Corporation Law

CORPORATION LAW INTRODUCTION

Definition and attributes of a corporation A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence. A corporation, being a creature of law, "owes its life to the state, its birth being purely dependent on its will," it is "a creature without any existence until it has received the imprimatur of the state acting according to law." A corporation will have no rights and privileges of a higher priority than that of its creator and cannot legitimately refuse to yield obedience to acts of its state organs. (Tanyag v. Benguet Corporation) A corporation has four (4) attributes: (1) (2) (3) (4)

It is an artificial being; Created by operation of law; With right of succession; Has the powers, attributes, and properties as expressly authorized by law or incident to its existence.

CLASSIFICATION OF PRIVATE CORPORATIONS

Stock v. Non-Stock Corporations Stock Definition

Non-Stock

Corporations which have capital stock divided into shares and are authorized to distribute to the holders of shares dividends or allotments of the surplus profits on the basis of the shares (§3)

All other private corporations (§3)

Purpose

Primarily to make profits for its shareholders

May be formed or organized for charitable, religious, educational, professional, cultural, fraternal, literary, scientific, social, civic service, or similar purposes like trade, industry, agricultural and like chambers, or any combination thereof. (§88)

Distribution of Profits

Profit is distributed to shareholders

Whatever incidental profit made is not distributed among its members but is used for furtherance of its purpose. AOI or by-laws may provide for the distribution of its assets among its members upon its dissolution. Before then, no profit may be made by members.

Composition

Stockholders

Members

One where no part of its income is distributable as dividends to its members, trustees or officers. (§87)

Scope of right to vote

Each stockholder votes according to the proportion of his shares in the corporation. No shares may be deprived of voting rights except those classified and issued as "preferred" or "redeemable" shares, and as otherwise provided by the Code. (Sec. 6)

Each member, regardless of class, is entitled to one (1) vote UNLESS such right to vote has been limited, broadened, or denied in the AOI or bylaws. (Sec. 89)

Voting by proxy

May be denied by the AOI or the bylaws. (Sec. 89)

Cannot be denied. (Sec. 58)

Voting by mail

May be authorized by the by-laws, with the approval of and under the conditions prescribed by the SEC. (Sec. 89)

Not possible.

Who exercises Corporate Powers §23

Board of Directors or Trustees

Members of the corporation

Governing Board

Board of Directors or Trustees, consisting of 5-15 directors / trustees.

Board of Trustees, which may consist of more than 15 trustees unless otherwise provided by the AOI or by-laws. (Sec, 92)

Directors / trustees shall hold office for 1 year and until their successors are elected and qualified (Sec. 23).

Board classified in such a way that the term of office of 1/3 of their number shall expire every year. Subsequent elections of trustees comprising 1/3 of the board shall be held annually, and trustees so elected shall have a term of 3 years. (Sec. 92)

Election of officers

Officers are elected by the Board of Directors (Sec. 25), except in close corporations where the stockholders themselves may elect the officers. (Sec. 97)

Officers may directly elected by the members UNLESS the AOI or by-laws provide otherwise. (Sec. 92)

Place of meetings

Any place within the Philippines, if provided for by the by-laws (Sec. 93)

Generally, the meetings must be held at the principal office of the corporation, if practicable. If not, then anyplace in the city or municipality where the principal office of the corporation is located. (Sec. 51)

Transferability of interest or membership

Transferable.

Generally non-transferable since membership and all rights arising therefrom are personal. However, the AOI or by-laws can provide otherwise. (Sec. 90)

Term of trustees

directors

or

Distribution of assets in case of dissolution

See Sec. 94.

CIR VS. CLUB FILIPINO (5 SCRA 321; 1962) FACTS: Club Filipino owns and operates a club house, a sports complex, and a bar restaurant, which is incident to the operation of the club and its gold course. The club is operated mainly with funds derived from membership fees and dues. The BIR seeks to tax the said restaurant as a business.

HELD: The Club was organized to develop and cultivate sports of all class and denomination for the healthful recreation and entertainment of its stockholders and members. There was in fact, no cash dividend distribution to its stockholders and whatever was derived on retail from its bar and restaurants used were to defray its overhead expenses and to improve its golf course. For a stock corporation to exist, 2 requisites must be complied with: (1) a capital stock divided into shares (2) an authority to distribute to the holders of such shares, dividends or allotments of the surplus profits on the basis of shares held. In the case at bar, nowhere in the AOI or by-laws of Club Filipino could be found an authority for the distribution of its dividends or surplus profits.

FORMATION AND ORGANIZATION OF CORPORATION Requirements in the formation of a corporation Who may form a corporation (See SEC. 10) INCORPORATORS

REQUIREMENTS

COMMENTS

Definition

stockholders or members mentioned in the articles of incorporation as originally forming and composing the corporation and who are signatories thereof stockholders or members mentioned in the articles of incorporation as originally forming and composing the corporation and who are signatories thereof



Characteristic





Number



Age



Residence



natural persons

not less than 5; not more than 15

compare with Corporators which include all stockholders or members, whether incorporators or joining the corporation after its incorporation.

excludes corporations and partnerships



may be more than 15 for nonstock corp. except educational corp.



does not prevent the “one-man (person) corporation” wherein the other incorporators may have only nominal ownership of only one share of stock; not necessarily illegal



residence a requirement; citizenship requirement only in certain areas such as public utilities, retail trade banks, investment houses, savings and loan associations, schools

of legal age majority should be residents of the Philippines

Steps in the formation of a corporation Mutual Agreement to perform certain acts required for organizing a corporation 12345-

Organize and establish a corporation Comply with requirements of corporation code Contribute capital/resources Mode of use of capital/resource and control/management of capital/resource distribution/disposition of capital/resource (embodied in constitutive documents)

STEPS a. Promotional Stage (See SEC. 2. Definitions)

COMMENTS Promoter   

brings together persons who become interested in the enterprise aids in procuring subscriptions and sets in motion the machinery which leads to the formation of the corporation itself formulates the necessary initial business and financial plans and, if necessary, buys the rights and property which the business may need, with the understanding that the corporation when formed, shall take over the same.

b. Drafting articles of incorporation (See SEC. 14)

(see chart below)

c. Filing of articles; payment of fees.

  



d. Examination of articles; approval or rejection by SEC.

AOI & the treasurer‟s affidavit duly signed & acknowledged must be filed w/ the SEC & the corresponding fees paid failure to file the AOI will prevent due incorporation of the proposed corporation & will not give rise to its juridical personality. It will not even be a de facto corp. Under present SEC rules, the AOI once filed , will be published in the SEC Weekly Bulletin at the expense of the corp. (SEC Circular # 4, 1982).

Process: a) SEC shall examine them in order to determine whether they are in conformity w/ law. b) If not, the SEC must give the incorporators a reasonable time w/in w/c to correct or modify the objectionable portions. Grounds for rejection or disapproval of AOI: a) AOI /amendment not substantially in accordance w/ the form prescribed b) purpose/s are patently unconstitutional, illegal, immoral, or contrary to government rules & regulations; c) Treasurer‟s Affidavit is false;

d) required percentage of ownership has not been complied with (Sec. 17) e) corp.‟s establishment, organization or operation will not be consistent w/ the declared national economic policies (to be determined by the SEC, after consultation w/ BOI, NEDA or any appropriate government agency -PD 902-A as amended by PD 1758, Sec. 6 (k)) 

e. Issuance of certificate of incorporation.

Decisions of the SEC disapproving or rejecting AOI may be appealed to the CA by petition for review in accordance w/ the ROC.

Certificate of Incorporation will be issued if: a) SEC is satisfied that all legal requirements have been complied with; and b) there are no reasons for rejecting or disapproving the AOI. 

It is only upon such issuance that the corporation acquires juridical personality. (See Sec. 19. Commencement of corporate existence) 

Should it be subsequently found that the incorporators were guilty of fraud in procuring the certificate of incorporation, the same may be revoked by the SEC, after proper notice & hearing.

b. Drafting articles of incorporation (See SEC. 14) CONTENTS OF AOI

Corporate Name

COMMENTS 

Essential to its existence since it is through it that the corporation can sue and be sued and perform all legal acts



A corporate name shall be disallowed by the SEC if the proposed name is either: (1)

identical or deceptively or confusingly similar to that of any existing corporation or to any other name already protected by law; or

(2)

patently deceptive, confusing or contrary to existing laws. (Sec. 18)

LYCEUM OF THE PHILS. VS. CA (219 SCRA 610) The policy underlying the prohibition against the registration of a corporate name which is “identical or deceptively or confusingly similar” to that of any existing corporation or which is “patently deceptive or patently confusing” or “contrary to existing laws is:

1.

the avoidance of fraud upon the public which would have occasion to deal with the entity concerned; 2. the prevention of evasion of legal obligations and duties, and 3. the reduction of difficulties of administration and supervision over corporations. 

A corporation can only have one (1) primary purpose. However, it can have several secondary purposes.



A corporation has only such powers as are expressly granted to it by law & by its articles of incorporation, those which may be incidental to such conferred powers , those reasonably necessary to accomplish its purposes & those which may be incident to its existence.



Corporation may not be formed for the purpose of practicing a profession like law, medicine or accountancy

Principal Office

   

must be within the Philippines specify city or province street/number not necessary important in determining venue in an action by or against the corp., or on determining the province where a chattel mortgage of shares should be registered

Term of Existence

 

cannot specify term which is longer than 50 years at a time may be renewed for another 50 years, but not earlier than 5 years prior to the original or subsequent expiry date UNLESS there are justifiable reasons for an earlier extension.

Incorporators and Directors

 

names, nationalities & residences of the incorporators; names, nationalities & residences of the directors or trustees who will act as such until the first regular directors or trustees are elected; treasurer who has been chosen by the pre-incorporation subscribers/members to receive on behalf of the corporation, all subscriptions /contributions paid by them.

Purpose Clause



Capital Stock

   

   Other matters



amount of its authorized capital stock in lawful money of the Philippines number of shares into which it is divided in case the shares are par value shares, the par value of each, names, nationalities and residences of the original subscribers, and the amount subscribed and paid by each on his subscription, and if some or all of the shares are without par value, such fact must be stated for a non-stock corporation, the amount of its capital, the names, nationalities and residences of the contributors and the amount contributed by each 25% of 25% rule to be certified by Treasurer paid up capital should not be less than P5,000 Classes of shares into w/c the shares of stock have been divided; preferences of & restrictions on any such class; and any denial or restriction of the pre-emptive right of stockholders should also be expressly stated in said articles.



If the corporation is engaged in a wholly or partially nationalized business or activity, the AOI must contain a prohibition against a transfer of stock which would reduce the Filipino ownership of its stock to less than the required minimum.

Any corporation may be incorporated as a close corporation, except: a) mining or oil companies; b) stock exchanges; c) banks; d) insurance companies; e) public utilities; f) educational institutions; & g) corporations declared to be vested w/ public interest

De Facto Corporations: Requisites User of Corporate Powers What is a ‘de facto’ corporation? A „de facto‟ corporation is a defectively organized corporation, which has all the powers and liabilities of a „de jure‟ corporation and, except as to the State, has a juridical personality distinct and separate from its shareholders, provided that the following requisites are concurrently present: (1)

That there is an apparently valid statute under which the corporation with its purposes may be formed;

(2)

That there has been colorable compliance with the legal requirements in good faith; and,

(3)

That there has been use of corporate powers, i.e., the transaction of business in some way as if it were a corporation.

Can a corporation transact business as a ‘de facto’ corporation while application is still pending with SEC? No. In the case of Hall v. Piccio (86 Phil. 603; 1950), where the supposed corporation transacted business as a corporation pending action by the SEC on its articles of incorporation, the Court held that there was no „de facto‟ corporation on the ground that the corporation cannot claim to be in „good faith‟ to be a corporation when it has not yet obtained its certificate of incorporation.

Formation under apparently valid statute. MUNICIPALITY OF MALABANG V. BENITO (29 SCRA 533; 1969) WON a corporation organized under a statute subsequently declared void acquires status as ‗de facto‘ corporation. No. A corporation organized under a statute subsequently declared invalid cannot acquire the status of a ‗de facto‘ corporation unless there is some other statute under which the supposed corporation may be validly organized. Hence, in the case at bar, the mere fact that the municipality was organized before the statute had been invalidated cannot conceivably make it a ‗de facto‘ corporation since there is no other valid statute to give color of authority to its creation.

Colorable compliance with the legal requirements in good faith. BERGERON V. HOBBS (71 N.W. 1056, 65 Am. St. Rep. 85) The constitutive documents of the proposed corporation were deposited with the Register of Deeds but not on file in said office. One of the requirements for valid incorporation is the filing of constitutive documents in the Register of Deeds. Was there ‗colorable‘ compliance enough to give the supposed corporation at least the status of a ‗de facto‘ corporation? No. The filing of the constitutive documents in the Register of Deeds is a condition precedent to the right to act as a corporate body. As long as an act, required as a condition precedent, remains undone, no immunity from individual liability is secured.

HARRIL V. DAVIS (168 F. 187; 1909) The constitutive documents were filed with the clerk of the Court of Appeals but not with the clerk of court in the judicial district where the business was located. Arkansas law requires filing in both offices. Was there ‗colorable‘ compliance enough to give the supposed corporation at least the status of a ‗de facto‘ corporation? No. Neither the hope, the belief, nor the statement by parties that they are incorporated, nor the signing of the articles of incorporation which are not filed, where filing is requisite to create the corporation, nor the use of the pretended franchise of the nonexistent corporation, will constitute such a corporation de facto as will exempt those who actively and knowingly use s name to incur legal obligations from their individual liability to pay them. There could be no incorporation or color of it under the law until the articles were filed (requisites for valid incorporation).

HALL v. PICCIO (29 SCRA 533; 1969) In the case of Hall v. Piccio, where the supposed corporation transacted business as a corporation pending action by the SEC on its articles of incorporation, the Court held that there was no ‗de facto‘ corporation on the ground that the corporation cannot claim to be in ‗good faith‘ to be a corporation when it has not yet obtained its certificate of incorporation. NOTE: The validity of incorporation cannot be inquired into collaterally in any private suit to which such corporation may be a party. Such inquiry must be through a quo warranto proceeding made by the Solicitor General. (Sec. 20)

CORPORATION BY ESTOPPEL (Sec. 21) Distinguish a de facto corporation from a corporation by estoppel. The „de facto‟ doctrine differs from the estoppel doctrine in that where all the requisites of a „de facto‟ corporation are present, then the defectively organized corporation will have the status of a „de jure‟ corporation in all cases brought by and against it, except only as to the State in a direct proceeding. On the other hand, if any of the requisites are absent, then the estoppel doctrine can apply only if under the circumstances of the particular case then before the court, either the defendant association is estopped from defending on the ground of lack of capacity to be sued, or the defendant third party had dealt with the plaintiff as a corporation and is deemed to have admitted its existence. (De facto – has status of „de jure‟ corpo, except separate personality against State, provided all requisites are present)

What are the effects of a Corporation by Estoppel in suits brought: (1)

against the Corporation? Considered a corporation in suits brought against it if it held itself out as such and denies capacity to be sued;

(2)

against third party?

Third party cannot deny existence of corporation if it dealt with it as such.

EMPIRE vs. STUART (46 Mich. 482, 9 N.W. 527; 1881) Company was sued on a promissory note. Its defense was that at the time of its issuance, it was defectively organized and therefore could not be sued as such. The Corporation cannot repudiate the transaction or evade responsibility when sued thereon by setting up its own mistake affecting the original organization.

LOWELL-WOODWARD vs. WOODS (104 Kan. 729; 1919) Corporation sued a partnership on a promissory note. The latter as defense alleged that the plaintiff was not a corporation. One who enters into a contract with a party described therein as a corporation is precluded, in an action brought thereon by such party under the same designation, from denying its corporate existence.

ASIA BANKING VS STANDARD PRODUCTS (46 Phil. 145; 1924) The corporation sued another corporation a promissory note. The defense was that the plaintiff was not able to prove the corporate existence of both parties. The defendant is estopped from denying its own corporate existence. It is also estopped from denying the other‘s corporate existence. The general rule is that in the absence of fraud, a person who has contracted or otherwise dealt with an association is such a way as to recognize and in effect admit its legal existence as a corporate body is thereby estopped from denying its corporate existence. CRANSON VS IBM (234 MD. 477, 200 A. 2D 33 ; 1964) IBM sued Cranson in his personal capacity regarding a typewriter bought by him as President of a defectively organized company whose Articles were not yet filed when the obligation was contracted. IBM, having dealt with the defectively organized company as if it were properly organized and having relied on its credit instead of Cranson‘s, is estopped from asserting that it was not incorporated. It cannot sue Cranson personally. SALVATIERRA VS GARLITOS (103 Phil. 757; 1958) Salvatierra leased his land to the corporation. He filed a suit for accounting, rescission and damages against the corporation and its president for his share of the produce. Judgment against both was obtained. President complains for being held personally liable. He is liable. An agent who acts for a non-existent principal is himself the principal. In acting on behalf of a corporation which he knew to be unregistered, he assumed the risk arising from the transaction. ALBERT VS UNIVERSITY PUBLISHING CO., INC. (Jan. 30, 1965) Mariano Albert entered into a contract with University Publishing Co., Inc. through Jose M. Aruego, its President, whereby University would pay plaintiff for the exclusive right to publish his revised Commentaries on the Revised Penal Code. The contract stipulated that failure to pay one installment would render the rest of the payments due. When

University failed to pay the second installment, Albert sued for collection and won. However, upon execution, it was found that University was not registered with the SEC. Albert petitioned for a writ of execution against Jose M. Aruego as the real defendant. University opposed, on the ground that Aruego was not a party to the case. The Supreme Court found that Aruego represented a non-existent entity and induced not only Albert but the court to believe in such representation. Aruego, acting as representative of such non-existent principal, was the real party to the contract sued upon, and thus assumed such privileges and obligations and became personally liable for the contract entered into or for other acts performed as such agent. The Supreme Court likewise held that the doctrine of corporation by estoppel cannot be set up against Albert since it was Aruego who had induced him to act upon his (Aruego's) willful representation that University had been duly organized and was existing under the law.

BY-LAWS (Sec. 46 & 47) When adopted: (a) No later than one (1) month after receipt from SEC of official notice of issuance of Cert. of incorporation. Requirement:

Affirmative vote of stockholders representing at least majority of outstanding capital stock (Stock Corp.) or members (NonStock) Must be signed by stockholders or members voting for them

(b) Prior to incorporation Requirement:

Where kept:

Approval of all incorporators; must be signed by all of them

(1) In the principal office of the corporation ; and (2) Securities and Exchange Commission

When effective:

Only upon the SEC‟s issuance of a certification that the by-laws are not inconsistent with the Corporation Code.

