Philippine Mining: The Grandfather Rule for Foreign Investments

If you are a foreign investor thinking of putting in capital for mining businesses in the Philippines, you must have asked if there is a limit on foreign ownership for Philippine mining companies. The Supreme Court again discussed this issue in a recent ruling denying a motion for reconsideration filed by certain mining companies in the Philippines. The controversy is anchored on the requirement that mining, among other activities, is reserved by the Constitution — the highest law of the land — for Filipinos. Sec. 2, Art. XII of the Constitution, which provides that the exploration, development, and utilization of of natural resources is reserved to Filipinos, whether natural persons or juridical persons. Filipino juridical persons refer to “corporations or associations at least sixty per centrum of whose capital is owned by such citizens.”

Not Moot and Academic

It was argued that the case has become moot and academic because: (1) the applications for Mineral Production Sharing Agreements or MPSAs, reserved for Filipino corporations, were purportedly converted to an application for a Financial Technical Assistance Agreement or FTAA; and (2) all the shares for the foreign investor, the Canadian-owned MBMI Resources, Inc., were already sold to a Filipino company.

However, the SC stated that it may still take cognizance of the case. For one, the “elaborate corporate layering” is “deftly exceptional in character” that was “evidently designed to circumvent the constitutional caveat allowing only Filipino citizens and corporations 60%-owned by Filipino citizens to explore, develop, and use the country’s natural resources.” The case, according to the SC, is an “opportunity to establish a controlling principle that will “guide the bench, the bar, and the public.”

Control Test

Under the Control Test, which is the more liberal rule, there is no need to trace the shareholdings in the corporation. The SC cited Department of Justice (DOC) Opinion No. 020, Series of 2005, which discussed this rule in this manner: “Under the above-quoted SEC Rules, there are two cases in determining the nationality of the Investee Corporation. The first case is the ‘liberal rule’, later coined by the SEC as the Control Test in its 30 May 1990 Opinion, and pertains to the portion in said Paragraph 7 of the 1967 SEC Rules which states, ‘(s)hares belonging to corporations or partnerships at least 60% of the capital of which is owned by Filipino citizens shall be considered as of Philippine nationality.’ Under the liberal Control Test, there is no need to further trace the ownership of the 60% (or more) Filipino stockholdings of the Investing Corporation since a corporation which is at least 60% Filipino-owned is considered as Filipino.”

Corporate Layering

There is no issue that corporate layering is allowed under the Republic Act (R.A.) No. 7042, also known as the Foreign Investments Act of 1991 (FIA), as amended by R.A. 8179. However, when it is used to “circumvent the Constitution and pertinent laws, then it becomes illegal.”

The Grandfather Rule

The Control Test does not preclude the application of the “stricter, more stringent” rule — the Grandfather Rule. The application of the two tests is not alternative, but cumulative, in nature. This means that the two rules can be applied jointly. The use of the Grandfather Rule as a “supplement” to the Control Test is not proscribed by the Constitution or the Philippine Mining Act of 1995. It is, in fact, used “so that the intent underlying the averted Sec. 2, Art. XII of the Constitution be given effect.”

Both the direct and indirect shareholdings in the corporation are determined to arrive at the actual Filipino ownership and control in a corporation. The Grandfather Rule, as defined in the work of Dean Cesar Villanueva, is “the method by which the percentage of Filipino equity in a corporation engaged in nationalized and/or partly nationalized areas of activities, provided for under the Constitution and other nationalization laws, is computed, in cases where corporate shareholders are present, by attributing the nationality of the second or even subsequent tier of ownership to determine the nationality of the corporate shareholder.”

The Grandfather Rule, standing alone, should not be used to determine the Filipino ownership and control in a corporation — it is only when the Control Test is first complied with that the Grandfather Rule may be applied. There is no need to apply the Grandfather Rule in the following cases:

  • If the subject corporation’s Filipino equity falls below the threshold 60%, the corporation is immediately considered foreign-owned, in which case, the need to resort to the Grandfather Rule disappears.
  • If there is no doubt as to who has the “beneficial ownership” and “control” of the corporation, and a corporation complies with the 60-40 Filipino to foreign equity requirement.

On the other hand, even if the 60-40 Filipino to foreign equity ratio is apparently met, a resort to the Grandfather Rule is necessary if doubt exists as to the locus of the “beneficial ownership” and “control.” This “doubt” refers to various indicia that the “beneficial ownership” and “control” of the corporation do not in fact reside in Filipino shareholders but in foreign stakeholders. “Significant indicators,” as provided in DOJ Opinion No. 165, Series of 1984 (which applied the pertinent provisions of the Anti-Dummy Law) are as follows:

1. That the foreign investors provide practically all the funds for the joint investment undertaken by these Filipino businessmen and their foreign partner;

2. That the foreign investors undertake to provide practically all the technological support for the joint venture;

3. That the foreign investors, while being minority stockholders, manage the company and prepare all economic viability studies.

The application of the Grandfather Rule cannot go beyond the level of what is reasonable. The Supreme Court cited the suggestion of the Securities and Exchange Commission (SEC) that the Grandfather Rule be applied on two (2) levels of corporate relations for publicly-held corporations or where the shares are traded in the stock exchanges, and to three (3) levels for closely held corporations or the shares of which are not traded in the stock exchanges.

Applying these principles to the facts of the case, the SC found that 39.98% of Tesoro’s shares are directly owned by MBMI, a Canadian company, while 59.97% of Tesoror’s shares are owned by Sara Marie Mining, Inc. (Sara Marie), a Filipino company. This arrangement, at first glance, complies with the 60-40 Filipino to foreign equity requirement. The doubt lies in the fact that 69.35% of the capital contribution in Tesoro comes from MBMI. On the other hand, MBMI paid for 99% of the paid-up capital in Sara Marie (Sara Marie, in turn, holds 59.97% of Tesoro’s shares). The fact that MBMI had practically provided all the funds in Sara Marie and Tesoro creates serious doubt as to the true extent of MBMI’s control and ownership over both Sara Marie and Tesoro.

Applying the Grandfather Rule, the foreign participation in Tesoro is 59.99%, computed in this manner:

33.33/100 (foreign equity in Sara Marie) x 59.97 (Sara Marie’s share in Tesoro) = 19.99%

19.99% + 39.98% (MBMI’s direct participation in Tesoro) + .02% (shares of foreign individual SHs in Tesoro) = 59.99%

Considering that foreign ownership in Tesoro amounts to 59.99% of its shares, it does not comply with the minimum Filipino equity requirement (60%) imposed in Sec. 2, Art. XII of the Constitution.

[N.B. I also posted this post at the Philippine e-Legal Forum. For convenience, there are references to both the 28 January 2015 and 21 April 2014 decisions in Narra Nickel Mining and Development Corp., Tesoro Mining and Development, Inc. and McArthur Mining, Inc. vs. Redmont Consolidated Mines Corp., G.R. No. 195580. To remove clutter, we have removed quotation marks to indicate the exact quote lifted from the SC decisions.]

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