Republic ofthe Philippines

. Department of Finance

Securities and Exchange Commission

SEC Building, EDSA, Greenhills, Mandaluyong

City

27 October 2011

.~

SEC Opinion No. 11- 44

Re: Nationality Restrictions;
Control Test and Grandfather
Composition of the Board

Rule;

ATTY. WILFREDO M. PENAFLOR

President
Northern Luzon UPC Asia Corporation
20/F ACCRALAWTower,
tl1
2nd Avenue corner 30 Street,
Crescent Park West, Bonifacio Global City,
Taguig City 0339, Metro Manila

Gentlemen:
This refers to your letter dated 01 August 2011 requesting confirmation by the
Commission of your position that the proposed ownership structure and composition of
the Board of Northern Luzon UPC Asia Corporation ("NLUPC") is legal and valid, and
does not violate the nationality restrictions prescribed by the Philippine Constitution and
applicable laws.
As disclosed in your letter, NLUPC is a domestic corporation established to
develop, construct and own the Caparispisan and Balaoi wind energy projects in
Pagudpud, IIocos Norte. It has secured from the Department of Energy Service
Contracts for the exploration, development and utilization of wind resources. As a
developer and owner of wind energy projects, NLUPC is subject to the nationality
restriction imposed by the Philippine Constitution and other pertinent laws.
Under the proposed corporate structure of NLUPC, PWCo, an entity organized
and existing under Philippine laws and 100% owned by Filipino individuals, shall own
and hold 38,128,778 redeemable preferred shares with a par value of PhPl.OO per
share, allegedly comprising sixty percent (60%) of the total outstanding capital stock of
NLUPC. The remaining forty percent (40%) thereof, allegedly composed of 25,418,719
common shares with a par value of PhPlOO.OOper share, shall be owned and held by
UPPWCo, a joint venture between two foreign companies, namely UPBV and XCo, that
is likewise organized and existing under Philippine laws.
The foregoing proposed corporate structure is illustrated in your letter as follows:
,~

'

Page 2 of

UPBV

PWCo

~
.38,128,778
Preferred Shares
Par value of P1/share

XCo

100%

100/0

II

(foreign companies) .

Filipino Individuals

i!

~~
NLUPC

I.
.

UPPWCo

25,418,719 Common Shares

Par value of PlOD/share

:J;.

.,

Your letter also states that NLUPC's Articles of Incorporation are proposed to be
amended to reflect the above-described corporate structure and the following features
of the preferred shares:
(a) Each will be of equal rank, preference and priority and identical
in all respects, regardless of its issuance;

(b) Each shall have the same voting rights as common

shares;
(c) The preferred shares shall be entitled to 6% per annum noncumulative, non-participating dividend out of the unrestricted earnings of
NLUPC;
(d) The dividends owing to the holder of the preferred shares must
first be paid before any dividends are paid to the holders of the common
shares;
(e) In the event of the NLUPC's liquidation, voluntary or involuntary
dissolution, distribution of assets or winding-up, if after paying debts and
liabilities of NLUPC, there are insufficient assets to pay for and liquidate all
the shares of the Corporation, the preferred shares will be paid the par
value of the shares plus any and all unpaid dividends ahead of the
common shares;
(f) The preferred shares shall not be convertible

into common

shares;
(g) The preferred shares shall be redeemable upon approval of the
Board of Directors and at the redemption price equal to the issue price
plus any accrued and undistributed dividends. Shareholders' vote shall not
be required for redemption. However, the preferred shares shall be
redeemable only if the redeemed shares are replaced with at least an
equivalent amount of newly paid-in shares so as to maintain NLUPC'stotal

