The Lending and Secured Finance Review: Philippines
The principal domestic pieces of legislation applicable to corporate lending and secured financing are Republic Act No. 386 (the Civil Code), An Act to Regulate the Sale Of Property under Special Powers Inserted in or Annexed to Real Estate Mortgages (Act No. 3135) and Republic Act No. 11057 (the Personal Property Security Act (PPSA)).
Commercial lending in the Philippines is typically offered by banking institutions. These are subject to the oversight of the Bangko Sentral ng Pilipinas (BSP). In addition, lending companies may also be authorised by the Securities and Exchange Commission to engage in lending activities pursuant to the Lending Company Regulation Act of 2007. Typically, the operations of these lending companies are limited to small business loans and loans to retail customers.
Legal and regulatory developments
i The PPSA
The PPSA was enacted on 17 August 2018 to strengthen the legal framework for secured transactions in the Philippines. It provides for the creation, perfection, determination of priority, establishment of a centralised notice registry and enforcement of security interests in personal property (tangible and intangible), except aircraft and ships.
The PPSA took effect on 9 February 2019. However, its full implementation is conditioned upon the issuance of the relevant implementing rules and regulations and the establishment and operation of a new registry (wherein notices of security interests created under the PPSA may be registered). In this connection, the implementing rules and regulations of the PPSA (PPSA Rules) were published on 18 November 2019 and took effect on 3 December 2019. The PPSA Rules directed the Land Registration Authority to establish the registry within six months from the publication of the PPSA Rules.2 To date, the registry has not been established. The period between the effectiveness of the PPSA until the date of establishment of the registry is referred to in the said law as the 'Transition Period'.3
The PPSA covers all movable securities used in all transactions of any form that secure an obligation with movable collateral (whether tangible or intangible), except interest in aircraft subject to the Civil Aviation Authority Act of 2008 and interest in ships subject to the Ship Mortgage Decree of 1978.4
The PPSA amended or repealed certain laws that are inconsistent with its provisions.5 This includes the Civil Code with respect to the creation of pledges, and the Chattel Mortgage Law with respect to the creation of chattel mortgages and registration procedures for security interests over personal property in the Philippines.
The new rules introduced by the PPSA on the creation and perfection of security interests on personal property are further discussed in Section IV.ii.
The PPSA also sets out a new set of rules for determining priority of security interest over the same collateral. Under the PPSA, the priority of security interests in the same collateral is still determined by the time of perfection; however, there are specific rules that apply depending on the nature and kind of property involved.
With respect to enforcement, there are two ways by which the security interest may be enforced under the PPSA: a secured creditor may sell or otherwise dispose of the collateral, publicly or privately; or a secured creditor may propose to the debtor and grantor to take all or part of the collateral in total or partial satisfaction of the secured obligation, subject to certain notice and consent requirements.6 The debtor is also required to satisfy any deficiency. Under previous laws governing pledges, a secured creditor is no longer entitled to recover any deficiency after a foreclosure sale.
ii Amendments to the Manual of Regulations on Foreign Exchange Transactions
The BSP introduced amendments to the Manual of Regulations on Foreign Exchange Transactions, which is a consolidation of all regulations governing foreign exchange transactions. The amendments aim to liberalise the restrictions applicable to private sector foreign currency-denominated loans, among others.
Under prior BSP regulations, prior approval must be secured to enter into a private sector foreign currency-denominated loan.
This requirement was removed in BSP Circular No. 984, Series of 2017. Under this issuance, foreign currency-denominated loans of private sector borrowers that are not publicly guaranteed no longer require prior BSP approval to enable the borrower to service payment of the principal and interest on the loan from foreign currency purchased from the Philippine banking system. For this purpose, the BSP requires that such loans be registered with the BSP within a certain period after drawdown or utilisation of loan proceeds.
Further, under BSP Circular No. 1030, Series of 2019, foreign currency loans of resident private sector borrowers from banks operating in the Philippines that are not publicly guaranteed no longer require subsequent registration. Borrowers are only required to report these loans to the BSP using prescribed forms.
iii Basel III Implementing Guidelines
In December 2010, the Basel Committee on Banking Supervision introduced a set of reforms, Basel III, including standards to strengthen the definition of capital, and the introduction of capital buffers to withstand economic and financial strength. The BSP adopted these reforms in stages.
