The Energy Mergers & Acquisitions Review: Philippines
In 2008, the Philippines passed a landmark piece of legislation ahead of any Asian country: Republic Act No. 9513, otherwise known as the Renewable Energy Act of 2008 (the RE Act), which established the basic legal framework and signalled the aspiration of the Philippine government to transition its energy market into the increased utilisation of renewable energy (RE) resources. The RE Act outlined policy mechanisms, including net metering, feed-in tariff (FIT) system, Renewable Portfolio Standards for on-grid and off-grid areas (RPS), the Green Energy Option Programme (GEOP) and the Renewable Energy Market (REM), among others.
As part of its energy reform agenda, the Philippine Department of Energy (DOE) launched the National Renewable Energy Programme (NREP)2 in 2011, which presents a clear roadmap towards the development of emerging RE technologies, including biomass, geothermal, solar, run-of-river hydro, ocean and wind. From 5,438 MW in 2010, the NREP aims to increase to 15,304 MW the total RE-based capacity installation in the Philippine power market. After the NREP launch, the Energy Regulatory Commission (ERC) approved the net metering rules3 and the FIT rates4 to further implement the RE Act.
In 2016, through the initiative of the National Renewable Energy Board (NREB), a collaboration between the private and public sectors of the Philippine power industry, the DOE completed the remaining policy mechanisms including the rules on RPS,5 GEOP6 and REM.7 With all these rules in place, the Philippines was set to accelerate use of RE resources.
Year in review
After the RE Act and NREP, many RE developers overwhelmingly responded to the Philippine government's call for action and applied for RE service contracts (RESCs), the primary licence that grants developers exclusive right to explore, develop and utilise identified RE resources over a specific contract area. With the implementation of the FIT programme in 2012, approximately 1,323 MW of new RE plants were built within three years, with solar contributing 525 MW and wind contributing 393 MW. This surge in new capacities in 2016 yielded huge foreign investments into the Philippines amounting to approximately 160 billion Philippine pesos. In 2016, the Philippines then distinguished itself as one of the leaders in the global RE industry with the construction of the 150 MW Bangui Wind Farm, the largest wind project in South East Asia, and the 132.5 MW Helios Solar Farm, the largest solar plant in South East Asia.
After the FIT programme ended, however, only an additional 280 MW of new renewable energy capacity was constructed by the developers. As of 2020, 10 years after the effectivity of the RE Act, only a total of 2,338,69 MW of additional capacity totalling 221 billion Philippine pesos in investment had been built, with FIT-qualified solar, biomass and wind plants comprising most of these new plants. With only 10 years left under the NREP, this reported new MW capacity will certainly fall short of the projected 10,000 MW target capacity by 2030. The DOE's issuance of the RPS, GEOP and REM did not result in any major construction of new plants given the difficulty in securing power supply agreements under the DOE's competitive selection process rules,8 the bureaucratic process in securing numerous permits and the declaration by the DOE of its 'technology-neutral' policy after the FIT programme, despite its clear statutory mandate to develop 'energy resources with preferential bias for environment-friendly, indigenous and lost-cost sources of energy'.9
As a consequence of the slowdown in newly installed capacity for RE projects since 2016, the RE share in the total Philippine energy and generation mix drastically dropped. From a high of 33.2 per cent share in the total installed generating capacity in the Philippines, the RE share dropped to 29 per cent in 2020. In terms of power generation, from a high of 26.3 per cent in 2010, the share of RE in the total power generation by source went down to a meagre 20 per cent. The inverse is true, however, for coal: from 29 per cent in installed generating capacity in 2010, coal capacity increased to 41 per cent in 2020, and from 34 per cent in power generation by source in 2010, coal generation increased to 54 per cent in 2020. Naturally, the energy self-sufficiency of the Philippines, which is measured in terms of utilisation of local indigenous versus imported energy resources, declined from 57 per cent in 2010 to 46 per cent in 2020.
Legal and regulatory framework
The RE industry is governed by the following hierarchy of Philippine laws and regulations:
- the 1987 Constitution;
- the RE Act; and
- DOE circulars and issuances.