Page 3 of II
paid-in -equity at the same level immediately prior to redemption.
Redeemed shares shall be retired and no longer issuable;
(h) Pre-emptive rights shall not be granted on the part of any
stockholder of preferred shares; and
(i) The preferred shares must be held by Filipino citizens or
corporations or associations of whose capital is 100% owned by Filipino
citizens.
Your letter further states that as part of the proposed ownership structure,
NLUPC's Board of Directors shall be composed of 10 members, four (4) of whom shall
be Filipino citizens and shall be nominated by the preferred shareholpers; another four
(4) of whom, who may be Filipino or foreign citizens, shall be nominated by the
common shareholders and the remaining two (2) shall be independent directors, who
must be Filipino citizens, and shall be jointly nominated by preferred and common
shareholders. All of the directors must be elected by the NLUPC shareholders at large.
The independent directors will each hold one (1) preferred share to qualify for the NLUPC Bqard and shall, upon nomination and prior to the election, submit to the
Corporate 'Secretary a letter of confirmation stating that he holds no interests affiliated
with the Corporation, management or any shareholder of the Corporation at the time of
his election or appointment and/or re-election as director.
Given the foregoing, NLUPCseeks confirmation on:
(1) Whether or not the proposed ownership structure and
composition of the Board of NLUPC is legal and valid, and does not violate
the nationality restrictions prescribed by the Philippine Constitution and
applicable laws; and
(2) Whether or not the ownership of NLUPC prescribed by the
Philippine Constitution and applicable laws is determined based on the
shares of stock that can vote in the election of directors regardless of the
classification, features and par value of such shares.
The legal capacity of a corporation to enter into-eo-production, joint venture and
production-sharing agreements with the State for the exploration, development and
utilization of natural resources including all forces of potential energy is regulated by
Article XII, Section 2 of the 1987 Constitution, to wit:
Section 2. All landsof 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 resourcesare owned by the
State. With the exceptionof agriculturallands, a// other natural resourcesshall
not be alienated. The exploration, development, and utilization of natural
resources shall be under the full control and supervision of the State.
The State may directly undertakesuch activities, or it may enter into coproduction, joint venture, or production-sharing agreements with
Filipino citizens, or corporations or associations at least 60 per centum
of whose capital is owned by such citizens. Suchagreementsmay be for a

Page 4 of

period not exceeding twenty-five years, renewable for not more than twenty-five
years, and under such terms and conditions as may provided by law. x x x
xxx
x x x [Emphasis supplied].

Corollary thereto, Executive Order No. 858 (EO 858)1 identifies the exploration,
development and utilization of natural resourcesas one of the investment areas and/or
activities reserved to Philippine nationals, thereby, allowing only up to forty percent
(40%) foreign equity participation, to wit:
section 1. Only the investment areas and/or activities listed in
the Annex hereof shall be reserved to Philippine nationals, and hereafter
shall be referred to as the Eight Regular Foreign Investment Negative List. The
extent of foreign equity in these areas shall be limited to the
percentages indicated in the List.

xxx

AnnexA
xxx

xxx

Up to Forty Percent (40%) Foreign Equity

1'7. Exploration, development and utilization of natural resourcesx x x
x x x x x x {Emphasissupplied}

Section 3(a) of Republic Act No. 7042 (RA 7042), otherwise known as the
Foreign. Investment Act of 1991, as amended by Republic Act No. 8179, defines
Philippine national as .
Section. 3. Definitions. - As used in this Act:
a) the term "Philippine Nationar
shall mean a citizen of the
Philippines or a domestic partnership or association wholly owned by citizens of
the Philippines; or a corporation organized under the laws of the
Philippines of which at least sixty percent (60%) of the cilpital stock
outstanding and entitled to vote is owned and held by citizens of the
Philippines or a corporation organized abroad and registered as doing business
in the Philippine under the Corporation Code of which one hundred percent
(100%) of the capital stock outstanding and entitled to vote is wholly owned by
Filipinos or a trustee. of funds for pension or other employee retirement or
separation benefits, where the trustee is a Philippine national and at least sixty
percent (60%) of the fund will accrue to the benefit of Philippine nationals:
provided, That where a corporation and its non-Filipino stockholders
own stocksin a Securities and Exchange Commission(SEC) registered
enterprise, at least sixty percent (60%) of the capital stock
outstanding and entitled to vote of each of both corporations must be
owned and held by citizens of the Philippinesand at least sixty percent
(60%) of the members of the Board of Directors of each of both
corporations must be citizens of the Philippines, in order that the
corporation shall be considereda Philippine national:

Further, private sector participation in the exploration, development,

utilization and commercializationof wind energy resourcesis reinforced in Executive
1

Promulgating the Eight Regular Foreign Investment Negative List (05 February 2010).

