The Stay Order in Rehabilitation Cases: Is it Constitutional?
By Atty. Danilo P. Ventajar
On November 2000, the Supreme Court promulgated the Interim Rules on Corporate Rehabilitation (the “Rules”), which took effect on December 15, 2000. It is intended to govern proceedings relating to petitions for rehabilitation filed by corporations, partnerships, and associations pursuant to Presidential Decree No. 902-A, as amended (Rule 1, Sec. 1 of the Interim Rules on Corporate Rehabilitation).
The adoption of the Rules was triggered by the passage of Republic Act No. 8799 (the Securities Regulations Code) which transferred from the Securities and Exchange Commission (SEC) to the regular courts the jurisdiction to hear rehabilitation cases.
Rehabilitations are proceedings in rem, which could be commenced in the specially designated commercial courts either by a debtor who foresees the impossibility of meeting debts when they fall due or by any creditor or group of creditors holding at least one-fourth of the debtors’ total debts.
Following prevailing jurisprudence (RCBC v. IAC (G.R. No. 74851, December 9, 1999.]), the filing of a petition for rehabilitation does not automatically stay claims by creditors and other claimants of the debtor. There is nevertheless some degree of “automaticity” to the extent that stay of claims will follow as a matter of course within five (5) days from filing of the petition if the court finds the same to be sufficient in form and substance. (A debtor’s petition is sufficient in form and substance when it alleges all the material facts and includes all the documents required by Rule 4-2. [Answer to Question 23 of the Bench Book on Corporate Rehabilitation.]) Rule 4, Sec. 2 of the Rules list down the requirements of form and substance:
“SECTION 2. Contents of the Petition. — The petition filed by the debtor must be verified and must set forth with sufficient particularity all the following material facts: (a) the name and business of the debtor; (b) the nature of the business of the debtor; (c) the history of the debtor; (d) the cause of its inability to pay its debts; (e) all the pending actions or proceedings known to the debtor and the courts or tribunals where they are pending; (f) threats or demands to enforce claims or liens against the debtor; and (g) the manner by which the debtor may be rehabilitated and how such rehabilitation may benefit the general body of creditors, employees, and stockholders.
“The petition shall be accompanied by the following documents:
a. An audited financial statement of the debtor at the end of its last fiscal year;
b. Interim financial statements as of the end of the month prior to the filing of the petition;
c. Schedule of Debts and Liabilities which lists all the creditors of the debtor indicating the name and address of each creditor, the amount of each claim as to principal, interest, or penalties due as of the date of filing, the nature of the claim, and any pledge, lien, mortgage judgment, or other security given for the payment thereof;
d. An Inventory of Assets which must list with reasonable specificity all the assets of the debtor, stating the nature of each asset, the location and condition thereof, the book value or market value of the asset, and attaching the corresponding certificate of title therefor in case of real property, or the evidence of title or ownership in case of movable property, the encumbrances, liens or claims thereon, if any, and the identities and addresses of the lienholders and claimants. The Inventory shall include a Schedule of Accounts Receivable which must indicate the amount of each, the persons from whom due, the date of maturity, and the degree of collectibility categorizing them as highly collectible to remotely collectible;
e. A rehabilitation plan which conforms to the minimal requirements set out in section 5, Rule 4 of these Rules;
f. A Schedule of Payments and disposition of assets which the debtor may have effected within three (3) months immediately preceding the filing of the petition;
g. A Schedule of the Cash Flow of the debtor for three (3) months immediately preceding the filing of the petition, and a detailed schedule of the projected cash flow for the succeeding three (3) months;
h. A Statement of Possible Claims by or against the debtor which must contain a brief statement of the facts which might give rise to the claim and an estimate of the probable amount thereof;
i. An Affidavit of General Financial Condition which shall contain answers to the questions or matters prescribed in Annex "A" hereof;
j. At least three (3) nominees for the position of Rehabilitation Receiver as well as their qualifications and addresses, including but not limited to their telephone numbers, fax number and e-mail address; and
k. A Certificate attesting, under oath, that (a) the filing of the petition has been duly authorized; and (b) the directors and stockholders have irrevocably approved and/or consented to, in accordance with existing laws, all actions or matters necessary and desirable to rehabilitate the debtor including, but not limited to, amendments to the articles of incorporation and by-laws or articles of partnership; increase or decrease in the authorized capital stock; issuance of bonded indebtedness; alienation, transfer, or encumbrance of assets of the debtor; and modification of shareholders' rights.
Five (5) copies of its petition shall be filed with the court.”
"The lack of any one requirement will render the petition insufficient as to form and substance and will result to its outright dismissal because “[t]he Stay Order and the appointment of a rehabilitation receiver are extraordinary, preliminary, ex parte remedies that will affect the rights of dozens, if not hundreds of creditors and other counter parties of the debtor. [F]urther, these documents are necessary for interested parties to submit meaningful comments on the petition. It is thus incumbent upon the petitioner to adhere strictly to the requirements for providing the documents required by the Rules.” (Bench Book on Corporate Rehabilitation, Answer to Question 24.) (Emphasis supplied.)
It is of course expected that with the assistance of an effective counsel the matter of complying with “form and substance” is almost assured and the subsequent issuance of the Stay Order is a matter of course. The coverage and efficacy of the Stay Order is described under Rule 4, Sec. 6, to wit:
“SEC. 6. Stay Order.— If the court finds the petition to be sufficient in form and substance, it shall, not later than five (5) days from the filing of the petition, issue an Order (a) appointing a Rehabilitation Receiver and fixing his bond; (b) staying enforcement of all claims, whether for money or otherwise and whether such enforcement is by court action or otherwise, against the debtor, its guarantors and sureties not solidarily liable with the debtor; (c) prohibiting the debtor from selling, encumbering, transferring, or disposing in any manner any of its properties except in the ordinary course of business; (d) prohibiting the debtor from making any payment of its liabilities outstanding as at the date of filing of the petition; (e) prohibiting the debtor’s suppliers of goods or services from withholding supply of goods and services in the ordinary course of business for as long as the debtor makes payments for the services and goods supplied after the issuance of the Stay Order; (f) directing the payment in full of all administrative expenses incurred after the issuance of the Stay Order; (g) fixing the initial hearing on the petition not earlier than forty five (45) days but not later than sixty (60) days from the filing thereof; (h) directing the petitioner to publish the Order in a newspaper of general circulation in the Philippines once a week for two (2) consecutive weeks; (i) directing all creditors and all interested parties (including the Securities and Exchange Commission) to file and serve on the debtor a verified comment on or opposition to the petition, with supporting affidavits and documents, not later than ten (10) days before the date of the initial hearing and putting them on notice that their failure to do so will bar them from participating in the proceedings; and (j) directing the creditors and interested parties to secure from the court copies of the petition and its annexes within such time as to enable themselves to file their comment on or opposition to the petition and to prepare for the initial hearing of the petition.”
The stay may thus appropriately be called the “soul” of the rehabilitation proceedings. Without it, no rehabilitation can ever be possible. It is the most powerful tool in the arsenal of the Rules that ensures that a corporation whose financial health is in ruins may be resuscitated and brought back to life.
It is “one of the fundamental debtor protections provided by the bankruptcy laws. The stay gives the debtor a breathing spell from the creditors and stops all collection efforts, all harassment, and all foreclosure actions.” (9A Am Jur 2d § 1369, pp 283-284)
To secured creditors, however, the stay order is anathema to the very purpose of the security offered by the debtor as enticement to the granting of credit.
II. Statement of the Problem
May an overzealous mortgagee successfully challenge the validity of a stay order on the ground that it impairs the obligations of the debtor-mortgagor under the mortgage contract?
