The Control Test for Corporate Nationality (Part 2)

Malaluan is a lawyer, co-founder and trustee of AER; Lumba is a lawyer, teaches at the UP College of law and is a fellow of AER.  This piece was published in the August 1, 2011 edition of the BusinessWorld, pages S1/4 to S1/5.

 

Control Test Remains in Force

But a closer look at Redmont reveals that the decision does not represent an abandonment of the control test.

The application of the control test is further elaborated in DOJ Opinion No. 020, s. 2005 dated 5 May 2005:

In other words, based on the said SEC Rule and DOJ Opinion, the Grandfather Rule or the second part of the SEC Rule applies only when the 60-40 Filipino-foreign equity ownership is in doubt (i.e. in cases where the joint venture corporation with Filipino and foreign stockholders with less than 60% Filipino stockholders [or 59%] invests in other joint venture corporation which is either 60-40% Filipino-alien or 59% less Filipino). Stated differently, where the 60-40 Filipino-foreign equity ownership is not in doubt, the Grandfather Rule will not apply.”

In Redmont, the SEC found that out of the authorized capital stock of the corporations in question, the domestic corporations paid nothing for the stocks they subscribed to in each of the corporations, and the foreign corporation “provided practically all the funds.” The SEC concluded that doubt exists in this particular case, thus calling for the application of the grandfather rule.

This is confirmed by new SEC Chairperson Teresita Herbosa in a letter to Action for Economic Reforms dated 27 June 2011. She stated:

“We advise that the decision in the Redmont case amply elucidates the Commission’s position on how to determine the qualification of a corporation to engage in nationalized economic activities.

To reiterate and clarify, the Commission is not abandoning the control test as the general rule. However, in cases where compliance with the citizenship restrictions is doubtful, as in the Redmont case, the Commission will apply the grandfather rule considering that applying the control test would result in circumvention of the Constitutional and statutory restrictions on foreign capital.” (emphasis supplied)

More important, there was a change in position on the part of the SEC Office of the General Counsel in a later opinion dated 19 April 2011 (SEC-OGC Opinion No. 11-26). While not ruling on a query on the legality of certain investments subject of the request for opinion, it discussed “for purposes of information” the rules applicable to foreign participation in investments. In its discussion, it reiterated the control test as a standing rule.

The clarification made by the SEC Chairperson in the letter dated 27 June 2011, and the SEC OGC opinion dated 19 April 2011, put to rest any doubt on the applicability of the control test occasioned by Redmont and Medusa.

In sum, the control test remains in force.

SEC Cannot Unilaterally Abandon the Control Test

Indeed, the SEC, and much less the SEC OGC, cannot unilaterally abandon the control test in favor of the grandfather rule.

First, there are obvious practical difficulties in abandoning the control test that has been consistently applied by the SEC and relied upon by investors for more than two decades.

Second, apart from these considerations, it is doubtful whether the SEC can, at this time and by mere administrative fiat, legally do away with the control test since it has been embodied in a law – the Foreign Investments Act (FIA).  To quote:

[T]he term Philippine national shall mean a citizen of the Philippines; or a domestic partnership or association wholly owned by citizens of the Philippines; or a corporation organized under the laws of the Philippines of which at least sixty percent (60%) of the capital stock outstanding and entitled to vote is owned and held by citizens of the Philippines; x x x  (Sec 3 (a), Republic Act No. 7042 as amended by Republic Act No. 8179) (emphasis supplied)

As confirmed in several SEC opinions, (see SEC Opinion dated 23 November 1993 and SEC-OGC Opinion No. 17-07 dated 27 September 2007) the cited provision is the statutory embodiment of the control test.  What used to be a mere administrative practice has now been elevated to the level of a statutory imperative rendering it beyond the SEC’s authority to abandon. The FIA itself states:

Section 12. Consistent Government Action. – No agency, instrumentality or political subdivision of the Government shall take any action in conflict with or which will nullify the provisions of this Act, or any certificate or authority granted hereunder.

Moreover, it is the NEDA and not the SEC that is authorized to adopt the appropriate metric because it is the sole entity vested with the power to issue rules implementing the FIA.  It has already issued said rules, wherein, in Rule I, Section 1 (b), it adopted the control test.

The government has the discretion to select from a range of options what would be in the best interest of the country, as long as it is consistent with the relevant constitutional restriction to reserve control to Filipinos. Assuming that the 60% Filipino equity in a corporation investing in another corporation is not held by dummies, they can outvote the foreign equity and control its entire equity in the corporation it invests in. This is what the control test essentially means: control of a corporation results in control over its equity in another corporation.

 

Consistency and Stability of Rules

In deciding an investment destination, investors look at how the investment climate in the Philippines has improved over time, and also how it stands vis-à-vis other countries.

The perception remains that rules here are more predisposed to changes. The inconsistency and instability evoked by rulings or issuances such as Redmont and Medusa give the Philippines this bad international reputation.

We need to send a credible signal that rules and administrative interpretations will be applied consistently. Such institutionalization and stability of rules is a challenge not just for SEC, but the Philippine government as a whole.

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