Dear Attorney,

I hope this message finds you well. I am a cautious investor who wishes to gain clarity on a specific aspect of Philippine corporate law—particularly on how the “Grandfather Rule” applies in determining foreign ownership and control in Philippine corporations. I am writing to seek your expert opinion because I have encountered multiple interpretations of this rule, and I want to ensure I am following the proper legal framework when structuring my investments or business in the Philippines. While I understand that the liberal or control test is frequently applied, I have come across circumstances in which government agencies or courts explicitly require use of the Grandfather Rule instead. Additionally, I have observed some confusion about how to illustrate ownership layering or corporate structuring when applying this rule in practice, especially when we factor in multiple tiers of shareholding.

In light of these concerns, I respectfully request your guidance regarding the intricacies, legal foundations, and practical impact of the Grandfather Rule under Philippine law. I would appreciate an explanation of the relevant statutory provisions, administrative regulations, and judicial precedents. Moreover, I would value your input on which scenarios specifically necessitate the application of the Grandfather Rule, as well as how to draw an illustrative diagram that clarifies ownership structures.

Thank you for your time in considering my inquiry. I look forward to hearing from you.

Respectfully yours,
A Prudent Investor

II. LEGAL ARTICLE ON THE GRANDfather RULE IN THE PHILIPPINES

Introduction

The “Grandfather Rule” is a cornerstone principle in Philippine corporate law that addresses how to determine the permissible level of foreign ownership in specific industries. It operates alongside or in contrast to the so-called control test (or “Liberal Rule”), and it plays an especially critical role in industries with statutory or constitutional limitations on foreign equity. Though its application can be complicated, especially with layered shareholding structures, understanding the precise mechanics of the Grandfather Rule is indispensable for compliance with Philippine foreign ownership regulations. This comprehensive examination will provide a background on constitutional and statutory foundations, discuss notable regulatory issuances and court decisions, and detail the practical aspects of illustrating layered ownership structures under this rule.

Overview of Relevant Constitutional and Statutory Provisions

a. Constitutional Requirements
The 1987 Philippine Constitution imposes foreign ownership caps on various economic activities. Most notably, Section 11, Article XII limits the operation of public utilities to corporations that are at least 60% owned by Filipino citizens. Similarly, certain industries like mass media and the exploitation of natural resources are constitutionally mandated to be fully or predominantly controlled by Filipinos. This sets the stage for the necessity of a precise method to determine the true extent of foreign ownership in corporate structures, especially where layered or multi-tiered shareholdings exist.

b. Key Statutes and Regulatory Instruments
Several statutes and regulations, including the Foreign Investments Act, the Anti-Dummy Law (Commonwealth Act No. 108), and various Securities and Exchange Commission (SEC) Circulars, impose specific guidelines on foreign participation in industries with nationalized or partially nationalized restrictions. The intricacy in many of these laws arises from the reality that corporations themselves can be shareholders in other corporations, leading to convoluted shareholding matrices. In certain contexts, the Supreme Court has emphasized that the intention of the law is to ensure that control and beneficial ownership remain, to a large degree, in the hands of Filipinos when foreign ownership caps are mandated.
The Essence of the Grandfather Rule

a. Definition
The Grandfather Rule is a method of determining the ultimate percentage of Filipino ownership in a corporation by “drilling down” or “looking through” the layers of shareholdings until the actual beneficial ownership is ascertained. Where the control test (or Liberal Rule) generally looks to who wields actual control or management authority, the Grandfather Rule is more precise and mechanical. It breaks down ownership layer by layer to see what proportion of the corporation is genuinely Filipino-owned versus foreign-owned.

b. Legal Origins
Although not explicitly named in the Constitution, the Grandfather Rule traces its origins to several decisions and opinions by the SEC, as well as Supreme Court rulings interpreting constitutional provisions that impose restrictions on foreign ownership. The rule is a logical outgrowth of the core principle that corporations cannot be used as “dummies” to sidestep constitutional limits. Whenever there is evidence of potential circumvention or a suspicion that foreign investors might indirectly own more than the statutorily allowed stake, the SEC or the courts apply the Grandfather Rule to obtain a precise accounting of ownership.