Special corporations: By-laws and/or amendments thereto must be accompanied by a certificate of the appropriate government agency to the effect that such by-laws / amendments are in accordance with law.       

banks or banking institutions building and loan associations trust companies insurance companies public utilities educational institutions other special corporations governed by special laws

Contents of By-laws - Subject to the provisions of the Constitution, this Code, other special laws, and the articles of incorporation, a private corporation may provide in its by-laws for: 1)

the time, place and manner of calling and conducting regular or special meetings of the directors or trustees;

2)

the time and manner of calling and conducting regular and special meetings of the stockholders or members;

3)

the required quorum in meetings of stockholders or members and the manner of voting herein;

4)

the form for proxies of stockholders and members and the manner of voting them;

5)

the qualifications, duties and compensation of directors or trustees, officers and employees;

6)

the time for holding the annual election of directors or trustees and the mode or manner of giving notice thereof;

7)

the manner of election or appointment and the term of office of all officers other than directors or trustees;

8)

the penalties for violation of the by-laws;

9)

in the case of stock corporations, the manner of issuing certificates; and

10) such other matters as may be necessary for the proper or convenient transaction of its corporate business and affairs. FLEISCHER V. BOTICA NOLASCO CO. (47 Phil. 583; 1925) As a general rule, the by-laws of a corporation are valid if they are reasonable and calculated to carry into effect the objective of the corporation and are not contradictory to the general policy of the laws of the land. Under a statute authorizing by-laws for the transfer of stock, a corp. can do no more than prescribe a general mode of transfer on the corp. books and cannot justify an restriction upon the right of sale. GOVT. OF P.I. V. EL HOGAR Is a provision in the by-laws allowing the BOD, by vote of absolute majority, to cancel shares valid? No. It is a patent nullity, being in direct conflict with Sec. 187 of the Corp. Law which prohibits forced surrender of unmatured stocks except in case of dissolution. Is a provision in the by-laws fixing the salary of directors valid? Yes. Since the Corporation Law does not prescribe the rate of compensation, the power to fix compensation lies with the corporation. Is a provision requiring persons elected to the Board of Directors to own at least P 5,000 shares valid? Yes. The Corporation Law gives the corporation the power to provide qualifications of its directors. CITIBANK, N.A. v. CHUA (220 SCRA 75) 

Where the SEC grants a license to a foreign corporation, it is deemed to have approved its foreign-enacted by-laws. Sec. 46 of the Corporation Code which states that by-laws are not valid without SEC approval applies only to domestic corporations.



A board resolution appointing an attorney-in-fact to represent the corporation during pre-trial is not necessary where the by-laws authorize an officer of the corporation to make such appointment.

LOYOLA GRAND VILLAS v. CA (276 SCRA 681) ISSUE: Whether the failure of a corporation to file its by-laws within one (1) month from the date of its incorporation, as mandated by Art. 46 of the Corporation Code, results in the corporation's automatic dissolution. RULING: No. Failure to file by-laws does not result in the automatic dissolution of the corporation. It only constitutes a ground for such dissolution. (Cf. Chung Ka Bio v. IAC, 163 SCRA 534) Incorporators must be given the chance to explain their neglect or omission and remedy the same.

THE CORPORATE ENTITY The Theory of Corporate Entity When does the corporation’s existence as a legal entity commence? Upon issuance by the SEC of the certificate of incorporation (Sec. 19)

What rights does the corporation acquire? The right to: 1) 2) 3) 4)

sue and be sued; hold property in its own name; enter into contracts with third persons; & perform all other legal acts.

Since corporate property is owned by the corporation as a juridical person, the stockholders have no claim on it as owners, but have merely an expectancy or inchoate right to the same should any of it remain upon the dissolution of the corporation after all corporate creditors have been paid. Conversely, a corporation has no interest in the individual property of its stockholders, unless transferred to the corporation. Remember that the liability of the stockholders is limited to the amount of shares. SAN JUAN STRUCTURAL & STEEL FABRICATORS v. CA (296 SCRA 631) A corporation is a juridical person separate and distinct from its stockholders or members. Accordingly, the property of the corporation is not the property of its stockholders or members and may not be sold by the stockholders or members without express authorization from the corporation's Board of Directors. In this case, the sale of a piece of land belonging to Motorich Corporation by the corporation treasurer (Gruenberg) was held to be invalid in the absence of evidence that said corporate treasurer was authorized to enter into the contract of sale, or that the said contract was ratified by Motorich. Even though Gruenberg and her husband owned 99.866% of Motorich, her act could not bind the corporation since she was not the sole controlling stockholder. STOCKHOLDERS OF F. GUANZON V. REGISTER OF DEEDS (6 SCRA 373) Properties registered in the name of the corporation are owned by it as an entity separate and distinct from its members. While shares of stock constitute personal property, they do not represent property of the corporation. A share of stock only typifies an aliquot part of the corporation's property or the right to share in its proceeds to that extent when distributed according to law and equity, but its holder is not the owner of any part of the capital of the corporation. Nor is he entitled to the possession of any definite portion of its property or assets. The act of liquidation made by the stockholders of the corp of the latter‘s assets is not and cannot be considered a partition of community property, but rather a transfer or conveyance of the title of its assets to the individual stockholders. Since the purpose of the liquidation, as well as the distribution of the assets, is to transfer their title from the corporation to the stockholders in proportion to their shareholdings, that transfer cannot be effected without the corresponding deed of conveyance from the corporation to the stockholders. It is, therefore, fair and logical to consider the certificate of liquidation as one in the nature of a transfer or conveyance. CARAM V. CA (151 SCRA 373; 1987) The case of the unpaid compensation for the preparation of the project study. The petitioners were not involved in the initial stages of the organization of the airline. They were merely among the financiers whose interest was to be invited and who were in fact persuaded, on the strength of the project study, to invest in the proposed airline.

There was no showing that the Airline was a fictitious corp and did not have a separate juridical personality to justify making the petitioners, as principal stockholders thereof, responsible for its obligations. As a bona fide corp, the Airline should alone be liable for its corporate acts as duly authorized by its officers and directors. Granting that the petitioners benefited from the services rendered, such is no justification to hold them personally liable therefor. Otherwise, all the other stockholders of the corporation, including those who came in late, and regardless of the amount of their shareholdings, would be equally and personally liable also with the petitioner for the claims of the private respondent. PALAY V. CLAVE (124 SCRA 640; 1983) The case of the reliance on a default provision of the contract granting automatic extra-judicial rescission. The court found no badges of fraud on the part of the president of the corporation. The BOD had literally and mistakenly relied on the default provision of the contract. As president and controlling stockholder of the corp, no sufficient proof exists on record that he used the corp to defraud private respondent. He cannot, therefore, be made personally liable because he appears to be the controlling stockholder. Mere ownership by a single stockholder or by another corporation of all or nearly all of the capital stock of a corporation is not of itself sufficient ground for disregarding the separate corporate personality. MAGSAYSAY V. LABRADOR (180 SCRA 266) The case of the assignment by Senator Magsaysay of a certain portion of his shareholdings in SUBIC granting his sisters the right to intervene in a case filed by the widow against SUBIC. The words "an interest in the subject," to allow petitioners to intervene, mean a direct interest in the cause of action as pleaded, and which would put the intervenor in a legal position to litigate a fact alleged in the complaint, without the establishment of which plaintiff could not recover. Here, the interest, of petitioners, if it exists at all, is indirect, contingent, remote, conjectural, consequential and collateral. At the very least, their interest is purely inchoate, or in sheer expectancy of a right in the management of the corporation and to share in the profits thereof and in the properties and assets thereof on dissolution, after payment of the corporate debts and obligations. While a share of stock represents a proportionate or aliquot interest in the property of the corp, it does not vest the owner thereof with any legal right or title to any of the property, his interest in the corporate property being equitable and beneficial in nature. Shareholders are in no legal sense the owners of corporate property, which is owned by the corp as a distinct legal person.

PIERCING THE CORPORATE VEIL Q: What is the theory of corporate entity? A: That a corporation has a personality distinct from its stockholders, and is not affected by the personal rights, obligations and transactions of the latter. Q: When Can the Veil of Corporate Entity be Pierced? A: The veil of corporate fiction may be pierced when it is used as a shield to further an end subversive of justice, or for purposes that could not have been intended by law that created it or to defeat public convenience, justify wrong, protect fraud or defend crime or to perpetuate fraud or confuse legitimate issues or to circumvent the law or perpetuate deception or as an alter ego, adjunct or business conduit for the sole benefit of the stockholders. Q: What are the effects of disregarding the corporate veil? (1) Stockholders would be personally liable for the acts and contracts of the corporation whose existence at least for the purpose of the particular situation involved is ignored. (2) Court is not denying corporate existence for all purposes but merely refuses to allow the corporation to use the corporate privilege for the particular purpose involved.

Contrary to law / public policy; evasion of liability to government STATE V. STANDARD OIL (49 Ohio, St., 137, N.E. 279, 15; 1892) Where all or a majority of stockholders comprising a corporation do an act which is designed to affect the property and business of the company, as if it had been a formal resolution of its Board of Directors and the acts done is ultra vires, the act should be regarded as the act of the corporation, and may be challenged by the state in a quo warrranto proceeding.

LAGUNA TRANS V. SSS (107 Phil. 833; 1960) Where the corporation was formed by and consisted of the members of a partnership whose business and property was conveyed to the corporation for the purpose of continuing its business, such corporation is presumed to have assumed partnership debts.

MARVEL BLDG. CORP. V. DAVID (94 Phil. 376; 1954) The fact that:    

certificates in possession of Castro were endorsed in blank; Castro had enormous profits and had motive to hide them; other subscribers had no incomes of sufficient magnitude; and directors never met;

shows that other shareholders may be considered dummies of Castro. Hence, corporate veil may be pierced.

Evasion of liability to creditors TAN BOON BEE CO. V. JARENCIO (163 SCRA 205; 1988) Tan BBC (T) supplies paper to Graphics Publishing Inc (G) but the latter fails to pay. G's printing machine levied upon to satisfy claim but PADCO, another corpo intercedes, saying it is the owner of the machine, having leased such to G. Printing machine was allowed by the Court to satisfy G's liability. Both G and PADCO's corporate entities pierced because they have: the same board of directors, PADCO owns 50% of G, PADCO never engaged in the business of printing. Obviously, the board is using PADCO to shield G from fulfilling liability to T. NAMARCO v. AFCorp (19 SCRA 962; 1967) Associated Financing Corp. (AFC), through its pres. F. Sycip (who together with wife, own 76% of AFC) contracts with NAMARCO for an exchange of sugar (raw v. refined). N delivers, AFC doesn't since it did not have sugar to supply in the first place. N sues to recover sum of money plus damages. Sycip held jointly and severally liable with AFC. AFC's corporate veil was pierced because it was used as Sycip's alter ego, corpo used merely as an instrumentality, agency or conduit of another to evade liability. JACINTO V. CA (198 SCRA 211) Jacinto, president/GM and owner of 52% of corpo, owes MetroBank sum of money, signs trust receipts therefor. Jacinto absconds. Jacinto ordered to jointly and severally pay MetroBank. Corpo veil pierced because it was used as a shield to perpetuate fraud and/or confuse legitimate issues. There was no clear cut delimitation between the personality of Jacinto and the corporation.

Evasion of liability / obligation to employees

CLAPAROLS V. CIR (65 SCRA 613; 1975) Both predecessor and successor were owned and controlled by petitioner and there was no break in the succession and continuity of the same business. All the assets of the dissolved Plant were turned over to the emerging corporation. The veil of corporate fiction must be pierced as it was deliberately and maliciously designed to evade its financial obligation to its employees.

INDOPHIL TEXTILE MILL WORKERS UNION V. CALICA (205 SCRA 698) Rule: The doctrine of piercing the veil of corporate entity applies when corporate fiction is used to defeat public convenience, justify wrong, protect fraud or defend crime, or when it is made as a shield to confuse the legitimate issues or where a corporation is the mere alter ego or business conduit of a person, or where the corporation is so organized and controlled and its affairs are so conducted as to make it merely an instrumentality, agency, conduit or adjunct of another corporation. Case at bar: Union sought to pierce corporate veil alleging that the creation of Acrylic is a devise to evade the application of the CBA Indophil had with them (or it sought to include the other union in its bargaining leverage). SC: Legal corporate entity is disregarded only if it is sought to hold the officers and stockholders directly liable for a corporate debt or obligation. Union does not seek to impose such claim against Acrylic. Mere fact that businesses were related, that some of the employees of Indophil are the same persons manning and providing for auxiliary services to the other company, and that physical plants, officers and facilities are situated in the same compound - not sufficient to apply doctrine.

NAFLU V. OPLE (143 SCRA 125; 1986) Libra/Dolphin Garments was but an alter ego of Lawman Industrial, therefore, the former must bear the consequences of the latter's unfair acts. It cannot deny reinstatement of petitioners simply because of cessation of Lawman's operations, since it was in fact an illegal lock-out, the company having maintained a run-away shop and transferred its machines and assets there. Here, the veil of corporate fiction was pierced in order to safeguard the right to self-organization and certain vested rights which had accrued in favor of the union. Second corporation sought the protective shield of corporate fiction to achieve an illegal purpose.

ASIONICS PHILS. v. NLRC (290 SCRA 164) A corporation is invested by law with a personality separate and distinct from those of the persons composing it as well as from that of any other legal entity to which it may be related. Mere ownership by a single stockholder or by another corporation of all or nearly all of the capital stock of a corporation is not of itself sufficient ground for disregarding the separate corporate personality. Where there is nothing on record to indicate the President and majority stockholder of a corporation had acted in bad faith or with malice in carrying out the retrenchment program of the company, he cannot be held solidarily and personally liable with the corporation.

Evasion of liability on contract VILLA-REY TRANSIT V. FERRER (25 SCRA 849; 1968) Jose M. Villarama, operator of a bus company, Villa Rey Transit, which was authorized to operate 32 units from Pangasinan to Manila and vice-versa, sold 2 CPCs to Pantranco. One of the conditions included in the contract of sale was that the seller (Villarama) "shall not, for a period of 10 years from the date of the sale, apply for any TPU service identical or competing with the buyer (Pantranco)." Barely 3 months after the sale, a corporation called Villa Rey Transit, Inc. was organized, with the wife of Jose M. Villarama as one of the incorporators and who was subsequently elected as treasurer of the Corporation. Barely a month after its registration with the SEC, the corporation bought 5 CPCs and 49 buses from one Valentin Fernando, and applied with the

Public Service Commission (PSC) for approval of the sale. Before the PSC could take final action on the said application, however, 2 of the 5 CPCs were levied upon pursuant to a writ of execution issued by the CFI in favor of Eusebio Ferrer, judgment creditor, against Valentin Fernando, judgment debtor. During the public sale conducted, Ferrer was the highest bidder, and a certificate of sale was issued in his name. Shortly thereafter, he sold the said CPCs to Pantranco, and they jointly submitted their contract of sale to the PSC for approval. The PSC issued an order that pending resolution of the applications, Pantranco shall have the authority to provisionally operate the service under the 2 CPCS that were the subject of the contract between Ferrer and Pantranco. Villa Rey Transit took issue with this, and filed a complaint for annulment of the sheriff's sale of the CPCs and prayed that all the orders of the PSC relative to the dispute over the CPCs in question be annulled. Pantranco filed a third-party complaint against Jose M. Villarama, alleging that Villarama and Villa Rey Transit are one and the same, and that Villarama and/or the Corporation is qualified from operating the CPCs by virtue of the agreement entered into between Villarama and Pantranco. Given the evidence, the Court found that the finances of Villa-Rey, Inc. were managed as if they were the private funds of Villarama and in such a way and extent that Villarama appeared to be the actual owner of the business without regard to the rights of the stockholders. Villarama even admitted that he mingled the corporate funds with his own money. These circumstances negate Villarama's claim that he was only a part-time General Manager, and show beyond doubt that the corporation is his alter ego. Thus, the restrictive clause with Pantranco applies. A seller may not make use of a corporate entity as a means of evading the obligation of his covenant. Where the Corporation is substantially the alter ego of one of the parties to the covenant or the restrictive agreement, it can be enjoined from competing with the covenantee.

Close Corporations CEASE V. CA (93 SCRA 483; 1979) The Cease plantation was solely composed of the assets and properties of the defunct Tiaong plantation whose license to operate already expired. The legal fiction of separate corporate personality was attempted to be used to delay and deprive the respondents of their succession rights to the estate of their deceased father. While originally, there were other incorporators of Tiaong, it has developed into a closed family corporation (Cease). The head of the corporation, Cease, used the Tiaong plantation as his instrumentality. It was his business conduit and an extension of his personality. There is not even a showing that his children were subscribers or purchasers of the stocks they own.

DELPHER TRADES V. CA (157 SCRA 349; 1988) The Delpher Trades Corp. is a business conduit of the Pachecos. What they really did was to invest their properties and change the nature of their ownership from unincorporated to incorporated form by organizing Delpher and placing the control of their properties under the corporation. This saved them inheritance taxes. This is the reverse of Cease; however, it does not modify the other cases. It stands on its own because of the facts.

Parent-Subsidiary Relationship Q: What is the general rule governing parent-subsidiary relationship? A: The mere fact that a corporation owns all or substantially all of the stocks of another corporation is not alone sufficient to justify their being treated as one entity. Q:

When may it be disregarded by the courts? (1)

if the subsidiary was formed for the payment of evading the payment of higher taxes

(2)

where it was controlled by the parent that its separate identity was hardly discernible

(3)

parent corporations may be held responsible for the contracts as well as the torts of the subsidiary

Q: What are the criteria by which the subsidiary can be considered a mere instrumentality of the parent company?

1. 2. 3. 4. 5. 6. 7. 8.

