Corporatization as PPP (Public-Private Partnerships Series: Paper No. 5) Alberto C. Agra and Faye Josephine R.

Miguel-Raola Forensic Solutions

Introduction Corporatization is the transformation of a public entity into one that has the structure and attributes of a private corporation, such as a board of directors, officers, and shareholders. The objective is for the government to retain ownership of the entity, and at the same time ensure that goods and/ or services are delivered efficiently a goal that is sometimes difficult to attain in a government bureaucracy.

Corporatization has been the policy of the Peoples Republic of China and was used in New Zealand and in most states of Australia in the reform of their electricity markets. Corporatization was likewise used by many other countries and industries like the Dutch water supply companies.i In the United States of America, municipalities and counties form local government corporations for purposes of funding transportation, water and sewer infrastructure, economic development ventures, and other projects that will benefit the public. Corporatization has not, however, gained a foothold in the Philippines despite its inherent value as a form of public-private partnership (PPP). As a background, PPP is currently undertaken under the following frameworks:ii

1. Build-Operate-Transfer (BOT) - A contractual arrangement whereby the project proponent undertakes the construction and financing of a given infrastructure facility, and the subsequent operation and maintenance thereof. The project proponent operates the facility over a fixed term during which it is allowed to charge facility users appropriate tolls, fees, rentals, and charges not exceeding those proposed in its bid, or as negotiated and incorporated in the contract to enable the project proponent to recover its investment, and operating and maintenance expenses in the project. BOT arrangements are undertaken under Republic Act No. 6957, as amended by Republic Act No. 7718, otherwise known as the BOT Law;

2. Procurement - The acquisition of goods, consulting services, and the contracting for infrastructure projects by a procuring entity is called

procurement. It also includes lease of goods and real estate. Republic Act No. 9184, or the Government Procurement Reform Act (GPRA), is the principal law on procurement.

3. Joint Venture (JV) - A contractual arrangement whereby two or more parties pool their assets in undertaking a particular activity and agree to share in profits and losses. Other than the general law on partnerships, there is no statute governing joint ventures. However, as mandated by Executive Order No. 423 issued by then President Gloria MacapagalArroyo, the National Economic Planning Agency (NEDA) issued the 2008 JV Guidelines and Procedures for Entering into Joint Venture Agreements between Government and Private Entities (2008 NEDA JV Guidelines) in consultation with the Government Procurement Policy Board.

In the case of joint ventures undertaken under the 2008 NEDA JV Guidelines, it is a private sector entity (or group of private sector entities) on one hand, and a government entity (or group of government entities) on the other, which contribute money/ capital, services, assets (including equipment, land, or intellectual property), or a combination of all these. Parties to a JV share risks to jointly undertake an investment activity to accomplish a specific, limited, or special goal or purpose, with the end view of facilitating private sector initiative in a particular industry or sector, and eventually transferring ownership of the investment activity to the private sector under competitive market conditions.

At present, there are no JV guidelines issued by the National Government applicable to local government units.

4. Lease - When the government leases out its property as lessor, it does not disburse public funds to procure, but instead receives money as rentals. The applicable law is, thus, not the GPRA but Executive Order No. 301 (1987). Heads of agencies shall have the authority to determine the reasonableness of the terms of the lease and the rental rates thereof, and to enter into such lease contracts without need of prior approval from higher authorities, subject to compliance with the uniform standards established by the Department of Public Works and Highways and to the audit jurisdiction of the Commission on Audit (COA).

On the other hand, when the government is the lessee, GPRA provisions on negotiated procurement apply. The lessee-government agency must conduct a cost-benefit analysis to assess the feasibility of entering into a

lease contract for privately-owned real estate as against purchasing or leasing government-owned real estate. In the case of a proposed lease of a vacant lot or other land spaces, the procuring entity shall determine the reasonableness of the proposed rate using a comparative price analysis. The government entity must also determine the reasonableness of the rate using either the computation based on the observed depreciation or straight-line depreciation.