On 15 January 2013, the BSP released the Basel III Implementing Guidelines on Minimum Capital Requirements. This issuance, which took effect in 2014, sets out guidelines on the revised risk-based capital adequacy framework, specifically on the minimum capital and disclosure requirements.
In October 2014, the Implementing Guidelines on the Framework for Dealing with Domestic Systemically Important Banks under Basel III were issued to address systemic risk and interconnectedness by identifying banks that are deemed systemically important within the domestic banking industry and imposing minimum capital buffers on them.
On 9 June 2015, the BSP issued the Basel III Leverage Ratio Framework, which acts as a supplementary measure to risk-based capital requirements. The leverage ratio intends to restrict the build-up of leverage in the banking sector. On 10 March 2016, the BSP issued the Basel III Framework on Liquidity Standards – Liquidity Coverage Ratio and Disclosure Standards.
These reforms are applicable only to universal and commercial banks and their subsidiary banks and quasi-banks.
i Documentary stamp tax
The National Internal Revenue Code of 1997 (NIRC), as amended by the Tax Reform for Acceleration and Inclusion Act, which took effect on 1 January 2018, prescribes the taxes applicable on loan and security transactions.
Section 179 of the NIRC provides that documentary stamp tax (DST) is due on every original issue of debt instruments at the rate of 1.5 Philippine pesos on each 200 Philippine pesos of the issue price, or a fractional part thereof.
With respect to security agreements, Section 195 of the NIRC provides that DST is due on every:
mortgage or pledge of lands, estate, or property, real or personal, heritable or movable, whatsoever, where the same shall be made as a security for the payment of any definite and certain sum of money lent at the time or previously due or owning or forborne to be paid, being payable, and on conveyance of land, estate or property whatsoever, in trust or to be sold, or otherwise converted into money which shall be intended only as a security, either by express stipulation or otherwise.
DST is based on the amount secured: if it does not exceed 5,000 Philippine pesos, DST is 40 Philippine pesos; and on each 5,000 Philippine pesos or fractional part thereof in excess of 5,000 Philippine pesos, an additional tax of 20 Philippine pesos will be imposed.
An omnibus loan and security agreement (OLSA) structure is typically used to save on DST costs. The OLSA structure is based on Revenue Regulations No. 9-94 issued by the Bureau of Internal Revenue (BIR). Under this regulation, where only one instrument is prepared, made, signed and executed to cover a loan agreement or promissory note, or a pledge or mortgage, the instrument shall be treated as covering only one taxable transaction and the DST shall be paid and computed on the full amount of the loan. This means that if a loan agreement and a pledge or mortgage is in a single agreement, the DST will be that payable on the loan (i.e., that under Section 179 of the NIRC).
ii Gross receipts tax
Banks and non-bank financial intermediaries performing quasi-banking functions are subject to gross receipts tax (GRT) due on transactions within the Philippines that are covered by Section 121 of the NIRC. This Section imposes GRT at the rates of 1 to 5 per cent on interest, commissions and discounts from lending activities of banks and non-bank financial intermediaries performing quasi-banking functions depending on the remaining maturities of instruments from which such receipts are derived, and 7 per cent on other items of gross income.
In practice, GRT is shifted or 'passed on' to borrowers through contractual stipulations in the loan agreement, notwithstanding that under the NIRC, banks and non-bank financial intermediaries performing quasi-banking functions are directly liable for GRT.
Revenue Memorandum Circular No. 62-2016, issued by the BIR, provides clarification on the proper tax treatment of GRT. Under this issuance, if the GRT is contractually passed on to the borrower, the passed-on GRT paid by the borrower to the bank will be treated as receipt of gross income and shall itself be subject to GRT. To illustrate, if the recipient is a bank, the interest received by the bank under a loan agreement that provides that the borrower shoulders the GRT on the interest shall be subject to GRT at the rate of 5 per cent. The borrower will remit this passed-on GRT to the bank along with the interest due. The amount of passed on GRT shall form part of the other items of gross income, which itself is subject to 7 per cent GRT.