c. Objective
The primary objective is to prevent any subterfuge or corporate layering scheme that effectively places control in foreign hands above and beyond the permissible limit. By requiring a detailed breakdown of each tier of ownership, the Grandfather Rule ensures transparency and upholds the policy that Filipinos must hold the majority beneficial interest in industries that are constitutionally or statutorily restricted to them.
Comparison with the Control Test (Liberal Rule)

a. The Control Test Explained
The control test or Liberal Rule focuses on who actually controls the corporate entity. It examines voting rights, board composition, and other indices of control, rather than simply counting shareholdings in a strictly numerical way. In cases where there is no suspicion of circumvention, the SEC and other regulatory bodies often default to the control test.

b. Why the Grandfather Rule May Override the Control Test
The Supreme Court and the SEC have held that if there is a strong indication that layering or structuring is used to circumvent foreign ownership restrictions, regulators will resort to the Grandfather Rule. Particularly, if the ownership structure is complex or exhibits signs that the corporate layering is designed to conceal beneficial ownership, the more exacting Grandfather Rule is invoked to ensure compliance.
A classic scenario arises when a corporation that is partially foreign-owned invests in another company, which, in turn, invests in yet another, each subject to some foreign equity ceiling. By applying the Grandfather Rule, each layer of ownership is broken down by substituting the respective foreign and Filipino stakes at each step, ensuring that the ultimate beneficial ownership does not exceed the permissible limit.

c. Balancing Policy Considerations
Philippine regulatory agencies must balance two sometimes competing objectives: (1) encouraging foreign investment under a more flexible and business-friendly approach, and (2) preserving the constitutional mandate to keep certain industries predominantly in Filipino hands. The control test is generally more flexible, while the Grandfather Rule is stricter and more mechanical. Over the years, the government has issued a variety of circulars and opinions providing guidance on when to apply one or the other, typically guided by policy directions at the time.
Applicable Jurisprudence

a. Leading Supreme Court Decisions
Over the decades, multiple Supreme Court rulings have recognized and enforced the principle underlying the Grandfather Rule. One of the recurring themes in the jurisprudence is that when a corporation invests in another entity, and there is a legitimate concern that the ultimate ownership may exceed what the Constitution or specific laws permit for foreign investors, the authorities must pierce through the corporate veil and examine the ultimate ownership structure.

b. Pronouncements from the Securities and Exchange Commission (SEC)
The SEC has consistently taken the stance that it has the authority to inquire into the true ownership structure when it suspects that the layering of corporations is used to circumvent the law. The SEC opinions often illustrate example calculations on how to “look through” multiple tiers. They have also issued memoranda clarifying that if a corporation’s by-laws or actual practices show that voting control or beneficial ownership is predominantly in foreign hands, the Grandfather Rule will be applied, notwithstanding the nominal compliance with the 60-40 ratio at the first level of shareholding.

c. Illustrations in Administrative Rulings
Administrative rulings and interpretative opinions sometimes provide step-by-step examples of how the layering is computed. For instance, if Corporation A is 60% Filipino-owned and 40% foreign-owned, and it invests in Corporation B, then, for certain regulated industries, one might have to “drill down” and effectively treat 40% of A’s stake in B as foreign. If B itself has foreign shareholding, that portion might combine or add up in ways that ultimately yield a figure exceeding the cap for a particular industry. The instructions in these rulings often revolve around applying arithmetic computations repeatedly until the final ownership fraction is derived.
Illustrative Computation and Diagram

a. Basic Hypothetical Example
Imagine a scenario:
- Corporation X invests in Corporation Y.
- Corporation X is 70% Filipino-owned and 30% foreign-owned.
- Corporation Y also has direct foreign investors who own 20%.
Under a simplistic control test, one might simply note that Filipinos control 70% of X, and Y itself is 80% Filipino-owned. If X owns 40% of Y, a cursory view might suggest that foreigners do not exceed 40% in Y. However, the Grandfather Rule might recast X’s 40% stake in Y as effectively 28% Filipino (70% of 40%) and 12% foreign (30% of 40%). When combined with the direct 20% foreign ownership in Y, the total foreign ownership in Y might be 32%, which is within the permissible limit if the cap is 40%. But if further layering was involved, or if the foreign percentages were higher, the resulting total foreign beneficial interest in Y might breach the threshold.