5. Concession - An agreement between the state and a private corporation, wherein the state grants the private corporation the privilege of operating a public service, business, or government function, or exercising a right which would otherwise be exclusive to the government. Republic Act No. 9136, otherwise known as the Electric Power Industry Reform Act, defines a Concession Contract as the award by the government to a qualified private entity of the responsibility for financing, operating, expanding, maintaining, and managing specific government-owned assets.

6. Disposition or Divestment - A manner or scheme of taking away, depriving, or withdrawing of an authority, power, or title. The modes of disposition or divestment are enumerated in COA Circular No. 89-296 dated January 27, 1989, as follows: (a) public auction; (b) sale thru negotiation; (c) barter; (d) transfer to other government agencies; and (e) destruction or condemnation.

The guiding principle of corporatization is the intent to capture the advantages of a privately run company including efficiency, productivity, and financial sustainability while retaining government accountability. The transformation from a public entity to one with the commercial orientation of a private company would typically include three ring-fencing activities:

1. Establishment of a distinct legal identity for the company under which the governments role is clearly identified as owner;

2. Segregation of the companys assets, finances, and operations from other government operations; and

3. Development of a commercial orientation and managerial independence while remaining accountable to the government or electorate.iii

Scope and Corporatization Precedents

There are many areas where corporatization may be explored to increase efficiencies, provide better services to the public, and enhance profitability. These may include proprietary functions and services such as accounting and financial services; administrative human resource functions (e.g., payroll services, recruitment/hiring, training, benefits administration, records management, etc.); information technology; road maintenance and repair; tourism services, including convention center management; library services; school construction and maintenance; and income-generating services such as parking buildings. Corporatization provides an avenue for private sector investment in these areas while at the same time ensuring or at least mitigating the risks inherent in private sector involvement in public affairs. It can be undertaken both by the national government and by local government units.

The Energy Development Corporation (EDC) can be cited as an example of successful corporatization undertaken by the national government. The Philippine National Oil Company (PNOC) was created on November 9, 1973 through Presidential Decree No. 334 to provide and maintain an adequate and stable supply of oil. In 1976, EDC was incorporated as a subsidiary of PNOC to undertake the exploration, development, utilization, and marketing of geothermal and other viable energy sources in the country. For more than three decades, it has undertaken its mandate to lessen the countrys dependence on imported fuel, commissioning geothermal power plants and eventually entering the power generation business. In 2006, it launched its initial public offering (IPO) and was given the Bull Run Award by the Philippine Stock Exchange for launching the biggest IPO of 2006. On November 29, 2007, EDC became a private corporation under Red Vulcan Holdings Corporation after the successful sale of 60% of its controlling stakes.iv

In the local government sphere, Cebu Property Ventures Development Corporation (CPVDC) started as a joint venture corporation between the Province of Cebu and Ayala Land, Inc. The Province of Cebu formed CPVDC as a subsidiary corporation with an authorized capital stock of P1 Billion, and conducted the flotation of Cebu Equity Bond Units and the Secondary Share Sale Program via a public offering through the local stock exchanges. The company was registered with the Securities and Exchange Commission on August 2, 1990 and started commercial operations on September 1, 1996.

When CPVDC started as a joint venture, its ownership profile showed a 74.8% to 25.2% partnership between the Province of Cebu and Ayala Land, Inc. The Province of Cebu contributed patrimonial properties as its equity contribution