This would result in a situation where GRT is imposed on the reimbursement of GRT. To address this and ensure that all GRT is passed on to the borrower, lenders typically incorporate the GRT in the computation of the applicable rate of interest on the loan.
iii The Foreign Account Tax Compliance Act
On 13 July 2015, the Philippines and the United States signed the Agreement between the Government of the United States of America and the Government of the Republic of the Philippines to Improve International Tax Compliance and to Implement FATCA (PH–US FATCA IGA), which is a reciprocal intergovernmental agreement to implement provisions of the Foreign Account Tax Compliance Act (FATCA) to promote transparency in financial accounts between the two nations for tax purposes.
Specifically, Philippine financial institutions will need, among other things, to perform due diligence procedures for new and pre-existing individual and entity account holders that meet a certain threshold, and report the total amount of gross income paid or credited to accounts of US account holders.
FATCA reporting will not take place until the PH–US FATCA IGA has been concurred in by the Senate and has entered into force. President Duterte ratified the PH–US FATCA IGA on 1 December 2016 and it was transmitted to the Senate for concurrence, where it remains pending.
Credit support and subordination
Security may be taken over real property by way of a real estate mortgage.
The primary laws governing the creation, perfection and foreclosure of a mortgage on real property are the Civil Code and Act No. 3135. Under Article 2085 of the Civil Code, to constitute a mortgage it is necessary that the mortgagor be the owner of the item mortgaged. Generally, there is no specified form to the mortgage agreement. The document is not required to be registered in the Registry of Deeds for validity. The registration of the security interest and annotation in the certificate of title (if the mortgaged item is land) will bind third parties and constitute public notice to third parties on the creation of the security interest from the date of its recordation. Nevertheless, an unregistered mortgage is binding between the parties.7
A real estate mortgage may be foreclosed extrajudicially or judicially. Extrajudicial foreclosure may be made where a clause is inserted in the contract giving the mortgagee the power, upon default of the mortgagor, to foreclose the mortgage by an extrajudicial sale of the mortgaged property (Act No. 3135, as amended by Act No. 4148, Section 1). The sale should be made after giving notice and should be at a public auction, in the province in which the property is situated.
Owing to foreign ownership restrictions on land, a foreign mortgagee cannot bid or purchase land at a foreclosure sale. Its right is limited to receiving the net proceeds from the sale.
Security interest on personal property
The PPSA introduced new rules governing the creation of security interest over personal property in the Philippines and registration of such security interests. Under the PPSA Rules, parties are free to enter into any form of security arrangements over movable property as long as the security arrangement is not inconsistent with the PPSA or the PPSA Rules. Further, subject to existing law, parties may also apply the PPSA Rules to other functional equivalents of security interest, including fiduciary transfers of title; financial lease; assignment or transfer receivables; and sale with retention of title.8
Under the PPSA, a security interest over personal property may be created by (1) a 'security agreement', (2) an operating lease for not less than one year, or (3) the sale of an account receivable (unless otherwise stipulated by the parties in the document of sale).9 Except as otherwise provided in the PPSA, the PPSA Rules, or the agreement of the parties, a security interest will continue in the collateral notwithstanding the sale, lease, license, exchange, or other disposition of the collateral.10 A security interest is extinguished when all secured obligations have been discharged and there are no outstanding commitments to extend the credit secured by the security interest.11
A security agreement must be in writing, which identifies the collateral and the secured obligation, signed by the parties and shall provide for the language to be used in the agreements and notices.12 A model security agreement is annexed to the PPSA Rules.13 There is no requirement under the PPSA that the security agreement be in a public instrument, but it is advisable given the practical effects of placing documents in a public instrument (i.e., admissible in court as evidence without the need for further proof of its authenticity and due execution). In creating a security interest, it would be sufficient that the collateral be reasonably identified, whether in a general or specific manner.14 For example, a description such as 'all personal property', 'all equipment', 'all inventory' or 'all personal property within a generic category' of the grantor shall be sufficient.15 The security agreement may provide for the creation of a security interest in future property or after-acquired asset, but the security interest in that property will be created only when the grantor acquires rights in it or the power to encumber it.16 The security agreement may also provide that a security interest in a tangible asset that is transformed into a product extends to the product (but it shall be limited to the value of the encumbered asset before it became part of the product).17 It may likewise provide that a security interest in a tangible asset extends to its replacement (but it shall be limited to the value of the encumbered asset before it was replaced).18
The PPSA provides that security interest over personal property may be perfected to bind third parties through the following means: registration of a notice with the registry, actual or constructive possession of the tangible collateral by the secured creditor or a depositary acting for the secured creditor, or control of the investment property or deposit account.