III. Theoretical Framework
This will paper will analyze the arguments supporting the notion that a stay of claims of secured creditors is repugnant to the non-impairment of contracts clause of the Constitution as opposed to the foundation supporting the power of the State to cause aberrations in the freedom and autonomy of contracts for public ends.
The 1987 Constitution states:
“No law impairing the obligation of contracts shall be passed.” (Sec. 10, Art. III, 1987 Constitution; the same phraseology appears in the 1935 and 1973 Constitutions.)
The non-impairment of contract clause (briefly, the “contract clause”) is of American origin having been adopted from the Federal Constitution of the United States.
In Clemons v. Nolting (G.R. No. 17959, January 24, 1922.), the Philippine Supreme Court described the clause in this wise:
“Contracts are made for things, not names or sounds, and the obligation of the contract arises from its terms and the means which the law affords for its enforcement. Under the Civil Code the contract constitutes the law of the parties unless it violates some provision of law or public policy. The parties themselves make the law by which they shall be governed, and it is the business of the courts to see that the parties to a legal contract comply with its terms. A law which changes the terms of a legal contract between parties, either in the time or mode of performance, or imposes new conditions, or dispenses with those expressed, or authorizes for its satisfaction something different from that provided in its terms, is law which impairs the obligation of a contract and is therefore null and void. An interference with the terms of a legal contract by legislation is unwarranted and illegal. A contract is not fulfilled by the delivery of one thing which is different from the thing the contract provides for. Words in contracts are to be given the meaning which they were understood to have by the parties at the time of the making of the contract. There cannot exist in this jurisdiction one law for debtors and another law for creditors. The genus, the nature, and the spirit of our Government amount to a prohibition of such acts of legislation, and the general principles of law and reason forbid them."
“The Legislature may enjoin, permit, forbid, and punish; it may declare new crimes and establish rules of conduct for all its citizens in future cases; it may command what is right and forbid what is wrong, but it cannot change innocence into guilt and punish innocence as a crime, or violate the rights of an antecedent lawful private contract or the right of private property. (Calder vs. Bul, 3 Dallas, 388.)
“The fundamental maxims of a free government seem to require that the rights of personal liberty and private property should be held sacred, and that includes contractual rights. (Wilkinson vs. Leland, 2 Peters, 657.)”
In U.S. v. Conde (G.R. No. 18208, February 14, 1922.), the Court further explained:
“The obligation of the contract is the law which binds the parties to perform their agreement if it is not contrary to the law of the land, morals or public order. That law must govern and control the contract in every aspect in which it is intended to bear upon it, whether it affect its validity, construction, or discharge. Any law which enlarges, abridges, or in any manner changes the intention of the parties, necessarily impairs the contract itself. If a law impairs the obligation of a contract, it is prohibited by the Jones Law , and is null and void.” (The Jones Law refers to the Act of Congress of August 29, 1916, entitled "An Act to declare the purpose of the people of the United States as to the future political status of the Philippine Islands, and to provide a more autonomous government for those Islands.")
Within the framework of this paper, the most direct application of the constitutional guarantee to contractual relationships would be the protection given to a mortgagor from a legislative enactment that would alter or change the original intent of the parties to the effect that if the mortgagee fails to pay the loan, he may proceed to foreclose the mortgaged asset.
Since a creditor normally approves a credit to a debtor because the latter guarantees the performance of the loan obligation by subjecting real property or real rights or even chattels as security in case of non-fulfillment of said obligation within the period agreed upon, the prohibition imposed on him by a commercial court to stay his claim against the mortgagor who is in default and in the meantime has filed for rehabilitation is precisely the law which the constitution proscribes.
Thus, in the case of PCIB v. CA et al. (G.R. No. 76853. April 18, 1989), the Court said:
“SEC's order for suspension of payments of Philfinance as well as for all actions of claims against Philfinance could only be applied to claims of unsecured creditors. Such order can not extend to creditors holding a mortgage, pledge or any lien on the property unless they give up the property, security or lien in favor of all the creditors of Philfinance. This ruling find support in Chartered Bank vs. Imperial and National Bank (48 Phil. 931). where We held:
"It is, therefore, clear and evident that the law recognizes and respects the right of a creditor holding a mortgage, pledge or lien of any kind, attachment or execution on the property of the debtor, recorded and not dissolved under said Act, to refrain from voting the election of an assignee, and consequently, to preserve said right; to refrain from taking part or intervening in the insolvency proceedings and to retain the property mortgaged to him and the respective security or lieu, the court having no power, even if the debtor is adjudged insolvent, to dispose of said property, security or lien and cede or transfer them to the sheriff or assignee by virtue of said adjudication . . . as long as the creditor does not voluntarily deliver or assign said property, security or lien for the benefit of all the creditors of the insolvent."
“It is true that the aforequoted ruling deals with insolvency but by analogy the same could be adopted in this case considering that the rights of a preferred creditor remain to be respected and recognized in every existing situation. To hold otherwise would render the said rights inutile and illusory. Besides, We find no substantial difference between the suspension of actions in the instant case and that under the Insolvency Law. Consequently, the herein order of suspension, could not have a different interpretation as regards secured credits than that already given by this Court. The records show that PCIB neither surrendered the pledged shares of stock and bonds nor participated in the proceedings before the SEC regarding the suspension of payments or actions of claims against Philfinance or in the latter's subsequent dissolution and liquidation. The pledged properties being still in PCIB's possession, the Receiver could not possess the same for equitable distribution to the creditors of Philfinance."
While the subject matter of the PCIB case was one of suspension of payments, the ruling therein clearly laid down the Court’s slant in favor of protecting the contractual right of secured creditors to enforce the mortgage securing the principal obligation. Thus, should the case have ripened to receivership, the same ruling will have been applicable – that the secured creditors are not affected thereby and may proceed to foreclose their respective securities.
This legal regime was short-lived as the PCIB case was abrogated in a line of cases which sustained the right of the SEC to stay execution of claims in cases of corporations under management committees or rehabilitation receivers. The case of BPI v. CA (G.R. No. 97178, January 10, 1994.) entrenched this new doctrine in Philippine jurisprudence:
“More importantly, the doctrine in the PCIB case has since been abrogated. In Alemar's Sibal & Sons v. Elbinias, BF Homes, Inc. v. Court of Appeals, 8 Araneta v. Court of Appeals, and RCBC v. Court of Appeals, we already ruled that whenever a distressed corporation asks SEC for rehabilitation and suspension of payments, preferred creditors may no longer assert such preference, but shall stand on equal footing with other creditors. Foreclosure shall be disallowed so as not to prejudice other creditors or cause discrimination among them. If foreclosure is undertaken despite the fact that a petition for rehabilitation has been filed, the certificate of sale shall not be delivered pending rehabilitation. If this has already been done, no transfer certificate of title shall likewise be effected within the period of rehabilitation. The rationale behind PD 902-A, as amended, is to effect a feasible and viable rehabilitation. This cannot be achieved if one creditor is preferred over the others."
“While it is recognized that petitioner is a preferred creditor whose claim is secured by real estate mortgage on the properties of respondent RUBY, its right to enforce its claim in court is suspended with the placing by SEC of respondent under rehabilitation. This rule will enable the management committee or rehabilitation receiver to effectively exercise his/its power free from any judicial or extrajudicial interference that might unduly hinder the rescue of the distressed company.”
In RCBC v. IAC (G.R. No. 74851, Dec. 9, 1999), the Court further clarified the “equality in equity” concept which the earlier rulings defined:
“Petitioner additionally argues in its motion for reconsideration that, being a mortgage creditor, it is entitled to rely on its security and that it need not join the unsecured creditors in filing their claims before the SEC-appointed receiver. To support its position, petitioner cites the Court's ruling in the case of Philippine Commercial International Bank vs. Court of Appeals, (172 SCRA 436 ) that an order of suspension of payments as well as actions for claims applies only to claims of unsecured creditors and cannot extend to creditors holding a mortgage, pledge, or any lien on the property."