9. 10. 11.

the parent corp. owns all or most of the capital stock of the subsidiary. the parent and subsidiary have common directors and officers the parent finances the subsidiary the parent subscribes to all the capital stock of the subsidiary or otherwise causes its incorporation the subsidiary has grossly inadequate capital the parent pays the salaries and other expenses or losses of the subsidiary the subsidiary has substantially no business except with the parent corp. or no assets except those conveyed to or by the parent corp. in the papers of the parent corp. or in the statements of its officers, the subsidiary is described as a department or division of the parent corp. or its business or financial responsibility is referred as the parent‟s own the parent uses the property of the subsidiary as its own the directors or the executives of the subsidiary do not act independently in the interest of the subsidiary but take their orders from the parent corp. in the latter‟s interest the formal legal requirements of the subsidiary are not observed (Garrett vs. Southern Railway)

(Note: Sir Jack said that we must not stop after we’ve gone through the 11 points in order to determine whether or not there is a subsidiary or instrumentality. We must go further and consider other circumstances which may help determine clearly the true nature of the relationship. --- Em)

GARRETT VS. SOUTHERN RAILWAY (173 F. Supp. 915, E.D. Tenn. 1959) This case involved a Workers Compensation claim by a wheel moulder employed by Lenoir Car Works. The plaintiff sought to claim from Southern Railway Company, which acquired the entire capital stock of Lenoir Car Works. Plaintiff contended that Southern so completely dominated Lenoir that the latter was a mere adjunct or instrumentality of Southern. The general rule is that stock ownership alone by one corporation of the stock of another does not thereby render the dominant corporation liable for the torts of the subsidiary, unless the separate corporate existence of the subsidiary is a mere sham, or unless the control of the subsidiary is such that it is but an instrumentality or adjunct of the dominant corporation. In the case, it was found that there were two distinct operations. There was no evidence that Southern dictated the management of Lenoir. In fact, evidence shows that Marius, the manager of the subsidiary, was in full control of the operation. He established prices, handled negotiations in CBAs, etc. Lenoir paid local taxes, had local counsel and maintain a Workmen‘s Compensation Fund. There was also no evidence that Lenoir was run solely for the benefit of Southern. In fact, a substantial part of its requirements in the field of operation of Lenoir was bought elsewhere. Lenoir sold substantial quantities to other companies. Policy decisions remained in the hands of Marius. Hence, the complaint against Southern Railway was dismissed.

KOPPEL VS. YATCO (77 Phil. 496; 1946) This case involved a complaint for the recovery of merchant sales tax paid by Koppel (Philippines), Inc. under protest to the Collector of Internal Revenue. Although the Court of First Instance did not deny legal personality to Koppel (Philippines), Inc. for any and all purposes, it dismissed the complaint saying that in the transactions involved in the case, the public interest and convenience would be defeated and would amount to a perpetration of tax evasion unless resort was had to the doctrine of "disregard of the corporate fiction." The facts show that 99.5% of the shares of stocks of K-Phil were owned by K-USA. K-Phil. acted as a representative of K-USA and not as an agent. K-Phil. also bore alone its own incidental expenses (e.g. Cable expenses) and also those of its ―principal‖. Moreover, K-Phil‘s share in the profits was left in the hands of K-USA. Clearly, K-Phil was a mere branch or dummy of K-USA, and was therefore liable for merchant sales tax. To allow otherwise would be to sanction a circumvention of our tax laws and permit a tax evasion of no mean proportion and the consequent commission of a grave

injustice to the Government. Moreover, it would allow the taxpayer to do by indirection what the tax laws prohibit to be done directly. LIDDELL & CO. VS. CIR (2 SCRA 632; 1961) Liddel Motors Inc. was an alter ego of Liddel & Co. At the time of its incorporation, 98% of the Liddel Inc.‘s stock belonged to Frank Liddel. As to Liddel Motors, Frank supplied the original capital funds. The bulk of the business of Liddel Inc. was channeled through Liddel Motors. Also, Liddel Motors pursued no other activities except to secure cars, trucks and spare parts from Liddel Inc. and then sell them to the general public. To allow the taxpayer to deny tax liability on the ground that the sales were made through another and distinct corporation when it is proved that the latter is virtually owned by the former or that they were practically one and the same is to sanction the circumvention of tax laws. YUTIVO VS. CTA (1 SCRA 160; 1961) Southern Motors was actually owned and controlled by Yutivo as to make it a mere subsidiary or branch of the latter created for the purpose of selling vehicles at retail. Yutivo financed principally, if not wholly, the business of Southern Motors and actually exceeded the credit of the latter . At all times, Yutivo, through the officers and directors common to it and the Southern Motors exercised full control over the cash funds, policies, expenditures and obligations of the latter. Hence, Southern Motors, being a mere instrumentality or adjunct of Yutivo, the CTA correctly disregarded the technical defense of separate corporate identity in order to arrive at the true tax liability of Yutivo. LA CAMPANA VS. KAISAHAN (93 Phil. 160; 1953) The La Campana Gaugau Packing and La Campana Coffee Factory were operating under one single business although with 2 trade names. It is a settled doctrine that the fiction of law of having the corporate identity separate and distinct from the identity of the persons running it cannot be invoked to further the end subversive of the purpose for which it was created. In the case at bar, the attempt to make the two businesses appear as one is but a device to defeat the ends of the law governing capital and labor relations and should not be permitted to prevail. PROMOTER’S CONTRACTS PRIOR TO INCORPORATION Liability of Corporation for Promoter’s Contracts While a corporation could not have been a party to a promoter's contract since it did yet exist at the time the contract was entered into and thus could not possibly have had an agent who could legally bind it, the corporation may make the contracts its own and become bound thereon if, after incorporation, it: (1) (2)

Adopts or ratifies the contract; or Accepts its benefits with knowledge of the terms thereof.

It must be noted, however, that the contract must be adopted in its entirety; the corporation cannot adopt only the part that is beneficial to it and discard that which is burdensome. Moreover, the contract must be one which is within the powers of the corporation to enter, and one which the usual agents of the company have express or implied authority to enter.

McARTHUR V. TIMES PRINTING CO. (48 Minn. 319, 51 N.W. 216; 1892) It is not a requisite that a corporation's adoption or acceptance of a promoter's contract be expressed, but it may be inferred from acts or acquiescence on the part of the corporation, or its authorized agents, as any similar original contract might be shown. The right of agents to adopt an agreement originally made by promoters depends upon the purposes of the corporation and the nature of the agreement. The agreement must be one which the corporation itself could make and one which the usual agents of the company have express or implied authority to enter into.

CLIFTON v. TOMB (21 F. 2d 893; 1921) Whatever may be the proper legal theory by which a corporation may be bound by the contract (ratification, adoption, novation, a continuing offer to be accepted or rejected by the corporation), it is necessary in all cases that the corporation should have full knowledge of the facts, or at least should be put upon such notice as would lead, upon reasonable inquiry, to the knowledge of the facts. CAGAYAN FISHING DEV. CO. v. SANDIKO (65 Phil. 223; 1937) A promoter could not have acted as agent for a corporation that had no legal existence. A corporation, until organized, has no life therefore no faculties. The corporation had no juridical personality to enter into a contract. Also see Caram v. CA

Corporate Rights under Promoter’s Contracts Should the other contracting party fail to perform its part of the bargain, the corporation which has adopted or ratified the contract may either sue for: (1) (2)

Specific performance; or Damages resulting from breach of contract.

The fact of bringing an action on the contract has been held to constitute sufficient adoption or ratification to give the corporation a cause of action.

BUILDERS DUNTILE CO. v. DUNN (229 Ky. 569, 17 S.W. 2d 715; 1929) When the corporation was formed, the incorporators took upon themselves the whole thing, and ratified all that had been done on its behalf. Though there was no formal assignment of the contract to the corporation, the acts of the incorporators were an adoption of the contract. Therefore the corporation has the right to sue for damages for the breach of contract. RIZAL LIGHT V. PSC (25 SCRA 285; 1968) The incorporation of (Morong) and its acceptance of the franchise as shown by this action in prosecuting the application filed with the Commission for approval of said franchise, not only perfected a contract between the municipality and Morong but also cured the deficiency pointed out by the petition. The fact that Morong did not have a corporate existence on the day the franchise was granted does not render the franchise invalid, as Morong later obtained its certificate of incorporation and accepted the franchise.

Personal Liability of Promoter on Pre-Incorporation Contracts GENERAL RULE:

EXCEPTION:

Promoters are personally liable on their contracts made on behalf of a corporation to be formed. If there is an express or implied agreement to the contrary. It must be noted that the fact that the corporation when formed has adopted or ratified the contract does not release the promoter from responsibility unless a novation was intended.

WELLS VS. FAY & EGAN CO. (143 Ga. 732, 85 S.E. 873; 1915) Individual promoters cannot escape liability where they buy machinery, receive them in their possession and authorize one member to issue a note, in contemplation of organizing a corporation which was not formed. (see Campos' notes p. 258-259). The agent is personally liable for contracts if there is no principal. The making of partial payments by the

corporation, when later formed, does not release the promoters here from liability because the corporation acted as a mere stranger paying the debt of another, the acceptance of which by the creditor does not release the debtors from liability over the balance. Hence, there is no adoption or ratification.

HOW & ASSOCIATES INC. VS. BOSS (222 F. Supp. 936; 1963) The rule is that if the contract is partly to be performed before incorporation, the promoters solely are liable. Even if the promoter signed "on behalf of corporation to be formed, who will be obligor," there was here an intention of the parties to have a present obligor, because three-fourths of the payment are to be made at the time the drawings or plans in the architectural contract are completed, with or without incorporation. A purported adoption by the corporation of the contract must be expressed in a novation or agreement to that effect. The promoter is liable unless the contract is to be construed to mean: 1) that the creditor agreed to look solely to the new corporation for payment; or 2) that the promoter did not have any duty toward the creditor to form the corporation and give the corporation the opportunity to assume and pay the liability.

QUAKER HILL VS. PARR (148 Colo. 45, 364 P. 2d 1056; 1961) The promoters here are not liable because the contract imposed no obligation on them to form a corporation and they were not named there as obligors/promissors. The creditor-plaintiff was aware of the inexistence of the corporation but insisted on naming it as obligor because the planting season was fast approaching and he needed to dispose of the seedlings. There was no intent here by plaintiff-creditor to look to the promoters for the performance of the obligation. This is an exception to the general rule that promoters are personally liable on their contracts, though made on behalf of a corporation to be formed.

Fiduciary relationship between corporation and promoter OLD DOMINION VS. BIGELOW (203 Mass. 159, 89 N.E. 193; 1909) A promoter, notwithstanding his fiduciary duties to the corporation, may still sell properties to it, but he must pursue one of four courses to make the contract binding. These are: 1) provide an independent board of officers in no respect directly or indirectly under his control, and make full disclosure to the corporation through them; 2) make full disclosure of all material facts to each original subscriber of shares in the corporation; 3) procure a ratification of the contract after disclosing its circumstances by vote of the stockholders of the completely established corporation; or 4) be himself the real subscriber of all the shares of the capital stock contemplated as a part of the promotion scheme. The promoter is liable, even if owning all the stock of the corporation at the time of the transaction, if further original subscription to capital stock contemplated as an essential part of the scheme of promotion came in after such transaction.

CORPORATE POWERS

General Powers of Corporation (Sec. 36)  

To sue and be sued in its corporate name; Of succession by its corporate name for the period of time stated in the articles of incorporation and the certificate of incorporation;



To adopt and use a corporate seal;



To amend its articles of incorporation in accordance with the provisions of this Code;



To adopt by-laws not contrary to law, morals, or public policy, and to amend or repeal the same in accordance with this Code;



In case of stock corporations, to issue of sell stocks to subscribers and to sell treasury stocks in accordance with the provisions of this Code; and to admit members to the corporation if it be a non-stock corporation;



To purchase, receive, take, grant, hold, convey, sell, lease, pledge, mortgage and otherwise deal with such real and personal property, including securities and bonds of other corporations, as the transaction of the lawful business of the corporation may reasonably and necessarily require, subject to the limitations prescribed by law and the Constitution; (NOTE: There are two (2) general restrictions on the power of the corp. to acquire and hold properties: (1) that the property must be reasonable and necessarily required by the transaction of its lawful business, and (2) that the power shall be subject to the limitations prescribed by other special laws and the Constitution.)

 

To adopt any plan of merger or consolidation as provided in this Code; To make reasonable donations, including those for the public welfare of for hospital, charitable, cultural, scientific, civic, or similar purposes: Provided that:

no corporation, domestic or foreign, shall give donations in aid of any political party or candidate or for purposes of partisan political activity;



To establish pension, retirement and other plans for the benefit of its directors, trustees, officers and employees; and



To exercise such other powers as may be essential or necessary to carry out its purpose or purposes as stated in its articles of incorporation.

Specific Powers of Corporation 

Extension or shortening of the corporate term (Sec. 37)



Increase or decrease of the capital stock (Sec. 38)



Incur, create or increase bonded indebtedness (Sec. 38)



Denial of the pre-emptive right (Sec. 39)



Sale or other disposition of substantially all its assets. (Sec. 40) 

Implied Powers

A sale is deemed to substantially cover all the corporate property and assets if such sale renders the corporation incapable of continuing the business or accomplishing the purpose for which it was incorporated.



Acquisition of its own shares. (Sec. 41)

 

Investment in another corporation or business. (Sec. 42) Declaration of dividends. (Sec. 43)



Entering into management contracts. (Sec. 44)

Under Sec. 36, a corporation is given such powers as are essential or necessary to carry out its purpose or purposes as stated in the articles of incorporation. This phrase gives rise to such a wide range of implied powers, that it would not be at all difficult to defend a corporate act versus an allegation that it is ultra vires. A corporation is presumed to act within its powers and when a contract is not its face necessarily beyond its authority; it will, in the absence of proof to the contrary, be presumed valid.

The Ultra Vires Doctrine Black’s Law Dictionary Definition: Ultra vires acts are those acts beyond the scope of the powers of the corporation, as defined by its charter or laws of state of incorporation. The term has a broad application and includes not only acts prohibited by the charter, but acts which are in excess of powers granted and not prohibited, and generally applied either when a corporation has no power whatever to do an act, or when the corporation has the power but exercises it irregularly.

Q: What are the consequences of ultra vires acts? 

The corporation may be dissolved under a quo warrranto proceeding.



The Certificate of Registration may be suspended or revoked by the SEC.



Parties to the ultra vires contract will be left as they are, if the contract has been fully executed on both sides. Neither party can ask for specific performance, if the contract is executory on both sides. The contract, provided that it is not illegal, will be enforced, where one party has performed his part, and the other has not with the latter having benefited from the former‟s performance.



Any stockholder may bring an individual or derivative suit to enjoin a threatened ultra vires act or contract. If the act or contract has already been performed, a derivative suit for damages against the directors maybe filed, but their liability will depend on whether they acted in good faith and with reasonable diligence in entering into the contracts. When the suit against the injured party who had no knowledge that the corporation was engaging in an act not included expressly or impliedly in its purposes clause.



Ultra vires acts may become binding by the ratification of all the stockholders, unless third parties are prejudiced thereby, or unless the acts are illegal.

REPUBLIC OF THE PHILS. v. ACOJE MINING (7 SCRA 361; 1963) Resolution adopted by the company to open a post office branch at the mining camp and to assume sole and direct responsibility for any dishonest, careless or negligent act of its appointed postmaster is NOT ULTRA VIRES because the act covers a subject which concerns the benefit, convenience, and welfare of the company‘s employees and their families. While as a rule an ultra vires act is one committed outside the object for which a corporation is created as defined by the law of its organization and therefore beyond the powers conferred upon it by law, there are however certain corporate acts that may be performed outside of the scope of the powers expressly conferred if they are necessary to promote the interest or welfare of the corporation. CARLOS v. MINDORO SUGAR CO. (57 SCRA 343, 1932) The BOD of the Phil Trust Co. adopted a resolution which authorized its president to purchase at par and in the name of the corp. bonds of MSC. These bonds were later resold and guaranteed by PTC to third persons. PTC paid plaintiff the corresponding interest payments until July 1, 1928 when it alleged that it is not bound to pay such interest or to redeem the obligation because the guarantee given for the bonds was illegal and void.

Held: The act of guaranty by PTC was well within its corporate powers. Furthermore, having received money or property by virtue of the contract which is not illegal, it is estopped from denying liability. Even if the then prevailing law (Corp. Law) prohibited PTC from guaranteeing bonds with a total value in excess of its capital, with all the MSC properties transferred to PTC based on the deed of trust, sufficient assets were made available to secure the payment of the corresponding liabilities brought about by the bonds. GOV’T v. EL HOGAR (50 Phil 399; 1932) (This case is an example of how the implied powers concept may be used to justify certain acts of a corporation.) A quo warranto proceeding instituted by the Gov't against El Hogar, a building and loan ass'n to deprive it of its corp. franchise. 1. El Hogar held title to real property for a period in excess of 5 years in good faith, hence this cause will not prosper. 2. El Hogar owned a lot and bldg. at a business district in Manila allegedly in excess of its reasonable requirements, held valid bec, it was found to be necessary and legally acquired and developed. 3. El Hogar leased some office space in its bldg.; it administered and managed properties belonging to delinquent SHs; and managed properties of its SHs even if such were not mortgaged to them. Held: first two valid, but the third is ultra vires bec. the administration of property in that manner is more befitting of the business of a real estate agent or trust company and not of a building and loan ass'n. 4.

Compensation to the promoter and organizer allegedly excessive and unconscionable. Held: Court cannot dwell on the issue since the promoter is not a party in the proceeding and it is the corp. or its SHs who may bring a complaint on such.

5. Issuance of special shares did not affect El Hogar's character as a building and loan ass'n nor make its loans usurious. 6. Corporate policy of using a depreciation rate of 10 % per annum is not excessive, bec. accdg. to the SC, the by-laws expressly authorizes the BOD to determine each year the amount to be written down upon the expenses of installation and the property of the corp. 7. The Corp. Law does not expressly grant the power of maintaining reserve funds but such power is implied. All business enterprises encounter periods of gains and losses, and its officers would usually provide for the creation of a reserve to act as a buffer for such circumstances. 8. That loans issued to member borrowers are being used for purposes other than the bldg. of homes not invalid bec. there is no statute which expressly declares that loans may be made by these ass'ns solely for the purpose of bldg. homes. 9. Sec. 173 of the Corp. Law provides that "any person" may become a SH on a bldg. and loan ass'n. The word "person" is used on a broad sense including not only natural persons but also artificial persons.

BISSEL v. MICHIGAN SOUTHERN ( 22 NY 258; 1860) Two railroad corporations contend that they transcended their own powers and violated their own organic laws. Hence, they should not be held liable for the injury of the plaintiff who was a passenger in one of their trains. Held: The contract between the two corporations was an ultra vires act. However, it is not one tainted with illegality, therefore, the accompanying rights and obligations based on the contract of carriage between them and the plaintiff cannot be avoided by raising such a defense. PIROVANO v. DELA RAMA STEAMSHIP (96 Phil 335 , 1954) This case involved the issue of whether or not the defendant corporation performed an ultra vires act by donating the life insurance proceeds to the minor children of Pirovano, the deceased president of the defendant company under whose management the company grew and progressed to become a multi-million peso corporation. Held:

NO.

