MID-TERM EXAMINATION

Banking and Financial Law

October 31, 2020

STUDENT NO. 2012 30474

1. What is a pari passu representation? Is it breached by a borrower who allows a subsequent

loan agreement to be notarized? What about if the borrower is the Republic of the
Philippines? Explain. (10 points)

Pari passu is a Latin term which literally means “on equal footing”. As used in banking, it is a
principle under the concept of loan agreements, usually under the section on representations and
warranties, where the borrower warrants to the lender that the latter is on equal footing with the
borrower’s other lenders, if any, in terms of preference of credit under the New Civil Code (NCC).
This means that on the occasion of default on the part of the borrower, the lender shall have the
same and equal preference as all other lenders in the satisfaction of their respective credit
accommodations. Pari passu representations are intended to benefit the lender and guard the latter’s
rights against borrower in the event of default.

As a general rule, a pari passu representation is breached when a borrower allows a subsequent loan
agreement to be notarized. Under the law (NCC 2244, par. 14), a loan agreement that is notarized
enjoys a preference of credit which violates the representation since this subsequent loan will now
have preference over all others. Unless this preference is expressly waived, this will breach the
representation.

However, if the borrower is the Republic of the Philippines, the pari passu representation will not be
violated even if the loan agreement is notarized. Government issued securities are recognized as the
most secure investments because a sovereign, like the Republic of the Philippines, has the inherent
power of taxation and, theoretically, can never be insolvent. In that regard, preference of credit will
no longer have much relevance in terms of the pari passu representation provision in the loan
agreement since the lender is assured of payment by virtue of the credit reliability of the Republic of
the Philippines—that is, there is essentially still pari passu because, like any other lender, the lender
is assured of payment.

2. What is a “judgment currency clause” in a loan agreement? Is Republic Act No. 8183
relevant to a discussion of such clause? Explain (10 points)

A judgment currency clause is a provision in a loan agreement which allows parties to initiate a
second suit or action in order to enforce a judgment which decides the case on its merits but which
judgment provides for payment of loan obligations in a currency different from the currency
stipulation in the contract entered into by the parties. Under this judgment currency clause, there is
no res judicata and the parties can ask the courts to fix the payment in favor of the winning party in
accordance with the currency stipulated in their original agreement. For instance, if the Philippine
court ruled in favor of A (lender) but gave the award in Pesos, A may institute an action to enforce
the agreement if for example the kind of currency stipulated in the agreement is in US Dollars.
 Republic Act No. 8183 is relevant in the discussion of judgment currency clauses because the
former is the law which repealed the Uniform Currency Act (UCA). Prior to its repeal, the UCA
limited the currency stipulations to Philippine pesos as legal tender. With Republic Act No. 8183,
parties may now stipulate the currency in which the agreement shall be carried out provided that
such currency is convertible to Philippine peso. Because of such repealing law, transactions
involving foreign exchanges are facilitated and foreign investments are encouraged.

As applied in the instant issue, since the judgment currency clause requires that the jurisdiction
where enforcement is to be carried out recognizes the contract stipulations on currency, Republic
Act No. 8183 is a necessary legislation for such clause to be validly included in the loan agreement.

3. A commercial bank wants to acquire shares in a company engaged in real estate development.
Do you think it can do that? Why? (10 points)

No, it cannot. Unlike universal banks, commercial banks have a limited authority in investing in
entities, through acquisition of shares thereon, as provided under the law. A commercial bank can
only acquire equity in allied enterprises, whether financial or non-financial. This is one main
difference between commercial and universal banks. Allied enterprises are enumerated under the
law and a common feature of these enterprises is that they are engaged in businesses “allied” to
banking and finance (i.e. credit financing companies, insurance companies etc.). On the other hand,
non-allied enterprises are those that are engaged in business that are not directly related (“non-
allied”) to financing activities (i.e. warehouse companies, clothing companies etc.).

In the instant case, real estate development is not an allied enterprise. While it involves sale and
some level of financing, its business is primarily concerned with real property or land. Hence, as a
non-allied enterprise, a commercial bank cannot acquire shares thereon.