“Ordinarily, the Court would refrain from discussing additional matters such as that presented in RCBC's second ground, and would rather limit itself only to the relevant issues by which the controversy may be settled with finality."
“In view, however, of the significance of such issue, and the conflicting decisions of this Court on the matter, coupled with the fact that our decision of September 14, 1992, if not clarified, might mislead the Bench and the Bar, the Court resolved to discuss further."
“It may be recalled that in the herein en banc majority opinion (pp. 256-275, Rollo, also published as RCBC vs. IAC, 213 SCRA 830 ), we held that: . . .
"whenever a distressed corporation asks the SEC for rehabilitation and suspension of payments, preferred creditors may no longer assert such preference, but . . . stand on equal footing with other creditors. Foreclosure shall be disallowed so as not to prejudice other creditors, or cause discrimination among them. If foreclosure is undertaken despite the fact that a petition for rehabilitation has been filed, the certificate of sale shall not be delivered pending rehabilitation. Likewise, if this has also been done, no transfer of title shall be effected also, within the period of rehabilitation. The rationale behind PD 902-A, as amended, is to effect a feasible and viable rehabilitation. This cannot be achieved if one creditor is preferred over the others."
"In this connection, the prohibition against foreclosure attaches as soon as a petition for rehabilitation is filed. Were it otherwise, what is to prevent the petitioner from delaying the creation of a Management Committee and in the meantime dissipate all its assets. The sooner the SEC takes over and imposes a freeze on all the assets, the better for all concerned. (pp. 265-266, Rollo; also p. 838, 213 SCRA 830)"
“The foregoing majority opinion relied upon BF Homes, Inc. vs. Court of Appeals (190 SCRA 262  — per Cruz, J.: First Division) where it was held that "when a corporation threatened by bankruptcy is taken over by a receiver, all the creditors should stand on an equal footing. Not anyone of them should be given preference by paying one or some of them ahead of the others. This is precisely the reason for the suspension of all pending claims against the corporation under receivership. Instead of creditors vexing the courts with suits against the distressed firm, they are directed to file their claims with the receiver who is a duly appointed officer of the SEC" (pp. 269-270; emphasis in the original). This ruling is a reiteration of Alemar's Sibal & Sons, Inc. vs. Hon. Jesus M. Elbinias (pp. 99-100; 186 SCRA 94  — per Fernan, C.J.: Third Division)."
“Taking the lead from Alemar's Sibal & Sons, the Court also applied this same ruling in Araneta vs. Court of Appeals (211 SCRA 390  — per Nocon, J .: Second Division)."
“All the foregoing cases departed from the ruling of the Court in the much earlier case of PCIB vs. Court of Appeals (172 SCRA 436  — per Medialdea; J .: First Division) where the Court categorically ruled that:
“SEC's order for suspension of payments of Philfinance as well as for all actions of claims against Philfinance could only be applied to claims of unsecured creditors. Such order can not extend to creditors holding a mortgage, pledge or any lien on the property unless they give up the property, security or lien in favor of all the creditors of Philfinance . . . (p. 440.)."
“Thus, in BPI vs. Court of Appeals (229 SCRA 223  — per Bellosillo, J .: First Division) the Court explicitly stated that ". . . the doctrine in the PCIB Case has since been abrogated. In Alemar's Sibal & Sons v. Elbinias, BF Homes, Inc. v. Court of Appeals, Araneta v. Court of Appeals and RCBC v. Court of Appeals, we already ruled that whenever a distressed corporation asks SEC for rehabilitation and suspension of payments, preferred creditors may no longer assert such preference, but shall stand on equal footing with other creditors. . . (pp. 227-228)."
“It may be stressed, however, that of all the cases cited by Justice Bellosillo in BPI, which abandoned the Court's ruling in PCIB, only the present case satisfies the constitutional requirement that "no doctrine or principle of law laid down by the court in a decision rendered en banc or in division may be modified or reversed except by the court sitting en banc" (Sec 4, Article VIII, 1987 Constitution). The rest were division decisions."
“It behooves the Court, therefore, to settle the issue in this present resolution once and for all, and for the guidance of the Bench and the Bar, the following rules of thumb are laid down:
“1. All claims against corporations, partnerships, or associations that are pending before any court, tribunal, or board, without distinction as to whether or not a creditor is secured or unsecured, shall be suspended effective upon the appointment of a management committee, rehabilitation receiver, board, or body in accordance with the provisions of Presidential Decree No. 902-A."
"2. Secured creditors retain their preference over unsecured creditors, but enforcement of such preference is equally suspended upon the appointment of a management committee, rehabilitation receiver, board, or body. In the event that the assets of the corporation, partnership, or association are finally liquidated, however, secured and preferred credits under the applicable provisions of the Civil Code will definitely have preference over unsecured ones."
"In other words, once a management committee, rehabilitation receiver, board or body is appointed pursuant to P.D. 902-A, all actions for claims against a distressed corporation pending before any court, tribunal, board or body shall be suspended accordingly."
"This suspension shall not prejudice or render ineffective the status of a secured creditor as compared to a totally unsecured creditor. P.D. 902-A does not state anything to this effect. What it merely provides is that all actions for claims against the corporation, partnership or association shall be suspended. This should give the receiver a chance to rehabilitate the corporation if there should still be a possibility for doing so. (This will be in consonance with Alemar's, BF Homes, Araneta, and RCBC insofar as enforcing liens by preferred creditors are concerned.)"
"However, in the event that rehabilitation is no longer feasible and claims against the distressed corporation would eventually have to be settled, the secured creditors shall enjoy preference over the unsecured creditors (still maintaining PCIB ruling), subject only to the provisions of the Civil Code on Concurrence and Preferences of Credit (our ruling in State Investment House, Inc. vs. Court of Appeals, 277 SCRA 209 )."
"The majority ruling in our 1992 decision that preferred creditors of distressed corporations shall, in a way, stand on equal footing with all other creditors, must be read and understood in the light of the foregoing rulings. All claims of both a secured or unsecured creditor, without distinction on this score, are suspended once a management committee is appointed. Secured creditors, in the meantime, shall not be allowed to assert such preference before the Securities and Exchange Commission. It may be stressed, however, that this shall only take effect upon the appointment of a management committee, rehabilitation receiver, board, or body, as opined in the dissent.”"
In all these, however, no clear disquisition on the underlying authority to impair the contractual rights of secured creditors had been presented.
We shall, therefore, refer to American jurisprudence for guidance in this regard.
The seminal ruling on the matter is the case of Home Building & Loan Assn. v. Blaisdell (290 U.S. 398 (Home Building & Loan Assn. v. Blaisdell (No. 370) 189 Minn. 422, 448; 249 N.W. 334, 893, affirmed) where the US Supreme Court exhaustively discussed the interplay between the non-impairment of contract clause vis-à-vis the general welfare clause. In Blaisdell, the Federal Supreme Court ruled:
“In the construction of the contract clause, the debates in the Constitutional Convention are of little aid. But the reasons which led to the adoption of that clause, and of the other prohibitions of Section 10 of Article I, are not left in doubt, and have frequently been described with eloquent emphasis. The widespread distress following the revolutionary period, and the plight of debtors, had called forth in the States an ignoble array of legislative schemes for the defeat of creditors and the invasion of contractual obligations. Legislative interferences had been so numerous and extreme that the confidence essential to prosperous trade had been undermined and the utter destruction of credit was threatened. ‘The sober people of America’ were convinced that some ‘thorough reform’ was needed which would ‘inspire a general prudence and industry, and give a regular course to the business of society.’ The Federalist, No. 44. It was necessary to interpose the restraining power of a central authority in order to secure the fo-undations even of "private faith." The occasion and general purpose of the contract clause are summed up in the terse statement of Chief Justice Marshall in Ogden v. Saunders, 12 Wheat. pp. 213, 354, 355:
“The power of changing the relative situation of debtor and creditor, of interfering with contracts, a power which comes home to every man, touches the interest of all, and controls the conduct of every individual in those things which he supposes to be proper for his own exclusive management, had been used to such an excess by the state legislatures, as to break in upon the ordinary intercourse of society, and destroy all confidence between man and man. This mischief had become so great, so alarming, as not only to impair commercial intercourse and threaten the existence of credit, but to sap the morals of the people and destroy the sanctity of private faith. To guard against the continuance of the evil was an object of deep interest with all the truly wise, as well as the virtuous, of this great community, and was one of the important benefits expected from a reform of the government.”"
