraph, for cash, for property, for existing securities, or in exchange for claims or interests, or for any other appropriate purpose;

(6) provide for the inclusion in the charter of the debtor, if the debtor is a corporation, or of any corporation referred to in paragraph (5)(B) or (5)(C) of this subsection, of a provision prohibiting the issuance of nonvoting equity securities, and providing, as to the several classes of securities possessing voting power, an appropriate distribution of such power among such classes, including, in the case of any class of equity securities having a preference over another class of equity securities with respect to dividends, adequate provisions for the election of directors representing such preferred class in the event of default in the payment of such dividends; and

(7) contain only provisions that are consistent with the interests of creditors and equity security holders and with public policy with respect to the manner of selection of any officer, director, or trustee under the plan and any successor to such officer, director, or trustee.

(b) Subject to subsection (a) of this section, a plan may—

(1) impair or leave unimpaired any class of claims, secured or unsecured, or of interests;

(2) subject to section 365 of this title, provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor not previously rejected under such section;

(3) provide for—

(A) the settlement or adjustment of any claim or interest belonging to the debtor or to the estate; or

(B) the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest;

(4) provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests;

(5) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims; and

(6) include any other appropriate provision not inconsistent with the applicable provisions of this title.

(c) In a case concerning an individual, a plan proposed by an entity other than the debtor may not provide for the use, sale, or lease of property exempted under section 522 of this title, unless the debtor consents to such use, sale, or lease.

(d) Notwithstanding subsection (a) of this section and sections 506 (b), 1129 (a)(7), and 1129 (b) of this title, if it is proposed in a plan to cure a default the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law.

2. Under the Interim Rules

Under the Section 5, Rule 4 of the Interim Rules, the rehabilitation plan must include, viz.:

(a) The desired business targets or goals and the duration and coverage of the rehabilitation.

(b) The terms and conditions of such rehabilitation which shall include the manner of its implementation, giving due regard to the interests of secured creditors.

(c) Material financial commitments to support the rehabilitation plan.

(d) The means for the execution of the rehabilitation plan, which may include conversion of the debts or any portion thereof to equity, restructuring of the debts, dacion en pago, or sale of assets or of the controlling interest.

(e) A liquidation analysis that estimates the proportion of the claims that the creditors and shareholders would receive if the debtor's properties were liquidated;

(f) Other relevant information to enable a reasonable investor to make an informed decision on the feasibility of the rehabilitation plan.

D. The Stay Order

1. Under Chapter 11 of the United States Bankruptcy Code

An Automatic Stay under Chapter 11 of the United States Bankruptcy Code stops all collection activities, foreclosures, and repossessions on any debt or claim that arose before the filing of the bankruptcy petition. The Stay automatically goes into effect upon the filing of the petition (Internet Legal Resources 2005).

The Stay is intended to provide a temporary suspension or moratorium on the collection of claims against the debtor in order that discussions and/or negotiations can take place for the purpose of finding a solution to the debtor's financial difficulties (Internet Legal Resources 2005).

2. Under the Interim Rules

If the court finds the petition to be sufficient in form and substance, it shall, not later than five days from the filing of the petition, issue a Stay Order (Sec. 6, Rule 4).

The Stay Order shall contain the following: (a) appointment of a Rehabilitation Receiver and amount of his bond; (b) order staying enforcement of all claims, whether for money or otherwise and whether such enforcement is by court action or otherwise, against the debtor, its guarantors and sureties which are not solidarily liable with the debtor; (c) prohibition against the debtor from selling, encumbering, transferring, or disposing in any manner any of its properties except in the ordinary course of business; (d) prohibition against the debtor from making any payment of its liabilities outstanding as at the date of filing of the petition; (e) prohibition against the debtor's suppliers of goods or services from withholding supply of goods and services in the ordinary course of business for as long as the debtor makes payments for the services and goods supplied after the issuance of the stay order; (f) order directing the payment in full of all administrative expenses incurred after the issuance of the stay order; (g) date of the initial hearing on the petition which must be not earlier than 45 days but not later than 60 days from the filing thereof; (h) order directing the petitioner to publish the Order in a newspaper of general of general circulation in the Philippines once a week for two (2) consecutive weeks; (i) order directing all creditors and all interested parties (including the Securities and Exchange Commission) to file and serve on the debtor a verified comment on or opposition to the petition, with supporting affidavits and documents, not later than ten (10) days before the date of the initial hearing and putting them on notice that their failure to do so will bar them from participating in the proceedings; and (j) order directing the creditors and interested parties to secure from the court copies of the petition and its annexes within such time as to enable themselves to file their comment on or opposition to the petition and to prepare for the initial hearing of the petition (Sec. 6, Rule 4).

