The control test as the primary test

As a rule, the control test applies. The primacy of the control test over the grandfather rule
can be traced to DOJ Opinion No. 19, s. 1989 (the “1989 DOJ Ruling”), which states:

. . . the “Grandfather Rule”, which was evolved and applied by the SEC in
several cases, will not apply in cases where the 60-40 Filipino-alien equity
ownership in a particular natural resource corporation is not in
doubt. (underscoring supplied)

In other words, according to the Department of Justice, the control test generally applies,
with the grandfather rule applicable only when the 60-40 Filipino-alien equity ownership is
in doubt.

On the basis of the 1989 DOJ Ruling, the SEC issued several opinions doing away with the
grandfather rule. For example, in a May 30, 1990 opinion, the SEC stated:

. . . the Commission En Banc, on the basis of the Opinion of the

Department of Justice No. 18., S. 1989 dated January 19, 9189 voted and
decided to do away with the strict application/computation of the so called
“grandfather rule”. . . and instead applied the so-called “control test”
method for determining corporate nationality. (underscoring supplied)(see
also SEC Opinion dated August 6, 1991; SEC Opinion dated October 14,
1991)

Around two years after the issuance of the 1989 DOJ Ruling, Congress enacted
the Foreign Investments Act of 1991 (“FIA”), which expressly embodied the control
test. Section 3(a) of the FIA (as amended by Republic Act No. 8179) provides:

. . . the term Philippine national 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 capital 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
Philippines 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 stocks in 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 Philippines and at least sixty percent
(60%) of the members of the Board of Directors, in order that the
corporation shall be considered a Philippine national.” (underscoring
supplied)

Similarly, Section 1(a) of the rules and regulations implementing the FIA expressly
provides for the application of the control test:
 Philippine national shall mean a citizen of the Philippines or a domestic
partnership or association wholly owned by the citizens of the Philippines;
or a corporation organized under the laws of the Philippines of which at
least sixty percent (60%) of the capital 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 Philippines
under the Corporation Code of which 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 benefits of the Philippine nationals; Provided, that where
a corporation and its non-Filipino stockholders own stocks in 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 Philippines
and at least sixty percent (60%) of the members of the Board of Directors of
each of both corporation must be citizens of the Philippines, in order that
the corporation shall be considered a Philippine national. The control test
shall be applied for this purpose. (underscoring supplied)

While the control test was enshrined in the FIA and its implementing rules, the SEC
continues to apply the grandfather rule when the Filipino equity ownership is “in doubt” (as
provided in the 1989 DOJ Ruling). For example, in SEC-OGC Opinion No. 22-07
dated December 7, 2007, the SEC stated:

. . . when there is doubt as to the actual extent of Filipino equity in the

investee corporation, the Commission is not precluded from using the
Grandfather Rule.

UP College of Law, Prof. Raul Palabrica, makes a great summary of the SEC position in his
Philippine Daily Inquirer column:

. . . this should not be taken to mean that the grandfather rule is already
history. In an inverse way, the SEC pointed out that the “grandfather rule
will not apply in cases where the 60-40 Filipino equity ownership … is not in
doubt.”

The rule therefore is: While the control test shall be used as standard to
determine the nationality of corporations, the grandfather rule will be
applied if there are questions about compliance with Filipino ownership
requirements. (see Raul Palabrica, Nationality Ownership Rule, Philippine
Daily Inquirer, October 19, 2007)

Based on the FIA and its implementing rules and regulations (which embody the control
test), my personal view is that the control test should be the test used in determining the
nationality of a corporation. While the 1989 DOJ opinion made reference to the
application of the grandfather rule when the 60-40 equity ownership interest is in doubt, the
1989 DOJ opinion was issued prior to the enactment of the FIA. Also, I believe that if there
is doubt as to the 60-40 Filipino-alien equity ownership interest in the investing corporation
that has a 60% equity in a corporation engaged in a partly nationalized activity, what
should be applied is the Anti-Dummy Law (in conjunction with the control test), not the
grandfather rule. Thus, if 60% of the shares of the investing corporation is held by
Filipinos as dummies for foreigners, that 60% equity in the investing corporation will not be
deemed held by Philippine nationals. Applying the control test, the investee corporation
will not also be a Philippine national.

A return to the grandfather rule?

It is noteworthy that a recent SEC case raises the issue of whether the SEC is now going
back to the grandfather rule as the primary test for determining the nationality of a
corporation. In Redmont Consolidated Mines Corporation vs. McArthur Mining
Corporation, SEC En Banc Case No. 09-09-177 dated March 25, 2010, the SEC applied
the grandfather rule because the foreign investor provided “practically all the funds” of the
Philippine mining companies; as such, the SEC concluded that the 60-40 Filipino alien
equity ownership was in doubt and therefore the grandfather rule should be
applied. However, the SEC did not stop there – the SEC made statements that seem to
indicate a return to the grandfather rule. The SEC said:

The avowed purpose of the Constitution is to place in the hands of Filipinos

the exploitation of our natural resources. Necessarily, therefore, the Rule
interpreting the constitutional provision should not diminish that right
through the legal fiction of corporate ownership and control. But the
constitutional provision, as interpreted and practiced via the 1967 SEC
Rules, has favored foreigners contrary to the command of the Constitution.
Hence, the Grandfather Rule must be applied to accurately determine the
actual participation, both direct and indirect, of foreigners in a corporation
engaged in a nationalized activity or business.

Compliance with the constitutional limitation(s) on engaging in nationalized

activities must be determined by ascertaining if 60% of the investing
corporation’s outstanding capital stock is owned by “Filipino citizens”, or as
interpreted, by natural or individual Filipino citizens. If such investing
corporation is in turn owned to some extent by another investing
corporation, the same process must be observed. One must not stop until
the citizenships of the individual or natural stockholders of layer after layer
of investing corporations have been established, the very essence of the
Grandfather Rule.

Lastly, it was the intent of the framers of the 1987 Constitution to adopt the
Grandfather Rule.

While the constitutional deliberations certainly made reference to the grandfather rule,
there is nothing in the Constitution that ultimately embodied the grandfather rule. In the
absence of any provision in the Constitution embodying the grandfather rule, I believe that
Congress can adopt a law (in this case the FIA) embodying the control test.

Hopefully, the statements made by the SEC in Redmont do not signal a return to the
grandfather rule. A change in the rules of the game will have a tremendous adverse
impact on investor confidence in the Philippines.

One final note. Redmont involved mining companies that require 60% Filipino ownership
because these mining companies apparently applied for a Mineral Production Sharing
Agreement (which can be granted to Philippine nationals only). In Redmont, the SEC
appears to have reached the conclusion that the 60-40 Filipino-alien equity ownership was
in doubt because the foreign investor provided “practically all the funds” of the Philippine
mining companies. My own view is that the fact that the foreign investor may have
contributed a big chunk of the corporate funds should not, by itself, put the 60-40
Filipino-alien equity ownership in doubt. The important consideration is whether the
Filipino stockholders legally and beneficially own and control 60% of the shares in the
relevant company (and do not otherwise act as dummies for the foreigners). If the
foreigner wishes to provide greater financial support for the mining project, that should be
fine for as long as Filipinos remain the legal and beneficial owner of 60% of the shares in
the mining company (or in a layered structure, the investing company). We should not
deprive Filipinos of the ability to enter into contracts with foreigners whereby foreigners
provide greater funding to projects that remain under Filipino control.

RECENT CASES

Narra Nickel Mining and Development Corp. vs. Redmont Consolidated Mines
Corp. (G.R. No. 195580)