Presented to the Accountancy Department
De La Salle University - Manila
3rd Term, A.Y. 2019-20
In partial fulfillment
of the course
In MODADV1 [K31]
Road to Bankruptcy: The Philippine Economy During the COVID-19 Pandemic and its
Implications on Corporate Liquidation
Submitted by:
Bhagia, Vishal
Submitted to:
Dr. Rodiel C. Ferrer, CPA
July 19, 2020
Introduction
Corporations are a common form of business that individuals partake into because of its
advantages such as the perpetual life provided and limited liability. It is these benefits that
incentivize 3rd parties to invest or provide a line of credit to the corporation but it is not definite
that a corporation always succeeds in its business plans. This is brought by uncertainties in firm
performance as a result of extremely competitive markets, asymmetric information, evolving
technologies, and other factors that are not within the grasp of corporations. Thus, if an entity
enters the decline stage of their business cycle without a proper plan of attack, it is more or less
likely that the entity will enter a state of insolvency. Entities that enter insolvency are unable to
satisfy the claims of their creditors. It is from this scenario that corporations must properly account
for any other assets that may be realized to resolve any deficiency in the payment of debts.
This is especially the case for the Philippine economy because of the ramifications brought by the
COVID-19 pandemic. As of July 15, 2020, there was a total 58,850 number of cases reported with
multiple sectors of the economy still operating on a skeletal workforce system that only allows
businesses of basic necessities – such as the food or medical industry – to operate (Department of
Health, 2020). Because of a declined level of global demand, export-oriented entities are not able
to conduct operations at 100% capacity. As a result of the community quarantine and physical
distancing measures required by the government since March 17, 2020, corporations continue to
incur losses and are not able to maximize customer revenue. In fact, the Philippine Institute of
Development Studies have estimated that the Philippines will lose PHP 276.3 billion to PHP 2.5
trillion due to the adverse effects the pandemic has left on its economy (Abrigo et al., 2020).
It is because of these extremely special circumstances that creditors may require a corporation to
liquidate – creditors want to protect their particular interests and avoid any future losses. With the
global economy being put on halt by the pandemic, creditors to an insolvent corporation are
desperate in looking for assets that they may salvage. Thus, it is significant to recognize the
direction that all parties to an insolvent corporation, including the corporation itself, may take as
they continue to serve their particular interests. These are the issues tackled by the paper
“Insolvency and Rehabilitation in the Philippines During the COVID-19 Pandemic”.
Synthesis
Although the IAS and International Financial Reporting Standards (IFRS) do not provide strict
requirements as to the process by which entities – proprietorships, partnerships or corporations,
are to undergo during their liquidation, the Philippines has multiple laws that provide guidance to
these entities. Among these laws include the Republic Act No, 10142, or the Financial
Rehabilitation and Insolvency Act (FRIA), the New Civil Code of the Philippines, and the Revised
Corporation Code (RCC). These laws have been initiated so that the debtors are encouraged to
resolve the claims of the creditors such that they do not incur extreme levels of losses. Under these
laws, insolvent corporations may opt for 3 different options: Rehabilitation, Liquidation and the
Suspension of Payments.
A corporation that undergoes rehabilitation procedures is considered similar to a restart of
operations such that creditors are paid using future earnings (San Pedro et al., 2020). It may be
done through court supervision where the rehabilitation is either voluntary or involuntary. The
former is one where the corporation itself approves a motion to rehabilitate their corporation
procedures in order to avoid future civil or criminal liability because of the financial distress of the
corporation and impossibility to meet debts. The latter on the other hand is one where the creditors
bring the petition forward because of the volume of their debt. These creditors are provided this
option only if their credit is at least 25% of the subscribed capital stock or if they have an aggregate
claim of 1,000,000 Pesos. However, in order to ensure the integrity of the rehabilitation operations,
the court requirement is that the petitioner provides a rehabilitation plan and rehabilitation receiver.
The corporation may also go through a pre-negotiated rehabilitation where the creditors must
approve the plan of rehabilitation. However, the creditors must consist of secured claims and
unsecured claims in order to provide better representation. The corporation may even opt for an
informal restructuring agreement with the creditors however this requires a greater level of
approval from the unsecured creditors. This is in line with providing the creditors a just and fair
possibility to receive funds in satisfaction of their credit.