The Stay Order shall be effective from the date of its issuance until the dismissal of the petition or the termination of the rehabilitation proceedings (Sec. 11, Rule 4).

The petition shall be dismissed if no rehabilitation plan is approved by the court upon the lapse of 180 days from the date of the initial hearing. The court may grant an extension beyond this period only if it appears by convincing and compelling evidence that the debtor may successfully be rehabilitated (Sec. 11, Rule 4).

In no instance, however, shall the period for approving or disapproving a rehabilitation plan exceed eighteen months from the date of filing of the petition (Sec. 11, Rule 4).

E. Relief from the Stay Order

1. Under Chapter 11 of the United States Bankruptcy Code

In certain circumstances, a creditor may move to lift or modify the Automatic Stay. For example, if a particular property is not necessary for reorganization, the creditor may request for an order granting relief from the Automatic Stay in order to be able to foreclose on the property (Internet Legal Resources 2005).

2. Under the Interim Rules

The court may, on motion or motu proprio, terminate, modify, or set conditions for the continuance of the Stay Order, or relieve a claim from the coverage thereof upon showing that (a) any of the allegations in the petition, or any of the contents of any attachment, or the verification thereof has ceased to be true; (b) a creditor does not have adequate protection over property securing its claim; or (c) the debtor's secured obligation is more than the fair market value of the property subject of the stay and such property is not necessary for the rehabilitation of the debtor (Sec. 12, Rule 4).

The creditor shall be considered as lacking adequate protection if it can be shown that: (a) the debtor failed or refuses to honor a pre-existing agreement with the creditor to keep the property insured; (b) the debtor failed or refuses to take commercially reasonable steps to maintain the property; or (c) the property has depreciated to an extent that the creditor is under-secured (Sec. 12, Rule 4, Interim Rules).

Upon showing of a lack of adequate protection, the court shall order the Rehabilitation Receiver to (a) make arrangements to provide for the insurance or maintenance of the property, or (b) make payments or otherwise provide additional or replacement security that the obligation is fully secured (Sec. 12, Rule 4).

If such arrangements are not feasible, the court shall modify the Stay Order in order to allow the secured creditor lacking adequate protection to enforce its claim against the debtor (Sec. 12, Rule 4, Interim Rules).

However, the court may deny the creditor the foregoing remedies if such remedies would prevent the continuation of the debtor as a going concern or otherwise prevent the approval and implementation of a rehabilitation plan (Sec. 12, Rule 4, Interim Rules).

F. The Debtor in Possession, U.S. Trustee, Case Trustee, and Rehabilitation Receiver

1. Under Chapter 11 of the United States Bankruptcy Code

Upon the filing of a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code or, in an involuntary case, the entry of an Order for such relief, the debtor automatically the identity of "debtor in possession." The term refers to a debtor that has possession and control of its assets while undergoing reorganization without the appointment of a case trustee (Ezine Articles 2005).

A debtor in possession is considered as a fiduciary or trustee and has the corresponding duties and powers. Such duties include accounting for property, examining and objecting to claims, and filing of tax returns and reports, as may be required by the court and the U.S. Trustee. A debtor in possession may employ attorneys, accountants, brokers, or other professionals, subject to court approval (Internet Legal Resources 2005).

A case trustee is rarely appointed. A party in interest or the U.S. Trustee may move for the appointment of a case trustee, and the court may order the appointment, for cause such as fraud, dishonesty, incompetence, or gross mismanagement, or if it is in the best interests of creditors, equity security holders, or other interested parties (Internet Legal Resources 2005).

The U.S. Trustee has the duty of monitoring reorganization cases and the standing to appear and be heard on any issue in the case. The case trustee, on the other hand, takes charge of the management of the assets and operation of the debtor's business. The case trustee may also file the plan of reorganization (Internet Legal Resources 2005).

2. Under the Interim Rules

The Rehabilitation Receiver does not take over the management and control of the debtor but shall closely oversee and monitor the operations of the debtor during the proceedings, and for this purpose shall have the powers, duties and functions of a receiver under Presidential Decree No. 902-A, as amended, and the Rules of Court (Sec. 14, Rule 4).