4. Nadine placed P1 million with Bank ABC not as a deposit but as a 10% participation in a P10
million commercial paper issued by Company X to Bank ABC and registered with the
Securities and Exchange Commission. It was agreed between Nadine and Bank ABC that the
latter would return the placement to the former, should Company X fail to pay the
commercial paper. What do you call this liability of Bank ABC to Nadine? Is it insurable by
the Philippine Deposit Insurance Corporation? Explain your answers. (10 points)

The liability of Bank ABC to Nadine is secondary—that is, the bank is essentially a surety to the
obligation in that, in the event that the primary obligor is unable to meet the obligation under the
commercial paper, the Nadine is with recourse against the bank. This agreement between the bank
and Nadine is in the nature of a deposit substitute and the bank is engaging in quasi-banking by
relending the funds from the public (like Nadine) to Company X, as evidenced by the commercial
paper issued with recourse.

This transaction, being in the nature of quasi-banking, is covered by the PDIC insurance. While
quasi-banking is not explicitly stated as a core function and deposit substitutes are not also expressly
enumerated in the General Banking Law, the fact that quasi-banking can be exercised by
commercial and universal banks alike without need for certification shows that it is intended to be a
core function of banks. Quasi-banking is the activity and deposit substitute is the result thereof—
being two different sides of the same coin, and with quasi-banking being considered as a core
function, deposit substitutes are covered by the PDIC in the event of default by the bank and the re-
lender can have recourse against the bank in case the latter defaults.
5. Raymond invested P500,000 in Philippine government bonds forming part of Bank DEF’s
portfolio. Assuming that the Department of Justice inquires from Bank DEF whether
Raymond has such an investment, can Bank DEF invoke the Law on Secrecy of Bank Deposits
to refuse the Department of Justice’s inquiry? Explain. (10 points)

Yes, the bank can refuse and invoke the Law on Secrecy of Bank Deposits. The bank can invoke
this law and state that the law prohibits any disclosure by the bank or its officers of information on
deposits of whatever nature and equally prohibits any person, office, bureau or government official
from examining and inquiring into deposits.

While the law provides for exceptions, the instant case does not fall under any, namely: (a) written
consent of the depositor, (b) impeachment cases, (c) court order in cases involving bribery of public
officials and other cases under the Anti-Graft and Corrupt Practices Act, (d) when the deposit is the
subject matter of a litigation, (e) when the deposit is the subject matter of a case in violation of the
Anti-Money Laundering Act, (f) when the public official is under investigation for unexplained
wealth, (g) with the Bureau of Internal Revenue for certain instances like application for
compromise tax payment, (h) when the Office of the Ombudsman investigates the depositor, among
others. The facts of the instant case do not specify whether the inquiry of the Department of Justice
is based on an actual complaint filed or an ongoing investigation or is pursuant to a court order.

6. Company Y entered into two loan agreements, one in 2017 and the other in 2019. The 2017
loan agreement contains a cross-acceleration clause. Suppose that Company Y fails to pay an
instalment under the 2019 loan agreement, will the lender in the 2017 loan agreement be able
to declare Company Y in default? Explain. (10 points)

No, the lender, on the basis of the cross-acceleration clause in the 2017 loan agreement, cannot
declare the company in default automatically. A cross-acceleration clause is a provision in the loan
agreement which allows a lender (lender “A”) to declare a borrower who defaults against another
lender (lender “B”) even if the borrower has not yet defaulted in the obligation with lender A—
hence, the term “cross” because default in one can give ground for default in another. However, the
term “acceleration” in “cross acceleration” requires that, for lender A to declare Company Y in
default, lender B, as the lender against whom the default originally occurred, must accelerate the
obligation first. Unless lender B accelerates, then lender A has not ground for declaring Company Y
in default. As discussed previously, this clause is for the benefit of the borrower since the latter is
given time to meet the obligation during the period before acceleration.