~
Page 5 of II

" I

Section 1. Exploration, Development and Utilization of OSW Energy

Resources. - Subject to existing rights, the government, through the

DOE, shall engage in the assessment, exploration, extraction,

harnessing, development and utilization of ocean, solar and wind
(OSW) energy resources, preferably with the participation of the
private sector under a production-sharing contract awarded by the
Secretary of the DOE, after due consultation with the host community/ies and
local government unit/s concerned, through public bidding or negotiation. The
production sharing contractor must be technically and financially capable of
undertaking the operations required in the contract.

xxx

xxx

xxx

section 7. Qualification of Contractor. - A contractor under this Order

shall be a qualified natural or juridical person seeking to explore,
develop, utilize and harness OSW energy resources in the Philippines
for purposes of producing power and/or types of energy. Details of
. financial, technical and other qualifications of a contractor shall be specified by
the Secretary of the DOE in the implementing rules and regulations of this Order.

The Implementing Rules and Regulations of EO 462 reiterate the constitutional

requirement that the controlling interests of enterprises entering into co-production,
joint venture or sharing agreements in the exploration, development, utilization and
commercialization of natural resources should be held by Filipino citizens or by
corporations or associations at least sixty percent (60%) of the capital of which is
owned by Filipino citizens, to wit:
Section 4 (w). "Qualifiedpersonu - any citizen of the Philippines with
capacity to contract, or a corporation, partnership, association, cooperative or
any other business aggrupation, organized under the laws of the Republic
of the Philippinesat least sixty percent (60%) of the capital of which is
owned by citizens of the Philippines.

xxx

xxx

xxx

Section 19. Renewable Energy Service/Operating Contract

Enabling Private Sector Participation in the Exploration, Development, Utilization and COmmercialization
of Ocean, Solar and Wind Energy Resources for Power Generation and Other Energy Uses.
.
2

Page 6 of 1I

The State may directly undertake such activities, or it may enter

into co-production, joint venture or co-production sharing agreements
with Filipino citizens or corporations or associations at least sixty
percent (60%) of whose capital is owned by Filipinos. Foreign RE
Developers may also be allowed to undertake RE development through an RE
Service/Operating Contract with the government, subject to Article XII, Section 2
of the Philippine Constitution.

In determining compliance with the nationality restrictions laid down in the

Constitution and other pertinent laws, the Commission, in a plethora of opinions, has
consistently applied the following manner of calculating the Filipino interest in a
corporation:
Shares 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, but if the percentage of Filipino ownership in
the corporation or partnership is less than 60%, only the number of
shares corresponding to such percentage shall be counted as of
Philippine nationality. Thus, if 100,000 shares are registered in the name of a
corporation . or partnership at least 60% of the capital stock or capital
.. respectively, of which belong to a Filipino citizens, all of the said shares shall be
recorded as owned by Filipinos. But if less than 60%, or, say, only 50% of the
capital stock or capital of the corporation or partnership, respectively belongs to
Filipino citizens, only 50,000 shares shall be counted as owned by Filipinos and
the other 50,000 shares shall be recorded as belonging to aliens.

xxx

xxx

xxx

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.

The second case is the Strict Rule or the Grandfather Rule proper
and pertains to the portion in said Paragraph 7 of the 1967 SEC Rules
which states, "but if the percentage of Filipino ownership in the
corporation or partnership is less than 60%, only the number of shares
corresponding to such percentage shall be counted as of Philippine
nationality. " Under the Strict Rule or Grandfather Rule Proper, the combined
totals in the Investing Corporation and the Investee Corporation must be traced
(i.e., "grandfathered7 to determine the total percentage of Alipino ownership.