“But full recognition of the occasion and general purpose of the clause does not suffice to fix its precise scope. Nor does an examination of the details of prior legislation in the States yield criteria which can be considered controlling. To ascertain the scope of the constitutional prohibition, we examine the course of judicial decisions in its application. These put it beyond question that the prohibition is not an absolute one, and is not to be read with literal exactness, like a mathematical formula. Justice Johnson, in Ogden v. Saunders, supra, p. 286, adverted to such a misdirected effort in these words:
“It appears to me that a great part of the difficulties of the cause arise from not giving sufficient weight to the general intent of this clause in the constitution and subjecting it to a severe literal construction which would be better adapted to special pleadings.
And after giving his view as to the purport of the clause --
"that the States shall pass no law attaching to the acts of individuals other effects or consequences than those attached to them by the laws existing at their date, and all contracts thus construed shall be enforced according to their just and reasonable purport.””
-- Justice Johnson added:
“But to assign to contracts, universally, a literal purport, and to exact for them a rigid literal fulfillment could not have been the intent of the constitution. It is repelled by a hundred examples. Societies exercise a positive control as well over the inception, construction and fulfillment of contracts as over the form and measure of the remedy to enforce them.”
“The inescapable problems of construction have been: what is a contract? What are the obligations of contracts? What constitutes impairment of these obligations? What residuum of power is there still in the States in relation to the operation of contracts, to protect the vital interests of the community? Questions of this character, of no small nicety and intricacy, have vexed the legislative halls, as well as the judicial tribunals, with an uncounted variety and frequency of litigation and speculation. (Story on the Constitution, § 1375.)"
“The obligation of a contract is "the law which binds the parties to perform their agreement." Sturges v. Crowninshield, 4 Wheat. 122, 197; Story, op. cit., § 1378. This Court has said that:
“[T]he laws which subsist at the time and place of the making of a contract, and where it is to be performed, enter into and form a part of it, as if they were expressly referred to or incorporated in its terms. This principle embraces alike those which affect its validity, construction, discharge and enforcement. . . . Nothing can be more material to the obligation than the means of enforcement. . . . The ideas of validity and remedy are inseparable, and both are parts of the obligation, which is guaranteed by the Constitution against invasion.”
“Von Hoffman v. City of Quincy, 4 Wall. 535, 550, 552. See also Walker v. Whitehead, 16 Wall. 314, 317. But this broad language cannot be taken without qualification. Chief Justice Marshall pointed out the distinction between obligation and remedy. Sturges v. Crowninshield, supra, p. 200. Said he:
“The distinction between the obligation of a contract and the remedy given by the legislature to enforce that obligation has been taken at the bar, and exists in the nature of things. Without impairing the obligation of the contract, the remedy may certainly be modified as the wisdom of the nation shall direct.”
“And in Von Hoffman v. City of Quincy, supra, pp. 553, 554, the general statement above quoted was limited by the further observation that:
“It is competent for the States to change the form of the remedy, or to modify it otherwise, as they may see fit, provided no substantial right secured by the contract is thereby impaired. No attempt has been made to fix definitely the line between alterations of the remedy, which are to be deemed legitimate, and those which, under the form of modifying the remedy, impair substantial rights. Every case must be determined upon its own circumstances.”
“And Chief Justice Waite, quoting this language in Antoni v. Greenhow, 107 U.S. 769, 775, added: "In all such cases, the question becomes, therefore, one of reasonableness, and of that the legislature is primarily the judge."
“The obligations of a contract are impaired by a law which renders them invalid, or releases or extinguishes them (Sturges v. Crowninshield, supra, pp. 197, 198) and impairment, as above noted, has been predicated of laws which, without destroying contracts, derogate from substantial contractual rights. In Sturges v. Crowninshield, supra, a state insolvent law which discharged the debtor from liability was held to be invalid as applied to contracts in existence when the law was passed. See Ogden v. Saunders, supra. In Green v. Biddle, 8 Wheat. 1, the legislative acts, which were successfully assailed, exempted the occupant of land from the payment of rents and profits to the rightful owner and were parts of a system the object of which was to compel the rightful owner to relinquish his lands or pay for all lasting improvements made upon them, without his consent or default.”
“In Bronson v. Kinzie, 1 How. 311, state legislation which had been enacted for the relief of debtors in view of the seriously depressed condition of business following the panic of 1837, and which provided that the equitable estate of the mortgagor should not be extinguished for twelve months after sale on foreclosure, and further prevented any sale unless two-thirds of the appraised value of the property should be bid therefor, was held to violate the constitutional provision. It will be observed that, in the Bronson case, aside from the requirement as to the amount of the bid at the sale, the extension of the period of redemption was unconditional, and there was no provision, as in the instant case, to secure to the mortgagee the rental value of the property during the extended period. McCracken v. Hayward, 2 How. 608, Gantly's Lessee v. Ewing, 3 How. 707, and Howard v. Bugbee, 24 How. 461, followed the decision in Bronson v. Kinzie; that of McCracken, condemning a statute which provided that an execution sale should not be made of property unless it would bring two-thirds of its value according to the opinion of three householders; that of Gantly's Lessee, condemning a statute which required a sale for not less than one-half the appraised value, and that of Howard, making a similar ruling as to an unconditional extension of two years for redemption from foreclosure sale. In Planters' Bank v. Sharp, 6 How. 301, a state law was found to be invalid which prevented a bank from transferring notes and bills receivable which it had been duly authorized to acquire. In Von Hoffman v. City of Quincy, supra., a statute which restricted the power of taxation which had previously been given to provide for the payment of municipal bonds was set aside. Louisiana v. Police Jury, 111 U.S. 716, and Seibert v. Lewis, 122 U.S. 284 are similar cases.”
“In Walker v. Whitehead, 16 Wall. 314, the statute, which was held to be repugnant to the contract clause, was enacted in 1870, and provided that, in all suits pending on any debt or contract made before June 1, 1865, the plaintiff should not have a verdict unless it appeared that all taxes chargeable by law on the same had been duly paid for each year since the contract was made, and further, that in all cases of indebtedness of the described class, the defendant might offset any losses he had suffered in consequence of the late war either from destruction or depreciation of property. See Daniels v. Tearney, 102 U.S. 415, 419. In Gunn v. Barry, 15 Wall. 610, and Edwards v. Kearzey, 96 U.S. 595, statutes applicable to prior contracts were condemned because of increases in the amount of the property of judgment debtors which were exempted from levy and sale on execution. But, in Penniman's Case, 103 U.S. 714, 720, the Court decided that a statute abolishing imprisonment for debt did not, within the meaning of the Constitution, impair the obligation of contracts previously made, and the Court said:
“The general doctrine of this court on this subject may be thus stated: in modes of proceeding and forms to enforce the contract, the legislature has the control, and may enlarge, limit, or alter them, provided it does not deny a remedy or so embarrass it with conditions or restrictions as seriously to impair the value of the right.””