The application of these laws is interpreted by the Philippine Supreme Court through its promulgated decisions.
i 1987 Constitution and nationality restrictions
The 1987 Constitution, the fundamental law in the Philippines, adopted the Regalian Doctrine, or jura regalia, which means that all lands of the public domain, waters, minerals, coal, petroleum and other mineral oils, all forces of potential energy, fisheries, forests or timber, wildlife, flora and fauna, and other natural resources, including RE resources, are owned by the state. The exploration, development and utilisation of these natural resources shall be under the full control and supervision of the Philippine government. The state may directly undertake such activities or it may enter into coproduction, joint venture or production-sharing agreements with Filipino citizens or corporations at least 60 per cent of whose capital is owned by such citizens.10 Accordingly, a foreign investor that proposes to engage in the business of developing RE resources in the Philippines is limited to a maximum of 40 per cent voting capital. Commonwealth Act No. 108, the 'Act to Punish Acts of Evasion of the Laws on Nationalisation of Certain Rights, Franchises or Privileges', punishes any person who allows his name or citizenship to be used to violate these nationality restrictions and any foreigner profiting thereby.
In 2011, the Philippine Supreme Court ruled in Gamboa v. Teves, et al.11 that the term 'capital' in the 1987 Constitution refers only to shares of stock entitled to vote in the election of directors. The 40 per cent of the voting and total number of outstanding shares of stock of a shareholder does not, however, preclude that shareholder from having economic interest higher than 40 per cent. The Supreme Court ruling in Roy v. Herbosa12 emphasised the need to disabuse any notion that dividends accruing to any particular stock are determinative of that stock's 'beneficial ownership' of the corporation. So long as Filipinos have a controlling interest of a partly nationalised corporation through legal and beneficial ownership of 60 per cent of the outstanding capital stock, coupled with 60 per cent of the voting rights, their decision to declare more dividends for a particular stock over other kinds of stock is their sole prerogative – an act of ownership that would presumably be for the benefit of the partly nationalised corporation itself.
ii The RE Act and incentives
The RE Act provides for the overall regulatory framework to promote accelerated advancement of RE resources into useful forms of energy. The RE Act requires all developers to apply for an RESC, a service agreement with the Republic of the Philippines, through the DOE, with a 25-year term, extendable to another 25 years, in which the developer is given the exclusive right over a particular area for exploration and development of RE resources. The RESC serves as the foundation for the developer to build an RE power plant in the Philippines.
The RE Act promotes the efficient and cost-effective commercial application of these RE systems by providing fiscal and non-fiscal incentives to RE developers engaged in the utilisation of RE resources and the actual operation of RE systems or facilities. To encourage investments in RE, an RE developer with an RESC shall be entitled to the following fiscal incentives:
- an income tax holiday (ITH) for seven years from the start of commercial operations;
- 10 per cent corporate tax rate on its net taxable income after seven years of the ITH availment compared to the regular 25 per cent corporate income tax rates;
- exemption from tariff duties in the importation of machinery and equipment, and materials and parts thereof within the first ten years of the issuance of a Certificate of Registration to an RE developer;
- special realty taxes not exceeding 1.5 per cent of their original cost less accumulated depreciation or net book value on civil works, equipment, machinery and other improvements actually and exclusively used for RE facilities;
- deduction from gross income for the next seven consecutive taxable years of the net operating loss carry-over (NOLCO) during the first three years from the start of commercial operations provided the NOLCO had not been previously offset as a deduction from gross income, and the loss is a result from the operation and not from the availment of incentives under the RE Act;
- accelerated depreciation if an RE project fails to receive an ITH before full operation;
- zero value-added tax (VAT) on:
- the sale of fuel from RE sources or power generated from RE sources;
- the purchase of local goods, properties and services needed for the construction and installation of the plant facilities; and
- the whole process of exploration and development of RE sources up to its conversion into power, including services performed by subcontractors or contractors, and the installation of the plant facility as well as the exploration and development of RE resources and their conversion into power;
- tax exemption on all proceeds from the sale of carbon emission credits; and
- tax credit equal to 100 per cent of the value of VAT and customs duties that would have been paid on the RE machinery, equipment, materials and parts had these items been imported for purchases of machinery, equipment, materials and parts from a domestic manufacturer, fabricator or supplier, provided:
- said equipment, machinery and spare parts are reasonably needed and shall be used exclusively by the registered RE developer;
- the purchase of such equipment, machinery and spare parts is made from an accredited or recognised domestic source upon prior approval by the DOE; and
- acquisition of such machinery, equipment, materials and parts shall be made within the validity of the RESC.