The AOI of the corporation provided two relevant items: ―(1) to invest and deal with moneys of the company not immediately required, in such manner as from time to time may be determined; and (2) to aid in any other manner any person, association or corporation of which any obligation or in which any interest is held by this corporation or in the affairs of prosperity of which this corporation has a lawful interest.‖ From this, it is obvious that the corporation properly exercised within its chartered powers the act of availing of insurance proceeds to the heirs of the insured and deceased officer. HARDEN v. BENGUET CONSOLIDATED (58 Phil 141) A contract between Benguet and Balatoc provided that Benguet will bring in capital, eqpt. and technical expertise in exchange for capital shares in Balatoc. Harden was a SH of Balatoc and he contends that this contract violated the Corp.Law which restricts the acquisition of interest by a mining corp. in another mining corp. Held: Harden has no standing bec. if any violation has been committed, the same can be enforced only in a criminal prosecution by an action of quo warranto which may be maintained only by the Attorney-General.

CONTROL AND MANAGEMENT Allocation of Power and Control Q: What are the three levels of corporate control/power? Board of directors or trustees- responsible for corporate policies and the general management of the business and affairs of the corporation. Officers- execute the policies laid down by the board. Stockholders or members- have residual power over fundamental corporate changes like amendments of articles of incorporation.

Who Exercises Corporate Powers Board of directors or trustees Q: What are the powers of the BOD? The BOD is responsible for corporate policies and the general management of the business affairs of the corporation. (See Citibank v Chua) (a)

Authority (Sec. 24)

(b)

Requirements (i)

Qualifying share (Sec. 24)

(ii)

Residence (Sec. 24)

(iii)

Nationality

(iv)

Disqualifications (Sec. 27) conviction by final judgment of offense punishable > 6 yrs. prison violation of Corporation code within 5 years prior to date of election or appointment

(c)

How elected (Sec. 24) The formula for determining the number of shares needed to elect a given number of directors is as follows: X = Y x N1 N+1

+1

X = being the number of shares needed to elect a given number of directors Y = being the total number of shares present or represented at the meeting N1 = being the number of directors desired to be elected N = being the total number of directors to be elected (d)

How removed (Sec. 28) By a vote of the SHs holding or representing at least 2/3 of the outstanding capital stock, or by a vote of at least 2/3 of the members entitled to vote, provided that such removal takes place at either a regular meeting of the corporation or at a special meeting called for the purpose. In both cases, there must be previous notice to the SHs / members of the intention to propose such removal at the meeting. Removal may be with or without cause. However, removal without cause may not be used to deprive minority SHs or members of the right of representation to which they may be entitled under Sec. 24 of the Code.

(e)

How vacancy filled (Sec. 29) If vacancy due to removal or expiration of term:

Must be filled by the SHs in a regular or special meeting called for that purpose.

If "vacancy" due to increase Only by means of an election at a regular or special SHs in number of directors meeting duly called for the purpose, or in the same or trustees: meeting authorizing the increase of directors or trustees if so stated in the notice of the meeting.

All other vacancies:

Note:

(f)

May be filled by the vote of at least a majority of the remaining directors or trustees, if still constituting a quorum.

Directors or trustees so elected to fill vacancies shall be elected only for the unexpired term of their predecessors in office.

How compensated (Sec. 30) If provided in by-laws:

That compensation stated in the by-laws.

If not provided in by-laws:

Directors shall not receive any compensation other than reasonable per diems, as directors. However, compensation other than per diems may be granted to directors by a majority vote of the SHs at a regular or special stockholders' meeting.

Note: In no case shall the total yearly compensation of directors, as such directors, exceed 10% of the net income before income tax of the corporation during the preceding year. (g)

Matters requiring Board of Directors' action

(h)

Liability (See subsequent discussion under Duties of Directors and Controlling Stockholders.) (i) In general (Sec. 31) (ii) Business judgment rule

(iii) Dealings with the corporation (Sec. 32) (iv) Contracts between corporations with interlocking directors (Sec. 33)

(i)

(v)

Disloyalty (Sec. 34)

(vi)

Watered stocks (Sec. 65)

Executive Committee (Sec. 35) See subsequent discussion under Board Committees.

RAMIREZ VS. ORIENTALIST CO AND FERNANDEZ (38 Phil. 634; 1918) In this case, the board of directors, before the financial inability of the corporation to proceed with the project was revealed, had already recognized the contracts as being in existence and had proceed with the necessary steps to utilize the films. The subsequent action by the stockholders in not ratifying the contract must be ignored. The functions of the stockholders are limited of nature. The theory of a corporation is that the stockholders may have all the profits but shall return over the complete management of the enterprise to their representatives and agents, called directors. Accordingly, there is little for the stockholders to do beyond electing directors, making by-laws, and exercising certain other special powers defined by law. In conformity with this idea, it is settled that contracts between a corporation and a third person must be made by directors and not stockholders. LOPEZ VS. ERICTA (45 SCRA 539; 1972) In this case, the Board of Regents of the University of the Philippines terminated the ad interim appointment of Dr. Blanco as Dean of the College of Education by not acting on the matter. In the transcript of the meeting which was latter agreed to be deleted, it was found out that the BOR, consisting of 12 members, voted 5 in favor of Dr. Blanco's appointment 3 voted against, and 4 abstained. The core of the issue is WON the 4 abstentions will be counted in favor of Dr. Blanco's appointment or against it. The SC held that such abstentions be counted as negative vote considering that those who abstained, 3 of which members of the Screening Committee, intended to reject Dr. Blanco's appointment. ZACHARY VS. MILLIN (294 Mic. 622; 1940) The issue in this case is regarding the validity of the director's meeting at the company's laboratory on December 8, 1937 wherein Zachary was removed as president of the company. Zachary that he was not notified of the meeting thus, the action was void. On the other hand, the defendants contend that the notice requirement was waived by Zachary's presence at the meeting. The SC held that the validity of the meeting was not affected by the failure to give notice as required by the by-laws, provided that the parties were personally present. Since all the parties were present at the meeting of December 8, and understood that the meeting was to be a directors' meeting, then the action taken is final and may not be voided by any informality in connection with its being called. PNB VS. CA (83 SCRA 238; 1978) The action was brought by the mortgagor (Tapnio) against PNB for damages in connection with the failure of the latter's board of directors to act expeditiously on the proposed lease of the former's sugar quota to one Tuazon. The Supreme Court held that while the PNB has the ultimate authority to approve or disapprove the proposed lease since the quota was mortgaged to PNB, the latter certainly cannot escape liability for observing, for the protection of the interest of the private respondents, that degree of care, precaution and vigilance which the circumstances justly demand in approving or disapproving the lease of the said sugar quota.

Corporate officers and agents (a)

Minimum set of officers and their qualifications (Sec. 25)

The minimum set of officers are: (1) (2) (3)

president (who shall be a director); secretary (who shall be a resident and Filipino citizen); and treasurer (who may or may not be a director)

The by-laws, however, may provide for other officers. Any 2 or more positions may be held concurrently by the same person, except that no one shall act as (a) president and secretary, or (b) president and treasurer at the same time. (b)

Disqualifications (Sec. 27) - Conviction by final judgment of an offense punishable by imprisonment > 6 yrs. -

(c)

Violation of Corporation Code committed within 6 yrs. prior to the date of election or appointment

Liability in general (Sec. 31) See discussion under Duties of Directors and Controlling Stockholders. .

(d)

Dealings with the corporation (Sec. 32) -

Generally voidable (See discussion under Duties of Directors and Controlling Stockholders)

What is the doctrine of apparent authority? The doctrine of apparent authority provides that a corporation will be liable to innocent third persons for the acts of its agent where the representation was made by the agent in the course of business and acting within his/her general scope of authority even though, in the particular case, the agent is secretly abusing his authority and attempting to perpetrate a fraud upon his/her principal or some other person for his/her own ultimate benefit.

FIRST PHILIPPINE INTERNATIONAL BANK & RIVERA v. CA (January 24, 1996) The authority of a corporate officer in dealing with third persons may be actual or apparent. The doctrine of "apparent authority," with special reference to banks, was laid out in Prudential Bank v. CA (223 SCRA 350) where it was held that: A bank is liable for the wrongful acts of its officers done in the interest of the bank or in the course of dealings of the officers in their representative capacity but not for acts outside the scope of their authority. A bank holding out its officers and agents as worthy of confidence will not be permitted to profit by the frauds they may thus be enabled to perpetrate in the apparent scope of their employment; nor will it be permitted to shrink from its responsibility for such frauds, even though no benefit may accrue to the bank therefrom. Accordingly, a bank is liable to innocent third persons where the representation is made in the course of its business by its agent acting within the general scope of his authority even though, in the particular case, the agent is secretly abusing his authority and attempting to perpetrate a fraud upon his principal or some other person for his own ultimate benefit. Application of these principles is especially necessary because banks have a fiduciary relationship with the public and their stability depends on the confidence of the people in their honesty and efficiency. Such faith will be eroded where banks do not exercise strict care in the selection and supervision of its employees, resulting in prejudice to their depositors.

YU CHUCK V. KONG LI PO (46 Phil. 608; 1924)

The power to bind a corporation by contract lies with its board of directors or trustees. Such power may be expressly or impliedly be delegated to other officers and agents of the corporation. It is also well settled that except where the authority of employing servants or agents is expressly vested in the board, officers or agents who have general control and management of the corporation's business, or at least a specific part thereof, may bind the corporation by the employment of such agents and employees as are usual and necessary in the conduct of such business. Those contracts of employment should be reasonable. Case at bar: contract of employment in the printing business was too long and onerous to the business (3-year employment; shall receive salary even if corp. is insolvent).

THE BOARD OF LIQUIDATORS V. HEIRS OF MAXIMO KALAW (20 SCRA 987; 1967) Kalaw was a corporate officer entrusted with general management and control of NACOCO. He had implied authority to make any contract or do any act which is necessary for the conduct of the business. He may, without authority from the board, perform acts of ordinary nature for as long as these redound to the interest of the corporation. Particularly, he contracted forward sales with business entities. Long before some of these contracts were disputed, he contracted by himself alone, without board approval. All of the members of the board knew about this practice and have entrusted fully such decisions with Kalaw. He was never questioned nor reprimanded nor prevented from this practice. In fact, the board itself, through its acts and by acquiescence, have laid aside the by-law requirement of prior board approval. Thus, it cannot now declare that these contracts (failures) are not binding on NACOCO. ZAMBOANGA TRANSPO V. BACHRACH MOTORS (52 Phil. 244; 1928) A chattel mortgage, although not approved by the board of directors as stipulated in the by-laws, shall still be valid and binding when the corporation, through the board, tacitly approved and ratified it. The following acts of the board constitute implied ratification: 1.

Erquiaga is one of the largest stockholder, and was the all-in-one officer (he was the President, GM, Attorney, Auditor, etc.)

2.

Two other directors approved his actions and expressed satisfaction with the advantages obtained by him in securing the chattel mortgage.

3.

The corporation took advantage of the benefits of the chattel mortgage. There were even partial payments made with the knowledge of the three directors.

ACUNA V. BATAC PRODUCERS COOPERATIVE MARKETING ASSOCIATION (20 SCRA 526; 1967) Acuna entered into an agreement with Verano, manager of PROCOMA, in which the former would be constituted as the latter's agent in Manila. Acuna diligently went about his business and even used personal funds for the benefit of the corporation. During the face-to-face meeting with the board, Acuna was assured that there need not be any board approval for his constitution as agent for it would only be a mere formality. Later on, the board disapproved the agency and did not pay him. The SC ruled that the agreement was valid due to the ratification of the corp. proven by these acts: 1. 2. 3.

He was assured by the board that no board approval was necessary. He delivered P 20,000, performed his work with the knowledge of the board. Due to acquiescence, the board cannot disown or disapprove the contract.

Board Committees The By-laws of the corporation may create an executive committee, composed of not less than 3 members of the Board, to be appointed by the Board. The executive committee may act, by majority vote of all its members, on such specific matters within the competence of the board, as may be delegated to it in either (1) the By-laws, or (2) on a majority vote of the board. However, the following acts may never be delegated to an executive committee: (1) (2) (3) (4)

approval of any action for which shareholders' approval is also required; the filling of vacancies in the board (refer to Sec. 29); the amendment or repeal of by-laws or the adoption of new by-laws; the amendment or repeal of any resolution of the board which by its express terms is not so amendable or repealable; and

(5)

a distribution of cash dividends to the shareholders.

HAYES V. CANADA, ATLANTIC AND PLANT S.S CO., LTD. (181 F. 289; 1910) In this case, the Executive Committee: a) b) c)

removed the Treasurer and appointed a new one fixed the annual salary of the members of the Executive Committee amended the by-laws by giving the President the sole authority to call a stockholder's meeting and a board of directors meeting d) amended the composition of the ExeCom by limiting it to just 2 persons. Was these actions valid? No, because the Executive Commmittee usurped the powers vested in the board and the stockholders. If their actions was valid, it would put the corp. in a situation wherein only two men, acting in their own pecuniary interests, would have absorbed the powers of the entire corporation. "Full powers" should be interpreted only in the ordinary conduct of business and not total abdication of board and stockholders' powers to the ExeCom. "FULL POWERS" does not mean unlimited or absolute power.

Stockholders or Members In the following basic changes in the corporation, although action is usually initiated by the board of directors or trustees, their decision is not final, and approval of the stockholders or members would be necessary: (1) (2) (3) (4) (5)

Amendment of articles of incorporation; Increase and decrease of capital stock; Incurring, creating or increasing bonded indebtedness; Sale, lease, mortgage or other disposition of substantially all corporate assets; Investment of funds in another business or corporation or for a purpose other than the primary purpose for which the corporation was organized; (6) Adoption, amendment and repeal of by-laws; (7) Merger and consolidation; (8) Dissolution of corporation In all of these cases, even non-voting stocks, or non-voting members, as the case may be, will be entitled to vote. (Sec. 6)

BOARD OF DIRECTORS AND ELECTION COMMITTEE OF SMB VS. TAN (105 Phil. 426; 1959) Meeting was invalid for lack of notice. By-laws provide for a 5-day notice before meeting. March 26 posting not enough for March 28 election.

JOHNSTON VS. JOHNSTON (61 O.G. No. 39, 6160; 1965) As a general rule, a quorum at a stockholders' meeting, once reached, cannot be nullified by a subsequent walkout. However, the proceedings can be nullified if the walkout was for a reasonable and justifiable cause. In this case, F. Logan Johnston, who owned and/or represented more than 50% of the corporation's outstanding shares, was prohibited from voting the shares of the Silos family (which he had validly purchased) and of the minor children of Albert S. Johnston (of whom he was guardian) on the ground that such shares must first be registered in the names of the wards, thereby prompting the walkout. The Court of Appeals held that the walkout was neither unreasonable nor unjustifiable. It noted however that there was no formal declaration of a quorum before the withdrawal from the meeting by F. Logan Johnston. PONCE VS. ENCARNACION (94 Phil. 81; 1953)

Upon good cause, such as a Chairman of the Board failing to call a meeting, either by his absence or neglect, the Court may grant a stockholder the authority to call such a meeting. DETECTIVE AND PROTECTIVE BUREAU VS. CLORIBEL (26 SCRA 225; 1968) The Corporation Law says that every director must own at least one (1) share of the capital stock of the corporation. GOKONGWEI VS. SEC (89 SCRA 336; 1979) 

Section 21 of the Corporation Law provides that a corporation may prescribe in its by-laws the qualifications, duties, and compensation of its directors.



A stockholder has no vested right to be elected director for he impliedly contracts that the will of the majority shall govern.



Amended by-laws are valid for the corporation has its inherent right to protect itself.

ROXAS V. DELA ROSA (49 Phil. 609; 1926) Under the Law, directors can only be removed from office by a vote of the stockholders representing 2/3 of subscribed capital stock, while vacancies can be filled by a mere majority. A director cannot be removed by a mere majority by disguising it as filling a vacancy. ANGELES V. SANTOS (64 Phil. 697; 1937) Court may appoint a receiver when corporate remedy is unavailable when board of directors perform acts harmful to the corporation. Generally, stockholders cannot sue on behalf of the corporation. The exception is when the defendants are in complete control of the corporation. CAMPBELL V. LEOW’S INC. (134 A. 2d 852; 1957) The stockholders have an implied power to remove a director for cause. Even when there is cumulative voting, stockholders can still remove directors for cause. DELA RAMA V. MA-AO SUGAR CENTRAL CO, INC. (27 SCRA 247; 1969) A corporation may use its funds to invest in another corporation without the approval of the stockholders if done in pursuance of a corporate purpose. However, if it is purely for investment, the vote of the stockholders is necessary.

VOTING Pledgors, mortgagors, executors, receivers, and administrators (Sec. 55) - Pledgors or mortgagors have the right to attend and vote at stockholders' meetings. Exception: If the pledgee or mortgagee is expressly given by the pledgor or mortgagor such right in writing which is recorded on the appropriate corporate books. - Executors, administrators, receivers and other legal representatives duly appointed by the court may attend and vote in behalf of the stockholders or members without need of any written proxy. Joint owners of stock (Sec. 56) - Generally, consent of all co-owners shall be necessary.

Treasury shares (Sec. 57) - Treasury shares have no voting right for as long as such shares remain in the Treasury.

Proxies (Sec. 58) - Proxies must be in writing, signed by the stockholder/member, filed before the scheduled meeting with the corporate secretary. - Unless otherwise provided in the proxy, it shall be valid only for the meeting for which it is intended. No proxy shall be valid and effective for a period longer than five (5) years at any one time. - Voting trusts may be voted by proxy unless the agreement provides otherwise. (Sec. 59) - It must be noted however that directors or trustees cannot vote by proxy at board meetings. (Sec. 25) - Note that in Sec. 89, non-stock corporations are permitted to waive the right to use proxies via their AOI or by-laws. Voting trust (Sec. 59) - Voting trusts must be in writing, notarized, specifying the terms and conditions thereof, certified copy filed with SEC. Failure to comply with this requirement renders the agreement ineffective and unenforceable. - As a general rule, voting trusts are valid for a period not exceeding 5 years at any one time, and automatically expire at the end of the agreed period unless expressly renewed. However, in the case of a voting trust specifically required as a condition in a loan agreement, said voting trust may exceed 5 years but shall automatically expire upon payment of the loan. - Voting trusts may be voted by proxy unless the agreement provides otherwise. (Sec. 59) Pooling agreement - Pooling agreements refer to agreements between 2 or more SHs to vote their shares the same way. They are different from voting trust agreements in that they do not involve a transfer of stocks but are merely private agreements between 2 or more SHs to vote in the same way. - Sec. 100, par. 2 of the Corporation Code provides for pooling and voting agreements in close corporations. Although there is no equivalent provision for widely-held corporations, Justice and Prof. Campos are of the opinion that SHs of widely-held corporations should not be precluded from entering into voting agreements if these are otherwise valid and are not intended to commit any wrong or fraud on the other SHs that are not parties to the agreement.