“In Barnitz v. Beverly, 163 U.S. 118, the Court held that a statute which authorized the redemption of property sold on foreclosure, where no right of redemption previously existed, or which extended the period of redemption beyond the time formerly allowed, could not constitutionally apply to a sale under a mortgage executed before its passage. This ruling was to the same effect as that in Bronson v. Kinzie, supra, and Howard v. Bugbee, supra. But in the Barnitz case, the statute contained a provision for the prevention of waste, and authorized the appointment of a receiver of the premises sold. Otherwise, the extension of the period for redemption was unconditional, and, in case a receiver was appointed, the income during the period allowed for redemption, except wht was necessary for repairs and to prevent waste, was still to go to the mortgagor.”
“None of these case, and we have cited those upon which appellant chiefly relies, is directly applicable to the question now before us in view of the conditions with which the Minnesota statute seeks to safeguard the interests of the mortgagee-purchaser during the extended period. And broad expressions contained in some of these opinions went beyond the requirements of the decision, and are not controlling. Cohens v. Virginia, 6 Wheat. 264, 399.”
“Not only is the constitutional provision qualified by the measure of control which the State retains over remedial processes, but the State also continues to possess authority to safeguard the vital interests of its people. It does not matter that legislation appropriate to that end "has the result of modifying or abrogating contracts already in effect." Stephenson v. Binford, 287 U.S. 251, 276. Not only are existing laws read into contracts in order to fix obligations as between the parties, but the reservation of essential attributes of sovereign power is also read into contracts as a postulate of the legal order. The policy of protecting contracts against impairment presupposes the maintenance of a government by virtue of which contractual relations are worthwhile -- a government which retains adequate authority to secure the peace and good order of society. This principle of harmonizing the constitutional prohibition with the necessary residuum of state power has had progressive recognition in the decisions of this Court.”
“While the charters of private corporations constitute contracts, a grant of exclusive privilege is not to be implied as against the State. Charles River Bridge v. Warren Bridge, 11 Pet. 420. And all contracts are subject to the right of eminent domain. West River Bridge v. Dix, 6 How. 507. [n14] The reservation of this necessary authority of the State is deemed to be a part of the contract. In the case last cited, the Court answered the forcible challenge of the State's power by the following statement of the controlling principle -- a statement reiterated by this Court speaking through Mr. Justice Brewer, nearly fifty years later, in Long Island Water Supply Co. v. Brooklyn, 166 U.S. 685, 692:
“But into all contracts, whether made between States and individuals, or between individuals only, there enter conditions which arise not out of the literal terms of the contract itself; they are superinduced by the preexisting and higher authority of the laws of nature, of nations or of the community to which the parties belong; they are always presumed, and must be presumed, to be known and recognized by all, are binding upon all, and need never, therefore, be carried into express stipulation, for this could add nothing to their force. Every contract is made in subordination to them, and must yield to their control, as conditions inherent and paramount, wherever a necessity for their execution shall occur.”
“The legislature cannot "bargain away the public health or the public morals." Thus, the constitutional provision against the impairment of contracts was held not to be violated by an amendment of the state constitution which put an end to a lottery theretofore authorized by the legislature. Stone v. Mississippi, 101 U.S. 814, 819. See also Douglas v. Kentucky, 168 U.S. 488, 497-499; compare New Orleans v. Houston, 119 U.S. 265, 275. The lottery was a valid enterprise when established under express state authority, but the legislature, in the public interest, could put a stop to it. A similar rule has been applied to the control by the State of the sale of intoxicating liquors. Beer Co. v. Massachusetts, 97 U.S. 25, 32, 33; see Mugler v. Kansas, 123 U.S. 623, 664, 665. The States retain adequate power to protect the public health against the maintenance of nuisances despite insistence upon existing contracts. Fertilizing Co. v. Hyde Park, 97 U.S. 659, 667; Butchers' Union Co. v. Crescent City Co., 111 U.S. 746, 750. Legislation to protect the public safety comes within the same category of reserved power. Chicago, B. & Q. R. Co. v. Nebraska, 170 U.S. 57, 70, 74; Texas & N.O. R. Co. v. Miller, 221 US. 408, 414; Atlantic Coast Line R. Co. v. Goldsboro, 232 U.S. 548, 558. This principle has had recent and noteworthy application to the regulation of the use of public highways by common carriers and "contract carriers," where the assertion of interference with existing contract rights has been without avail. (Sproles v. Binford, 286 U.S. 374, 390, 391; Stephenson v. Binford, supra.)””
“The economic interests of the State may justify the exercise of its continuing and dominant protective power notwithstanding interference with contracts. In Manigault v. Springs, 199 U.S. 473, riparian owners in South Carolina had made a contract for a clear passage through a creek by the removal of existing obstructions. Later, the legislature of the State, by virtue of its broad authority to make public improvements, and in order to increase the taxable value of the lowlands which would be drained, authorized the construction of a dam across the creek. The Court sustained the statute upon the ground that the private interests were subservient to the public right. The Court said (id., p. 480):
“It is the settled law of this court that the interdiction of statutes impairing the obligation of contracts does not prevent the State from exercising such powers as are vested in it for the promotion of the common weal, or are necessary for the general good of the public, though contracts previously entered into between individuals may thereby be affected. This power, which in its various ramifications is known as the police power, is an exercise of the sovereign right of the Government to protect the lives, health, morals, comfort and general welfare of the people, and is paramount to any rights under contracts between individuals.””
“A statute of New Jersey prohibiting the transportation of water of the State into any other State was sustained against the objection that the statute impaired the obligation of contracts which had been made for furnishing such water to persons without the State. Hudson Water Co. v. McCarter, 209 U.S. 349. Said the Court, by Mr. Justice Holmes (id., p. 357):
“One whose rights, such as they are, are subject to state restriction cannot remove them from the power of the State by making a contract about them. The contract will carry with it the infirmity of the subject matter.”
“The general authority of the legislature to regulate, and thus to modify, the rates charged by public service corporations affords another illustration. Stone v. Farmers Loan & Trust Co., 116 U.S. 307, 325, 326. In Union Dry Goods Co. v. Georgia Public Service Corp., 248 U.S. 372, a statute fixing reasonable rates, to be charged by a corporation for supplying electricity to the inhabitants of a city, superseded lower rates which had been agreed upon by a contract previously made for a definite term between the company and a consumer. The validity of the statute was sustained. To the same effect are Producers Transportation Co. v. Railroad Comm'n, 251 U.S. 228, 232, and Sutter Butte Canal Co. v. Railroad Comm'n, 279 U.S. 125, 138. Similarly, where the protective power of the State is exercised in a manner otherwise appropriate in the regulation of a business it is no objection that the performance of existing contracts may be frustrated by the prohibition of injurious practices. (Rast v. Van Deman & Lewis Co., 240 U.S. 342, 363; see also St. Louis Poster Advertising Co. v. St. Louis, 249 U.S. 269, 274.)”
“The argument is pressed that, in the cases we have cited, the obligation of contracts was affected only incidentally. This argument proceeds upon a misconception. The question is not whether the legislative action affects contracts incidentally, or directly, or indirectly, but whether the legislation is addressed to a legitimate end and the measures taken are reasonable and appropriate to that end. Another argument, which comes more closely to the point, is that the state power may be addressed directly to the prevention of the enforcement of contracts only when these are of a sort which the legislature in its discretion may denounce as being in themselves hostile to public morals, or public health, safety or welfare, or where the prohibition is merely of injurious practices; that interference with the enforcement of other and valid contracts according to appropriate legal procedure, although the interference is temporary and for a public purpose, is not permissible. This is but to contend that, in the latter case, the end is not legitimate in the view that it cannot be reconciled with a fair interpretation of the constitutional provision.”