The Rehabilitation Receiver is considered as an officer of the court. He is primarily tasked with studying the best way to rehabilitate the debtor and to ensure that the value of the debtor's property is reasonably maintained pending the determination of whether or not the debtor should be rehabilitated, as well as implement the rehabilitation plan after its approval (Sec. 14, Rule 4).

Accordingly, the Rehabilitation Receiver shall have the following powers and functions:

(a) To verify the accuracy of the petition, including its annexes such as the Schedule of Debts and Liabilities and the Inventory of Assets submitted in support of the petition.

(b) To accept and incorporate, when justified, amendments to the Schedule of Debts and Liabilities.

(c) To recommend to the court the disallowance of claims and rejection of amendments to the Schedule of Debts and Liabilities that lack sufficient proof and justification.

(d) To submit to the court and make available for review by the creditors, a revised Schedule of Debts and Liabilities.

(e) To investigate the acts, conduct, properties, liabilities, and financial condition of the debtor, the operation of its business and the desirability of the continuance thereof; and, any other matter relevant to the proceeding or to the formulation of the rehabilitation plan.

(f) To examine under oath the directors and officers of the debtor and any other witnesses that he may deem appropriate.

(g) To make available to the creditors documents and notices necessary for them to follow and participate in the proceedings.

(h) To report to the court any fact ascertained by him pertaining to the causes of the debtors' problems, fraud, preferences, dispositions, encumbrances, misconduct, mismanagement, and irregularities, committed by the stockholders, directors, management, or any other person against the debtor.

(i) To employ such person or persons such as lawyers, accountants, appraisers, an staff as are necessary in performing his functions and duties as Rehabilitation Receiver.

(j) To monitor the operations of the debtor and to immediately report to the court any material adverse change in the debtor's business.

(k) To evaluate the existing assets and liabilities, earnings and operations of the debtor.

(l) To determine and recommend to the court the best way to salvage and protect the interests of the creditors, stockholders, and the general public.

(m) To study the rehabilitation plan proposed by the debtor or any rehabilitation plan submitted during the proceedings, together with any comments made thereon.

(n) To prohibit and report to the court any encumbrance, transfer, or disposition of the debtor's property outside of the ordinary course of business or what is allowed by the court.

(o) To prohibit and report to the court any payments outside of the ordinary course of business.

(p) To have unlimited access to the debtor's employees, premises, books, records, and financial documents during business hours.

(q) To inspect, copy, photocopy, or photograph any document, paper, book, account, or letter, whether in the possession of the debtor or other persons.

(r) To gain entry into any property for the purpose of inspecting, measuring, surveying, or photographing it or any designated relevant object or operation thereon.

(s) To take possession, control, and custody of the debtor's assets.

(t) To notify counter-parties and the court as to contracts that the debtor has decided to continue to perform or breach.

(u) To be notified of, and to attend all meetings of the board of directors and stockholders of the debtor.

(v) To recommend any modification of an approved rehabilitation plan as he may deem appropriate.

(w) To bring to the attention of the court any material change affecting the debtor's ability to meet the obligations under the rehabilitation plan.

(x) To recommend the appointment of a management committee in the cases provided for under Presidential Decree No. 902-A, as amended.

(y) To recommend the termination of the proceedings and the dissolution of the debtor if he determines that the continuance in business of such entity is no longer feasible or profitable or no longer works to the best interest of the stockholders, parties-litigants, creditors, or the general public.

(z) To apply to the court for any order or directive that he may deem necessary or desirable to aid him in the exercise of his powers and performance of his duties and functions; and

(aa) To exercise such other powers as may from time to time be conferred upon him by the court (Sec. 14, Rule 4, Interim Rules).

G. Creditors’ meetings and modification of the proposed rehabilitation plan

1. Under Chapter 11 of the United States Bankruptcy Code

Under Chapter 11 of the United States Bankruptcy Code, the committee of creditors or equity holders for example “ordinarily consist of the persons, willing to serve, that hold the seven largest claims against the debtor of all of the kinds represented in the committee” or was “fairly chosen” and “is representative of the different kinds or claims to be presented” (Schwehr 2003).

