The Need for Stability in Administrative Interpretations: The Control Test for Corporate Nationality (Part 1)

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 AERThis piece was published in the July 25, 2011 edition of the BusinessWorld, pages S1/4 to S1/5.

 

The public tends to look at current economic performance.  But what really matters, for development to benefit all, is the country’s long-run economic performance.

Some emphasize the relatively high growth rates prior to the global economic crisis as an indication of good performance.  Yet we have learned from the past that the Philippines is capable of growth spurts that could not however be sustained even for the medium term.

In short, the Philippines’ long-run growth rate is far from satisfactory, and we are still searching for ways to ignite the country’s long-run growth potential. What is indisputable, though, is that foreign direct investments (FDIs) play a critical role in propelling an economy on a trajectory of sustained long-term growth. In the process, a virtuous cycle is created in which the economy becomes more receptive to investments involving transfers of technology and innovations. This, in turn, enhances productivity and creates jobs, raises incomes and reduces poverty, increases purchasing power of consumers and the size of domestic markets, and attracts even more investments.

But not all FDIs are good. They must be brought within specific regulatory regimes that address actual and identifiable problems, such as those on the environment and human rights. Also, their true impact on growth, employment, and structural transformation must be constantly monitored and evaluated.

Still, we all lament the country’s dismal performance in attracting FDIs.

FDIs in Activities with Nationality Restriction

To attract  FDIs, the Securities and Exchange Commission (SEC) in a 2 November 1989 en banc meeting resolved to adopt as a method for determining corporate nationality the opinion by the Department of Justice dated 19 January 1989 (Opinion No. 018, s. 1989), which states in relevant part:

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 percentage 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 of Philippine nationality. Thus, if 100,000 shares are registered in the name of a corporation or partnership at least 60% of the capital stock or capital respectively, of which belong to Filipino citizens, all of the said shares shall be recorded as owned by Filipinos. But if less than 60% or, say, only 50% of the capital stock or capital of the corporation or partnerships, respectively belongs to Filipino citizens, only 50,000 shares shall be counted as owned by Filipinos and the other 50,000 shares shall be recorded as belonging to aliens.

The first part of the rule which applies when a corporation is at least 60% Filipino-owned, commonly referred to as the “control test”, constitutes an interpretation that is favorable to foreign investors. Under this test, a corporation at least 60% Filipino investing in another corporation is deemed to be of Philippine nationality with respect to its entire equity in the corporation in which it invests. This is in contrast to the second part of the rule, commonly referred to as the “grandfather rule”, which applies when less than 60% of capital is Filipino-owned. In such instances, the investing corporation’s equity in the investee corporation shall be deemed Filipino only to the same extent that the investing corporation is Filipino-owned.

Doubt Created by Redmont and Medusa

The control test has been consistently applied by the SEC and relied upon by investors for more than two decades. However, in 2010 a doubt was created in the applicability of the control test by the March 2010 case of Redmont Consolidated Mines Corporation v McArthur Mining Corporation ( SEC En Banc Case No. 09-09-177 dated 25 March 2010) decided by the SEC en banc (for brevity, “Redmont”) and a December 2010 opinion issued by the SEC General Counsel concerning Medusa Mining Limited (SEC-OGC Opinion No. 10-31 dated 9 December 2010) (for brevity, “Medusa”).

In Redmont, the SEC en banc appears to suggest the abandonment of the control test in favor of the grandfather rule.  Thus:

We believe, that a revisit of the Control Test vis-à-vis the Grandfather Rule as enunciated in the 1967 SEC Rules, is in order.

x . . . . . x . . . . . x

The avowed purpose of the Constitution is to place in the hands of Filipinos the exploitation of our natural resources. Necessarily, therefore, the Rule interpreting the constitutional provision should not diminish that right through the legal fiction of corporate ownership and control. But the constitutional provision, as interpreted and practiced via the 1967 SEC Rules, has favored foreigners contrary to the command of the Constitution. Hence, the Grandfather Rule must be applied to accurately determine the actual participation, both direct and indirect, of foreigners in a corporation engaged in a nationalized activity or business…

In Medusa, the SEC General Counsel took what was merely a suggestion in Redmont a step further by essentially declaring the control test unconstitutional and henceforth abandoned. To quote:

However, we now opine that the control test must not be applied in determining if a corporation satisfies the Constitution’s citizenship requirements in certain areas of activities. The control test creates a legal fiction where if 60% of the shares of an investing corporation are owned by Philippine citizens then all of the shares or 100% of that corporation’s shares are considered Filipino owned for purposes of determining the extent of foreign equity in an investee corporation engaging in an activity restricted to Philippine citizens. In other words, Philippine citizenship is being unduly attributed to foreign individuals who own the rest of the shares in a 60% Filipino equity corporation investing in another corporation. Thus, applying the control test effectively circumvents the Constitutional mandate that corporations engaging in certain activities must be 60% owned by Filipino citizens…


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