“Undoubtedly, whatever is reserved of state power must be consistent with the fair intent of the constitutional limitation of that power. The reserved power cannot be construed so as to destroy the limitation, nor is the limitation to be construed to destroy the reserved power in its essential aspects. They must be construed in harmony with each other. This principle precludes a construction which would permit the State to adopt as its policy the repudiation of debts or the destruction of contracts or the denial of means to enforce them. But it does not follow that conditions may not arise in which a temporary restraint of enforcement may be consistent with the spirit and purpose of the constitutional provision, and thus be found to be within the range of the reserved power of the State to protect the vital interests of the community. It cannot be maintained that the constitutional prohibition should be so construed as to prevent limited and temporary interpositions with respect to the enforcement of contracts if made necessary by a great public calamity such as fire, flood, or earthquake. See American Land Co. v. Zeiss, 219 U.S. 47. The reservation of state power appropriate to such extraordinary conditions may be deemed to be as much a part of all contracts as is the reservation of state power to protect the public interest in the other situations to which we have referred. And if state power exists to give temporary relief from the enforcement of contracts in the presence of disasters due to physical causes such as fire, flood or earthquake, that power cannot be said to be nonexistent when the urgent public need demanding such relief is produced by other and economic causes.””
“Whatever doubt there may have been that the protective power of the State, its police power, may be exercised -- without violating the true intent of the provision of the Federal Constitution -- in directly preventing the immediate and literal enforcement of contractual obligations, by a temporary and conditional restraint, where vital public interests would otherwise suffer, was removed by our decisions relating to the enforcement of provisions of leases during a period of scarcity of housing. Block v. Hirsh, 256 U.S. 135; Marcus Brown Holding Co. v. Feldman, 256 U.S. 170; Edgar A. Levy Leasing Co. v. Siegel, 258 U.S. 242. The case of Block v. Hirsh, supra, arose in the District of Columbia, and involved the due process clause of the Fifth Amendment. The cases of the Marcus Brown Company and the Levy Leasing Company arose under legislation of New York, and the constitutional provision against the impairment of the obligation of contracts was invoked. The statutes of New York, [n15] declaring that a public emergency existed, directly interfered with the enforcement of covenants for the surrender of the possession of premises on the expiration of leases. Within the City of New York and contiguous counties, the owners of dwellings, including apartment and tenement houses (but excepting buildings under construction in September, 1920, lodging houses for transients and the larger hotels), were wholly deprived until November 1, 1922, of all possessory remedies for the purpose of removing from their premises the tenants or occupants in possession when the laws took effect (save in certain specified instances), providing the tenants or occupants were ready, able and willing to pay a reasonable rent or price for their use and [p441] occupation. People v. La Fetra, 230 N.Y. 429, 438, 130 N.E. 601; Levy Leasing Co. v. Siegel, id. 634, 130 N.E. 923. In the case of the Marcus Brown Company, the facts were thus stated by the District Court (269 Fed. 306, 312):
“The tenant defendants herein, by law older than the state of New York, became at the landlord's option trespassers on October 1, 1920. Plaintiff had then found and made a contract with a tenant it liked better, and had done so before these statutes were enacted. By them plaintiff is, after defendants elected to remain in possession, forbidden to carry out his bargain with the tenant he chose, the obligation of the covenant for peaceable surrender by defendants is impaired, and, for the next two years, Feldman et al. may, if they like, remain in plaintiff's apartment, provided they make good month by month the allegation of their answer, i.e., pay what "a court of competent jurisdiction" regards as fair and reasonable compensation for such enforced use and occupancy.””
“Answering the contention that the legislation, as thus applied, contravened the constitutional prohibition, this Court, after referring to its opinion in Block v. Hirsh, supra, said:
“In the present case, more emphasis is laid upon the impairment of the obligation of the contract of the lessees to surrender possession and of the new lease which was to have gone into effect upon October 1, last year. But contracts are made subject to this exercise of the power of the State when otherwise justified, as we have held this to be. (256 U.S. p. 198. This decision was followed in the case of the Levy Leasing Company, supra.)””
“In these cases of leases, it will be observed that the relief afforded was temporary and conditional, that it was sustained because of the emergency due to scarcity of housing, and that provision was made for reasonable compensation to the landlord during the period he was [p442] prevented from regaining possession. The Court also decided that, while the declaration by the legislature as to the existence of the emergency was entitled to great respect, it was not conclusive, and, further, that a law depending upon the existence of an emergency or other certain state of facts to uphold it may cease to operate if the emergency ceases or the facts change even though valid when passed.”
“It is always open to judicial inquiry whether the exigency still exists upon which the continued operation of the law depends. (Chastleton Corp. v. Sinclair, 264 U.S. 543, 547, 548.)"
“It is manifest from this review of our decisions that there has been a growing appreciation of public needs and of the necessity of finding ground for a rational compromise between individual rights and public welfare. The settlement and consequent contraction of the public domain, the pressure of a constantly increasing density of population, the interrelation of the activities of our people and the complexity of our economic interests, have inevitably led to an increased use of the organization of society in order to protect the very bases of individual opportunity. Where, in earlier days, it was thought that only the concerns of individuals or of classes were involved, and that those of the State itself were touched only remotely, it has later been found that the fundamental interests of the State are directly affected, and that the question is no longer merely that of one party to a contract as against another, but of the use of reasonable means to safeguard the economic structure upon which the good of all depends.”
“It is no answer to say that this public need was not apprehended a century ago, or to insist that what the provision of the Constitution meant to the vision of that day it must mean to the vision of our time. If, by the statement that what the Constitution meant at the time [p443] of its adoption it means today, it is intended to say that the great clauses of the Constitution must be confined to the interpretation which the framers, with the conditions and outlook of their time, would have placed upon them, the statement carries its own refutation. It was to guard against such a narrow conception that Chief Justice Marshall uttered the memorable warning -- "We must never forget that it is a constitution we are expounding" (McCulloch v. Maryland, 4 Wheat. 316, 407) -- "a constitution intended to endure for ages to come, and, consequently, to be adapted to the various crises of human affairs." Id., p. 415. When we are dealing with the words of the Constitution, said this Court in Missouri v. Holland, 252 U.S. 416, 433, we must realize that they have called into life a being the development of which could not have been foreseen completely by the most gifted of its begetters. . . . The case before us must be considered in the light of our whole experience, and not merely in that of what was said a hundred years ago.”
“Nor is it helpful to attempt to draw a fine distinction between the intended meaning of the words of the Constitution and their intended application. When we consider the contract clause and the decisions which have expounded it in harmony with the essential reserved power of the States to protect the security of their peoples, we find no warrant for the conclusion that the clause has been warped by these decisions from its proper significance, or that the founders of our Government would have interpreted the clause differently had they had occasion to assume that responsibility in the conditions of the later day. The vast body of law which has been developed was unknown to the fathers, but it is believed to have preserved the essential content and the spirit of the Constitution. With a growing recognition of public needs [p.444] and the relation of individual right to public security, the court has sought to prevent the perversion of the clause through its use as an instrument to throttle the capacity of the States to protect their fundamental interests. This development is a growth from the seeds which the fathers planted. It is a development forecast by the prophetic words of Justice Johnson in Ogden v. Saunders, already quoted. And the germs of the later decisions are found in the early cases of the Charles River Bridge and the West River Bridge, supra, which upheld the public right against strong insistence upon the contract clause. The principle of this development is, as we have seen, that the reservation of the reasonable exercise of the protective power of the State is read into all contracts, and there is no greater reason for refusing to apply this principle to Minnesota mortgages than to New York leases.”
What stands out from this landmark ruling is the delineation made by the court between the obligation of the contract and remedy so provided thereunder. To reiterate, it is competent for States to change the form of the remedy, or to modify it otherwise, as they may see fit, provided no substantial right secured by the contract is thereby impaired.