7. Norman imported goods from a U.S. exporter. Bank XYZ issued a letter of credit in favor of
the U.S. exporter for the account of Norman. The U.S. exporter made a compliant
presentation to the U.S. correspondent bank of Bank XYZ of all the documents listed in the
letter of credit. However, Norman instructed Bank XYZ not to pay the U.S. exporter, because
he was not satisfied with the quality of the goods shipped by the U.S. exporter. Can Bank
XYZ disregard Norman’s instruction? Explain. (10 points)

Yes, the Bank can disregard Norman’s instruction unless the ground for the contrary instruction is
fraud as to the Letter of Credit (LOC) and the attached documents themselves. Under the principle
of independence of LOC transactions, the LOC, while accompanying the underlying obligation in
 order to facilitate trade and commerce between parties that are practically strangers (usually
importers and exporters), it is independent of the underlying contract on the goods and services.
LOCs are referred to as primarily “documentary” in nature and are governed by the rule on strict
compliance on documentary requirements. This means that, as far as Bank XYZ is concerned, it
only looks at the LOC and the required documents to be attached thereon in deciding whether to pay
an exporter (seller). If the documents are complete and regular, then the Bank XYZ, notwithstanding
any contrary instruction from the seller, can proceed with payment. There is no privity of contract
between Bank XYZ and the parties to the import-export arrangement and any defenses or
disagreements between the two are outside the ambit of the bank’s concerns. The parties to the
contract of sale of goods and services must deal with the issue amongst themselves since the link to
the bank is extinguished once the bank has performed its obligation to receive and scrutinize the
documents and make payments based on the LOC.

8. Bank JKL sold, on a without-recourse basis, to Novette a participation in Philippine

government securities. Is this transaction covered by Section 245 of the Manual of
Regulations for Banks? Explain. (10 points)

Yes, it is covered by the Section 245 of the Manual for Regulations for Banks. Deposit substitute
refers to funds other than savings, demand or current, and time or fixed deposits which the banks
sources from the public. On top of the requirement that it is evidenced by a debt instrument and used
for relending or other repurchase agreements, a participation in a security, in order to be considered
a deposit substitute, must be on a with recourse basis. However, in the instant case, although this is
on a without recourse basis, the Philippine government is the payee thereof. Hence, as an entity that
can never default, the transaction is still covered.

9. Explain “systemic risk” in banking. (10 points)

Systemic risk refers to the risk faced by the whole banking system when one bank in the system
defaults or goes under. Due to the nature of banks being an industry vested with public interest,
much of the risks in banking involves a breach of “trust”. For instance, one cause for systemic risk
are interbank linkages. In a banking system, banks would interact with each other by engaging in
lending activities and equity investments in one another. If one bank which has huge credit
accommodations with another, or several others, goes under, then this default will destabilize the
lending bank/s in so far as the debts of the defaulting bank will not be remitted on time or at all for
the lending banks to utilize the same as originally intended. Another instance is when banks employ
a payment schedule called net structure system where payments are not real time hence, there’s a
possibility that, in the interim when payments are not made, a bank will go under and due to the
interconnected nature of the system, the ones involved will follow suit. Lastly, there is also the issue
on the public perception on the stability, reliability and viability of banks. Due to the breach of trust
in one bank, the public may perceive this weak link to be representative of the whole system which
can systemically put the whole banking system at risk.

10. Explain SBL and DOSRI as prudential measures. (10 points)

The Single Borrower Limit (SBL) refers to the limit imposed by the Monetary Board on banks in
terms of the extent at which a bank invests in equity and gives credit accommodations to a single
borrower. As a principle, it is based on the idea that the higher the involvement of a bank in a single
entity, the greater is the exposure of that bank to the risks which the entity might encounter. Banks
are not encouraged to put “all their eggs in one basket” by not pooling more than 20% of its total net
worth in a single borrower. As a prudential measure, it reduces the risk to which the bank is exposed
by ensuring that, in the event one borrower defaults, the bank’s core functions (which is lending and
borrowing) will not be exposed to too much destabilization.

The Directors, Officers, Stockholders and Other Related Interests (DOSRI) refers to credit
accommodations and loan transactions extended to the DOSRI of a bank. Commonly known as
“insider trading” the DOSRI as a prudential measure requires that banks, for the purpose of lending
to DOSRI, must ensure that the transaction is done in the regular business of the bank and does not
put the bank in a position less favorable than when it is engaged in “outsider trading” (non-DOSRI
or the regular clients). This prudential measure ensures that the integrity of a bank, as an institution
vested with public interest, is not prejudiced by the personal interest of its insiders (DOSRI) who
may, without this prudential measure, be able to influence banking operations and decisions to the
detriment of outsiders who also have interests thereon.

Rafael A. Morales