Moreover, the ultimate Filipino ownership of the shares must

first be traced to the level of the Investing Corporation and added to
the shares directly owned in the Investee Corporation. x x x

xxx

xxx

xxx

Page 7 of I

In other words, based on the said SEC Rule and DOl Opinion, the
Grandfather Rule or the second part of the SECRule applies only when the
60-40 Filipino-foreign equity ownership is in doubt (i.e. in cases where
the joint venture corporation with Filipino and foreign stockholders with less than
60% Filipino stockholdings [or 59%] invests in other joint venture corporation
which is either 60-40% Filipino-alien or 59% less Filipino). Stated differently,
where the 60-40 Filipino-foreign equity ownership is not in doubt, the
Grandfather Rule will not apply." (Emphasissupplied).J

Further, the Commission has consistently opined that the ownership of the
shares of stock of a corporation is based on the total outstanding or subscribed/issued
capital stock regardless of whether they are classified as common voting shares or
preferred shares without voting rights.4 It is further said that the test' for compliance
with the nationality requirement is based on the total outstanding capital stock
irrespective of the amount of the par value of shares,sand likewise without regard to
whether or not such shares have been fully or partially paid.6 This is, thus, the general
rule, such that when the provision merely uses the term "capital" without qualification
(as in Section 11, Article XII of the 1987 Constitution, which deals with equity structure
in a public utility company), the same should be interpreted to refer to the sum total of
the outstanding capital stock, irrespective of the nomenclature or classification as
common, preferred, voting or non-voting.?
However, the Supreme Court in the case of Gamboa v. Finance Secretary
(Gamboa case),8 construed the term "capital" in Section 11, Article XII of the
Constitution as shares of stock that can vote in the election of directors, to wit:
Indisputably, one of the rights of a stockholder is the right to participate
in the control or management of the corporation. This is exercised through his
vote in the election of directors because it is the board of directors that controls
or manages the corporation. In the absence of provisions in the articles of
incorporation denying voting rights to preferred shares, preferred shares have
the same voting righ~ as common shares. However, preferred shareholders are
often excluded from any contro/, that is, deprived of the right to vote in the
election of directors and on other matters, on the theory that the preferred
shareholders are merely investors in the corporation for income in the same
manner as bondholders. In fact, under the Corporation Code only preferred or
redeemable shares can be deprived of the right to vote. Commonshares cannot
be deprived of the right to vote in any corporate meeting, and any provision in .

SEC-OGC Opinion No. 11-26 dated 19 April 2011 citing Department of Justice Opinion No. 020, series of
2005, addressed to then Secretary of the Department of Finance, the Honorable Cesar Purisima; SECOGC Opinion No. 10-20 dated 27 May 2010; SEC-OGC Opinion No. 10-08 dated 08 February 2010; SEC
Opinion dated 02 January 1990; DOl Opinion No. 018 series of 1989, dated 19 January 1989.
4 SEC Opinion No. 04-30 dated 28 April 2004 addressed to Marlene Caluya.
5 SEC Opinion No. 04-49 dated 22 December 2004 addressed to Atty. Priscilla B. Valer of Romulo

Mabanta Buenaventura Sayoc & De Los Angeies .

SEC Opinion No. 06-36 dated 21 September 2006 addressed to Atty. Tadeo F. Hiladb of Angara Abelio
Concepcion Regala & Cruz Law Offices.
7 SEC-OGC Opinion No. 09-10 dated 19 May 2009 addressed to Congchingyan & Peralta Law Offices,
citing SEC-OGC Opinion No. 18-07 dated 28 November 2007 addressed to Rafael C. Bueno, Jr.
8

G.R. No. 176579, 28 June 2011.

. .

. l

r;
..
~---.:..----============
Page 8 of 11

~h~art~clesof incorporation restricting the right of common shareholders to vote

IS Invalid.
Considering that common shares have voting rights which translate to
contr~f a~ o~fosed to preferred shares which usually have no voting rights, the
term capital In Section 11, Article XII of the Constitution refers only to common
shares. However, if the preferred shares also have the right to vote in the
election of directors, then the term "capital" shall include such preferred shares
because the right to participate in the control or management of the corporation
is exercised through the right to vote in the election of directors. In short, the
term "capital" in Section 11, Article XII of the Constitution refers only
to shares of stock that can vote in the election of directors.
This interpretation is consistent with the intent of the framers of the
Constitution to place in the hands of Filipino citizens the control i and
management of public utilities.

