What to Do in an Insolvency: for Debtor and Creditor
What to Do in an Insolvency: for Debtor and Creditor
The economic damage brought about by the COVID-19 pandemic and the government response to it may result in greater use of the country’s insolvency law – the Financial Rehabilitation and Insolvency Act of 2010 (FRIA) or Republic Act No. 10142.
Without insolvency law, a business saddled with monetary liabilities could end up drowning in collection suits. Businesses don’t want to defend against multiple legal actions since that can entail steep legal fees. Leaving an insolvent business entity to its own devices in paying off its liabilities can prejudice creditors who the debtor chooses not to prioritize in payment, for one reason or another.
Similarly, enforcing judgments on collection suits against an insolvent business can mean creditors not party to the collection suit may end up getting less that what they are due. The situation of creditors, who may not know one another, can quickly turn to a competitive race about who gets paid first.
Insolvency proceedings prevent this free-for-all of civil litigation and foster predictability in commercial affairs by resolving competing claims for money. For this reason, FRIA serves both creditor and debtor.
For the Debtor
An insolvent company is one with its liabilities greater than their assets. It can file for insolvency as a way to preserve its remaining assets and shield itself against civil suits. To initiate insolvency proceedings, the debtor corporation “must acquire a majority vote of the board of directors and further authorized by the vote of the stockholders representing at least two-thirds (2/3) of the outstanding capital stock.” (FRIA, Section 12)
Insolvency proceedings are either liquidation or rehabilitation. Liquidation means the debtor wants an organized way of getting its creditors paid as much as they are entitled, the extent that the debtor is able to pay with its remaining cash and the proceeds from auction sales of its assets. Liquidation effectively winds down the business of the company and prepares it to close permanently.
Rehabilitation means the business has a chance of getting back to profitability if it follows a court-approved rehabilitation plan, which explores a combination of new sources of financing, and improving the cash flow and liquidity of the company.
The business is given a period of time to implement the rehabilitation plan. If the implementation fails or if the rehabilitation of the business is found to be unfeasible from the beginning, the proceedings are converted to one of liquidation. (FRIA, Section 75)
The debtor business benefits from a stay order during insolvency proceedings. Stay orders suspend all collection-related litigations against the debtor for the duration of the insolvency proceedings. In contrast to corporations, sole proprietorships can either file for suspension of payments or liquidation. Rehabilitation only applies to corporations.
Filing for insolvency puts the debtor in a position to bargain with those who have money claims against it – creditors – for debt restructuring or even outright debt forgiveness. Even if the rehabilitation fails and the assets of the company are liquidated, the owners of the company can sleep well knowing competing money claims have been adjudicated and resolved in just one court proceeding.
Their managers having learned valuable lessons, companies that come out from rehabilitation become leaner and operate more efficiently than before.
For the Creditor
Banks and lending companies are an obvious candidate for creditors that may be interested in filing insolvency proceedings against their debtors. But any business can have accumulated receivables as a result of laxity in billing or postponements requested by the clients. Businesses selling big ticket items like vehicles and construction equipment, or businesses rendering a complex and highly valued service like engineering and architecture worry about getting paid in a tough economic environment.
With regard to rehabilitation proceedings, Section 13 of FRIA states that:
SEC. 13. Circumstances Necessary to Initiate Involuntary Proceedings. — Any creditor or group of creditors with a claim of, or the aggregate of whose claims is, at least One million pesos (Php1,000,000.00) or at least twenty-five percent (25%) of the subscribed capital stock or partners’ contributions, whichever is higher, may initiate involuntary proceedings against the debtor by filing a petition for rehabilitation with the court if:
(a) there is no genuine issue of fact or law on the claim/s of the petitioner/s, and that the due and demandable payments thereon have not been made for at least sixty (60) days or that the debtor has failed generally to meet its liabilities as they fall due; or
(b) a creditor, other than the petitioner/s, has initiated foreclosure proceedings against the debtor that will prevent the debtor from paying its debts as they become due or will render it insolvent.
For creditor-initiated liquidation proceedings under Section 91 of FRIA, the petition has to show that “(a) there is no genuine issue of fact or law on the claims/s of the petitioner/s, and that due and demandable payments thereon have not been made for at least one hundred eighty (180) days or that the debtor has failed generally to meet its liabilities as they fall due; and (b) there is no substantial likelihood that the debtor may be rehabilitated.”
In contrast to corporations, creditors desiring to place sole proprietors and individuals in liquidation must have aggregate claims, individually or together with other creditors, that reach the amount of Php500,000, allege at least one act of insolvency enumerated under Section 105 of FRIA, and post a bond in the amount determined by the court.
Companies who worry about not getting paid are considered creditors. Under FRIA, creditors may file, individually or with other creditors, to place the non-paying entity (the “debtor”) in insolvency proceedings.
In insolvency, the debtor “corporation receives assistance from the court and a disinterested rehabilitation receiver to balance the interest to recover and continue ordinary business, all the while attending to the interest of its creditors to be paid equitably.” (Viva Shipping Lines, Inc. vs. Keppel Philippines Mining et. al., G.R. No. 177382, February 17, 2016)
Rehabilitation preserves the assets of the debtor and gets the company back to a state of profitability so that the creditors can potentially get paid more money compared to what they would get if the assets were liquidated. Creditors also have a say in the features of the rehabilitation plan. Comments and objections can be admitted with regard to the feasibility of the rehabilitation plan.
A court-supervised process of getting the business back to profitability and resolving property claims avoids the situation of the free-for-all in chasing after the debtor’s assets. The court and the rehabilitation receiver oversees the implementation of the rehabilitation plan and so preventing fraud and misappropriation, ultimately benefiting both debtor and creditor parties.
About Atty. Kenneth
Atty. Kenneth C. Varona is a lawyer with experience in civil and criminal litigation, contracts, immigration law, and intellectual property law. He worked in Metro Manila for three years before starting his own firm Varona Law in 2020. He also writes at Economerienda, a blog offering snackable insights on personal finance, business and life.