DOJ Opinion No. 144, s. 1977

DOJ OPINION NO. 144 , s. 1977 December 2, 1977 The Director of Mines Bureau of Mines Manila Sir : This has reference to the proposals received by your Office from foreign and/or domestic companies for mining service contracts to explore, develop and exploit mining resources covered by mineral reservations and mining leases. You state that while you foresee no serious legal problems on mining service contracts involving mineral reservations, you would like to be enlightened regarding service contracts involving mining leases, in the light of the provisions of Article XIV, Section 9 of the new Constitution, and of Section 44 of P.D. No. 463, otherwise known as the Mineral Resources Development Decree of 1974, which respectively provide as follows: "SEC. 9. The disposition, exploration, development, exploitation, or utilization of any of the natural resources of the Philippines shall be limited to citizens of the Philippines, or to corporations or associations at least sixty per centum of the capital of which is owned by such citizens. The National Assembly, in the national interest, may allow such citizens, corporations, or associations to enter into service contracts for financial, technical, management, or other forms of assistance with any foreign person or entity for the exploration, development, exploitation, or utilization of any of the natural resources. Existing valid and binding service contracts for financial, technical, management, or other forms of assistance are hereby recognized as such. "SEC. 44. Mining Lease Rights . . . . Provided, finally, That a lessee may on his own or through the Government, enter into a service contract with a qualified domestic or foreign contractor for the exploration, development and exploitation of his claims and the processing and marketing of the product thereof, subject to the rules and regulations that shall be promulgated by the Director, with the approval of the Secretary, and on the condition that if the service contractor will provide the necessary financial and technical resources, he may be paid from the proceeds of the operation not exceeding forty per centum (40%) thereof. Service contracts shall be approved by the Secretary upon recommendation of the Director." LexLib In this connection, you raise the following specific questions: "1. Can a Philippine corporation with 30% equity owned by foreigners enter into a mining service contract with a foreign company granting the latter a share of not more than 40% from the proceeds of the operations? "2. Can the foreign corporation owning the 30% equity in the local company be at the same time a mining service contractor of said local company, however, acquiring not more than 40% share of the proceeds of the operations? "3. Is a stipulation of payment of a management fee or any other fee over and above the 40% share of the proceeds derived from operations payable to the mining service contractor be ( sic ) violative of the constitutional provision on the matter? "4. Can a foreign company enter into an operating agreement with a mining lessee to develop leased mining claims instead of a mining service contract as provided under the above-cited Section 44 of P.D. No. 463? "5. Does an agreement providing for a pre-exploration period, the subsequent formation of a joint venture corporation between Filipino and foreign partners with respective equity of 70%-30%, and said joint venture corporation entering into a mining service contract with another foreign company to develop the said mining claims fall within the contemplation of a mining service contract?" The questions, which were apparently culled from pending contract proposals, are simplified into too general terms; hence, I shall confine myself to general observations. Query No. 1 : By law, a mining lease may be granted only to a Filipino citizen, or to a corporation or partnership registered with the Securities & Exchange Commission at least 60% of the capital of which is owned by Filipino citizens and possessing the technical competence and financial resources sufficient to develop the claim applied for. [Secs. 2(n), 11 & 37, P.D. No. 463.] The query is raised apparently in view of the fact that the 60-40 benefit-sharing scheme under the service contract may erode or circumvent the 60% citizenship requirement in the Constitution, since Philippine citizens own only 70% of the mining corporation which in turn will get only 60% of the proceeds of the mineral production. prcd The sixty percent Philippine equity requirement in mineral resource exploitation, which is carried over from the old Constitution, is intended to insure, among other purposes, the conservation of indigenous natural resources, for Filipino posterity [ Vol. X, Constl. Convention Records Journal, Nos. 131-139 (1966), pp. 114 et seq.]