,,

xxx

xxx

xxx

Mere legal title is insufficient to meet the 60 percent Filipino-owned

"capital" required in the Constitution. Full beneficial ownership of 60 percent of
the outstanding capital stock, coupled with 60 percent of the voting rights, is
required. The legal and beneficial ownership of 60 percent of the outstanding
capital stock must rest in the hands of Filipino nationals in accordance with the
constitutional mandate. Otherwise, the corporation is "considered as nonPhilippine national{s]. "
xxx

xxx

xxx

To construe broadly the term "capital" as the total outstanding capital

stock, including both common and non-voting preferred shares, grossly
contravenes the intent and letter of the Constitution that the "Stateshall develop
a self-reliant and independent national economy effectively controlled by
Alipinos. " A broad definition unjustifiably disregards who owns the all-important
voting stock, which necessarilyequates to control of the public utility.

It must be emphasized that the foregoing Supreme Court decision is

subject of a pending Motion for Reconsideration.
Considering that under the proposed corporate structure, 60% of NLUPC's shares
of stock will be owned legally and beneficially by PWCo, a domestic corporation 100%
owned by Filipino individuals, and the same 60% are voting preferred shares under the
proposed Amendment to its Articles of Incorporation, the Commission, notwithstanding
the pending Motion for Reconsideration in the Gamboa case, confirms that NLUPC's
proposed corporate structure complies with the aforementioned nationality restrictions
and is therefore legal and valid.
However, it must be emphasized that no transfer of stock or interest [including
redemption of shares by NLUPC] which shall reduce the ownership of Filipino citizens to
less than the required percentage of the capital stock as provided by existing laws shall
be allowed or permitted to be recorded in the proper books of the corporation and this

Page 9 of' 1
4..

restriction shall be indicated in all stock certificates issued by the corporation 9 and in
the Articles of Incorporation. Thus, any redemption of NLUPC'sredeemable preferred
shares owned and held by PWCo that will in effect reduce Filipino ownership to less
than that required by the Constitution and existing laws violates the aforementioned
nationality restrictions. Hence, we suggest that item (g) in the proposed Amendment to
the Articles of Incorporation be modified to the effect that "the preferred shares shall
be redeemable only if the redeemed shares are replaced with at least an equivalent
amount of newly paid-in shares so as to maintain NLUPC'stotal paid-in equity at the
same level immediately prior to redemption and as to ensure compliance with the
nationality requirements."
Similarly, issuance of shares by NLUPCthat will alter Filipino ownership to less
than that required by the Constitution and other existing I~ws also violates
aforementioned nationality restrictions.
With regard to the proposed composition of NLUPC'sBoard of Directors, Section
2-A of Commonwealth Act No. 108, as amended by Presidential Decree No. 715,
otherwise known as the "The Anti Dummy Law," allows foreigners to be elected as
members:,of the Board of Directors of corporations engaging in partially nationalized
activities including exploration, development, utilization and commercialization of
natural resources, to the extent of their allowable participation or share in capital in
such entities, viz --,
Section 2-A. Unlawful Use, Exploitation or Enjoyment. xxx
xxx xxx
And provided, finally, that the election of aliens as members of the board of
directors or governing body of corporations or associations engaging in partially
nationalized activities shall be allowed in proportion to their allowable

participation or share in the capital of such entities.