Non-voting shares (Sec. 6) - Preferred or redeemable shares. ITF shares And/or shares (Sec. 56) - Any one of the joint owners can vote said shares or appoint a proxy thereof.

Devices Affecting Control Proxy Device Sec 58. Proxies. – Stockholders and members may vote in person or by proxy in all meetings of stockholders or members. Proxies shall be in writing, signed by the stockholder or member and filed before the scheduled meeting with the corporate secretary. Unless otherwise provided in the proxy, it shall be valid only for the meeting for which it is intended. No proxy shall be valid and effective for a period longer than five (5) years at any one time. Character: agency relationship; revocable at will (by express revocation, by attending the meeting) and by death, except when coupled with interest or is a security.

IN RE GIANT PORTLAND CEMENT CO. (21 A.2d 697; 1941) Even if stocks are sold, the stockholder of record remains the owner of the stocks and has the voting right until the by-law requiring recording of transfer in the transfer book is complied with. Thus, a proxy given by the stockholder of record even if he has already sold the share/s of stock remains effective. STATE EX REL EVERETT TRUST V PACIFIC WAXED PAPER, (159 A.L.R. 297; 1945) The general rule is that a proxy is revocable even though by its express terms it is irrevocable. The exceptions are: (a) when authority is coupled with interest; (b) where authority is given as part of a security and is necessary to effectuate such a security. It is coupled with interest when there is interest in the share themselves (such as a right of first refusal in case of sale) and the rights inherent in the shares (such as voting rights; capacity to obtain majority). DUFFY V LOFT (17 Del. Ch. 376, 152 A. 849; 1930) Where a stockholder‘s meeting was validly convened, the proxies must be deemed present even if the proxies were not presented, provided: (a) their existence is established; (b) the agents were so designated to attend and act in SH‘s behalf; (c) the agents were present in the meeting. Q: Is it valid for the corporation to pay the expenses for proxy solicitation? A: In the case of Rosenfeld v. Fairchild Engine and Airplane Corp. (128 N.E. 2d 291; 1955), it was held that in a contest over policy (as opposed to a purely personal power contest), corporate directors have the right to make reasonable and proper expenditures, subject to the scrutiny of the courts when duly challenged, from the corporate treasury for the purpose of persuading the SHs of the correctness of their position and soliciting their support for policies which the directors believe, in all good faith, are in the best interests of the corporation. The SHs, moreover, have the right to reimburse successful contestants for the reasonable and bona fide expenses incurred by them in any such policy contest, subject to like court scrutiny. However, where it is established that such monies have been spent for personal power, individual gain or private advantage, and not in the belief that such expenditures are in the best interest of the stockholders and the corporation, or where the fairness and reasonableness of the amounts allegedly expended are duly and successfully challenged, the courts will not hesitate to disallow them. ROSENFELD V. FAIRCHILD (128 N.E. 2d 291; 1955) In a contest over policy, as compared to a purely personal power contest, corporate directors have the right to make reasonable and proper expenditures. Reason: in these days of giant corporations with vast numbers of SH‘s, if directors are not allowed to authorize reasonable expenses in soliciting proxies, corporate business may be hampered by difficulty in procuring quorum; or corporations may be at the mercy of persons seeking to wrest control for their purposes if the directors may not freely answer their challenge. But corp expense may be disallowed by courts where money was shown to have been spent for personal power, individual gain or private advantage, or where fairness and reasonableness of amount spent has been successfully challenged.

Voting Trust

A Voting Trust Agreement (VTA) is an agreement whereby the real ownership of the shares is separated from the voting rights, the usual aim being to insure the retention of incumbent directors and remove from the stockholders the power to change the management for the duration of the trust. Advantages    

Accumulates power. Small shareholders are given the chance to have a representation in the BOD or at least a spokesperson during stockholders‟ meetings. Continuity of management. More effective than proxies because it is irrevocable. Ensures that the required number of stockholders is met thereby facilitating smooth corporate operations.

Disadvantages   

Stockholders give up rights (voting and naked title) Susceptible to abuse Not used in widely held corporations

Rights given up by the shareholder in a VTA in exchange for the fiduciary obligation of the trustee:   

Voting rights Proprietary rights/naked title/legal ownership Incidental rights such as to attend meetings, to be elected, to receive dividends)

Rights retained by the shareholder    

Beneficial or equitable ownership Right to revoke VTA in case of breach by trustee Regain full ownership after the lapse of the period Right to an accounting by the trustee after the period of the VTA

How is a voting trust created? (1) (2)

(3)

A VTA is prepared in writing, notarized, and filed with the corporation and SEC. The certificates of stock covered by the VTA are cancelled and new ones (voting trust certificates) are issued in the name of the trustee/s stating that they are issued pursuant to the VTA. The transfer is noted in the books of the corporation.

(4)

The trustee/s execute and deliver to transferors the voting trust certificates. (Note that these certificates shall be transferable in the same manner and with the same effect as certificates of stock.)

(5)

At the end of the period of the VTA (or the full payment of the loan to which the VTA is made a condition, as the case may be), in the absence of any express renewal, the voting trust certificates as well as the certificates of stock in the name of the trustee/s shall be deemed cancelled and new certificates of stock shall be reissued in the name of the transferors.

EVERETT V. ASIA BANKING (49 Phil. 512; 1926) This case illustrates how VTA can give rise to effective control and how it can be abused. Original stockholders can set aside the VTA when their rights are trampled upon by the trustee. MACKIN, ET AL. V. NICOLLET HOTEL (25 F. 2d 783; 1928)

Invalidating circumstances of a VTA are:    

Want of consideration Voting power not coupled with interest Fraud Illegal or improper purpose

NIDC V. AQUINO (163 SCRA 153; 1988) A VTA transfers only voting or other rights pertaining to the shares subject of the agreement, or control over the stock. Stockholders of a corp. that lost all its assets through foreclosures cannot go after those properties. PNB-NIDC acquired those properties not as trustees but as creditors.

Pooling and voting agreements What are the advantages/disadvantages of a pooling agreement? Advantages: 1. there is a commitment to agree to a certain manner of voting 2. minority stockholders are able to control the corpo Disadvantages: 1. possibility of disagreement thus the need for an arbitration clause 2. there is no compelling reason for stockholders to act together

What rights does a shareholder give up/ retain with a pooling agreement? Shareholders retain their right to vote because the parties are not constituted as agents. However, the will of the parties may not be carried out due to non-compliance with the pooling agreement.

RINGLING v. RINGLING (29 Del. Ch. 318, 49 A. 2d 603; 1946) Generally, agreements and combinations to vote stock or control corporate fiction & policy are valid if they seek without fraud to accomplish only what parties might do as stockholders and do not attempt it by illegal proxies, trusts or other means in contravention of statutes or law. BUCK RETAIL STORE v. HARKERT (62 N.W. 2d 288; 1954) Stockholders‘ control agreements are valid where it is for the benefit of corporation where it works no fraud upon creditors or other stockholders and where it violates no statute or recognized public policy. MCQUADE v. STONEHAM (189 N.E. 234; 1934) An agreement among stockholders to divest directors of their power to discharge an unfaithful employee is illegal as against public policy. Stockholders may not by agreement among themselves control the directors in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries. CLARK v. DODGE (199 N.E. 641; 1936) If the enforcement of a particular contract damages nobody-not even the public, there is no reason for holding it illegal. Test is WON it causes damage to the corporation and stockholders.

Cumulative voting (see sec. 24)

Methods of Voting Straight voting:

1.

If A has 100 shares and there are 5 directors to be elected, he shall multiply 100 by five (equals 500) and distribute equally among the five candidates without preference

2.

Cumulative voting: If A has 100 shares and there are 5 directors to be elected, he shall (one candidate) multiply 100 by five (equals 500) and he can vote the 500 for only one candidate.

3.

Cumulative voting: If A has 100 shares, there are 5 directors to be elected, and he only (multiple candidates) wants to vote for two nominees, he can divide 500 votes between the two, giving each one 250 votes.

How to compute votes needed to get a director elected by cumulative voting: 1.

Frey’s formula (minimum no. of votes to elect one director) X= # of shares required Y= # of outstanding votes Z= # of directors to be elected X = _ Y__ + 1 Z+1

2.

Baker & Cary’s formula (minimum no. of votes needed to elect multiple directors) X= # of shares required Y= # of shares represented at meeting D= # of directors the minority wants to elect D‟= total # of directors to be elected X= Y x D + 1 D' + 1

NOTES 

Levels playing field or at least ensures that the minority can elect at least one representative to the board of directors (BOD)



Cannot of itself give the minority control of corporate affairs, but may affect and limit the extent of the majority‟s control



By-laws cannot provide against cumulative voting since this right is mandated by law in Section 24.

Classification of shares (see sec. 6) Type of shares 1.

Common:

2.

Preferred:

3.

Redeemable: share is purchased or taken up by the corporation upon the expiration of a fixed period (Sec. 8); right to vote may be restricted (Sec. 6)

NOTES

share with right to vote share has preference over dividends and distribution of assets upon liquidation; right to vote may be restricted (Sec. 6)



Stock can also be both preferred and redeemable.



Even though the right to vote of preferred and redeemable shares may be restricted, owners of these shares can still vote on certain matter provided for in Sec. 6.



SEC requires that where no dividends are declared for three consecutive years, in spite of available profits, preferred stocks will be given the right to vote until dividends are declared.

GOTTSCHALK V. AVALON REALTY (23 N.W. 2d 606; 1946)  

Provision granting right to vote to preferred stock previously prohibited from voting, constitutes diminution of the voting power of common stock. Provision in the articles of incorporation granting holders of preferred stock right to vote in case of default in payment of dividends after July 1, 1951 was construed as denial by necessary implication of the right to vote even prior to July 1, 1951.

Restriction on transfer of shares    

Peculiar to close corporations. Most common restriction: granting first option to the other stockholders and/or the corporation to acquire the shares of a stockholder who wishes to sell them. Restrictions on shares of stock must conform to the requirements in Sec. 98 This gives to the corporation and/or to its current management the power to prevent the transfer of shares to persons who they may see as having interests adverse to theirs.

Prescribing qualifications for directors; founder’s shares Directors (See Sec. 23, 27, 47) 

As long as the qualifications imposed are reasonable and not meant to unjustly or unfairly deprive the minority of their rightful representation in the BOD, such provisions are within the power of the majority to provide in the by-laws.



According to Gokongwei vs. SEC, aside from prescribing qualifications, by-laws can also provide for the disqualification of anyone in direct competition with the corporation.

Founder’s shares See Sec. 7 for definition 

Exception to the rule in sec. 6 that non-voting shares shall be limited to preferred and redeemable shares



If founder‟s shares enjoy the right to vote, this privilege is limited to 5 years upon SEC‟s approval, so as to prevent the perpetual disqualification of other stockholders.

Management contracts (sec. 44) 

Contract to manage the day-to-day affairs of the corporation in accordance with the policies laid down by the board of the managed corporation.



BOD can and usually delegate many of its functions but it can‟t abdicate its responsibility to act as a governing body by giving absolute power to officers or others, by way of a management contract or otherwise. It must retain its control over such officers so that it may recall the delegation of power whenever the interests of the corporation are seriously prejudiced thereby.

SHERMAN & ELLIS VS. INDIANA MUTUAL CASUALTY (41 F. 2d 588; 1930) Although corporations may, for a limited period, delegate to a stranger certain duties usually performed by the officers, there are duties, the performance of which may not be indefinitely delegated to outsiders.

UNUSUAL VOTING AND QUORUM REQUIREMENTS (Sec. 25, 97 [for close corporations])  

Increases veto power of the minority in some cases. In exchange for the numerical majority in the BOD, minority can ask for a stronger veto power in major corporate decisions.

BENITENDI VS. KENTON HOTEL (60 N.E. 2d 829; 1945) 

A requirement that there shall be no election of directors at all unless every single vote be cast for the same nominees, is in direct opposition to the statutory rule that the receipt of plurality of the votes entitles a nominee to election. (See Sec. 24)



Requiring unanimity before the BOD can take action on any corporate matter makes it impossible for the directors to act on any matter at all. In all acts done by the corporation, the major number must bind the lesser, or else differences could never be determined nor settled.



The State has decreed that every stock corporation must have a representative government, with voting conducted conformably to the statutes, and the power of decision lodged in certain fractions, always more than half, of the stock. This whole concept is destroyed when the stockholders, by agreement, by-law or certificates of corporation provides for unanimous action, giving the minority an absolute, permanent and all-inclusive power of veto.



The requirement of unanimous vote to amend by-laws is valid. Once proper by-laws have been adopted, the matter of amending them is no concern of the State.

Device

Favorable To:

Limitations

Cumulative voting

MINORITY: assures them of representation on the board

Can‟t give minority control of corp. affairs

Classification of shares

MINORITY: so long as they hold more common stock as opposed to the majority who holds more preferred stock

Preferred and redeemable stock can still vote on certain matters as provided in Sec. 6 or as may be provided by the corp.

Restriction on transfer of shares *applicable only to close corporations

MAJORITY: they can choose whether to keep or release shares and they can prevent opposition from acquiring shares

See Sec. 98

Prescribing qualifications for directors; founder’s shares

MAJORITY: they‟re the ones who can prescribe the qualifications in the by-laws

Qualifications must be reasonable and do not deprive minority of representation on the board

Management contracts

MAJORITY: allows them to delegate certain functions and duties without losing control over the corporation

  

Unusual voting and quorum requirements

MINORITY: gives them stronger veto power in certain corp. affairs

Cannot exceed five years BOD must retain control over corp. policies BOD must have power to recall contract

Subject to the limitations in Sec. 103.

MEETINGS Meetings of Directors / Trustees KINDS:

Meetings of the Board of Directors or Trustees may be either regular or special. (Sec. 49) REGULAR:

SPECIAL:

NOTICE:

Held monthly, unless otherwise provided in the by-laws. (Sec. 53) At any time upon call of the president or as provided in the bylaws.

Must be sent at least 1 day prior to the scheduled meeting, unless otherwise provided by the by-laws. Note:

Notice may be waived expressly or impliedly. (Sec. 53)

WHERE:

Anywhere in or outside the Philippines, unless the by-laws provide otherwise.

QUORUM:

Generally, a majority of the number of directors or trustees as fixed in the articles of incorporation shall constitute a quorum for the transaction of corporate business. (Sec. 25) Exceptions: (1) (2)

WHO PRESIDES:

If the AOI or by-laws provide for a greater majority; If the meeting is for the election of officers, which requires the vote of a majority of all the members of the Board

The president, unless the by-laws provide otherwise. (Sec. 54)

Meetings of Stockholders / Members KINDS:

Meetings of stockholders or members may be either regular or special. (Sec. 49) REGULAR:

Held annually on a date fixed in the by-laws. If no date is fixed, on any date in April of every year as determined by the Board of Directors or trustees.

Notice: Written, and sent to all stockholders or members of record at least 2 weeks prior to the meeting, unless a different period is required by the by-laws. SPECIAL:

At any time deemed necessary or as provided in the by-laws.

Notice: Written, and sent to all stockholders or members of record at least 1 week prior to the meeting, unless otherwise provided in the by-laws. Note:

Notice of any meeting may be waived expressly or impliedly by any SH or member. (Sec. 50)

WHERE:

In the city of municipality where the principal office of the corporation is located, and if practicable in the principal office of the corporation. Metro Manila is considered a city or municipality. (Sec. 51)

QUORUM:

Generally, a quorum shall consist of the stockholders representing a majority of the outstanding capital stock, or a majority of the members. Exception: If otherwise provided for in the Code or in the by-laws.

WHO PRESIDES:

The president, unless the by-laws provide otherwise. (Sec. 54)

WHAT IS THE EFFECT IF A STOCKHOLDER'S MEETING IS IMPROPERLY HELD OR CALLED? Generally, the proceedings had and/or any business transacted shall be void. However, the proceedings and/or transacted business may still be deemed valid if: (1)

Such proceedings or business are within the powers or authority of the corporation; and

(2)

All the stockholders or members of the corporation were present or duly represented at the meeting. (Sec. 51)

DUTIES OF DIRECTORS AND CONTROLLING STOCKHOLDERS

Duties and Liabilities of Directors WHAT IS THE 3-FOLD DUTY THAT DIRECTORS OWE TO THE CORPORATION? (1) Diligence (2) Loyalty (3) Obedience Obedience - directors must act only within corporate powers and are liable for damages if they acted beyond their powers unless in good faith. Assuming that they acted within their powers, liability may still arise if they have not observed due diligence or have been disloyal to the corporation.

WHEN DOES LIABILITY ON THE PART OF DIRECTORS, TRUSTEES OR OFFICERS ARISE? In general, liability of directors, trustees or officers arises when they either: (1) willfully and knowingly vote for or assent to patently unlawful acts of the corporation; or

(2) are guilty of gross negligence of bad faith in directing the affairs of the corporation; or (3) acquire any personal or pecuniary interest in conflict with their duty as such directors or trustees. In such cases, the directors or trustees shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons. When a director, trustee or officer attempts to acquire or acquires, in violation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to which equity imposes a disability upon him to deal in his own behalf, he shall be liable as a trustee for the corporation and must account for the profits which would otherwise have accrued to the corporation. (Sec. 31) In addition to this general liability, the Corporation Code provides for specific rules to govern the following situations: (1) (2) (3) (4)

Self-dealing directors (Sec. 32) Contracts between interlocking directors (Sec. 33) Disloyalty to the corporation (Sec. 34) Watered stocks (Sec. 65)

Duty of Diligence: Business Judgment Rule. WHAT IS THE BUSINESS JUDGMENT RULE? As a general rule, directors and trustees of the corporation cannot be held liable for mistakes or errors in the exercise of their business judgment, provided they have acted in good faith and with due care and prudence. Contracts intra vires entered into by the board of directors are binding upon the corporation, and the courts will not interfere unless such contracts are so unconscionable and oppressive as to amount to a wanton destruction of the rights of the minority. However, if due to the fault or negligence of the directors the assets of the corporation are wasted or lost, each of them may be held responsible for any amount of loss which may have been proximately caused by his wrongful acts or omissions. Where there exists gross negligence or fraud in the management of the corporation, the directors, besides being liable for damages, may be removed by the stockholders in accordance with Sec. 28 of the Code. (Campos & Campos) GENERAL RULE: Contracts intra vires entered into by BoD are binding upon the corporation and courts will not interfere. EXCEPTION:

When such contracts are so unconscionable and oppressive as to amount to a wanton destruction of the rights of the minority.