Specifically, a security interest in any tangible asset may be perfected by registration or possession (whether actual or constructive);19 while a security interest in investment property or deposit account may be perfected by registration or control (i.e., through (1) the creation of a security interest in favour of the deposit-taking institution or intermediary, (2) the conclusion of a control agreement or (3) for investment property in electronic security not held with an intermediary, the notation of the security interest in the books of the issuer).20
ii Guarantees and other forms of credit support
Corporate guarantees are typically provided by parents and affiliates of a borrower. A Philippine company can guarantee a debt of the borrower provided that the guarantor is authorised to give the guarantee under its articles of incorporation and has obtained the requisite corporate approvals.
iii Priorities and subordination
Priority of security interests
The priority of security interests in the same collateral is generally determined by time of perfection.21 However, with respect to security interests over personal property, there are rules for determining priority for specific types of properties.
Deposit accounts or investment property
For a deposit account or investment property where the secured creditor is the deposit-taking institution, the order of priority is as follows: (1) deposit-taking institution's right to set-off against the deposit account; (2) creation of a security interest in favour of the deposit-taking institution or the intermediary; (3) conclusion of a control agreement; and (4) registration.22
For security certificates, the order of priority is as follows: (1) possession; and (2) registration.23
For electronic securities not held with an intermediary, the order of priority is as follows: (1) notation in the books maintained by or on behalf of the issuer; (2) conclusion of a control agreement (determined on the basis of the time of conclusion); and (3) registration.24
For electronic securities held with an intermediary, the order of priority is as follows: (1) conclusion of a control agreement; and (2) registration.25
Instruments and negotiable documents
For an instrument or negotiable document, the order of priority is as follows: (1) possession; and (2) registration.26
Banks may only issue unsecured subordinated debt to the public with prior approval from the BSP.27 Banks applying for such authority must comply with the minimum amount of capital under Section 121 of the MORB and, if it will be offered to the general public, the issuing bank must be rated by an independent credit rating agency recognised by the BSP.28
Unsecured subordinated debts shall be issued in minimum denominations of 500,000 Philippine pesos or its equivalent in foreign currency.29
Legal reservations and opinions practice
i Effect of the PPSA on existing security arrangements
Although the PPSA became effective on 9 February 2019, its full implementation is conditioned upon the registry being established and operational.30
Under the PPSA, the creation of 'prior interest' is determined by prior law, and a prior interest is effective between parties, notwithstanding its creation not complying with the requirements of the PPSA.31 In this regard, 'prior interest' is defined as a security interest created or provided for by an agreement for another transaction that was made or entered into before the PPSA was effected, and that had not been terminated before the PPSA was effected, but excludes a security interest that is renewed or extended by a security agreement or other transaction made or entered into on or after the PPSA was effected.32 A security interest that was perfected under a prior law continues to be deemed perfected under the PPSA until the earlier of (1) the time that security interest would cease to be perfected under the prior law and (2) the beginning of the full implementation of the PPSA.33
Creation and perfection of security interests during the Transition Period are governed by the PPSA.34 During this period, registration of a security interest may be made with the Land Registration Authority in accordance with Section 4 of the Chattel Mortgage Law.35 However, the validity of this rule is questionable because the PPSA has repealed the Chattel Mortgage Law.
ii Financial assistance
There are no laws that prohibit a company from granting financial assistance for the purpose of the acquisition of its shares or those of a parent company. The same may be conducted provided that the corporation is duly authorised to engage in such activities under its articles of incorporation and the necessary corporate approvals are obtained.
iii Opinions practice
The counsel of the borrower, mortgagor or pledgor is commonly required to issue a legal opinion addressed to the lender confirming legal capacity; due authorisation of the borrower or obligor to enter into a loan agreement; the validity and enforceability of the agreements; compliance with applicable laws; and the creation and perfection of the security interests.