Since NLUPCis engaged in a partially nationalized activity with forty percent

(40%) foreign equity participation and its Board of Directors shall be composed of ten
(10) members, the Commission opines that four (4) foreigners may be elected as
members of NLUPC'sBoard of Directors.
However, the Commission has reservations on the proposed manner of
nominating and electing members of NLUPC'sBoard of Directors as such arrangement
dilutes the participation of a Philippine national, i.e. PWCo,in the election of the Board
of Directors of NLUPCas required in Section 2-A of the Anti-Dummy Law.
Well settled is the rule that corporations act through their respective Boards of
Directors and unless otherwise provided in its by-laws, it is the prerogative of the Board
of Directors of a corporation to appoint nominees in the Board of Directors of other
corporations of which it is a stockholder, whose acts shall be under the ultimate
direction of the Board of Directors of the appointing corporation.to It is for these
reasons that the nominating power of a corporate stockholder must be considered in
determining compliance with the allowable foreign participation prescribed by the

9 Section 15 of
10 SEC Opinion

the Corporation Code of the Philippines.

dated 10 July 1995 addressed to Mr. Jerome M. Tang of Intercon Diagnostic Laboratory ..

Page 10 of 11

Constitution and other

nationalized activity.

pertinent

laws in a corporation

engaged

in a partially

As disclosed in your letter, NLUPC's stockholders under the proposed corporate

structure consist of two corporations, namely PWCo and UPPWCo, which shall
respectively own 60% and 40% of NLUPC's shares. Thetotal number of directors to be
nominated by said corporate stockholders is the same as the total number of members
of NLUPC's Board, i.e. ten (10). The preferred stockholder, i.e. PWCo, will nominate
four (4) directors who shall be Filipino citizens, while the common stockholder, i.e.
UPPWCo, which is the foreign corporate stockholder, will nominate four (4) directors
who may be a Filipino or a foreigner. The preferred and common stockholders will
jointly nominate two (2) independent directors, who must be Filipino citizens. Thus,
those who will be nominated by PWCo and UPPWCo will essentially b~ those who will
be voted for and elected to become directors of NLUPC.
Under the Anti-Dummy Law, and consistent with the inherent right of
stockholders, aliens may be elected in proportion to their allowable participation or
share in the capital. Corollarily, the other side of the equation, that is, the Filipino
component~ ..should also be allowed representation in the Board in proportion to the
Filipino share or participation in the capital.
In the proposed. arrangement, UPPWCo, the foreign corporate shareholder, is
. absolutely allowed to nominate four (4) alien directors in NLUPC because of its forty
percent (40%) share therein. However, PWCo, the Filipino corporate stockholder, is not
similarly given the absolute power to nominate six (6) directors in NLUPC, by virtue,
and despite of, its sixty percent (60%) interest therein. Worse, the foreign corporate
stockholder has an equal say in the nomination of the two (2) independentdirectors. It
defeats the mandate of the Anti-Dummy Law and violates the inherent right of PWCo to
vote in proportion to the number of shares it owns, thus giving undue advantage to
UPPWCo. It should be pointed out that under the proposed arrangement, PWCo and
UPPWCo will practically have the same right to nominate and eventually vote for five
(5) directors each.
Accordingly, the proposed manner of nominating and electing members of
NLUPC's Board creates an unfair and anomalous situation wherein a Philippine national
is placed on equal footing with a foreigner in terms of participation in the governing
board of NLUPC, a corporation engaged in a partially nationalized activity, thereby,
providing a -means to circumvent our nationalization laWs.
Thus, the Commission holds that the procedure for the nomination and election
of members of NLUPC'sBoard should not permit the circumvention of the rules on
. allowable foreign participation as prescribed under the Constitution and pertinent laws.
Lastly, considering that under the proposed ownership structure, all NLUPC
shares shall have voting rights and the Filipino stockholders, through PWCo, shall own
and hold redeemable preferred shares with a par value of PhP1.00, and the foreign
stockholders shall own and hold common shares with a par value of Php 100.00, the
Commission believes that the said proposed ownership structure is determined
regardless of the par value of such shares.

Page II of II

The foregoing opinion is rendered based solely on the facts disclosed in the
query and relevant solely to the particular issues raised therein and shall not be used in
the nature of a standing rule binding upon the Commission whether of similar or
dissimilar circumstances.ll If, upon investigation, it will be disclosed that the facts relied
upon are different, this opinion shall be rendered void.
For the Commission En Bane,
L

. Garcia
Vesper Juli
rge.
Officer-i Office of the G eral C6unsel

11

SEC Memorandum Circular No. 15, series of 2003.

,!