b. Layered Corporate Structures
In more intricate scenarios, you could have three or more tiers of ownership, each with its own distribution of Filipino and foreign capital. The mechanical approach under the Grandfather Rule involves continually breaking down those percentages and attributing them to the next level, until no further layers remain. The result is an aggregated, “look-through” percentage of foreign versus Filipino ownership and control.

c. Significance of an Accurate Diagram
To illustrate how the Grandfather Rule works in practice, corporate counsel often draw a flow chart that shows each corporate entity and its corresponding Filipino-foreign ownership ratio. Arrows indicate the direction of investment. Once you multiply these percentages through each step, you arrive at a final proportion of foreign ownership that is “grandfathered” into the ultimate investee corporation.
Such an image illustration often includes:
- Box 1: Corporation A (Filipino ownership: X%, Foreign ownership: Y%)
- Box 2: Corporation B (Filipino ownership: X1%, Foreign ownership: Y1%)
- Arrow from A to B, indicating A’s percentage share in B
- Additional boxes for each subsidiary or affiliate if more layers exist
  Through these notations, you systematically break down the ownership structure until you can ascertain compliance (or noncompliance) with the relevant cap.
When is the Grandfather Rule Most Often Invoked?

a. Heavily Regulated Industries
The rule is frequently called upon in industries like mining, utilities, and certain areas of mass media or telecommunications, wherein the Constitution or relevant statutes impose strict foreign equity caps. If there is any sign that foreign investors might be using layering strategies to circumvent the cap, the SEC or relevant regulatory agency will require a thorough breakdown of ownership.

b. When the SEC Exercises its Investigative Powers
If a corporation’s organizational structure appears unusually complex, or if negative information or complaints suggest that nominally Filipino shareholders do not actually exercise their rights independently, the SEC may decide to apply the Grandfather Rule in an official investigation. This can take the form of requiring additional documentation, sworn statements, or the submission of ultimate beneficial ownership details.

c. Cases of Suspected Dummy Arrangements
The Anti-Dummy Law imposes penalties for any scheme that enables foreigners to exceed the permissible limit in a regulated industry by using Filipino “dummies.” If there is a complaint or evidence pointing to this type of arrangement, the SEC or the Department of Justice may direct a thorough look-through analysis. The Grandfather Rule becomes the tool of choice to identify how much ownership foreigners really have.
Implications and Practical Advice

a. Corporate Planning and Structuring
Filipino-majority owned corporations that anticipate investing in partially foreign-owned entities should keep detailed records and maintain clear lines of capital contributions. They should be prepared to undergo a step-by-step breakdown in the event regulators require it.
For foreign investors, it is essential to be mindful of industries that have strict equity limitations. Engaging counsel familiar with the Grandfather Rule early in the structuring process can help avoid surprises later on, especially if an apparently compliant ownership structure is found, upon closer scrutiny, to exceed the allowable threshold.

b. Documentation Requirements
Companies should anticipate demands for layers of documentation that prove actual beneficial ownership, including but not limited to:
- Share registers
- Deeds of assignment
- Voting trust agreements (if any)
- Corporate resolutions regarding voting entitlements
- Contracts that might indicate indirect control or beneficial interests
  Proper record-keeping eases the process of demonstrating compliance and helps mitigate legal risks.
c. Litigation Risks
Noncompliance or misrepresentation can lead to severe consequences. Violation of the Anti-Dummy Law can result in fines, imprisonment, or dissolution of the offending corporation. Additionally, the SEC can deny or revoke business registration. It is, therefore, crucial for corporations and their counsel to ensure that the ultimate beneficial ownership structure does not contravene any foreign equity limitation.
Policy Shifts and Reforms

a. Evolving Landscape
Philippine lawmakers and regulators occasionally revisit rules on foreign participation in certain sectors, aiming to strike a balance between protecting national interests and promoting foreign investment. Policy changes may result from global economic pressures, the government’s investment promotion strategies, or even shifts in judicial interpretation.