. I think it is implicit in this provision , even if it refers merely to ownership of stock in the corporation holding the mining concession, that beneficial ownership of the right to dispose, exploit, utilize, and develop natural resources shall pertain to Filipino citizens, and that the nationality requirement is not satisfied unless Filipinos are the principal beneficiaries in the exploitation of the country's natural resources. [See Roman Catholic Apostolic Adm. of Davao, Inc. v. Land Reg. Com., 102 Phil 596 (1957); BOI position, quoted in Walter J. Levy Final Report on New Petroleum Formulae (1970), p. 59.] This criterion of beneficial ownership is tacitly adopted in Section 44 of P.D. No. 463, above-quoted, which limits the service fee in service contracts to 40% of the proceeds of the operation, thereby implying that the 60-40 benefit-sharing ration is derived from the 60-40 equity requirement in the Constitution. The new Constitution introduces the service contract concept whereby a natural resource corporation may be allowed by law to enter into service contracts for financial, technical, management or other forms of assistance with a foreign contractor for the exploration, development, exploitation, or utilization of any of the natural resources. Pursuant to this provision, P.D. No. 463 now allows, under Section 44 above-quoted, service contracts in mining. The service contract system is obviously intended to enable Philippine citizens and entities to enlist the assistance of foreign capital to hasten the development of our natural resources, which are capital-intensive and sometimes high-risk ventures. A cursory reading of Section 44, above-quoted suggests that a Philippine corporation, with 30% foreign-owned equity, which holds a mining lease, may enter into a service contract with a foreign contractor for financial, technical, management, or other forms of assistance for the exploration, development, exploitation and utilization of his mining claims, and if the service contractor will provide the necessary financial and technical resources, the contractor may be paid from "the proceeds of the operation not exceeding forty percent (40%) thereof. Theoretically, the service fee that is payable to the contractor may be treated as an expense or a part of operating costs, deductible from the gross proceeds of the operations, and is therefore paid off before any surplus or income is realized by the mining company that may eventually accrue to the company's stockholders as dividends. It is observed, however, that the phrase "proceeds of the operation" is not defined in the law or in the implementing Rules and Regulations. The said rules provide that a service contract shall not be approved unless, among other things, the contract contains "a scheme for the repayment of service fees and repayment of advances" which may include the following: "(ii) Except for repayment of pre-production expenses which shall adhere as closely as possible to international practice, a provision that the interest charged on the fair value of the services rendered and actual funds advanced by the foreign entity shall not be more than the prevailing international interest rates charged for similar types of transaction." [Sec. 59.4(c), Consolidated Mines Adm. Order No. MRD-15, s. 1977.] The regulations would seem to allow an arrangement whereby the service contract stipulates for repayment to the contractor of pre-production expenses, and of refund of funds actually advanced by the foreign entity, as well as payment of fair value of services rendered, including interest at prevailing internationally accepted rates, and in addition, a further 40% share in "the proceeds of the operation". It is obvious that while payments to a service contractor may be justified as a service fee, and therefore, properly deductible from gross proceeds, the service contract could be employed as a means of going about or circumventing the constitutional limit on foreign equity participation and the obvious constitutional policy to insure that Filipinos retain beneficial ownership of our mineral resources. Thus, every service contract scheme has to be evaluated in its entirety, on a case to case basis, to determine reasonableness of the total "service fee", e.g. the valuation of services rendered, accounting of funds advanced, and most important the manner of computing the "proceeds of the operation" and the duration of the sharing in the said proceeds, in relation to the exposure of the foreign contractor, e.g., nature and extent of the risks assumed by the contractor, the magnitude of capital investment, and other relevant considerations, like the options available to the contractor to become equity participant in the Philippine entity holding the concession, or to acquire rights in the processing and marketing stages. This evaluation would involve considerations of fact and of policy which that Office is in a better position to assess. In fact, I understand that the Chamber of Mines of the Philippines, in its letter dated August 15, 1977 to the President, precisely requests that the guidelines for the terms and conditions of mining service contracts be now set out in detail. Queries Nos. 2 & 3: The above considerations apply with equal relevance to the situations described in the second and third queries. While there appears to be no basic legal object to a foreign corporation who is service contractor to a mining corporation to become equity participant in the same corporation, a