According to the FRIA, the corporations may also opt for liquidation procedures which is guided
by the RCC. Liquidation is the process of winding up the business proceedings of the corporation
and realizing all assets in satisfaction of the creditors’ claims. This may be done through voluntary
and involuntary methods as well. The author synthesized that the involuntary liquidation is to be
initiated by creditors that are largely affected while voluntary liquidation does not require much
attention from the creditors. This poses a problem to the creditors that are both partially secured
and completely unsecured. In fact, the common problem in liquidation is that the firm may result
in a deficiency which does not provide the creditors with complete assurance of payments.
Furthermore, because the stockholders and board of director members are protected by the
corporate veil, the creditors may be left with the possibility of losing assets.
The final option provided to financially difficult corporations is the suspension of payments.
However, this is distinguished from the rehabilitation plans as the entity still has sufficient assets
to cover its debts but foresees the impossibility of payment in the near future. The requirement,
other than the usual court petition processes, is to have 60% of the credits represented in a meeting.
The final step would be to obtain a 2/3 majority of the credits represented on whether the
suspension of payments is permitted or not.
Conclusion and Recommendations
It is obvious from the discussion of the author and the synthesis provided above that the
corporations that enter financial difficulty have multiple options in order to resolve the outstanding
credits. In each option, there is a level of involvement by the creditors which allows for proper
representation of one of the most valuable stakeholders. Investing in a corporation involves a great
level of risk due to the limited liability nature and, although the creditors are aware of this and
provided with more information relating to the credit risk of the firm, creditors must continue to
be protected. However, in the 3 options provided, it is barely suggested that unsecured creditors
are provided with a remedy in maximizing possible returns on credit. In fact, it was only available
in the process of filing for an informal rehabilitation plan. This should not be the case as
corporations may abuse the limited liability nature of a corporation. The available laws and
legislation should be catered towards protecting unsecured creditors since they bare the greatest
level of risk. In fact, the laws should be able to provide a greater level of scrutiny in determining
whether or not the board of directors has conducted their operations in the utmost profitable
manner – this is because certain members may be liable for the failure of a corporation but is
protected by limited liability.
Other than the possible amendments in providing greater security for unsecured creditors and other
stakeholders, special circumstances and fortuitous events should not be the extreme cause that
corporations are to enter bankruptcy. For example, the case of the COVID-19 pandemic has caused
millions of Filipinos to lose their jobs and stores to shut down because of the inability to pay rent
in certain premium spots. However, the government and private corporations should be able to
provide clauses in benefit of these small-medium enterprises (SMEs) that cannot afford large
expenses. Furthermore, it would be helpful if the government mandates creditors and other
stakeholders in allowing entities in financial difficulty to delay payments due to the extremely
special circumstances from COVID-19. In fact, it is not advantageous at all for the entire Philippine
economy to have SMEs go out of business since these constitute the foundation of the Philippine
workforce.
In conclusion, it is beneficial that the current legislation allows for multiple options for
corporations to resolve their credits, however it is even more important to provide unsecured
creditors with a greater level of security. This will provide future innovations on how corporate
liquidations may be conducted and it will pose different accounting practices. This is all in an
effort in providing all stakeholders with a just process by which they may not be defrauded.
References
https://pidswebs.pids.gov.ph/CDN/PUBLICATIONS/pidsdps2015.pdf
https://www.doh.gov.ph/covid-19/case-tracker
https://www.forbes.com/sites/theyec/2018/01/11/business-life-cycle-spectrum-where-areyou/#522ed6bdef5e
https://lawphil.net/statutes/repacts/ra2010/ra_10142_2010.html
https://s3.amazonaws.com/documents.lexology.com/bb0eb06f-fd8e-4426-b4eeef4f79099779.pdf?AWSAccessKeyId=AKIAVYILUYJ754JTDY6T&Expires=1594978595&Si
gnature=Ql19VokK4Dgr8wjkQCcOGfJloYw%3D