The RE Act also provides for, among others, the following key incentives:
- priority and must despatch for RE generating units with intermittent RE resources;
- cash generation-based incentive per kilowatt hour equivalent to 50 per cent of the universal charge for the power needed to service missionary areas chargeable against the Universal Charge for Missionary Electrification;13 and
- exemption from universal charge by power and energy generated through the retail electricity supplier for the RE developers' own consumption or for free distribution in the off-grid areas.
iii DOE issuances and regulations
DOE Department Circular No. 2019-10-0013, the 'Omnibus Guidelines Governing the Award and Administration of Renewable Energy Contracts and the Registration of Renewable Energy Developers', provides for the specific requirements for the award and grant of different types of RESCs per RE resource, e.g., biomass energy operating contract for biomass resources; solar energy operating contract for solar resources; hydropower service contract for hydropower resources; and wind energy service contract for wind energy resources.
The DOE may directly award an RESC to an RE applicant who has identified an area duly verified and confirmed by the DOE as available for development and utilisation of the proposed RE resource.14
The Omnibus Guidelines also provided for registration of RE projects for own-use or non-commercial operations. The RE developer may apply for a Certificate of Registration (COR) with the DOE, which will serve as proof of registration and basis for availment of fiscal and non-fiscal incentives under the RE Law. The COR has an initial validity of five years, renewable for the same period until the end-of-project life is reached at a maximum of 25 years.15
In 2018, the DOE issued Department Circular No. DC2018-02-0003 entitled 'Adopting and Prescribing the Policy for the Competitive Selection Process in the Procurement by the Distribution Utilities of Power Supply Agreement for the Captive Market' (the CSP Rules), which required all utilities to conduct public bidding before they can enter into any supply contracts for captive customers with any supplier. The 2018 CSP Rules were recently amended by the DOE through Department Circular No. DC2021-09-0030 to allow an unsolicited proposal as an acceptable form of public bidding. The distribution utilities must comply with the CSP Rules, as amended, in their efforts to comply with the RPS rules.
iv Philippine Competition Act and clearance
The developments in the Philippine RE industry for the past 10 years have seen several corporate mergers and acquisitions (M&As) of different RE developers. In 2015, Republic Act No. 10667 entitled 'An Act Providing for a National Competition Policy Prohibiting Anti-Competitive Agreements, Abuse of Dominant Position and Anti-Competitive Mergers and Acquisitions, Establishing the Philippine Competition Commission and Appropriating Funds Therefor' was enacted, requiring parties to M&As that satisfy the thresholds set out in the implementing rules and regulations to notify the Philippine Competition Commission (PCC) before the execution of definitive agreements relating to the relevant transaction. An agreement consummated in violation of the requirement to notify the PCC shall be considered void and shall subject the parties to an administrative fine of 1 per cent to 5 per cent of the value of the transaction.
Section 4(eee) of Republic Act No. 11494, as amended by Republic Act No. 11519, 'An Act Extending the Availability of Appropriations under Republic Act No. 11494', otherwise known as the 'Bayanihan to Recover As One Act' (the Bayanihan 2), exempts from compulsory notification M&As with transaction values below 50 billion Philippine pesos if entered into within two years of the effectivity of Bayanihan 2 on 15 September 2020. Bayanihan 2 also suspends the PCC's exercise of motu proprio review of these transactions for one year. Under the implementing rules issued by the PCC, the following M&As are therefore still subject to compulsory notification:
- those whose transaction value is at least 50 billion Philippine pesos; or
- those entered into before 15 September 2020 and that exceed the applicable thresholds when the definitive agreement was signed.