A legal opinion confirming the above may also be required from the lender's counsel.
iv Choice of law and enforcement of foreign judgments
As a rule, a choice of law in a contractual agreement would be recognised by a court in the Philippines, provided there are substantive factors that justify the choice (e.g., part of the contract was performed in that jurisdiction, a party is a resident of that jurisdiction).
A Philippine court may disregard the parties' choice of law and apply the laws of the Philippines: (1) with respect to matters bearing upon the authority and capacity of any Philippine national to enter into and perform the transactions contemplated by the activities; (2) in determining compliance of the activities with all requirements of governmental approvals in the Philippines; and (3) in determining compliance of the activities with the formalities required under Philippine law for the conveyance of, and the creation of security interests in, property situated in the Philippines.
Moreover, if a suit is instituted in the Philippines, the foreign law must be proven in accordance with Philippine rules on evidence (i.e., the relevant piece of foreign legislation must be shown to exist). In this regard, a certificate of the person having custody of the official publication of the statute must be presented, which must be authenticated by the seal of the secretary, embassy, legation, consul general, consul, vice consul or consular agent, or by any officer in the foreign service stationed in the foreign country in which the record is kept. If a party fails to prove the foreign law, the foreign law will be presumed to be the same as the Philippine law on the matter pursuant to the doctrine of processual presumption.
As a rule, foreign judgments are presumed to be valid and binding, and may be enforced in the Philippines. However, a judgment against a Philippine national by a foreign court could be rejected by a Philippine court if: (1) the foreign court did not have jurisdiction in accordance with the jurisdictional rules of the foreign court; (2) the Philippine national had no notice of the proceedings; or (3) the judgment of the foreign court was obtained through collusion or fraud, or was based on a clear mistake of law or fact.
Loan trading may be done by novation, assignment or participation.
An assignment of credit is the process of transferring the right of the assignor to the assignee who would then have the right to proceed against the debtor.36 In novation through subrogation, the third party pays the obligation of the debtor to the creditor with the latter's consent. As a consequence, the paying party replaces the original creditor as subrogee of the latter.37
Assignment by the borrower of its rights and obligations in a loan agreement is typically allowed with the prior consent of the lender, or, in the case of a syndicated loan, all the lenders.
It is also typical to allow participations in a loan agreement, whereby a lender or a borrower shall be allowed to assign, transfer or sell a participation in all or any part of the loan advance or commitment, subject to consent requirements and minimum denomination. In the case of participations, there shall only be a total of not more than 19 lenders at any one time, otherwise the participating interest created may be deemed a security that will require compliance with the Securities Regulation Code.
There appears to be no established secondary market for loan trading in the Philippines. Loan trading is commonly negotiated between or among parties.
Outlook and conclusions
Credit extended to the private sector increased in 2019.38 However, growth in the Philippines is widely expected to slow down in 2020 as a result of the pervasive economic impact of the global covid-19 pandemic.39 On 23 March 2020, Republic Act No. 11469 or the Bayanihan to Heal as One Act was enacted, granting the President of the Philippines certain emergency powers to address the covid-19 pandemic's effects on the country. The law took effect on 25 March 2020 and shall remain in force for three months. This law authorises the President to adopt temporary emergency measures, which include, among others, directing banks, quasi-banks, financing companies, lending companies and other financial institutions, public and private, to implement a minimum of a 30-day grace period for the payment of all loans falling due within the period of the enhanced community quarantine (which is in place in many parts of the country, including Metro Manila) without incurring interests, penalties, fees, or other charges.