foreign corporation should not be allowed to violate the 40% limit of equity by a scheme of service contract jointly with equity holding. I understand that the question whether "a foreign corporation which has up to the maximum permissible equity participation in a Philippine mining corporation may enter into a service contract with the same Philippine corporation, and receive therefrom a service fee of up to 40% of the net profits of the mining operation in addition to the return on its equity interest", was among the matters elevated to the President by the Chamber of Mines of the Philippines, in its letter aforecited. With respect to the situation for a management fee or any other fee over and above the 40% service fee, this might directly violate the limitation in Section 44 of P.D. No. 463 which limits the service fee to 40% of the proceeds of operation. LexLib Query No. 4: Regarding the fourth question, your Office pointed out that among the salient features of an operating agreement is that the operator of the mining claim must always be a "qualified person", as defined in P.D. No. 463, must have absolute control of the mining operations, and may even acquire the mining claims subject thereof [Ltr. of April 25, 1977 by the Asst. Dir. of Mines]. The definition of "qualified person" in Section 2 of P.D. No. 463, i.e. a "Filipino citizen, of legal age and with capacity to contract, or a corporation or partnership registered with the Securities & Exchange Commission at least 60% of the capital of which is owned by Filipino citizens" would exclude a "foreign company". I may add that a person or entity which is not qualified to hold a mining lease, may not, with the exception of alien directors elected to represent foreign equity holders in a mining firm, or of technical personnel whose employment is specifically approved by the Secretary of Justice, intervene in the management, operation, administration or control of mining operations, pursuant to Section 2-A of the Anti-Dummy Law [C.A. No. 108, as amended] unless such intervention is pursuant to a service contract duly approved by the Secretary of Natural Resources upon recommendation of the Director of Mines in accordance with Section 44 of P.D. No. 463. Query No. 5: Your Office has amplified this question as contemplating the following situations: "a) An agreement granting a foreign company a period to explore the mining claims of the local company and the subsequent formation of a joint venture corporation between them with the exploration expenditures incurred therein to form part of the equity of such foreign company in the joint venture corporation; or "b) A joint venture corporation entering into a mining service contract with another foreign company to explore, develop and exploit the said mining claims." and invites attention to two proposed contracts, one involving Trident Mining & Industrial Corp., a local mining company, and Alusuisse Mining Phils., Inc., a foreign corporation, and the other involving Mankayan Mineral Development Co., Inc., a local mining company, and Mission Exploration Co., a foreign company. The query apparently is not limited to the legal question, but involves matters addressed to your sound official judgment, in the discharge of your function of processing and recommendation service contract proposals pursuant to Section 44 of P.D. No. 463. I would suggest a re-examination in the light of my earlier observations. I may add, in connection with the Trident-Alumining contract, that I find no basic legal objection to the stipulation giving the contractor which bears all exploration costs and assumes the risk of non-commercial discovery, the option to become equity participant in the Philippine entity holding the concession to the extent allowed by the Constitution and the laws in the absence of other considerations which would defeat the constitutional intent [See Execs. Order No. 353, Sec. 1.1, Guidelines for Service Agreements in oil exploration]. Regarding the proposed management fee of 5% of the net smelter returns of all products derived from the claims [Sec. 6.04], while the fee may properly be charged to operating expenses, the payment of this and other fees should not be utilized as a means to increase the share of the foreign contractor in the proceeds beyond the 40% limit in Section 44 of P.D. No. 463. In connection with the Mankayan-Mission contract, it is observed that the foreign contractor will immediately acquire 17% equity in the mining company in exchange for its financial assistance in bearing the costs of exploration and related feasibility studies, and in addition, get 40% of net proceeds before income taxes (after deducting amounts for debt servicing and reimbursements for expenditures incurred by Mission and Mankayan). This arrangement appears to be a service contract scheme jointly with equity participation which is contemplated in query number 2, and therefore among the matters submitted for resolution to the Office of the President in the aforementioned letter of the Chamber of Mines on the Philippines. cdll Please be advised accordingly. Very truly yours, (SGD.) VICENTE ABAD SANTOS Secretary of Justice