The U.S. trustee is required to appoint the members of the committee as soon as practicable after the order for relief. The U.S. trustee may also appoint equity holders’ committees and additional committees of creditors, which is done especially in larger cases (Schwehr 2003).

The committee or committees may consult with the debtor on the administration of the case, investigate the debtor's conduct or business operations and participate in the formulation of a plan. The committee or committees may hire lawyers with the legal fees to be paid from the debtor's bankruptcy estate. This can make reorganization very costly for the debtor (Internet Legal Resources 2005).

In small business cases the court may for cause, and on request of a party in interest, order that no creditor committee be appointed (Schwehr 2003).

2. Under the Interim Rules

Under the Interim Rules, the Rehabilitation Receiver may at his judgment, meet with the creditors or any interested party, either alone or together with the debtor, to discuss the rehabilitation plan with a view to clarifying or resolving any matter connected therewith (Sec. 21, Rule 4).

Thereafter, the debtor may modify its rehabilitation plan in the light of the comments of the Rehabilitation Receiver and creditors or any interested party and submit a revised or substitute rehabilitation plan for approval by the court. Such rehabilitation plan must be submitted to the court not later than one year from the date of the initial hearing (Sec. 22, Rule 4).

H. Approval of the plan

1. Under Chapter 11 of the United States Bankruptcy Code

An important phase of the reorganization proceedings under Chapter 11 of the United States Bankruptcy Code is the voting by impaired classes of creditors.

Creditors and interests are classified into different groups and voting is by class in order to guarantee the protection of creditors’ rights in the voting process. Each claim in a class must be substantially similar to the others so that the vote of the majority reflects the interests of the class as a whole. Each claim or interest within one class must be treated equally unless a claim holder or interest holder agrees to a less favorable treatment (Schwehr 2003).

Claims or interests are classified into impaired and unimpaired classes. If a class is unimpaired by a plan, it is “conclusively presumed to have accepted the plan.” Creditors with claims or interests that will not be affected by the plan will not be entitled to vote. On the other hand, a class which will not receive anything under a plan, will be deemed to have rejected the plan and does not need to be asked to vote (Schwehr 2003).

Chapter 11 of the United States Bankruptcy Code defines two different types of non-impairment. The first involves a class that is not impaired because the plan does not alter legal, equitable, and contractual rights of the holder of such claim or interest. The second type of non-impairment, also known as the reversing acceleration, gives the debtor the right to heal pre- or post petition defaults that triggered an acceleration clause to compensate the creditor for all damages incurred due to the debtor’s actions that caused the default, without altering the claims in any other way (Schwehr 2003).

In Re: Barrington Oaks Gen. Partnership, the court held that a claim will be considered as having been impaired where there has been “any modification of rights … regardless of whether the value of the rights are enhanced” (Schwehr 2003).

Equity security holders are also entitled to vote. A class of claims is considered to have approved of the plan if majority in number and two-thirds in value of holders of the claims have accepted the plan. On the other hand, a class of interest holders will be deemed to have accepted the plan if at least two-thirds in value of interests vote in favor of the plan (Schwehr 2003).

In addition, the best-interest-of-creditors and the feasibility tests must also be met. To meet the best-interest-of-creditors test, the debtor must prove that each holder of a claim or interest who has not accepted the plan will receive at least as much under the plan as he would receive in liquidation (Schwehr 2003).

The feasibility test, on the other hand, provides that the plan should not “likely to be followed by a liquidation, or the need for further financial reorganization.” Expert appraisal is needed in order to testify that the debtor’s cash flow will be sufficient to answer for its operating expenses and the payments proposed in the plan (Schwehr 2003).

The court can only confirm a consensual reorganization plan after all impaired classes have accepted the plan. If one or more impaired classes object to the plan, the proponent of the plan can request confirmation by a procedure known as “cram down” or non-consensual plan, provided at least one class of impaired claims has accepted the plan (Schwehr 2003).

Under “cram down” or a non-consensual plan, consent by an objecting class may no longer be required if the plan does not discriminate unfairly against dissenting classes and treats dissenting classes in a “fair” or “equitable” way.

The foregoing procedure requires the application of the absolute priority rule (Schwehr 2003). In other words, management, either alone or together with secured creditors, may not be allowed to impair claims by both secured and/or unsecured creditors.

One possible exception to the absolute priority rule is the “new value exception” which provides that equity holders may retain their interest even if creditors would not be paid in full by making contributions that are equivalent to the value of their previous equity in the insolvent or bankrupt debtor (Schwehr 2003).