In determining the transaction value, the PCC rules apply 50 billion Philippine pesos as the size-of-person and size-of-transaction thresholds for compulsory notification.
Cross-border transactions and foreign investment
The 40 per cent limitation of foreign investors in RE projects under the 1987 Constitution and the RE Act has not deterred foreign investment in the Philippine RE industry. In a record RE acquisition, Global Infrastructure Partners (GIP) bought Equis Energy for US$5 billion in 2018. Through its collaboration with local partners, Equis, now through GIP-backed Vena Energy, has built the largest portfolio of operating RE projects in the Philippines, including the 20.1 MW Garcia Solar Project, 54 MW Pillilla Wind Project, 132.5 MW Helios Solar Project, 30 MW Ironman Solar Project and 10.5 MW Zorro Solar Project.
In 2021, the PCC approved the US$1.16 billion acquisition by Scatec Solar ASA, a Norwegian RE company, of 100 per cent shares in SN Power AS, a wholly owned subsidiary of the Norwegian Investment Fund for Developing Countries (Norfund). SN Power AS entered the Philippines in 2005 through a joint venture with the 100 per cent Filipino company, Aboitiz Power Corporation. The joint venture operates hydropower plants in the Philippines.
The foregoing notwithstanding, the foreign chambers in the Philippines and several sectors have asked the Philippine government to ease foreign investment restrictions, particularly in the RE industry, to allow more foreign investors to enter the Philippine power market.
Project financing transactions of RE projects are commonly documented through an omnibus loan and security agreement, which combines the loan and the security agreements, i.e., mortgage agreement, security interest over the sponsors' shares, assignment of rights under material project agreements, and assignment of bank accounts and receivables, as separate parts of one document. The structure is tax-driven, and allows the borrower to save on documentary stamp taxes (DST) while not compromising the security granted to the financing lenders. Normally, the execution of a mortgage agreement and the loan facility is separately subjected to DST. Tax regulations, however, allow the imposition of only one DST (i.e., the DST yielding the highest tax) whenever only one instrument is prepared to document the loan and the agreements securing the loan.
An overlapping of security interests over the same collateral created under different security agreements is a common arrangement. Real property is encumbered through a real estate mortgage. With the passage of the new Personal Property Security Act,16 security interests over personal property, including shares of stock, are documented through a personal property security agreement. Sponsors are typically required by project lenders to secure the loan with the shares of stock they own in the project company. The project company is also required to assign by way of security its contractual rights and receivables, project revenues and rights to project bank accounts to the lenders.
The security documents for a project financing require compliance with certain formalities and registration with the register of deeds in order to make such documents binding not only between the parties to the agreement, but also against third parties. If the loan facility is a foreign currency loan provided by foreign creditors, the lenders will require the facility to be approved by and registered with the Bangko Sentral ng Pilipinas or the Philippine Central Bank. This allows the project company to source the foreign exchange needed to service its repayment obligations under the loan from the Philippine banking system.
An RE project is able to be financed by lending banks when risks are managed and allocated efficiently. The following are the risks to lending banks and the risk mitigation arrangements that can be entered into to manage such risks:
- project construction completion risk, which can be managed with:
- a turnkey construction contract that specifies performance obligations with penalty clauses;
- sponsor support until completion to manage cost overruns; and
- executed land use agreements to manage site availability;
- project performance:
- performance bond/guarantee from equipment suppliers on quantity and quality to ensure equipment performance;
- supply contracts specifying quantity, quality and pricing to manage input availability – match term of supply contract to term of offtake commitment; and
- an experienced management team;
- market risk – offtake contract specifying minimum quantities and prices, or sell output to creditworthy buyers;
- political risk – insurance or strong local sponsor in project shareholding, and increase project profile by involving multilateral development bank or other official agency in financing; and
- overall risk:
- security arrangements;
- debt service coverage;
- staged disbursements;
- disbursement conditions; and
- borrower representations and covenants.17
Financial covenants include thresholds for debt service coverage ratio and debt to equity ratio. Lenders would require a healthier threshold for the purposes of making restricted payments (i.e., release of funds to the borrower's distribution account for dividend payments) compared to the ratios to be maintained during the term of the loan. Local banks typically avoid financing merchant plants, and in recent deals, the remedy proposed whenever there are offtake issues, such as no power supply agreement yet in place, or offtake is reduced under the terms of such agreement, would be to increase the threshold for the financial ratios.