One Philippine case that relied on Blaisdell was Rutter v Esteban (G.R. No. L-3708. May 18, 1953.). It held:
“One of the arguments advanced against the validity of the moratorium law is the fact that it impairs the obligation of contracts which is prohibited by the Constitution. This argument, however, does not now hold water. While this may be conceded, it is however justified as a valid exercise by the State of its police power. The leading case on the matter is Home Building and Loan Association vs. Bleisdell, 290 U. S., 398, decided by the Supreme Court of the United States on January 8, 1934. Here appellant contested the validity of charter 339 of the laws of Minnesota of 1933, approved April 13, 1933, called the Minnesota Mortgage Moratorium Law, as being repugnant to the contract clause of the Federal Constitution. The statute was sustained by the Supreme Court of Minnesota as an emergency measure. "Although conceding that the obligations of the mortgage contract were impaired, the court decided that what it thus described as an impairment was, notwithstanding the contract clause of the Federal Constitution, within the police power of the State as that power was called into exercise by the public economic emergency which the legislature had found to exist". This theory was upheld by the Supreme Court. Speaking through Chief Justice Hughes, the court made the following pronouncements:
“Not only is the constitutional provision qualified by the measure of control which the State retains over remedial processes, but the State also continues to possess authority to safeguard the vital interest of its people. It does not matter that legislation appropriate to that end 'has the result of modifying or abrogating contracts already in effect.' . . . Not only are existing laws read into contracts in order to fix obligations as between the parties, but the reservation of essential attributes of sovereign power is also read into contracts as a postulate of the legal order. The policy of protecting contracts against impairment presupposes the maintenance of a government by virtue of which contractual relations are worth while, a government which retains adequate authority to secure the peace and good order of society. This principle of harmonizing the constitutional prohibition with the necessary residuum of state power has had progressive recognition in the decisions of this court.””
“But the ruling in the Blaisdell case has its limitations which should not be overlooked in the determination of the extent to be given to the legislation which attempts to encroach upon the enforcement of a monetary obligation. It must be noted that the application of the reserved power of the State to protect the integrity of the government and the security of the people should be limited to its proper bounds and must be addressed to a legitimate purpose. If these bounds are transgressed, there is no room for the exercise of the power, for the constitutional inhibition against the impairment of contracts would assert itself. We can cite instances by which these bounds may be transgressed. One of them is that the impairment should only refer to the remedy and not to a substantive right. The State may postpone the enforcement of the obligation but cannot destroy it by making the remedy futile (W. B. Worthen Co. vs. Kavanaugh, 79 L. ed. 1298, 1301-1303). Another limitation refers to the propriety of the remedy. The rule requires that the alteration or change that the new legislation desires to write into an existing contract must not be burdened with restrictions and conditions that would make the remedy hardly pursuing (Bronson vs. Kinziel, I How, 311, 317; 46 Har. Law Review, p. 1070). In other words, the Blaisdell case postulates that the protective power of the State, the police power, may only be invoked and justified by an emergency, temporary in nature, and can only be exercised upon reasonable conditions in order that it may not infringe the constitutional provision against impairment of contracts (First Trust Co. of Lincoln vs. Smith, 277 N. W., pp. 762, 769). As Justice Cardozo aptly said, "A different situation is presented when extensions are so piled up as to make the remedy a shadow . . . The changes of remedy now challenged as invalid are to be viewed in combination, with the cumulative significance that each imparts to all. So viewed they are seen to be an oppressive and unnecessary destruction of nearly all the incidents that give attractiveness and value to collateral security (W. B. Worthen vs. Kavanaugh, 295 U. S. 56, 62). In fine, the decision in the Blaisdell case is predicated on the ground that the laws altering existing contracts will constitute an impairment of the contract clause of the Constitution only if they are unreasonable in the light of the circumstances occasioning their enactment (47 Harvard Law Review, p. 660).”
“The question now to be determined is, is the period of eight (8) years which Republic Act No. 342 grants to debtors of a monetary obligation contracted before the last global war and who is a war sufferer with a claim duly approved by the Philippine War Damage Commission reasonable under the present circumstances?”
“It should be noted that Republic Act No. 342 only extends relief to debtors of prewar obligations who suffered from the ravages of the last war and who filed a claim for their losses with the Philippine War Damage Commission. It is therein provided that said obligation shall not be due and demandable for a period of eight (8) years from and after settlement of the claim filed by the debtor with said Commission. The purpose of the law is to afford to prewar debtors an opportunity to rehabilitate themselves by giving them a reasonable time within which to pay their prewar debts so as to prevent them from being victimized by their creditors. While it is admitted in said law that since liberation conditions have gradually returned to normal, this is not so with regard to those who have suffered the ravages of war and so it was therein declared as a policy that as to them the debt moratorium should be continued in force (Section 1).”
“But we should not lose sight of the fact that these obligations had been pending since 1945 as a result of the issuance of Executive Orders Nos. 25 and 32 and at present their enforcement is still inhibited because of the enactment of Republic Act No. 342 and would continue to be unenforceable during the eight-year period granted to prewar debtors to afford them an opportunity to rehabilitate themselves, which in plain language means that the creditors would have to observe a vigil of at least twelve (12) years before they could effect a liquidation of their investment dating as far back as 1941. This period seems to us unreasonable, if not oppressive. While the purpose of Congress is plausible, and should be commended, the relief accorded works injustice to creditors who are practically left at the mercy of the debtors. Their hope to effect collection becomes extremely remote, more so if the credits are unsecured. And the injustice is more patent when, under the law, the debtor is not even required to pay interest during the operation of the relief, unlike similar statutes in the United States (Home Building and Loan Association vs. Blaisdell, supra).”
“There are at least three cases where the Supreme Court of the United States declared the moratorium laws violative of the contract clause of the Constitution because the period granted to debtors as a relief was found unwarranted by the contemplated emergency. One of them is W. B. Worthen Co. vs. Thomas, 292 U. S., 426-435; 78 L. ed., 1344, 1347. Here the Legislature of Arkansas passed an act providing for an exemption, "without limitation as to amount or restriction with respect to particular circumstances or relations, of all monies paid or payable to any resident of the state under any life, sick, accident or disability insurance policy, from liability for the payment of the debts of the recipient", and an attempt was made to apply the statute to debts owing before its approval. The court held that "such an exemption, applied in the case of debts owing before the exemption was created by the legislature, constitutes an unwarranted interference with the obligation of contracts in violation of the constitutional provision", and cannot be sustained even as emergency legislation, because it contains no limitation as to time, amount, circumstances or need (supra, 292 U. S., pp. 426-432).”
“The other case is W. B. Worthen vs. Kavanaugh (supra). Here certain Municipal Improvement Districts organized under the laws of Arkansas were empowered to issue bonds and to mortgage benefit assessments as security therefor. One of these districts acted upon the powers thus conferred. Some of the bonds were in default for nonpayment of principal and interest. So an action was brought by the bond-holders to foreclose the assessments upon the lots of delinquent owners. These bonds and mortgages were executed under the statutes then in force. Later the legislature of Arkansas passed three acts making changes in the remedies available under the former statutes, which changes were attacked as an unconstitutional impairment of contracts. The court sustained this view holding that the "changes in the remedies available for the enforcement of a mortgage may not, even when the public welfare is invoked as an excuse, be pressed so far as to cut down the security of a mortgage without moderation or reason or in a spirit of oppression. . . . A State is free to regulate the procedure in its courts even with reference to contracts already made, and moderate extensions of the time for pleading or for trial will ordinarily fall within the power so reserved; but a different situation is presented when extensions are so piled up as to make the remedy a shadow.”