2. Under the Interim Rules

The court may approve a rehabilitation plan even over the opposition by creditors holding a majority of the total liabilities of the debtor if, in its judgment, the rehabilitation of the debtor is feasible and the opposition of the creditors is manifestly unreasonable (Sec. 23, Rule 4, Interim Rules).

In determining whether or not the opposition of the creditors is manifestly unreasonable, the court shall consider the following: (a) that the plan would likely provide the objecting class of creditors with compensation greater than that which they would have received if the assets of the debtor were sold by a liquidator within a three-month period; (b) that the shareholders or owners of the debtor lose at least their controlling interest as a result of the plan; and (c) the Rehabilitation Receiver has recommended approval of the plan (Sec. 23, Rule 4, Interim Rules).

In approving the rehabilitation plan, the court shall issue the necessary orders or processes for its immediate and successful implementation. It may impose such terms, conditions, or restrictions as the effective implementation and monitoring thereof may reasonably require, or for the protection and preservation of the interests of the creditors should the plan fail (Sec. 23, Rule 4, Interim Rules).

There is no required classification of creditors under the Interim Rules since they do not prescribe a procedure for securing creditors’ approval of a rehabilitation plan. Further, the Interim Rules do not expressly require the application of the absolute priority rule in “cram down”.

I. Legal Effects of the Confirmation

1. Under Chapter 11 of the United States Bankruptcy Code

The confirmation of a plan gives rise to new contractual rights that replace or supersede pre-petition contracts thus discharging the debtor from debts arising before the confirmation (Internet Legal Resources 2005). All parties in interest, even those who voted against the plan, and those who have not filed their claims, will be bound by the confirmation of the plan (Schwehr 2003).

2. Under the Interim Rules

The approval of the rehabilitation plan by the court will be binding upon the debtor and all persons who may be affected by it, including the creditors, whether or not such persons have participated in the proceedings or opposed the plan and whether or not their claims have been scheduled (Sec. 24 [a], Rule 4).

The debtor shall comply with the provisions of the plan and shall take all actions necessary to carry out the plan. Payments shall be made to the creditors in accordance with the provisions of the plan. Contracts and other arrangements between the debtor and its creditors shall be interpreted as continuing to apply to the extent that they do not conflict with the provisions of the plan. Finally, any compromises on amounts or rescheduling of timing of payments by the debtor are binding on creditors regardless of whether or not the plan is successfully implemented (Sec. 24, Rule 4).

An approved rehabilitation plan may, on motion, be altered or modified if, in the judgment of the court, such alteration or modification is necessary to achieve the desired targets or goals set forth therein (Sec. 26, Rule 4).

IV. Conclusion

The Interim Rules are similar in object and content to Chapter 11 of the United States Bankruptcy Code. Substantial differences however exist with respect to the conduct of creditors’ meetings and modification of the proposed rehabilitation plan, as well as concerning the approval of the plan.

Under the Interim Rules, the Rehabilitation Receiver may at his judgment, meet with the creditors or any interested party, either alone or together with the debtor, to discuss the rehabilitation plan with a view to clarifying or resolving any matter connected therewith (Sec. 21, Rule 4). In other words, the Rehabilitation Receiver is not required under the Rules to call a meeting of creditors.

On the other hand, under Chapter 11 of the United States Bankruptcy Code, the U.S. trustee is required to appoint the members of the creditors’ committee as soon as practicable after the order for relief, except upon the request of a party in interest in a case in which the debtor is a small business and for cause where the court may order that a committee of creditors not be appointed. The U.S. trustee may appoint other committees of creditors and equity holders, especially in larger cases.

The creditors’ committee or committees may consult with the debtor on the administration of the case, investigate the debtor's conduct or business operations and participate in the formulation of a plan. The said committee or committees may hire lawyers with the legal fees to be paid from the debtor's bankruptcy estate. Although this can make reorganization very costly for the debtor, it provides creditors with the opportunity of protecting their interests.

Since the Interim Rules do not require the creation of a creditors’ committee, the debtor practically exercises his own discretion in either modifying or retaining the rehabilitation plan, with or without taking into consideration comments by the Rehabilitation Receiver and creditors or any interested party, before submitting a copy thereof for approval by the court.