b. Legislative Amendments
From time to time, amendments to the Foreign Investments Act or other sector-specific laws alter the permissible percentage of foreign ownership or simplify compliance requirements. Some business lobby groups advocate for more transparent and less restrictive rules, citing competitiveness. Others defend a stricter application of the Grandfather Rule, asserting national economic security and constitutional mandates.

c. Administrative Guidelines
The SEC and other relevant agencies periodically update their guidelines. These may come in the form of circulars that clarify how to perform the computations, specify required disclosures, or indicate which types of entities and transactions will draw heightened scrutiny. Practitioners must keep abreast of these updates to ensure ongoing compliance.
Common Misinterpretations and Pitfalls

a. Belief that 60-40 at the First Layer Automatically Suffices
A widespread misconception is that if a corporation meets the 60-40 Filipino-foreign ratio at the first level, it is conclusively compliant. In reality, if that corporation invests in another entity subject to foreign equity restrictions, regulators may “look through” to ascertain the genuine proportion of foreign ownership. Relying solely on the first layer can be perilous if the foreign ownership at the upper layers is itself derived from another structure that is partially foreign-owned.

b. Overlooking Voting Arrangements
Sometimes, corporations fail to consider that special voting rights or contractual arrangements (such as veto powers or supermajority provisions in favor of foreign investors) could trigger an application of the Grandfather Rule. Even if shareholdings meet the nominal threshold, if foreigners can effectively control the enterprise through non-traditional means, regulators or courts may regard that as exceeding the permissible foreign ownership limit.

c. Improper or Incomplete Paper Trail
In some cases, corporations do not maintain an updated stock and transfer book, or they fail to document changes in shareholdings. Without a clear record, the burden of proof falls heavily on the entity to show compliance. Particularly in a high-stakes investigation, incomplete records can be detrimental.

Strategies for Compliance

a. Early Consultation with Legal Counsel
Businesses involved in industries with foreign equity caps should consult specialized legal counsel at the earliest stages of structuring. This includes not only obtaining theoretical advice but also preparing potential diagrammatic representations that reflect how the layers of shareholdings might stack up under the Grandfather Rule.

b. Continuous Corporate Housekeeping
Regularly updating corporate books, ensuring that every transfer of shares is recorded, and documenting the beneficial ownership behind each corporate shareholder helps mitigate the risk of failing a Grandfather Rule test. Annual audits of shareholding structures, especially in heavily regulated industries, are prudent.

c. Risk Assessment for Multi-Tiered Investments
Before investing in a multi-tiered arrangement, conduct a thorough self-audit. Compute the ownership breakdown across each layer, testing whether the final percentage meets constitutional or statutory restrictions. This exercise can avert major legal or regulatory complications down the line.

Interaction with Other Doctrines

a. Piercing the Corporate Veil
The Grandfather Rule is conceptually related to the principle of piercing the corporate veil, in that both can be invoked to examine the substance of arrangements beyond mere form. When it appears that the corporate form is being used to evade a legal obligation, courts or regulators can look at the substance of the transaction rather than the superficial percentages.

b. Control versus Beneficial Ownership
While the control test (or Liberal Rule) looks to actual corporate governance control, the Grandfather Rule zeroes in on the economic benefits. Thus, a corporation might appear nominally compliant if foreign owners hold only a minority stake, but if that minority is structured in a way that foreigners reap the majority of the economic benefits (or hold special voting powers), the regulators could still apply the Grandfather Rule.

c. Anti-Dummy Law Enforcement
The Anti-Dummy Law remains a critical enforcement mechanism, as it authorizes law enforcement agencies to investigate corporate structures and penalize attempts to circumvent constitutional or statutory limitations. Consequently, the Grandfather Rule frequently arises in the context of Anti-Dummy Law investigations or in related administrative complaints.