Due diligence on RE projects in the Philippines primarily focuses on the compliance of the M&A transaction with the nationality requirements (i.e., the 60–40 Filipino-foreign investor limitation under the 1987 Constitution and RE Act).
To implement the constitutional mandate, Commonwealth Act No. 108, as amended, the 'Anti-Dummy Law', penalises any foreign national who intervenes in the management, operation, administration or control of any right, franchise, privilege, property or business, the exercise or enjoyment of which is expressly reserved by the Philippine Constitution to citizens of the Philippines, whether as an officer, employee or labourer, except technical personnel whose employment may be specifically authorised by the Secretary of Justice. Any violation of the Anti-Dummy Law shall be punished by imprisonment for not less than five nor more than 15 years and by a fine of not less than the value of the right, franchise or privilege which is enjoyed or acquired in violation of the provisions of the law but in no case less than 5,000 Philippine pesos.
Foreigners are also allowed to occupy seats on the board or governing body of entities engaged in wholly or partially nationalised business activities, in proportion to their allowable shareholdings. Thus, in a business that requires a 60–40 shareholding structure in favour of Filipinos, the board seats that foreign persons or entities may occupy shall also be limited to 40 per cent of the total seats.18
Pursuant to the above prohibition under the Anti-Dummy Law, the positions of foreign corporate officers in RE projects should be technical in nature if these foreign investors wish to participate in the operation of an RE project.
Other due diligence considerations include:
- the ownership of land for RE projects, which is also restricted to 60–40 foreign ownership, and the conversion of such lands from agricultural to industrial use for the construction of RE projects;
- the continuing validity of and compliance with the terms of the RESC and key permits issued by key government offices such as the ERC, the Department of Environment and Natural Resources, the National Commission on Indigenous People and the National Water Resources Board; and
- the existence of or possible offtake contracts.
Purchase agreements and documentation
M&A transactions involving RE projects are typically documented in the form of share purchase agreements (SPAs) between the foreign investor and local RE developer. These SPAs usually include, among others, the following standard provisions:
- governance structure, including the number of board of directors seats to which the shareholders are entitled, with foreign investors limited by the 40 per cent maximum participation in the voting capital of the RE company and designated officers with foreign nationals limited to technical positions only;
- representations and warranties, including the authority of the special purpose vehicle into which the foreign investor is buying to engage in the development of RE resources, government consents and approvals for the entry of the foreign investor, the absence of any major claims or litigation pending against any of the contracting parties, compliance with Philippine laws, the absence of any breach of contractual obligations with other parties, filing and payment of returns and taxes, etc.;
- exclusivity and cooperation, including provisions whereby contracting parties agree to work exclusively on the RE projects they have mutually identified without competing; and
- a dispute resolution mechanism, including the use of the International Chamber of Commerce (ICC) Rules of Arbitration as procedure to resolve contractual disputes between the parties.
Key regulatory issues
When entering into M&A transactions in the Philippines involving RE projects, the following key regulatory issues should be considered:
- 60–40 foreign investor limitation in the voting capital of the RE company that will operate the RESC, as required by the 1987 Constitution and the RE Act;
- conversion of land from agricultural to industrial use for the construction of RE projects, as required under certain circumstances in accordance with the rules of the Department of Agrarian Reform and the Local Government Code of the Philippines;19
- employment of foreign nationals limited to technical positions in the RE projects, as provided in the Anti-Dummy Law; and
- registration of the RESCs with the Board of Investments to ensure entitlement of the RE power plant to all incentives under the RE Act.