There is an expectation of a strong recovery in GDP growth in 2021, with expansionary fiscal and monetary policies partly offsetting slower domestic demand and disruptions in tourism, trade and manufacturing.40 Determined effort by the Philippine government to pursue infrastructure projects is expected to result in a more robust and vibrant debt market in the Philippines, with borrowers, including government institutions, increasingly seeking funding. This, in turn, is expected to produce a higher growth potential and healthier economy, consistent with stable inflation conditions; paired with the passing of new laws, including the PPSA, and the relaxation of foreign exchange rules in the country, this promises to result in a more robust market for corporate lending in the Philippines. That said, the long-term impact of global pandemic on the Philippine economy in general and the financial markets in particular remains to be seen.
1 Vicente D Gerochi IV is a partner and Camille Angela M Espeleta-Castillo is a senior associate at SyCip Salazar Hernandez & Gatmaitan.
2 PPSA Rules, Section 5.01.
3 PPSA, Section 55(d); PPSA Rules, Section 8.01(d).
4 PPSA, Section 4; PSA Rules, Section 4.01.
5 PPSA, Section 66; PSA Rules, Section 9.01.
6 PPSA, Section 58.
7 Civil Code, Article 2125.
8 PPSA Rules, Section 2.02.
9 PPSA, Section 5(a); PPSA Rules, Section 3.01.
10 PPSA Rules, Section 3.02.
11 PPSA Rules, Section 3.12.
12 PPSA, Section 6; PPSA Rules, Section 3.03.
13 PPSA Rules, Annex A.
14 PPSA, Section 7; PPSA Rules, Section 3.04.
15 PPSA Rules, Section 3.04.
16 PPSA, Section 5(b); PPSA Rules, Section 3.05(a).
17 PPSA Rules, Section 3.05(b).
18 PPSA Rules, Section 3.05(c).
19 PPSA Rules, Section 4.02.
20 PPSA Rules, Section 4.04 and Section 4.05.
21 PPSA Rules, Section 6.01.
22 PPSA, Section 18(a) to (d); PPSA Rules, Section 6.02(a) to (d).
23 PPSA, Section 18(e); PPSA rules, Section 6.03(a).
24 PPSA, Section 16(f) to (h); PPSA Rules, Section 6.02(e) to (f).
25 PPSA Rules, Section 6.02(g).
26 PPSA, Section 19; PPSA Rules, Section 6.03(b).
27 Manual of Regulations for Banks (MORB), Section 126.
28 MORB, Section 126.
29 MORB, Section 126.
30 PPSA, Section 68.
31 PPSA, Section 5; PPSA Rules, Section 8.02.
32 PPSA, Section 55(c); PPSA Rules, Section 8.01(c).
33 PPSA Rules, Section 8.03.
34 PPSA Rules, Sections 8.07 and 8.08.
35 PPSA Rules, Section 8.08.
36 Nyco Sales Corp v. BA Finance Corp, G.R. No. 71694, 16 August 1991.
37 Rodriguez v. Court of Appeals, G.R. No. 84220, 25 March 1992.
38 'Report on Economic and Financial Developments – Fourth Quarter 2019', accessible at
www.bsp.gov.ph/downloads/Publications/2019/LTP_4qtr2019.pdf (last accessed on 9 May 2020).
39 'Asian Development Outlook 2020 What Drives Innovation In Asia? Special Topic: The Impact of the Coronavirus Outbreak—An Update' accessible at www.adb.org/sites/default/files/publication/575626/ado2020.pdf (last accessed on 9 May 2020); 'Addressing the Social and Economic Impact of the COVID-19 Pandemic', accessible at www.neda.gov.ph/wp-content/uploads/2020/03/NEDA_Addressing-the-Social-and-Economic-Impact-of-the-COVID-19-Pandemic.pdf (last accessed on 9 May 2020).
40 'Philippine GDP Growth to Slide in 2020 Due to COVID-19, Strong Rebound Seen in 2021 — ADB', accessed at www.adb.org/news/philippine-gdp-growth-slide-2020-due-covid-19-strong-rebound-seen-2021-adb (last accessed 9 May 2020).