Another significant difference between the United States’ and the Philippines’ procedure on corporate reorganization or rehabilitation is that while Chapter 11 of the United States Bankruptcy Code require the procedural safeguard of voting by impaired classes of creditors prior to “cram down”, the Interim Rules do not require such procedure.

In addition, the Interim Rules do not prescribe compliance with either the best-interest-of-creditors test, i.e., requiring the debtor to prove that each holder of a claim or interest who has not accepted the plan will receive at least as much under the plan as he would receive in liquidation, and the feasibility test, i.e., requiring expert appraisal to testify that the debtor’s cash flow will be sufficient to answer for its operating expenses and payments under the proposed plan or, in short, that the rehabilitation plan will not likely be followed by a liquidation or need for further financial reorganization.

Under the Interim Rules, the court may approve a rehabilitation plan even over the opposition by creditors holding a majority of the total liabilities of the debtor if, in its judgment, the rehabilitation of the debtor is feasible and the opposition by the creditors is manifestly unreasonable (Sec. 23, Rule 4).

The purpose of the best-interest-of creditors test is to provide an additional safeguard to individual creditors whose interests may not carry significant weight in the voting process. The feasibility test on the other hand is intended to protect against the haphazard approval of a plan that is not economically feasible to the prejudice of creditors.

Another requirement under Chapter 11 of the United States Bankruptcy Code for the protection of creditors’ claims is that at least one class of impaired claims must have accepted the plan before the proponent may request for confirmation by the court under the “cram down” or non-consensual plan procedure.

Considering that the Interim Rules do not provide for voting by impaired classes, there is no requirement of acceptance of the plan by at least one class of impaired claims prior to “cram down” consideration by the court.

The “cram down” procedure under Chapter 11 of the United States Bankruptcy Code, furthermore, requires the application of the absolute priority rule, i.e., management, either alone or together with secured creditors, may not be allowed to impair claims by both secured and/or unsecured creditors.

One possible exception to this rule is the “new value exception” which provides that equity holders may retain their interest even if creditors would not be paid in full by making contributions that are equivalent to the value of their previous equity in the insolvent or bankrupt debtor.

The Interim Rules do not expressly provide for the adoption of an absolute priority rule prohibiting the impairment of claims by secured and/or unsecured creditors. Although the “new value exception” may have been adopted in practice, adherence to the same is also not required under the Rules.

V. Recommendation

The lack of substantial and procedural safeguards in the Interim Rules for the protection of claims by both secured and unsecured creditors allow a construction of the same that is excessively pro-debtor and anti-creditor.

The lack of safeguards may also defeat the purpose of the Rules to put distressed corporations back on their feet since the implementation of a plan that has been haphazardly adopted may likely eventually lead to the liquidation of the insolvent or bankrupt debtor where the creditors might be worse off than if the rehabilitation proceedings were not entered into in the first place.

There is therefore a need to consider the institution of safeguards for the protection of creditors’ claims and to provide against the undue approval of unfeasible rehabilitation plans following for example the model used by Chapter 11 of the United States Bankruptcy Code.

VI. Bibliography

Interim Rules of Procedure on Corporate Rehabilitation. November 21, 2000.

Presidential Decree No. 902-A. Reorganization of the Securities and Exchange Commission with Additional Powers and Placing the said Agency under the Administrative Supervision of the Office of the President. March 11, 1976.

Presidential Decree No. 1799. Amending Further Section 6 of Presidential Decree No. 902-A. January 16, 1981.

Keay, A., Boraine, A. and Burdette, D (2001). Preferential debts in corporate insolvency: a comparative study. International Insolvency Review Chichester: Winter 2001 Vol. 10, Iss. 3, p. 167.

Schwehr, B (2003). Corporate Rehabilitation Proceedings in the US and Germany. International Insolvency Review. Chicester: Spring 2003 Vol 12, Iss.1, p. 11.

United States Bankruptcy Code. Title 11, United States Code.

List of Reference Websites

Internet Legal Resources 2005.
http://www.lawfirmsoftware.com/free/info/bankruptcy/
chapter11.htm

Ezine Articles 2005.
http://ezinearticles.com/
?Bankruptcy-Chapters-Explained&id=58093

InvestorWords.com
http://www.investorwords.com/28/absolute_priority_rule.html

About
http://beginnersinvest.about.com/library/glossary/
bldef-absolutepriorityrule.htm