Case Studies and Practical Examples

Case Study 1: A telecommunication company is 60% owned by a Filipino partnership and 40% by a foreign investor. The Filipino partnership itself is composed of several corporations, one of which turns out to be substantially owned by the same foreign investor. By applying the Grandfather Rule, regulators discover that the real foreign ownership behind the telecommunication company is above 40%, violating the cap.
Case Study 2: A mining company secures an exploration permit, claiming that it is 60% Filipino-owned at the first level. Further scrutiny shows that one of the Filipino shareholders is a shell corporation beneficially owned by foreign nationals, pushing the effective foreign stake to above 40%. The Grandfather Rule calculation triggers a revocation of the permit.

Practical Tips for Drawing an Ownership Illustration (“Image Illustration” for the Grandfather Rule)
Start from the Ultimate Parent: Identify each entity at the top level, showing the breakdown of Filipino vs. foreign ownership.
Map Downward: For each subsidiary or affiliate, identify ownership percentages, distinguishing between Filipino and foreign stakes.
Multiply Through: At each layer, allocate the proportionate percentages. For instance, if a 70% Filipino-owned corporation owns 50% of another corporation, that 50% stake is effectively 35% Filipino-owned (70% of 50%) and 15% foreign-owned (30% of 50%).
Accumulate Totals: Add up the resulting foreign stakes from all relevant investment entities to see if the total foreign ownership in the target corporation breaches the limit.
Highlight Potential Red Flags: If the final ownership percentage is close to the threshold, it might be prudent to re-check all computations or to consult further clarifications from the SEC or specialized counsel.
Future Outlook

a. Increasing Scrutiny
As corporate structures become more globalized and sophisticated, it is likely that regulatory scrutiny will intensify. Consequently, the Grandfather Rule will remain a powerful tool for ensuring compliance with nationalization requirements.

b. Potential Digital Innovations
Regulators may one day adopt more advanced digital tools to track beneficial ownership in real-time. This would streamline the process of applying the Grandfather Rule and reduce reliance on cumbersome paper trails.

c. Ongoing Debates
The balancing act between attracting foreign direct investment and preserving the intent of constitutional restrictions will continue to shape how the Grandfather Rule is applied. Stakeholders can expect periodic policy debates over whether the rule is too stringent or is sufficiently robust to safeguard Filipino interests.

Conclusion

The Grandfather Rule is an essential mechanism for implementing Philippine constitutional and statutory restrictions on foreign equity in strategic industries. Its rigorous method of “looking through” layers of corporate ownership ensures that Filipinos genuinely hold at least 60% ownership—or the constitutionally or statutorily mandated percentage—in areas reserved for Filipino citizens. Whenever suspicion arises that corporate layering might be used to circumvent the law, the SEC and the courts rely on the Grandfather Rule to reveal the true beneficial ownership and impose sanctions if necessary.

Although the control test (or Liberal Rule) is sometimes applied for simplicity and administrative efficiency, the Grandfather Rule retains its paramount importance in contexts where the nominal 60-40 split is questionable. Consequently, businesses operating in or investing in regulated industries must be prepared to meet its rigorous standards. They should maintain transparent ownership records, consult specialized legal counsel, and, if necessary, draw out detailed diagrams demonstrating that they remain within permissible foreign equity limits.

Ultimately, staying informed about ongoing legal and policy developments is vital. Legislation, administrative regulations, and court rulings continue to refine and redefine the scope and method of applying the Grandfather Rule. Therefore, any prudent investor, corporation, or professional venturing into industries with foreign equity restrictions in the Philippines should invest time and resources to fully understand and comply with this rule, thereby safeguarding their ventures against legal repercussions.