WHAT KIND OF DILIGENCE IS EXPECTED OF DIRECTORS? Directors are expected to manage the corporation with reasonable diligence, care and prudence, i.e. the degree of care and diligence which men prompted by self-interest generally exercise in their own affairs. Thus, they can be held liable not only for willful dishonesty but also for negligence. Although they are not expected to interfere with the day-to-day administrative details of the business of the corporation, they should keep themselves sufficiently informed about the general condition of the business. WHAT FACTORS SHOULD BE CONSIDERED IN DETERMINING WHETHER REASONABLE DILIGENCE HAS BEEN EXERCISED? The nature of the business, as well as the particular circumstances of each case. The court should look at the facts as they exist at the time of their occurrence, not aided or enlightened by those which subsequently took place. (Litwin v. Allen)

OTIS AND CO. VS PENNSYLVANIA RAILROAD CO. (155 F. 2d 522; 1946) If in the course of management, the directors arrive at a decision for which there is a reasonable basis and they acted in good faith, as a result of their independent judgment, and uninfluenced by any consideration other than what they honestly believe to be for the best interest of the railroad, it is not the function of the court to say that it would have acted differently and to charge the directors for any loss or expenditures incurred. In the present case, the bond issue was adequately deliberated and planned, properly negotiated and executed; there was no lack of good faith; no motivation of personal gain or profit; there was no lack of diligence, skill or care in selling the issue at the price approved by the Commission and which resulted in a saving of approximately $9M to the corporation. MONTELIBANO VS. BACOLOD-MURCIA MILLING CO. (5 SCRA 36; 1962) The Bacolod-Murcia Milling Co. adopted a resolution which granted to its sugar planters an increase in their share in the net profits in the event that the sugar centrals of Negros Occidental should have a total annual production exceeding one-third of the production of all sugar central mills in the province. Later, the company amended its existing milling contract with its sugar planters, incorporating such resolution. The company, upon demand, refused to comply with the contract, stating that the stipulations in the resolution were made without consideration and that such resolution was, therefore, null and void ab initio, being in effect a donation that wasultra vires and beyond the powers of the corporate directors to adopt. This is an action by the sugar planters to enforce the contract. The terms embodied in the resolution were supported by the same cause and consideration underlying the main amended milling contract; i.e., the premises and obligations undertaken thereunder by the planters, and particularly, the extension of its operative period for an additional 15 years over and beyond the thirty years stipulated in the contract. As the resolution in question was passed in good faith by the board of directors, it is valid and binding, and whether or not it will cause losses or decrease the profits of the central, the court has no authority to review them. They hold such office charged with the duty to act for the corporation according to their best judgment, and in so doing, they cannot be controlled in the reasonable exercise and performance of such duty. It is a well-known rule of law that questions of policy or of management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its judgment of the board of directors; the board is the business manager of the corporation, and so long as it acts in good faith, its orders are not reviewable by the courts. LITWIN (ROSEMARIN ET. AL., INTERVENORS) VS. ALLEN ET. AL. (25 N.Y.S. 2d 667; 1940) FACTS: Alleghany Corp. bought terminals in Kansas City and St. Joseph. It needed to raise money to pay the balance of the purchase price but could not directly borrow money due to a borrowing limitation in its charter. Thus, it sold Missouri Pacific bonds to J.P. Morgan and Co. worth $IOM. J.P. Morgan, in turn, sold $3M worth of the bonds to Guaranty Trust Company. Under the contract, the seller was given an option to repurchase at same price within six months. HELD: Option given to seller is invalid. It is against public policy for a bank to sell securities and buy them back at the same price; similarly, it is against public policy for the bank to buy securities and give the seller the option to buy them back at the same price because the bank incurs the entire risk of loss with no possibility of gain other than the interest derived from the securities during the period that the bank holds them. Here, if the market price of the securities rise, the holder of the repurchase option would exercise it to recover the securities at a lower price at which he sold them. If the market price falls, the seller holding the option would not exercise it and the bank would sustain the loss. Directors are not in a position of trustees of an express trust who, regardless of good faith, are personally liable. In this case, the directors are liable for the transaction because the entire arrangement was improvident, risky, unusual and unnecessary so as to be contrary to fundamental conceptions of prudent banking practice. Yet, the advice of counsel was not sought. Absent a showing of exercise of good faith, the directors are thus liable. WALKER VS. MAN, ET. AL. (253 N.Y.S. 458; 1931) FACTS: Frederick Southack and Alwyn Ball loaned Avram $20T evidenced by a promissory note executed by Avram and endorsed by Lacey. The loan was not authorized by any meeting of the board of directors and was not for the benefit of the corporation. The note was dishonored but defendant-directors did not protest the note for non-payment; thus, Lacey, the indorser who was financially capable of meeting the obligation, was subsequently discharged.

HELD: Directors are charged not with misfeasance, but with non-feasance, not only with doing wrongful acts and committing waste, but with acquiescing and confirming the wrong doing of others, and with doing nothing to retrieve the waste. Directors have the duty to attempt to prevent wrongdoing by their co-directors, and if wrong is committed, to rectify it. If the defendant knew that an unauthorized loan was made and did not take steps to salvage the loan, he is chargeable with negligence and is accountable for his conduct. STEINBERG VS. VELASCO (52 Phil. 953; 1929) FACTS: The board of directors of Sibuguey Trading Company authorized the purchase of 330 shares of stock of the corporation and declared payment of P3T as dividends to stockholders. The directors from whom 300 of the stocks were bought resigned before the board approved the purchase and declared the dividends. At the time of purchase of stocks and declaration of dividends, the corporation had accounts payable amounting to P9,241 and accounts receivable amounting to P12,512, but the receiver who made diligent efforts to collect the amounts receivable was unable to do so. It has been alleged that the payment of cash dividends to the stockholders was wrongfully done and in bad faith, and to the injury and fraud of the creditors of the corporation. The directors are sought to be made personally liable in their capacity as directors. HELD: Creditors of a corporation have the right to assume that so long as there are outstanding debts and liabilities, the BOD will not use the assets of the corporation to buy its own stock, and will not declare dividends to stockholders when the corporation is insolvent. In this case, it was found that the corporation did not have an actual bona fide surplus from which dividends could be paid. Moreover, the Court noted that the Board of Directors purchased the stock from the corporation and declared the dividends on the stock at the same Board meeting, and that the directors were permitted to resign so that they could sell their stock to the corporation. Given all of this, it was apparent that the directors did not act in good faith or were grossly ignorant of their duties. Either way, they are liable for their actions which affected the financial condition of the corporation and prejudiced creditors. BARNES V. ANDREWS (298 F. 614; 1924) A complaint was filed against a corporate director for failing to give adequate attention (he relied solely on the President‘s updates on the status of the corp) to the affairs of a corporation which suffered depletion of funds. The director was not liable. The court said that despite being guilty of misprision in his office, still the plaintiff must clearly show that the performance of the director‘s duties would have avoided the losses. When a business fails from general mismanagement, business incapacity, or bad judgment, it is difficult to conjecture that a single director could turn the company around, or how much dollars he could have saved had he acted properly. FOSTER V. BOWEN (41 N.E. 2d 181; 1942) Cushing, a director and in charge of leasing a roller skating rink of the corp, leased the same to himself. Minority stockholders filed suit against Bowen, the corporation's President, to recover for company losses arising out of an alleged breach of fiduciary duty. Bowen was held to be not liable because: (1) Cushing's acts were not actually dishonest or fraudulent; (2) Cushing performed personal work such as keeping the facility in repair which redounded to the benefit of the company and even increased its income; (3) Bowen did not profit personally through Cushing's lease; and (4) the issue of the possible illegality of the lease was put before the Board of Directors, but the Board did not act on it but instead moved on to the next item on the agenda. Absent any bad faith on Bowen's part, and a showing that it was a reasonable exercise of judgment to take no action on the lease agreement at the time it was entered into, Bowen was not liable. LOWELL HOIT & CO. V. DETIG (50 N.E. 2d 602; 1943) Lowell Hoit filed action against directors of a cooperative grain company for an alleged willful conversion by the manager of grain stored in the company facility. The court said that the directors were not personally liable. There was no evidence that the directors had knowledge of the transaction between the manager and Lowell Hoit. The court will treat directors with leniency with respect to a single act of fraud on the part of a subordinate officer/agent. But directors could be held liable if the act of fraud was habitual and openly committed as to have been easily detected upon proper supervision. To hold directors liable, he must have participated in the fraudulent act; or have been guilty of lack of ordinary and reasonable supervision; or guilty of lack of ordinary care in the selection of the officer/agent.

BATES V. DRESSER (40 S.Ct.247; 1920) Coleman, an employee of the bank, was able to divert bank finances for his benefit, resulting in huge losses to the bank. The receiver sued the president and the other directors for the loss. The court said that the directors were not answerable as they relied in good faith on the cashier‘s statement of assets and liabilities found correct by the government examiner, and were also encouraged by the attitude of the president that all was well (the president had a sizable deposit in the bank). But the president is liable. He was at the bank daily; had direct control of records; and had knowledge of incidents that ordinarily would have induced scrutiny.

The self-dealing director WHAT IS A SELF-DEALING DIRECTOR? (Sec. 32) A self-dealing director is one who enters into a contract with the corporation of which he is a director. WHAT IS THE DIRECTORS?

NATURE

OF

CONTRACTS

ENTERED

INTO

BY

SELF-DEALING

Voidable at the option of the corporation, whether or not it suffered damages. It is possible that the self-dealing director may have the greatest interest in its welfare and may be willing to deal with it upon reasonable terms. However, such contract may be upheld by the corporation if all of the following conditions are present: (1)

The presence of the self-dealing director or trustee in the board meeting for which the contract was approved was not necessary to constitute a quorum for such meeting;

(2) The vote of such self-dealing director or trustee was not necessary for the approval of the contract; (3) The contract is fair and reasonable under the circumstances; (4) In the case of an officer, the contract has been previously authorized by the Board of Directors. In the event that either of or both conditions (1) and (2) are absent (i.e., the presence of the director/trustee was necessary for a quorum and/or his vote was necessary for the approval of the contract), the contract may be ratified by a 2/3 vote of the OCS or all of the members, in a meeting called for the purpose. Full disclosure of the adverse interest of the directors or trustees involved must be made at such meeting. DOCTRINE: A director of a corporation holds a position of trust and as such, he owes a duty of loyalty to his corporation. In case his interests conflict with those of the corporation, he cannot sacrifice the latter to his own advantage and benefit. As corporate managers, directors are committed to seek the maximum amount of profits for the corporation. This trust relationship "is not a matter of statutory or technical law. It springs from the fact that directors have the control and guidance of corporate affairs and property and hence of the property interests of the stockholders." (Prime White Cement Corp. v. IAC, 220 SCRA 103; 1993) PALTING V. SAN JOSE PETROLEUM (Dec. 17, 1966) The articles of inc. of respondent included a provision that relieves any director of all responsibility for which he may otherwise be liable by reason of any contract entered into with the corp., whether it be for his benefit or for the benefit of any other person, firm, association or partnership in which he may be interested, except in case of fraud.

SC: This is in direct contravention of the Corp Law, of the traditional fiduciary relationship between directors and the SH. The implication is that they can do anything short of fraud, even to their benefit, and with immunity. Note: This case was decided in 1966 under the Corporation Law, which had no provisions on self-dealing directors. MEAD V. MCCULLOUGH (21 Phil. 95; 1911) Issue: validity of sale of corp. property and assets to the directors who approved the same. Gen Rule: When purely private corporations remain solvent, its directors are agents or trustees for the SH. Exception: when the corp. becomes insolvent, its directors are trustees of all the creditors, whether they are members of the corp. or not, and must manage its property and assets with strict regard to their interest; and if they are themselves creditors while the insolvent corp is under their management, they will not be permitted to secure to themselves by purchasing the corp property or otherwise any personal advantage over the other creditors. Exception to Exception: A director or officer may in good faith and or an adequate consideration purchase from a majority of the directors or SH the property even of an insolvent corp, and a sale thus made to him is valid and binding upon the minority. In the case at bar, the sale was held to be valid and binding. Company was losing. 4 directors present during meeting all voted for the sale. They likewise constitute majority of SH. Contract was found to be fair and reasonable. PRIME WHITE CEMENT CORP. V. IAC (220 SCRA 103; 1993) Prime White Cement Corp. (through the President and Chairman of the Board) and Alejandro Te, a director and auditor of the corporation, entered into a dealership agreement whereby Te was obligated to act as the corporation's exclusive dealer and/or distributor of its cement products in the entire Mindanao area for 5 years. Among the conditions in the dealership agreement were that the corporation would sell to and supply Te with 20,000 bags of white cement per month, and that Te would purchase the cement from the corporation at a price of P 9.70 per bag. Relying on the conditions contained in the dealership agreement, Te entered into written agreements with several hardware stores which would enable him to sell his allocation of 20,000 bags per month. However, the Board of Directors subsequently imposed new conditions, including the condition that only 8,000 bags of cement would be delivered per month. Te made several demands on the corporation to comply with the dealership agreement. However, when the corporation refused to comply with the same, Te was constrained to cancel his agreements with the hardware stores. Notwithstanding the dealership agreement with Te, the corporation entered into an exclusive dealership agreement with a certain Napoleon Co for marketing of corporation's products in Mindanao. The lower court held that Prime White was liable to Te for actual and moral damages for having been in breach of the agreement which had been validly entered into. On appeal, the Supreme Court held that the dealership agreement is not valid and enforceable, for not having been fair and reasonable: the agreement protected Te from any market increases in the price of cement, to the prejudice of the corporation. The dealership agreement was an attempt on the part of Te to enrich himself at the expense of the corporation. Absent any showing that the stockholders had ratified the dealership agreement or that they were fully aware of its provisions, the contract was not valid and Te could not be allowed to reap the fruits of his disloyalty.

Using inside information USE OF INSIDE INFORMATION: Do directors and officers of a company owe any duty at all to stockholders in relation to transactions whereby the officers and directors buy for themselves shares of stock from the stockholders? MINORITY RULE: YES. Directors and officers have an obligation to the stockholders individually as well as collectively. MAJORITY RULE:

NO. Directors and officers owe no fiduciary duty at all to stockholders, but may deal with them at arm‟s length. No duty of disclosure of facts known to

the

director or officer exists. Nondisclosure cannot constitute constructive fraud. SPECIAL FACTS DOCTRINE: IT DEPENDS. Where special circumstances or facts are present which make in inequitable to withhold information from the stockholder, the duty to disclose arises, and concealment is fraud.

In the case of Gokongwei v. SEC (89 SCRA 336; 1979), the Supreme Court, quoting from the US case of Pepper v. Litton (308 U.S. 295-313; 1939) stated that a director cannot, "by the intervention of a corporate entity violate the ancient precept against serving two masters … He cannot utilize his inside information and his strategic position for his own preferment. He cannot violate rules of fair play by doing indirectly through the corporation what he could not do directly. He cannot use his power for his personal advantage and to the detriment of the stockholders and creditors no matter how absolute in terms that power may be and no matter how meticulous he is to satisfy technical requirements. For that power is at all times subject to the equitable limitation that it may not be exercised for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestuis."

Seizing Corporate Opportunity (Sec. 34) If a director acquires for himself, by virtue of his office, a business opportunity which should belong to the corporation, thereby obtaining profits to the prejudice of the corporation, he must account to the corporation for all such profits by refunding the same. However, if his act was ratified by 2/3 stockholders' vote, he need not refund said profits. This provision applies even though the director may have risked his own funds in the venture. Note: This provision is to be distinguished from Sec. 32 on contracts of self-dealing directors: contracts of self-dealing directors are voidable at the option of the corporation even if it has not suffered any injury; on the other hand, Sec. 34 applies only if the corporation has been prejudiced by the contract.

SINGER VS. CARLISLE (27 N.Y.S. 2d 190; 1941) In this case, it was held that the general allegations in the complaint of conspiracy of the directors to obtain corporate opportunity were deficient. The complaint should state specific transactions. Directorship in 2 competing corporations does not in and of itself constitute a wrong. It is only when a business opportunity arises which places the director in a position of serving two masters, and when, dominated by one, he neglects his duty to the other, that a wrong has been done. IRVING TRUST CO. VS. DEUTSCH (79 L. Ed. 1243; 1935) Fiduciary duty applies even if the corporation is unable to enter into transactions itself. LITWIN V ALLEN (25 N.Y.S. 2d 667; 1940) In this case, it was held that the common stock purchased by the defendants wasn‘t a business opportunity for the corporation. Having fulfilled their duty to the corporation in accordance with their best judgment, the defendant directors were not precluded from a transaction for their own account and risk.

Interlocking directors WHAT IS AN INTERLOCKING DIRECTOR?