(comprising its 74.8% ownership share), including the 23-hectare site of what was formerly the Lahug Airport. For its part, Ayala Land, Inc. initially contributed P63 Million as the initial 25% paid-up subscription for its 250 million shares, with the understanding that the full payment would be called by the Board when the properties offered by the Province would be free and clear of occupants, and thus ready for development. The company is now 76% owned by Cebu Holdings, Inc. (CHI) after a successful tender offering undertaken in 1995.v Corporatization may be undertaken by national government agencies, government-owned and -controlled corporations (GOCC), and local government units (collectively, the government sector). Evidently, the creation of a new corporation, whether as a subsidiary, another GOCC, or a quasimunicipal corporation in the case of local government units, should be by authority of law. In addition, Letter of Instructions No. 1520 issued by President Ferdinand Marcos on February 4, 1986 provided precedent for the practice that the creation of a new government corporation other than by special law may only be done with the approval of the President. Incidentally, corporatization is also understood to be the process of diversifying financing sources and bridging the funding gap by involving private capital. In this sense, all the PPP variations discussed above may be considered as corporatization modalities. For purposes of this paper, however, corporatization shall refer to a distinct PPP model entailing the creation of an entity separate from the national government or local government unit.

Corporatization

The creation of a corporation other than by special charter or law is accomplished through incorporation under the Corporation Code of the Philippines. EDC and CPVDC, for instance, were incorporated as stock corporations registered with the Securities and Exchange Commission. Concededly, there is a sentiment that the creation of new government corporations, particularly those involved in entrepreneurial or proprietary activities, should be limited because of budgetary constraints. It is submitted, however, that corporatization as proposed in this paper enhances private sector participation and minimizes the governments financial exposure in the areas where it is undertaken. In the case of local government units, Section 18 of the Local Government Code of 1991 (LGC) expressly empowers them to establish an organization that shall be responsible for the efficient and effective implementation of their development plans, program objectives and priorities; to create their own sources of revenue and to allocate their resources in accordance with their own priorities; and to acquire, develop, lease, encumber, alienate, or otherwise dispose of real or personal property held by them in their proprietary capacity; and to apply their resources and assets for productive,

developmental, or welfare purposes, in the exercise or in furtherance of their governmental or proprietary powers and functions and thereby ensure their development into self-reliant communities and active participants in the attainment of national goals. The LGC grants local government units full autonomy in the exercise of their proprietary functions and in the management of their economic enterprises. It should also be mentioned that no law or regulation specifically prohibits a local government unit, by itself or together with other local government units, from forming a corporation in accordance with the Corporation Code.

As the national policy veers more and more towards encouraging publicprivate partnerships in local development undertakings, local government units are also increasingly asserting that local fiscal autonomy encompasses more than just the basic tenets of allowing local government units to create their own sources of revenue and to allocate their resources according to their priorities, but also the right to form private corporations to further their development goals. This is consistent with the constitutional mandates of local autonomy and fiscal autonomy. The authority to create a corporation and to provide for its capitalization is evidently vested in the local legislative council. An ordinance enacted in accordance with the provisions of the LGC is therefore indispensable. The ordinance authorizing the creation of the corporation, and adopting its articles of incorporation and by-laws, may provide for sources of funds or capital contribution, and specify the rights and obligations of the incorporators, directors, and shareholders vis--vis the local government unit. Incorporation imbues the new or offspring corporation with a legal personality separate from the parent national government agency, GOCC, or local government unit. It allows the government sector to limit its liability up to the extent of its investment in the capital of the corporation. This is intended to protect the government sectors (other) assets from being used to discharge the liabilities of the corporation. Incorporation also grants the entity formed the right to enter into contracts, to sue and be sued, to borrow money or to invest funds, and to own property. It allows for governance by a board of directors, which shall be accountable to the shareholders, consisting wholly or partially of the government sector itself. In contrast with a joint venture undertaken under the 2008 NEDA JV Guidelines, corporatization does not limit the equity contribution of the government sector to less than fifty percent (50%) of the outstanding capital stock of the corporation. The government sector may take a majority or minority position depending on its contribution which may consist of money, equipment, land, intellectual property, or any other thing or service of value.

A major struggle of corporatization is the view that it is a relinquishment of public control in favor of the private corporation. The people admittedly lose a direct control in the issue of services, rates, terms, standards, working

conditions, etc., since such issues are being decided by the directors and corporate officers in the boardroom. It is important, therefore, to structure the corporation in a way that assures clarity in the responsibilities, obligations, and performance expectations, transparency in the conduct of the corporations affairs, and public accountability.