There is no representation and warranty insurance in Philippine financing deals. While such insurance has become a trend in other jurisdictions, local lenders do not require this as insurance deals normally just cover standard insurance for properties that are part of the collateral offered to lenders. If the property damaged can be restored or repaired, then insurance proceeds will go to the repair of the damaged properties. If the damaged property cannot be repaired or restored, then the insurance proceeds will be used to make a partial pre-payment of the loan.
Arbitration has been the preferred mode of dispute resolution of contracting parties to M&A deals and commercial transactions involving Philippine energy projects. Parties usually adopt the ICC Rules of Arbitration as the governing rules when settling contract disputes. In fact, the RESCs include a template provision for ICC arbitration in case of a dispute between the RE developer and the DOE. The RESC requires the appointment of a three-person arbitral tribunal in accordance with the ICC Rules of Arbitration.
To mitigate litigation risks, the standard arbitration provision entered into by contracting parties in an M&A transaction usually includes a 'mutual discussions' clause, which requires amicable discussions between high-ranking officers of each party to resolve any contractual misunderstanding.
The full implementation of the RE Act and the NREP is a promise that the Philippine government must keep, considering its importance in the thriving Philippine economy. The NREP is an honour pledge. While the Philippines has enacted all appropriate laws and rules to push for increase in RE utilisation, the Philippines has lagged behind its neighbours for the past four years. The DOE must change its technology-neutral policy and instead transition to RE as the preferred energy resource in the Philippines.
The DOE is currently revising the NREP to increase the 35 per cent new installation capacity target in 2030 to 50 per cent in 2040. With the full implementation of all RE policy mechanisms, the reduced costs in RE technologies and the impending change in Philippine government, there is hope of reversing the current trend of increased conventional fuel use and transition to cleaner RE resource utilisation.
1 Jay Layug, Jonathan Serrano and Richie Ramos-Pilares are senior partners at Puno and Puno Law Offices.
3 ERC Resolution No. 09, Series of 2013, 'A Resolution Adopting the Rules enabling the Net-Metering Programme for Renewable Energy'.
4 ERC Case No. 2011-006 RM: In the Matter of the Petition to Initiate Rule-Making for the Adoption of the Feed-in Tariff for Electricity Generated from Biomass, Ocean, Run-of-River Hydropower, Solar and Wind Energy Resources.
5 DOE Department Circular No. 2017-12-0015, 'Promulgating the Rules and Guidelines Governing the Establishment of the Renewable Portfolio Standards for On-Grid Areas' and DOE Department Circular No. 2018-08-0024, 'the Renewable Portfolio Standards for Off-Grid Areas'.
6 DOE Department Circular No. 2018-07-0019, 'Rules Governing the Establishment of the Green Energy Option Programme (GEOP) in the Philippines'.
7 DOE Department Circular No. 2019-12-0016, 'Promulgating the Renewable Energy Market Rules'.
8 DOE Department Circular No. DC2018-02-003, 'Competitive Selection Process in the Procurement by the Distribution Utilities of Power Supply Agreement for the Captive Market', as amended by DOE Department Circular No. DC2021-09-0030.
9 Republic Act No. 7638, the 'Department of Energy Act of 1992'.
10 Article XII, Section 2, 1987 Constitution of the Philippines.
11 GR No. 176579, 28 June 2011.
12 GR No. 207246 (Resolution), 18 April 2017.
13 'Missionary Electrification' refers to the provision of basic electricity service in unviable areas with the aim of bringing the operations in these areas to viability levels.
14 Omnibus Guidelines, Section 4.1.2(c).
15 id., Section 38.
16 Republic Act No. 11057.
17 International Finance Corporation, Project Finance in Developing Countries, 1999 edition, pp 40–41.
18 Heirs of Wilson Gamboa v. Margarito Teves, et al., GR No. 176579, 9 October 2012.
19 Republic Act No. 7160.