An interlocking director is one who occupies a position in 2 companies dealing with each other. WHAT IS THE RULE ON CONTRACTS INVOLVING INTERLOCKING DIRECTORS? Except in cases of fraud, and provided the contract is fair and reasonable under the circumstances, a contract between 2 or more corporations having interlocking directors shall not be invalidated on that ground alone. This practice is tolerated by the Courts because such an arrangement oftentimes presents definite advantages to the corporations involved. However, if the interest of the interlocking director in one corporation is substantial (i.e., stockholdings exceed20% of the OCS) and his interest in the other corporation or corporations is merely nominal, he shall be subject to the conditions stated in Sec. 32, i.e., for the contract not to be voidable, the following conditions must be present: (1)

The presence of the self-dealing director or trustee in the board meeting for which the contract was approved was not necessary to constitute a quorum for such meeting; (2) The vote of such self-dealing director or trustee was not necessary for the approval of the contract; (3) The contract is fair and reasonable under the circumstances; (4) In the case of an officer, the contract has been previously authorized by the Board of Directors. In the event that either of or both conditions (1) and (2) are absent (i.e., the presence of the director/trustee was necessary for a quorum and/or his vote was necessary for the approval of the contract), the contract may be ratified by a 2/3 vote of the OCS or all of the members, in a meeting called for the purpose. Full disclosure of the adverse interest of the directors or trustees involved must be made at such meeting. Note: The Investment House Law prohibits a director or officer of an investment house to be concurrently a director or officer of a bank, except as otherwise authorized by the Monetary Board. In no event can a person be authorized to be concurrently an officer of an investment house and of a bank except where the majority or all of the equity of the former is owned by the bank. (P.D. 129, Sec. 6, as amended) The Insurance Code likewise prohibits a person from being a director and/or officer of an insurance company and an adjustment company. (Sec. 187) GLOBE WOOLEN CO. V. UTICA GAS & ELECTRIC (121 N.E. 378; 1918) Maynard, president and chief stockholder of Globe but nominal SH in Utica Gas, obtained a cheap, 10-year contract for Utica to supply power. Maynard did not vote during the meeting for the approval of the contract. Can Globe seek to enforce contract? The Supreme Court held that Globe could not enforce the contract and that said contract was voidable at the election of Utica. It was found that based on the facts of the case, the contract was clearly one-sided. Maynard, although he did not vote, exerted a dominating influence to obtain the contract from beginning to end. The director-trustee has a constant duty not to seek harsh advantage in violation of his trust.

Watered stocks (Sec. 65) Any director or officer of the corporation: (1)

consenting to the issuance of stocks for a consideration less than its par or issued value or for a consideration in any form other than cash, valued in excess of its fair value, or (2) who, having knowledge thereof, does not forthwith express his objection in writing and file the same with the corporation secretary shall be solidarily liable with the stockholders concerned to the corporation and its creditors for the difference between the fair value received at the time of the issuance of the stock and the par or issued value of the same.

Fixing compensation of directors and officers GENERAL RULE:

EXCEPTIONS:

Directors as such are not entitled to compensation for performing services ordinarily attached to their office. (1)

If the articles of incorporation or the by-laws expressly so provide; (2) If a contract is expressly made in advance.

WHO FIXES THE COMPENSATION? EXCEPTION:

The stockholders only (majority of the OCS)

Per diems, which can be fixed by the directors themselves

APPLICABILITY OF COMPENSATION: Only to future and NOT past services. MAXIMUM AMOUNT ALLOWED BY LAW: Total yearly income of the directors shall not exceed 10% of the net income before income tax of the corporation during the preceding year (Sec. 30)

GOV'T OF THE PHILIPPINES VS. EL HOGAR FILIPINO (50 Phil. 399; 1927) The compensation provided in sec. 92 of the by-laws of El Hogar Filipino which stipulated that 5% of the net profit shown by the annual balance sheet shall be distributed to the directors in proportion to the attendance at board meetings is valid. The Corporation Law does not prescribe the rate of compensation for the directors of a corporation. The power to fix it , if any is left to the corporation to be determined in its by-laws. In the case at bar, the provision in question even resulted in extraordinarily good attendance. BARRETO VS. LA PREVISORA FILIPINA This action was brought by the directors of defendant corporation to recover 1% from each of the plaintiffs of the profits of the corporation for 1929 pursuant to a by-law provision which grants the directors the right to receive a life gratuity or pension in such amount for the corporation. The SC held that the by-law provision is not valid. Such provision is ultra vires for a mutual loan and building association to make. It is not merely a provision for the compensation of directors. The authority conferred upon corporations refers only to providing compensation for the future services of directors, officers, and employees after the adoption of the by-law in relation thereto. The by-law can't be held to authorize the giving of continuous compensation to particular directors after their employment has terminated for past services rendered gratuitously by them to the corporation. CENTRAL COOPERATIVE EXCHANGE INC VS. TIBE (33 SCRA 596; 1970) The questioned resolutions which appropriated the funds of the corporation for different expenses of the directors are contrary to the by-laws of the corporation; thus they are not within the board's power to enact. Sec. 8 of the by-laws explicitly reserved to the stockholders the power to determine the compensation of members of the board and they did restrict such compensation to actual transportation expenses plus an additional P30 per diems and actual expenses while waiting. Hence, all other expenses are excluded. Even without the express reservation, directors presumptively serve without pay and in the absence of any agreement in relation thereto, no claim can be asserted therefore. FOGELSON VS. AMERICAN WOOLEN CO. (170 F. 2d. 660; 1948) A retirement plan which provides a very large pension to an officer who has served to within one year of the retirement age without any expectation of receiving a pension would seem analogous to a gift or bonus. The size of such bonus may raise a justifiable inquiry as to whether it amounts to wasting of the corporate property. The disparity also between the president's pension plan and that of even the nearest of the other officers and employees may also be inquired upon by the courts. KERBS VS. CALIFORNIA EASTERN AIRWAYS (90 A. 2d 652; 1952)

This is an appeal filed to enjoin the California Eastern Airways from putting into effect a stock option plan and a profit-sharing plan. The SC held that the stock option plan was deficient as it was not reasonably created to insure that the corporation would receive contemplated benefits. A validity of a stock option plan depends upon the existence of consideration and the inclusion of circumstances which may insure that the consideration would pass to the corporation. The options provided may be exercised in toto immediately upon their issuance within a 6 month period after the termination of employment. In short, such plan did not insure that any optionee would remain with the corporation. With regard to the profit-sharing plan, it was held valid because it was reasonable and was ratified by the stockholders pending the action.

Close Corporations Sec. 97 provides that the AOI of a close corp. may specify that it shall be managed by the stockholders rather than the BoD. So long as this provision continues in effect: 

No stockholder‟s meeting need be called to elect directors;



Generally, stockholders deemed to be directors for purposes of this Code, unless the context clearly requires otherwise;



Stockholders shall be subject to all liabilities of directors. The AOI may likewise provide that all officers or employees or that specified officers or employees shall be elected or appointed by the stockholders instead of by the BoD.

Further, Sec. 100 provides that for stockholders managing corp. affairs: 

They shall be personally liable for corporate torts (unlike ordinary directors liable only upon finding of negligence)



If however there is reasonable adequate liability insurance, injured party has no right of action v. stockholders-managers

Duty of Controlling Interest A SH/director is still entitled to vote in a stockholder‟s meeting even if his interest is adverse to a corporation. But a stockholder able to control a corp. is still subject to the duty of good faith to the corp. and the minority. Persons with management control of corporation hold it in behalf of SHs and can not regard such as their own personal property to dispose at their whim. The ff. acts are legal: 



Transfer of managerial control through BoD resignation & seriatim election of successors if concomitant with the sale and actual transfer of majority interest or that which constitutes voting control; Disposal by controlling SH of his stock at any time & at such price he chooses

The ff. are illegal: 

Selling corp. office or management control by itself, that is NOT accompanied by stocks or stocks are insufficient to carry voting control;



Transferring office to persons who are known or should be known as intending to raid the corporate treasury or otherwise improperly benefit themselves at the expense of the corp. (Insuranshares Corp. V. Northern Fiscal);



Receiving a bonus or premium specifically in consideration of their agreement to resign & install the nominees of the purchaser of their stock, above and beyond the price premium normally attributable to the control stock being sold;

INSURANSHARES CORP. V. NORTHERN FISCAL CORP. (35 F. Supp. 22; 1940) The corp. is suing its former directors to recover damages as a result of the sale of its control to a group (corporate raiders) who proceeded to rob it of most of its assets mainly marketable securities. Are previous directors who sold corp. control liable? Yes, they are under duty not to sell to raiders. Owners of corp. control are liable if under the circumstances, the proposed transfer are such as to awaken a suspicion or put a prudent man on his guard. As in this case, control was bought for so much aside from being warned of selling to parties they knew little about, and also from fair notice that such outsiders indeed intended to raid the corp.

Duty to Creditors General rule: Corporate creditors can run after the corp. itself only, and not the directors for mismanagement of a solvent corp. If corp. becomes insolvent, directors are deemed trustees of the creditors and should therefore manage its assets with due consideration to the creditor‟s interest. If directors are also creditors themselves, they are prohibited from gaining undue advantage over other creditors.

Personal Liability of Directors In what instances does personal liability of a corporate director, trustee or officer validly attach together with corporate liability? When the director / trustee / officer: I.

(1) assents to a patently unlawful act of the corporation; (2) is in bad faith or gross negligence in directing the affairs of the corporation; (3) creates a conflict of interest, resulting in damages to the corporation, its stockholders or other persons

II.

Consents to the issuance of watered stocks, or who, having knowledge thereof, does not forthwith file with the corporate secretary his written objection thereto;

III. IV.

Agrees to hold himself personally and solidarily liable with the corporation; Is made, by a specific provision of law, to personally answer for his corporate action. (Tramat Mercantile v. CA, 238 SCRA 14)

UICHICO v. NLRC (G.R. No. 121434, June 2, 1997) In labor cases, particularly, corporate directors and officers are solidarily liable with the corporation for the termination of employment of corporate employees done with malice or in bad faith.

In the instant case, there was a showing of bad faith: the Board Resolution retrenching the respondents on the feigned ground of serious business losses had no basis apart from an unsigned and unaudited Profit and Loss Statement which had no evidentiary value whatsoever.

CORPORATE BOOKS AND RECORDS AND THE RIGHT OF INSPECTION Corporate Books and Records WHAT BOOKS AND RECORDS MUST A CORPORATION KEEP? (Sec. 74) (1) (2) (3) (4)

Record of all business transactions; Minutes of all meetings of stockholders or members; Minutes of all meetings of Board of Directors or Trustees; Stock and Transfer book

WHAT IS A STOCK AND TRANSFER BOOK? (Sec. 75) A stock and transfer book is a record of all stocks in the names of the stockholders alphabetically arranged. It likewise contains the following information: 

Installments paid and unpaid on all stock for which subscription has been made, and the date of any installment;



A statement of every alienation, sale or transfer of stock made, the date thereof, and by whom and to whom made;



Such other entries as the by-laws may prescribe

The stock and transfer book shall be kept in the principal office of the corporation or in the office of its stock transfer agent, and shall be open for inspection by any director or stockholder of the corporation at reasonable hours on business days. WHAT IS A STOCK TRANSFER AGENT? (Sec. 75) A stock transfer agent is one who is engaged principally in the business of registering transfers of stocks in behalf of a stock corporation. He or she must be licensed by the SEC; however, a stock corporation is not precluded from performing or making transfer of its own stocks, in which case all the rules and regulations imposed on stock transfer agents, except the payment of a license fee, shall be applicable. WHO IS THE CUSTODIAN OF CORPORATE RECORDS? In the absence of any provision to the contrary, the corporate secretary is the custodian of corporate records. Corollarily, he keeps the stock and transfer book and makes the proper and necessary entries. (Torres, et al. vs. CA, 278 SCRA 793; 1997)

Basis of the Right of Inspection Ordinary stockholders, the beneficial owners of the corporation, usually have no say on how business affairs of the corp. are run by the directors. The law therefore gives them the right to know not only the financial health of the corp. but also how its affairs are managed so that if they find it unsatisfactory, they can seek the proper remedy to protect their investment. WHAT IS THE NATURE OF THE RIGHT TO INSPECT?

PREVENTIVE :

deterrent to an ill-intentioned management knowing its acts are subject to scrutiny; and

REMEDIAL:

A dissatisfied SH may avail of this right as a preliminary step towards seeking more direct and appropriate remedies against mismanagement.

What Records Covered 1.

Records of ALL business transactions This includes book of inventories and balances, journal, ledger, book for copies of letters and telegrams, financial statements, income tax returns, vouchers, receipts, contracts, papers pertaining to such contracts, voting trust agreements (sec. 59)

2.

By-laws These are expressly required to be open to inspection by SH/members during office hours (Sec. 46). Note: There is no similar provision as to AOI, but these are filed with the SEC anyway.

3.

Minutes of director’s meetings This is to inform stockholders of Board policies. Such right arises only upon approval of the minutes, however.

4.

Minutes of stockholders' meetings

5.

Stock and transfer books These are records of all stocks in the names of the stockholders alphabetically arranged. contain all names of the stockholders of record. Useful for proxy solicitation for elections. SEC has however ruled that a SH cannot demand that he be furnished such a list but he is free to examine corp. books.

6.

Most recent financial statement Sec. 75 of the Code provides that within 10 days from the corporation's receipt of a written request from any stockholder or member, the corporation must furnish the requesting party with a copy of its most recent financial statement, which shall include a balance sheet as of the end of the last taxable year and a profit or loss statement for said taxable year.

Note: Under the Secrecy of Bank Deposits Act, records of bank deposits of the corporation are NOT open to inspection, EXCEPT under the following circumstances: (1)

Upon written consent of concerned depositor (presumably the corporation); (2) In cases of impeachment; (3) Upon court order in cases of bribery or dereliction of duty of a public official; and (4) In cases where the money deposited / invested is the subject matter of litigation (5) Upon order of a competent court in cases of unexplained wealth under RA 3019 or the Anti-Graft and Corrupt Practices Act (6) Upon order of the Ombudsman

Extent and Limitations on Right

1.

2. 3.

The exercise of this right is subject to reasonable limitations similar to a citizen‟s exercise of the right to information. Otherwise, the corp. might be impaired, its efficiency in operations hindered, to the prejudice of SHs. Such limitations to be valid must be reasonable and not inconsistent with law ( Sec. 36[5] and 46). A corp. may regulate time and manner of inspection but provisions in its by-law which gives directors absolute discretion to allow or disallow inspection are prohibited. Limitations as to time and place:  Exercise of right only at REASONABLE HOURS on BUSINESS DAYS.  Such business days should be THROUGHOUT THE YEAR. BoD cannot limit such to merely a few days within the year. (Pardo v. Hercules Lumber)

4.

By-laws cannot prescribe that authority of president must first be obtained.

5.

Inspection should be made in such a manner as not to impede the efficient operations

6.

7.

Place of inspection: Principal office of the corp. SH cannot demand that such records be taken out of the principal office. As to purpose:   

PRESUMPTION: that SH‟s purpose is proper. Corp. cannot refuse on the mere belief that his motive is improper (sec 74). BURDEN OF PROOF: lies with corp. which should show that purpose was illegal. To be legitimate, the purpose for inspection must be GERMANE to the INTEREST of the stockholder as such, and it is not contrary to the interests of the corporation. Legitimate: Not legitimate:

 

inquiry about failure to declare dividends for mere satisfaction or speculation.

Belief in good faith that a corp. is being mismanaged may be given due course even if later, this is proven unfounded. If motive can be clearly shown as inimical to corp., right may be denied.

Who May Exercise Right Every director, trustee, stockholder, member may exercise right personally or through an agent who can better understand and interpret records (impartial source, expert accountant, lawyer). As to VTA: both voting trustee and transferor SH of parent corp. over subsidiary: If the two are operated as SEPARATE entities

: NO right of inspection

If they are ONE AND THE SAME with respect to management and control, and inspection is demanded due to mismanagement of subsidiary by the parent‟s directors who are also directors of the subsidiary : With right of inspection If the subsidiary is wholly-owned by the parent, and its books & records are in the possession and control of the parent corporation : With right of inspection

(Gokongwei v. SEC)

Remedies available if Inspection Refused WHAT REMEDIES ARE AVAILABLE IF INSPECTION IS REFUSED BY THE CORPORATION? (1) Writ of mandamus. NOTE:

Writ shall not issue where it is shown that the petitioner’s purpose is improper and inimical to the interests of the corporation. Writ should be directed against the corporation. the president may be joined as party defendants.

The secretary and

(2) Injunction (3) Action for damages against the officer or agent refusing inspection. Also, penal sanctions such as fines and / or imprisonment (Sec. 74; Sec. 144) What defenses are available to the officer or agent? (1)

The person demanding has improperly used any information secured through any prior examination; or (2) Was not acting in good faith; or (3) The demand was not for a legitimate purpose.

PARDO V. HERCULES LUMBER (47 Phil. 965; 1924) BOD/Officers may deny inspection when sought at unusual hours or under improper conditions. But they cannot deprive the stockholders of the right altogether. In CAB, by-law provided that the inspection be made available only for a few days in a year, chosen by the directors. This is void.

GONZALES V. PNB (122 SCRA 490; 1983) G acquired 1 share of stock purposely to be able to exercise right to inspection with respect to transactions before he became a SH. G not in good faith. His obvious purpose was to arm himself with materials which he can use against the bank for acts done by the latter when G was a total stranger to the same. Right not available here.

VERAGUTH V. ISABELA SUGAR CO. (57 Phil. 266; 1932) There was nothing improper in the secretary‘s refusal since the minutes of these prior meetings have to be verified, confirmed and signed by the directors then present. Hence, Veraguth has to wait until after the next meeting.

GOKONGWEI V. SEC (April 11, 1979) The law takes from the SH the burden of showing impropriety of purpose and places upon the corporation the burden of showing impropriety of purpose and motive. Considering that the foreign subsidiary is wholly owned by SMC and therefore under its control, it would be more in accord with equity, good faith and fair dealing to construe the statutory right of Gokongwei as petitioner as SH to inspect the books and records of such wholly subsidiary which are in SMC‘s possession and control.

DERIVATIVE SUITS

Nature and Basis of derivative suit Suits of stockholders/ members based on wrongful or fraudulent acts of directors or other persons: a.

Individual suits - wrong done to stockholder personally and not to other stockholders (ex. When right of inspection is denied to a stockholder)

b.

Class suit - wrong done to a group of stockholders (ex. Preferred stockholders' rights are violated)

c.

Derivative suit - wrong done to the corporation itself  



Cause of action belongs to the corp. and not the stockholder But since the directors who are charged with mismanagement are also the ones who will decide WON the corp. will sue, the corp. may be left without redress; thus, the stockholder is given the right to sue on behalf of the corporation. An effective remedy of the minority against the abuses of management



An individual stockholder is permitted to bring a derivative suit to protect or vindicate corporate rights, whenever the officials of the corp. refuse to sue or are the ones to be sued or hold the control of the corp.



Suing stockholder is merely the nominal party and the corp. is actually the party in interest.



A SH can only bring suit for an act that took place when he was a stockholder; not before. (Bitong v. CA, 292 SCRA 503)

Requirements Relating to Derivative Suits WHAT ARE THE LEGAL PRINCIPLES CONCERNING DERIVATIVE SUITS? 1)

Stockholder/ member must have exhausted all remedies within the corp.

2)

Stockholder/ member must be a stockholder/ member at the time of acts or transactions complained of or in case of a stockholder, the shares must have devolved upon him since by operation of law, unless such transaction or act continues and is injurious to the stockholder.

