Grandfather Rule | Nationality of Corporations | General Principles | Corporations | BUSINESS ORGANIZATIONS

Nationality of Corporations: The Grandfather Rule

In the context of Philippine corporate law, determining the nationality of a corporation is critical in situations where the law imposes restrictions on foreign ownership, such as in land ownership, natural resources, public utilities, and certain industries like mass media and advertising. The Grandfather Rule is one of the methods used to determine the "true" nationality of a corporation, particularly in cases where ownership structures are complex and involve multiple layers of corporate entities.

I. Relevant Legal Provisions

1. 1987 Philippine Constitution

   • The Constitution provides specific limitations on foreign ownership in certain areas, such as:
     • Land ownership: Only Filipino citizens or corporations with at least 60% Filipino ownership may own land (Art. XII, Sec. 7).
     • Operation of public utilities: Only corporations that are at least 60% Filipino-owned may operate public utilities (Art. XII, Sec. 11).
     • Exploration, development, and utilization of natural resources: Limited to Filipino citizens or corporations with at least 60% Filipino equity (Art. XII, Sec. 2).

2. Foreign Investments Act of 1991 (RA 7042, as amended by RA 8179)

   • This law reiterates the restrictions on foreign ownership of certain industries and provides guidelines for determining corporate nationality.

3. Implementing Rules and Regulations (IRR) of the Foreign Investments Act

   • The IRR provides further details on how the nationality of a corporation should be determined, particularly through the application of the Control Test and the Grandfather Rule.

II. Control Test vs. Grandfather Rule

1. Control Test (Primary Rule)

   • Under the Control Test, a corporation is considered a Filipino corporation if at least 60% of its outstanding capital stock is owned by Filipino citizens. This is a straightforward test of equity ownership, and it is generally the rule used in most cases.

2. Grandfather Rule (Supplementary Test)

   • The Grandfather Rule is a more nuanced and detailed method of determining the true nationality of a corporation, especially in cases where ownership involves multiple layers of corporations, some of which may have foreign shareholders.
   • The rule "looks through" the corporate structure to determine the nationality of stockholders in each layer of ownership, ultimately determining how much of the corporation is truly Filipino-owned.

III. When is the Grandfather Rule Applied?

The Grandfather Rule is typically applied in the following cases:

1. Where the 60-40 ownership split is met only nominally but the control of the corporation appears to be in the hands of foreign interests. This is often referred to as the "doubtful" or "circumventive" ownership situation.
2. When a corporation’s capital is divided among several tiers of corporate entities, some of which are foreign, making the application of the straightforward Control Test insufficient or misleading.

IV. Mechanics of the Grandfather Rule

1. Tracing Ownership

   • The Grandfather Rule works by tracing the ownership of each shareholder to determine the ultimate ownership of the corporation.
   • In cases where a corporation (Corporation A) owns shares in another corporation (Corporation B), the Grandfather Rule looks at the shareholders of Corporation A to determine the true ownership of the shares held by Corporation A in Corporation B.

   Example:

   • Corporation A owns 60% of Corporation B, and Corporation A has a Filipino shareholder owning 50% of its stock and a foreign shareholder owning the remaining 50%.
   • Under the Grandfather Rule, only 30% of Corporation B would be considered Filipino-owned (i.e., 60% * 50% = 30%).

2. Layered Ownership

   • If there are multiple layers of ownership, the Grandfather Rule is applied recursively, meaning that each layer of ownership is examined until the nationality of the ultimate beneficial owners is ascertained.
   • This tracing ensures that the constitutional or statutory ownership requirements are not circumvented by layering corporations to conceal foreign control.

V. Jurisprudence on the Grandfather Rule

1. SEC Opinions and Rulings

   • The Securities and Exchange Commission (SEC) has issued several opinions clarifying the application of the Grandfather Rule.
   • In some cases, the SEC applies the Grandfather Rule directly, while in others, it has opted for the Control Test as the default rule, reserving the Grandfather Rule for situations where foreign control is suspected.

2. Land Bank of the Philippines v. CA (G.R. No. 127181, October 6, 2000)

   • In this case, the Supreme Court ruled that when determining corporate nationality, the Control Test should be the primary method, and the Grandfather Rule should be applied only as a supplementary rule.
   • The Court emphasized that the Grandfather Rule should be used when there is a need to "pierce the veil of corporate fiction" to reveal the true nationality of the controlling stockholders.

3. SEC Opinions on Tiered Ownership

   • In SEC rulings where multi-tiered corporate ownership is present, the Grandfather Rule has been applied to prevent foreigners from indirectly gaining control over corporations that are constitutionally reserved for Filipino citizens or corporations.

VI. Application of the Grandfather Rule: Key Considerations

1. Purpose of the Grandfather Rule

   • The Grandfather Rule is used to prevent foreign nationals from circumventing the Constitution and other laws restricting foreign ownership in certain industries. It ensures that ownership and control rest truly with Filipino citizens, even if the corporate structure appears to comply nominally with the 60-40 rule.

2. Interpretation by Regulatory Bodies

   • The application of the Grandfather Rule depends largely on the discretion of regulatory bodies like the SEC. If there is a reasonable suspicion that the foreign equity exceeds the allowable limit, the SEC may invoke the Grandfather Rule to determine the actual ownership.

3. Incorporation of the Grandfather Rule in the SEC Rules

   • The SEC has adopted the Grandfather Rule in cases where the Control Test alone may lead to an incorrect determination of nationality, particularly in the context of land ownership, public utilities, and other areas with strict foreign ownership limits.

VII. Conclusion

The Grandfather Rule serves as an important safeguard in determining the nationality of corporations in the Philippines, particularly in areas where the Constitution and laws restrict foreign ownership. While the Control Test is the primary method for determining corporate nationality, the Grandfather Rule acts as a supplementary rule, ensuring that ownership and control truly reflect the intent of the law. The rule prevents foreign nationals from using layered corporate structures to circumvent restrictions on foreign participation in key industries, thereby protecting the interests of Filipino citizens and upholding the country's constitutional mandates.

The Grandfather Rule's application requires careful scrutiny of corporate structures and ownership, and regulatory bodies such as the SEC are entrusted with the task of applying the rule when necessary to ensure compliance with the law.