Corporate lives in peril

Section 11, Article XII of the Philippine Constitution provides “No franchise, certificate or any other form of authorization for the operation of a public utility shall be granted except to citizens of the Philippines or to corporations or associations organized under the laws of the Philippines, at least sixty per centum of whose capital is owned by such citizens.” Based on this provision, there is a constitutional limitation on the ownership of public utility companies by foreigners. Foreigners are allowed to own up to 40 percent only of the capital of public utility companies.

In addition to public utilities, the term ‘capital’ is also used in other articles of the Constitution providing for limitations on the foreign ownership of private lands, the exploitation of natural resources, the ownership of educational institutions, the ownership of advertising agencies and the reservation of certain areas of investment for Filipino citizens or corporations 60 percent of whose capital is owned by Filipinos.

But what does the term ‘capital’ refer to?

In a Securities and Exchange Commission (SEC) opinion dated 15 February 1988, the SEC opined that the term ‘capital’ as used in Section 11 of Article XII of the Philippine Constitution refers to the ‘sum total of the shares subscribed and paid by the shareholders, or served to be paid, irrespective of their nomenclature.” The said opinion involved a public utility company which was contemplating an increase in its capital stock. The company disclosed that after the contemplated increase in capital stock, it was possible for the foreign shareholders to own more than 40 percent of the common stock of the corporation but the aggregate outstanding capital (common and preferred shares) would not exceed 40 percent. The SEC ruled then that the term ‘capital’ has been understood to mean money or other property or services, paid-in by a stockholder to a corporation, in exchange for shares of stock in a corporation regardless of the classification of the stocks, whether common or preferred. Thus, even if the foreign shareholders will end up owning more than 40 percent of the common stock of the corporation but not more than 40 percent of the total outstanding stock, the public utility would still be considered compliant with the Constitutional limitation on the foreign ownership of public utilities.

Recently however, the Supreme Court came out with a decision involving the common shares of Philippine Long Distance Telephone Co. which has sent the business community and foreign investors into a tailspin. The decision deals with the issue of whether the term ‘capital’ as used Section 11 Article XII of the Philippine Constitution refers to the total common shares only or to the total outstanding capital stock (which is the combined total of common and non-voting preferred shares) of a public utility.

The decision in the PLDT case sheds light on what the term ‘capital’ contemplates. In their decision, the Supreme Court ruled that the term ‘capital’ as used in the Constitution only refers to common shares since only common shares have voting rights and voting rights translate to control of the corporation. This is because the shares which hold voting rights determine who shall be elected to the board of directors of a corporation. However, the Supreme Court also noted that if preferred shares also have voting rights in the election of directors of a corporation then such preferred shares must also be considered included in the term ‘capital’. In other words, the term ‘capital’ refers only to shares which have voting rights in the election of the directors of the corporation. The Supreme Court stressed that their interpretation is consistent with the constitutional intention to reserve management and control of public utilities to Filipino citizens.

In the case of PLDT, the Supreme Court found that its authorized capital stock consisted of 77.85 percent preferred shares and 22.15 percent common shares. 99.44 percent of the preferred non-voting shares were owned by Filipinos while the remainder was owned by foreign nationals. On the other hand, 64.27 percent of the common shares were owned by foreign nationals while 35.73 percent of the shares were owned by Filipinos. In short, 64.27 percent of the shares with voting rights were held by foreign nationals. Thus, violating the Constitutional foreign equity limitation for public utilities.

While the PLDT case deals only with the foreign equity requirement of a public utility, the Supreme Court decision will also affect all other corporations subject to limited foreign equity requirements.

What is quite worrisome about the High Court’s ruling is the directive given to the SEC to implement their decision and apply the definition of the term ‘capital’ in determining the extent of the allowable foreign ownership in PLDT. The Supreme Court directed the SEC to determine if there is any violation of the Constitution and to apply the appropriate sanctions. The sanctions include suspension or revocation of the corporation’s certificate of registration. If the SEC looks into the capital structure of PLDT in compliance with the High Court’s order, an examination of the capital structure of other public utilities may not be far behind. Consequently, all corporations with limited foreign equity requirements may also be examined to determine compliance with foreign equity requirements.

The order given to the SEC puts in peril the lives of all corporations with limited foreign equity requirements. What will happen to corporations which exceed the foreign equity limitation based on the High Court’s interpretation of the term ‘capital’? Will these corporations face revocation of their certificates of registration? Should these corporations look into restructuring their equity in order to comply with the foreign ownership requirement? Should the foreign shareholders start divesting their shares which are in excess of the foreign equity limitation? How will affected corporations determine who among the foreign shareholders will be required to divest?

While the Supreme Court decision rests on solid ground, the practical implications of the said decision may not have been thoroughly considered. The term ‘capital’ not only applies to public utilities but to all other corporations with limited foreign equity requirements. The decision has far-reaching effects as not only is the existence of the corporation threatened but the livelihood of its employees as well. Consequently, the decision may affect the country’s economy if foreign investors pull out their capital. Perhaps, the prospective application of the decision may be considered in order to preserve those investments which are already in place.

In the meantime and until the SEC comes out with guidelines for the implementation of the High Court’s decision, corporations with limited foreign equity requirements will have to deal with the sword of Damocles hanging over their heads.

Kathleen L. Saga is a Supervisor of tax of Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected]or ksaga.kpmg.com