The presence of the board of directors and officers reduces political interference and intervention in the management of the corporations affairs. However, the government sector has to perform a delicate balancing act between its function as regulator of private business and as shareholder thereof, roles which have inherently different standards, purposes, and goals. As a regulator, its objective is to ensure the public good, often translating to the highest quality of goods or services at the lowest cost to the people. As a shareholder, it hopes to maximize profits and dividends. Corporate governance ensures the value and sustainability of the corporation through sound financial management, transparent accounting processes, and provisions for independent audit. Apart from the board of directors and officers, corporations may also establish supervisory boards, legal, financial, marketing, technical, and research and development departments which further contribute to the improvement of corporate governance. Performance is evaluated in the same way that private companies evaluate their performance, e.g., with the use of indicators such as profitability, efficiency, and investment.

Disposition/Eventual Privatization

Corporatization is often viewed as a preliminary step to privatization, because the structure allows the government to divest ownership of its shareholdings. The corporation may be structured to allow the government sector to participate in its management and operations over a period of time, as in the case of EDC. It may also allow for the disposition of the government sectors shares through public bidding, tender offer, or initial public offering (IPO), as in the case of CPVDC, which undertook a public offering of its shares shortly after incorporation, reducing the Province of Cebus ownership to 8.28%.vi

Corporatization benefits the private sector through the opportunity to profit from its investment. It also benefits the government because it bridges the funding gap (in undertaking projects for which it does not have sufficient resources) by inviting private capital initially through equity participation. More significantly, because of the increased efficiency and profitability attendant to good corporate governance, corporatization can increase the value of the government sectors share in the corporation, enabling it to generate larger revenues from eventual privatization.vii

This is the position of Forensic Solutions. Forensic Law and Policy Strategies, Inc. or Forensic Solutions is a think tank offering services in the fields of policy, law reform, advocacy and governance. The group provides forensic study and viable policy options, giving our clients a crucial advantage in navigating executive, administrative, legislative and judicial inquiries. Forensic Soluitions recently published a book on Knowing PPP, BOT and JV: A Legal Annotation. Alberto C. Agra was the immediate past Secretary of Justice, Solicitor General and Government Corporate Counsel. He teaches Law on Public Corporations, Administrative Law, Law on Public Officers and Law on Local Governments. He is an advocate of PPP. Faye Josephine R. Miguel-Raola is a former State Solicitor of the Office of the Solicitor General and Court Attorney of the Supreme Court. She is an expert on banking laws.

i R

References:

http://www.finance.reachinformation.com/corporatization.aspx; last viewed on February 18, 2011.

ii

Agra, Baltazar, Miguel-Raola, Ortilla-Mallari, Perez-Alabanza, Bruce, and Fong, Knowing PPP, BOT, and JV--A Legal Annotation, 2011.
iii

United States Agency for International Development (USAID), Good Practices in Public Water Utility Corporatization, November 2006; www.pwrf.info/Downloads/References/Contractualization/Good%20practices%20in%20public %20water%20utility%20corporatization.pdf; last viewed on February 15, 2011. United Nations Research Institute for Social Development, Neither Public Nor Private--Unpacking the Johannesburg Water Corporatization Model, by Laila Smith, Social Policy and Development Programme Paper Number 27, June 2006. Asian Development Bank, Peoples Republic of China Toll Roads Corporatization Strategy Toward Better Governance, by Xiaohong Yang and John Lee, 2008.
iv v

http://www.energy.com.ph/about-edc/milestones; last viewed on February 18, 2011.

http://www.cpvdc.com; last viewed on February 18, 2011.

vi

http://www.cpvdc.com/investor-relations/ownership-structure; last viewed on February 18, 2011.

vii

Journal of Corporate Finance, Can corporatization improve the performance of state-owned enterprises even without privatization?, by Varouj A. Aivazian, Ying Ge, and Jiaping Qiu, 2004.