Nationality of Corporations: Control Test

1. Constitutional and Statutory Framework

The nationality of corporations is a critical concept in Philippine law, particularly due to the constitutional and statutory restrictions on the ownership and operation of certain businesses and properties by foreign entities. The Constitution of the Philippines limits foreign participation in various sectors such as land ownership, natural resources, public utilities, educational institutions, and mass media.

Constitutional Provisions:

Article XII, Section 2 of the 1987 Philippine Constitution provides that the exploration, development, and utilization of natural resources shall be under the full control and supervision of the State and that foreign ownership should not exceed 40%.
Article XII, Section 11 states that no franchise, certificate, or authorization for the operation of a public utility shall be granted except to citizens of the Philippines or corporations where at least 60% of the capital is owned by Filipino citizens.

The statutory provisions on nationality requirements can be found in various laws like the Foreign Investments Act (RA 7042) and Republic Act No. 8179 amending the Foreign Investments Act, which specifies that businesses wholly or partially owned by foreign entities are restricted from engaging in activities that fall under the Philippine Constitution’s Foreign Investment Negative List (FINL).

2. The "Control Test" – Doctrine Overview

In determining the nationality of a corporation for purposes of compliance with the Constitution and other laws restricting foreign ownership, Philippine jurisprudence has adopted the Control Test (also referred to as the "Grandfather Rule" when used in certain contexts).

Under the Control Test, the nationality of a corporation is determined by the nationality of the stockholders who control the corporation. The test emphasizes the actual control of the corporation, and not merely the formal legal structure. The basic tenet of this rule is that the corporation's citizenship is aligned with that of the controlling shareholders.

The Supreme Court of the Philippines, in several cases, has expounded upon this principle, emphasizing that it is the actual control that should dictate whether the corporation is Filipino or foreign.

Landmark Case: Narra Nickel Mining v. Redmont Consolidated Mines (G.R. No. 195580, April 21, 2014)

One of the key cases that reinforced the application of the Control Test is Narra Nickel Mining and Development Corp. v. Redmont Consolidated Mines Corp. This case involved a dispute over the nationality of a mining corporation engaged in the extraction of natural resources, an activity reserved exclusively for Filipino citizens or corporations that are at least 60% Filipino-owned.

In this case, the Supreme Court ruled that the Control Test takes precedence over the Grandfather Rule in determining the nationality of a corporation. The Court rejected the argument that foreign shareholders holding minority ownership could exercise control through indirect means. Instead, it emphasized that control refers to both the ownership and management of the corporation.

The Control Test looks at the corporate governance structure, including the composition of the board of directors and the officers of the corporation. Even if a corporation is formally compliant with the 60-40 rule on the face of stock ownership, it can still be deemed foreign if it can be shown that foreign nationals exercise control over the corporation through voting power or influence over decision-making processes.

3. The Grandfather Rule vs. Control Test

While the Control Test is the prevailing doctrine, there are instances when the Grandfather Rule (or the "piercing the veil of corporate fiction" rule) is invoked to supplement or further clarify the nationality determination.

Grandfather Rule Defined

The Grandfather Rule involves tracing the nationality of shareholders through layers of ownership. If a Filipino-owned corporation is in turn owned by another corporation, which has foreign shareholders, the rule requires looking beyond the nominal ownership to the underlying layers to determine whether the foreign shareholders ultimately control the company.

For example, a corporation may appear to be 60% Filipino-owned, but the Grandfather Rule would trace the ownership of the 60% Filipino shareholders. If these Filipino shareholders are found to be mere dummies for foreign nationals, the corporation will be treated as foreign.

Control Test vs. Grandfather Rule in Practice

The Control Test is generally the preferred method in determining the nationality of a corporation. It simplifies the determination by focusing on effective control at the operational level, which is often evidenced by who controls the corporate board and decision-making power.
The Grandfather Rule is invoked when there is suspicion that the formal application of the Control Test is being circumvented through layers of corporate ownership to mask the true identity of the shareholders or ultimate control.

The Supreme Court has clarified that the Grandfather Rule is not automatically applied but is instead used to pierce the veil of corporate fiction when there is sufficient evidence of corporate structuring meant to evade nationality restrictions.

4. Key Considerations in Applying the Control Test

When determining control, the following factors are generally considered:

Ownership of voting shares: A simple majority of 60% of the capital stock is owned by Filipino citizens.
Management and decision-making: The composition of the board of directors and corporate officers (president, treasurer, etc.) must be predominantly Filipino to align with the ownership structure.
Corporate control and influence: Even if 60% of the capital stock is Filipino-owned, foreign nationals cannot exercise controlling influence over the corporation's policies and operations.

5. Practical Implications for Corporations

Corporations that engage in activities subject to nationality restrictions must ensure that they comply with the Control Test and constitutional requirements. This involves:

Structuring ownership to ensure compliance with the 60-40 rule.
Ensuring that control at the level of the board of directors and key officers is exercised by Filipinos.
Being prepared for potential challenges invoking the Grandfather Rule if foreign nationals are suspected of circumventing nationality restrictions through complex ownership structures.

6. Conclusion

The Control Test is the dominant method for determining the nationality of a corporation under Philippine law. It emphasizes actual control over nominal ownership and is used to ensure compliance with constitutional restrictions on foreign participation in certain sectors. While the Grandfather Rule can be applied to supplement this test, its application is more limited and is generally invoked only when there is suspicion of evasion of the nationality restrictions. Corporations must carefully structure both ownership and management to align with the requirements and avoid potential legal issues.