“The third case is Louisville Joint Stock Land Bank vs. Radford, 295 U. S. 555, 79 L. ed. 1593. This case presented for decision the question whether subsection (s) added to section 75 of the Bankruptcy Act by the Frazier-Lemke Act, June 28, 1934, chap. 869, 48 Stat. at L. 1289 U. S. C. title 11, sec. 203, is consistent with the Federal Constitution. The court said that it is unconstitutional if applied to farm mortgages already existing, holding that "property rights of holders of farm mortgages are unconstitutionally taken, in violation of the Fifth Amendment, by a statute (Bankruptcy Act, sec. 75 (s); Frazier-Lemke Act of June 28, 1934, chap. 869, 48 Stat. at L. 1289) applicable only to debts existing at the time of its enactment, which provides that a farmer whose farm is mortgaged, and who has failed to obtain the consents necessary to a composition under the Bankruptcy Act, may, upon being adjudged a bankrupt, if the mortgagee assents, purchase the mortgaged property at its then appraised value by agreeing to make deferred payments of stated percentages of the appraised value over a period of six years, with interest at 1 per cent per annum, or, if the mortgagee refuses his assent to such purchase, may obtain a stay of all proceedings for a period of five years, during which he shall retain possession of all or any part of his property, under the control of the court, provided he pays a reasonable rental therefor, and that at the end of five years he may pay into court the appraised price thereof, or, if a lien holder shall request a reappraisal by the court, the reappraised price, whereupon the court shall, by an order, turn over full possession and title of the property to the debtor, and he may apply for his discharge.”
“In addition, we may cite leading state court decisions which practically involved the same ruling and which reflect the tendency of the courts towards legislation involving modification of mortgage or monetary contracts which contains provisions that are deemed unreasonable or oppressive. Some of those which may be deemed representative are as follows:
“1. Pouquette vs. O'Brien, 100 Pac. 2nd series, 979 (1940). The Supreme Court of Arizona held unconstitutional a 1937 statute authorizing courts to extend for a period of not longer than two years all actions or foreclosures of real estate mortgages, and a 1939 statute authorizing the courts to extend foreclosure proceedings not later than March 4, 1941.
2. First Trust Joint Stock Land Bank of Chicago vs. Adolph Arp et al., 283 N.W. 441, 120 A.L.R. 932 (1939). The Supreme Court of Iowa declared unconstitutional the Moratorium Acts enacted in 1933,1935 and 1937, providing for extension of the 1933 Moratorium Act covering a period of six years.
3. First Trust Co. of Lincoln vs. Smith et al., 277 N.W. 762 (1938). The Supreme Court of Nebraska declared unconstitutional the Nebraska Moratorium Law as reenacted, extending the benefit of the remedy to a period of six years, as being repugnant to the contract clause of the Constitution.
4. Milkint vs. McNeely, Clerk of court, et al., 169 S.E. 790 (1933). The Supreme Court of Appeals of West Virginia declared unconstitutional certain acts of legislature enacted in 1932, extending the period of redemption three years beyond the one-year period then allowed by statute, being an impairment of contract as to sales made prior to enactment thereof.
5. Haynes vs. Treadway, 65 Pac. 892 (1901). The Supreme Court of California declared unconstitutional a statute which extends the right of redemption from six months to twelve months being a substantial impairment of the obligation contracts if applied to a mortgage already executed.
6. Swinburne vs. Mills, 50 Pac. 489 (1897). The Supreme Court of Washington declared a statute unconstitutional in so far as it provides that, on a decree for foreclosure of a mortgage executed before the act was passed, the debtor shall be entitled to have the order of sale stayed for one year, as being an impairment of the obligation of contract.”
“These cases apply with added force in this jurisdiction considering the conditions now prevailing in our country.”
The US case of Blaisdelle and the Philippine case of Rutter clearly show that the impairment of contract yields to the police power of the State examples of which were explained in the cases.
It is therefore indubitable that the provision of the law on the issuance of Stay Order is constitutional. The Stay Order does not in any way impair the obligation of the mortgage contract or even the remedy to enforce the same. If at all, there is only a delay in the enforcement of the remedy.
The exercise of police power by the State truly finds fruition once a rehabilitation plan is approved (or “crammed down” on the parties in special cases) pursuant to the provisions of the Rules. If the plan is pursued to its intended and logical end – the rehabilitation of the corporation – the impairment of the remedy under the mortgage contract finds redemption and the parties are brought to their ideal positions – that of the debtor being able to pay its obligations as they fall due and the creditors being satisfied at holding on to their security only as a second “way out”.
But what if the rehabilitation plan goes awry? Then the remedy of foreclosure ripens and the temporary injunction on its exercise is lifted. All told, the mortgagee-creditor will not be denied his right over the mortgage.
A secured creditor may not successfully challenge the constitutionality of the Interim Rules on Corporate Rehabilitation in so far as it provides for the issuance of Stay Order upon determination of the sufficiency in form and substance of a petition for rehabilitation.
This however does not mean that a secured creditor is relegated to a position of similar to that of an unsecured creditor as this has never been the intention of the doctrine of “equality in equity”. The Rules itself has so provided that the secured creditors while unable to enforce its contractual right against the debtor and his mortgaged property shall be “preferred” in the scheme of things. Rule 4, Sec. 5 thus states:
“SEC. 5. Rehabilitation Plan.— The rehabilitation plan shall include (a) the desired business targets or goals and the duration and coverage of the rehabilitation; (b) the terms and conditions of such rehabilitation which shall include the manner of its implementation, giving due regard to the interests of secured creditors; (c) the material financial commitments to support the rehabilitation plan; (d) the means for the execution of the rehabilitation plan, which may include conversion of the debts or any portion thereof to equity, restructuring of the debts, dacion en pago, or sale of assets or of the controlling interest; (e) a liquidation analysis that estimates the proportion of the claims that the creditors and shareholders would receive if the debtor’s properties were liquidated; and (f) such other relevant information to enable a reasonable investor to make an informed decision on the feasibility of the rehabilitation plan.”
Is this a recognition that the secured creditors will suffer a loss which the State is duty bound to compensate in the process? Is the loss suffered by the secured creditor tantamount to a loss occasioned by compensable taking of a property right as understood under the due process clause and the power of eminent domain? Is the effect of the Stay Order constitutive of taking without just compensation?
The answers to these questions will certainly assist our lawmakers in their efforts to overhaul our antiquated Insolvency Law and the Marcos-vintage Presidential Decree No. 902-A and to come up with a Bankruptcy Law that is attuned to international standards and best practices.
It is submitted that the provision “giving due regard to the interest of secured creditors” should be retained, expanded and properly defined in any proposed legislation on corporate recovery and insolvency. Such law should give due regard to the fact that the forced delay imposed on the secured creditor is a derogation of a property right and as such the State should devise reasonable compensation for any loss of opportunity suffered by the secured creditor.
Our lawmakers should consider the fact that to the extent the secured creditor is prevented from exercising his right to walk away from the affairs of the debtor still whole and unscathed could be tantamount to taking. Since any proposed law that includes a stay order may also be construed as constituting an exercise of eminent domain, it should address the issue of paying reasonable compensation to the secured creditors in the form of payment of interest accruing after the filing of the petition in addition to the adequate protection clause already incorporated in the present Rules.
This way, the interest of the State to assist the debtor and steer it back to the mainstream economy may be balanced with the interest of those who stake their resources to the business of the debtor with a reasonable expectation of profits that satisfies his so called “hurdle rate” secured in anticipation of a loss with a lien on property of the debtor.
("Hurdle rate" refers to the required rate of return in a discounted cash flow analysis, above which an investment makes sense and below which it does not. Often, this is based on the firm's cost of capital or weighted average cost of capital, plus or minus a risk premium to reflect the project's specific risk characteristics. also called required rate of return (http://www.investorwords.com/2362/feedback.cgi?2362; accessed on October 21, 2005).