3)

Any benefit recovered by the stockholder as a result of bringing derivative suit must be accounted for to the corp. who is the real party in interest.

4)

If suit is successful, plaintiff entitled to reimbursement from corp. for reasonable expenses including attorneys' fees.

EVANGELISTA VS. SANTOS (86 Phil. 387; 1950) The injury complained of is against the corporation and thus the action properly belongs to the corporation rather than the stockholders. It is a derivative suit brought by the stockholder as a nominal party plaintiff for the benefit of the corporation, which is the real party in interest. In this case, plaintiffs brought the suit not for the benefit of the corporation's interest, but for their own. Plaintiffs here asked that the defendant make good the losses occasioned by his mismanagement and to pay them the value of their respective participation in the corporate assets on the basis of their respective holdings. Petition dismissed for venue improperly laid.

REPUBLIC BANK VS. CUADERNO (19 SCRA 671; 1967)

In a derivative suit, the corporation is the real party in interest, and the stockholder merely a nominal party. Normally, it is the corp. through the board of directors which should bring the suit. But as in this case, the members of the board of directors of the bank were the nominees and creatures of respondent Roman and thus, any demand for an intracorporate remedy would be futile, the stockholder is permitted to bring a derivative suit. Should the corporation be made a party? The English practice is to make the corp. a party plaintiff while the US practice is to make it a party defendant. What is important though is that the corporation should be made a party in order to make the court's ruling binding upon it and thus bar any future re-litigation of the issues. Misjoinder of parties is not a ground to dismiss the action.

REYES VS. TAN (3 SCRA 198; 1961) The importation of textiles instead of raw materials, as well as the failure of the board of directors to take actions against those directly responsible for the misuse of the dollar allocations constitute fraud, or consent thereto on the part of the directors. Therefore, a breach of trust was committed which justified the suit by a minority stockholder of the corporation. The claim that plaintiff Justiniani did not take steps to remedy the illegal importation for a period of two years is also without merit. During that period of time plaintiff had the right to assume and expect that the directors would remedy the anomalous situation of the corporation brought about by their wrong-doing. Only after such period of time had elapsed could plaintiff conclude that the directors were remiss in their duty to protect the corporation property and business.

BITONG v. CA (292 SCRA 503) 

The power to sue and be sued in any court by a corporation even as a stockholder is lodged in the Board of Directors that exercises its corporate powers and not in the president or officer thereof. 



It was JAKA's Board of Directors, not Senator Enrile, which had the power to grant Bitong authority to institute a derivative suit for and in its behalf.

The basis of a stockholder's suit is always one in equity. However, it cannot prosper without first complying with the legal requisites for its institution. The most important of these is the bona fide ownership by a stockholder of a stock in his own right at the time of the transaction complained of which invests him with standing to institute a derivative action for the benefit of the corporation.

FINANCING THE CORPORATION

Sources of Financing WHERE CAN CAPITAL TO FINANCE THE CORPORATION BE SOURCED? 1) 2) 3)

Contributions (stockholders); also known as stockholder equity/equity investment Loans or advances (creditors) Profits (corporation itself)

Capital Structure WHAT IS MEANT BY CAPITAL STRUCTURE? This refers to the aggregate of the securities -- instruments which represent relatively longterm investment -- issued by the corporation. There are basically 2 kinds of securities: shares of stock and debt securities.

Capital and Capital Stock Distinguished

CAPITAL STOCK

CAPITAL

DEFINITION

the amount fixed, usually by the corporate charter, to be subscribed and paid in or secured to be paid in by the SHS of a corporation, and upon which the corporation is to conduct its operation

actual property of the corporation, including cash, real, and personal property. Includes all corporate assets, less any loss which may have been incurred in the business.

CONSTANCY

CONSTANT, unless amended by the AOI

FLUCTUATING

Shares of Stock: Kinds

DEFI NITIO N

VALU E

CO MM ON

PRE FER RED

Sto ck whi ch enti tles the ow ner of suc h sto cks to an equ al pro rat a divi sio n of pro fits

Stock which entitl es the holde r to some prefe rence either in the divid ends or distri butio n of asset s upon liquid ation, or in both

De pen ds if it‟s par or no par

State d par value

PA R

Fix ed in the A OI, an d ind ica ted in the sto ck cer tifi cat e. Ma y

NO PA R*

Val ue not fixe d in the AO I, an d the ref ore not indi cat ed in the sto

TRE ASU RY

REDE EMAB LE

FOU NDE R’S

Shar es that have been issu ed and fully paid but subs eque ntly reac quire d by the issui ng corp orati on by lawf ul mea ns.

Share s issued by the corpor ation that may be taken up by the corpor ation upon expira tion of a fixed period .

Spe cial shar es who se excl usiv e right s and privil eges are dete rmin ed by the AOI.



regard less of the existe nce of unrest ricted retain ed earnin gs

VOTI NG RIGH TS

Us uall y ves ted wit h the exc lusi ve righ t to vot e

Can vote only under certai n circu msta nces

PREF EREN CE UPO N LIQUI DATI ON

No adv ant age , prio rity, or pre fer enc e ove r

First crack at divid ends / profit s/ distri butio n of asset s

be sol d at a val ue hig he r, but not lo we r, tha n tha t fix ed in the A OI.

ck cer tific ate . Pri ce ma y be set by BO D, SH ‟s or fixe d in the AO I ev ent uall y.

De pe nd s if it‟s co m mo n or pr efe rre d.

De pe nd s if it‟s co m mo n or pre ferr ed.

No votin g right s for as long as such stoc k rem ains in the treas ury (Sec . 57)

Usuall y denie d voting rights.

any oth er SH in the sa me cla ss NOTE: Only preferred and redeemable shares may be deprived of the right to vote. (Sec. 6, Corporation Code) EXCEPTION: As otherwise provided in the Corporation Code. * No-par value shares may not be issued by the following entities: banks, trust companies, insurance companies, public utilities, building & loan association (Sec. 6)

Nature of Subscription Contract WHAT IS A SUBSCRIPTION CONTRACT? It is any contract for the acquisition of unissued stock in an existing corporation or a corporation still to be formed. This is notwithstanding the fact that the parties refer to it as a purchase or some other contract. (Sec. 60)

WHAT IS THE NATURE OF A SUBSCRIPTION CONTRACT? 

Subscriptions constitute a fund to which the creditors have a right to look for satisfaction of their claims.



The assignee in insolvency can maintain an action upon any unpaid stock subscription in order to realize assets for the payment of its debts.

 

A subscription contract is INDIVISIBLE (Sec. 64). A subscription contract subsists as a liability from the time that the subscription is made until such time that the subscription is fully paid.

GARCIA V. LIM CHU SING (59 Phil. 562; 1934) A share of stock or the certificate thereof is not an indebtedness to the owner nor evidence of indebtedness and therefore, it is not a credit. Stockholders as such are not creditors of the corporation. The capital stock of a corporation is a trust fund to be used more particularly for the security of the creditors of the corporation who presumably deal with it on the credit of its capital.

Pre-incorporation subscription RULE: When a group of persons sign a subscription contract, they are deemed not only to make a continuing offer to the corporation, but also to have contracted with each other as well. Thus, no one may revoke the contract even prior to incorporation without the consent of all the others. WHEN IS A PRE-INCORPORATION SUBSCRIPTION IRREVOCABLE? 1)

For a period of at least 6 months from the date of subscription; EXCEPTIONS:

(1)

unless all of revocation; or

the

other

subscribers

consent

to

the

(2)

unless the incorporation of said corporation fails to materialize within the said period or within a longer period as may be stipulated in the contract of subscription 2) After the AOI have been submitted to the SEC (Sec. 61)

UTAH HOTEL CO V. MADSEN (43 Utah 285, 134 Pac. 557; 1913) Sec 332 in express terms confers powers upon the stockholders ―to regulate the mode of making subscriptions to its capital stock and calling in the same by-laws or by express contract.‖ Since it may be done by express contract, this shows that it was intended that a contract to that effect may be entered into even before the corporation is organized, and the contract agreement is enforced if the corporation is in fact organized.

WALLACE V. ECLIPSE POCAHONTAS COAL CO (98 S.E. 293; 1919) One who has paid his subscription to the capital stock of the corporation may compel the issuance of proper certificates therefor.

Post-incorporation subscription NOTE:

Under the Corporation Code, there is no longer any distinction between a subscription and a purchase. Thus, a subscriber is liable to pay for the shares even if the corporation has become insolvent.

The Preemptive Right to Shares WHAT IS THE PRE-EMPTIVE RIGHT? It is the option privilege of an existing stockholder to subscribe to a proportionate part of shares subsequently issued by the corporation, before the same can be disposed of in favor others. WHY A PRE-EMPTIVE RIGHT? To protect existing stockholder equity. If the right is not recognized, the SH‟s interest in the corporation will be diluted by the subsequent issuance of shares.

Basis of Right; Common Law Rule Under the prevailing view in common law, the preemptive right is limited to shares issued in pursuance of an increase in the authorized capital stock and does not apply to additional issues of originally authorized shares which form part of the existing capital stock. This common law principle which was generally understood to be applicable in this jurisdiction has now to give way to the express provisions of the Corporation Code on the matter.

Extent and Limitations of Preemptive Right under the Code WHAT IS THE EXTENT OF THE PRE-EMPTIVE RIGHT? All stockholders of a stock corporation shall enjoy pre-emptive right to subscribe to all issues or dispositions of shares of any class, in proportion to their respective shareholdings. Exception: When such right is denied by the AOI or an amendment thereto. LIMITATIONS: The pre-emptive right does not extend to: (Sec. 39) 1) 2)

Initial Public Offerings (IPOs); Issuance of shares in exchange for property needed for corporate purposes, including cases wherein an absorbing corporation issues new stocks to the SH‟s in pursuance to the merger agreement (Sec. 39) Why? cash;

(a) Because it is beneficial for the corporation to save its (b) A swap is more expedient than determining the monetary

equivalent of the property. 3)

Issuance of shares in payment of a previously contracted debt (Sec. 39) Why?

(a) The obligation is extinguished outright; (b) Corporation does not have to shell out money to fulfill its obligations; (c) Money that would have otherwise been used for interest payments can be channelled to more corporate activities.

productive

Note: In Nos. (2) and (3), such acts require approval of 2/3 of the OCS or 2/3 of total members.

In Close Corporations In close corporations, the preemptive rights extends to ALL stock to be issued, including re-issuance of treasury shares, EXCEPT if provided otherwise by the AOI. (Sec. 102). Note that the limitations in Sec. 39 do not apply.

Waiver of Preemptive Right The waiver of the preemptive right must appear in the Articles of Incorporation or an amendment thereto in order to be binding on ALL stockholders, particularly future stockholders. (Sec. 39) If it appears merely in a waiver agreement and NOT in the AOI, and was unanimously agreed to by all existing stockholders:  The existing stockholders cannot later complain since they are all bound to their private agreement.  However, future stockholders will NOT be bound to such an agreement. Any stockholder who has not exercised his preemptive right within a reasonable time will be deemed to have waived it.

When the issue is in breach of trust The issue of shares may still be objectionable if the Directors have acted in breach of trust and their primary purpose is to perpetuate or shift control of the corporation, or to “freeze out” the minority interest.

Remedies when right violated/denied WHAT ARE THE REMEDIES WHEN THE PRE-EMPTIVE RIGHT IS UNLAWFULLY DENIED? (1) Injunction; (2) Mandamus; (3) Cancellation of the shares (NOTE: but only if no innocent 3rd parties are prejudiced) (4) In certain cases, a derivative suit

STOKES V. CONTINENTAL TRUST CO. (78 N.E. 1090; 1906) The directors were under the legal obligation to give the SH-plaintiff an opportunity to purchase at the price fixed before they could sell his property to a third party. By selling to strangers without first offering to sell to him, the defendant wrongfully deprived him of his property and is liable for such damages as he actually sustained.

THOM V. BALTIMORE TRUST (148 Atl. 234; 1930) Independently of the charters, the SHs of a corporation have a preferential right to purchase new issues of shares, to the proportional extent of their respective interests in the capital stock then outstanding, when the privilege can be exercised consistently with the object which the disposition of the additional stock is legally designed to accomplish. In the present case, every SH of the bank, for each of the shares, was to receive 1 1/2 shares of the stock co. (share in exchange for property). It would not be feasible to consummate a transfer based upon such consideration if the preemptive right were to be held enforceable with respect to every new issue of stock regardless of the object of the disposition. FULLER V. KROGH (113 N.W. 2d 25; 1962) Preemptive right is not to be denied when the property is to be taken as consideration for the stock except in those peculiar circumstances when the corporation has great need for the particular property, and the issuance of stock is the only practical and feasible method by which the corp. can acquire it for the best interest of the SHs. Ground: practical necessity. [cf. Sec. 39] DUNLAY V. M. GARAGE AND REPAIR (170 N.E. 917; 1930) If the issue of shares is reasonably necessary to raise money to be issued in the business of the corporation rather than the expansion of such business beyond original limits, the original SHs have no right to count on obtaining and keeping their proportional part of original stock. But even if preemptive right does not exist, the issue of shares may still be objectionable if the directors have acted in breach of trust and their primary purpose is to perpetuate or shift control of the corporation, or to ‗freeze out‘ minority interest. ROSS TRANSPORT V. CROTHERS (45 A. 2d 267; 1946) The doctrine of preemptive right is not affected by the identity of the purchasers. What it is concerned with is who did not get it. But when officers and directors sell to themselves and thereby gain an advantage, both in value and in voting power, another situation arises. In the case at bar, the directors were not able to prove good faith in the purchase and equity of transaction, since the corp. was a financial success. There was constructive fraud upon the other SHs.

Debt Securities Borrowings Borrowings are usually represented by promissory notes, bonds or debentures. Oftentimes, a financial institution will be willing to lend large amounts to private corporations only on the condition that such institution will have some representation on the Board of Directors. The role of such representative is to see to it that his institution's investment is protected from mismanagement or unfavorable corporate policies. Bonds and Debentures BONDS:

 secured by a mortgage or pledge of corporate property  must be registered with the SEC, as provided by Sec. 38 of the Corporation Code

DEBENTURES:  issued on the general credit of the corporation  not secured by any collateral; THEREFORE, are not bonded indebtedness in the true sense, and stockholder approval is NOT required (although it would generally be a good idea to obtain it) Convertible securities; stock options NOTE: Under the SEC rules, stock option must first be approved by the SEC.

Also, if the stock option is granted to non-stockholders, or to directors, officers, or managing groups, there must first be SH approval of 2/3 of the OCS before the matter is submitted to the SEC for approval. Of course it goes without saying that the corporation must set aside enough of the junior securities in case the holders of the option decide to exercise such option. MERRITT-CHAPMAN & SCOTT CORP. VS. NEW YORK TRUST CO. (184 F. 2d 954; 1950) If the corporation is allowed to declare stock dividends without taking account of the warrant holders (who have not yet exercised their warrant), the percentage of interest in the common stock capital of the corporation which the warrant holders would acquire, should they choose to do so, could be substantially reduced/diluted. Thus, the corporation is wrong in contending that a warrant holder must first exercise his warrant before they may be issued stock dividend.

Hybrid securities Because preferred shares and bonds are created by contract, it is possible to create stock which approximates the characteristics of debt securities. Hybrid securities, as the name implies, therefore combine the features of preferred shares and bonds. Determining the true nature of the security is crucial for tax purposes. The American courts use the following criteria: (1) Is the corporation liable to pay back the investor at a fixed maturity date? (2) Is interest payable unconditionally at definite intervals, or is it dependent on earnings? (3) Does the security rank at least equally with the claims of other creditors, or is it subordinate to them?

WHAT IS THE NATURE OF THE SECURITY AND THE PAYMENT MADE? BONDS

STOCK

WHAT IS PAID?

Interest

Dividends

TO WHOM PAID?

Creditor-investor

Stockholder

WHEN PAID?

Whether the corporation has profits or not

Only if there are profits

NATURE

Expense

Not an expense

TAXABILITY

Can be deducted for tax purposes

CANNOT be deducted

MATURITY DATE?

Yes

No

RANK ON DISSOLUTION

Ranked together with other corporate creditors

Superior to stockholders, inferior to corporate creditors

JOHN KELLY VS. CIR TALBOT MILLS VS. CIR (326 U.S. 521; 1946)

In the Kelly case, the annual payments made were interest on indebtedness (therefore, a bond is held) because there were sales of the debentures as well as exchanges of preferred stock for debentures, a promise to pay a certain annual amount if earned, a priority for the debentures over common stock and a definite maturity date in the reasonable future. In the Talbot Mills case, the annual payments made were dividends and not interest (therefore, shares are held), because of the presence of fluctuating annual payments with a 2% minimum, and the limitation of the issue of notes to stockholders in exchange only for stock. Besides, it is the Tax Court which has final determination of all tax issues which are not clearly delineated by law. JORDAN CO. VS. ALLEN (85 F. Supp. 437; 1949) The payments made, regardless of what they are called, are in fact dividends (on stocks) because of the absence of a maturity date and the right to enforce payment of the principal sum by legal action, among other factors. The following criteria should be used in determining whether a payment is for interest or dividends: (1) maturity date and the right to enforce collection; (2) treatment by the parties; (3) rank on dissolution; (4) uniform rate of interest payable or income payable only out of profits; (5) participation in management and the right to vote. It must be noted that these criteria are not of equal importance and cannot be relied upon individually. E.g. treatment accorded the issuance by the parties cannot be sufficient as this would allow taxpayers to avoid taxes by merely naming payments as interest.

The trust indenture Here, the bond issue usually involves 3 parties: (1) debtor-corporation (2) creditor-bondholder (3) trustee: representative of all the bondholders

ALADDIN HOTEL CO. VS. BLOOM (200 F. 2d 627; 1953) The rights of bondholders are to be determined by their contract and courts will not make or remake a contract merely because one of the parties may become dissatisfied with its provisions. If the contract is legal, the courts will interpret and enforce it. In the deed of trust and bonds in this case, there are provisions empowering bondholders of 2/3 of the principal amount or more, by agreement with the company, to modify and extend the date of payment of the bonds provided such extension affected all bonds alike. When this was done, the bondholders only followed such provisions in good faith. The company benefited because of such move, and the bondholders were not necessarily prejudiced, as defendants Joneses in this case were themselves owners of 72% of the bond issue.

CONSIDERATION FOR ISSUANCE OF SHARES Form of Consideration WHAT FORMS OF CONSIDERATION ARE ACCEPTABLE FOR ISSUANCE OF SHARES?  

cash; property actually received by the corporation: must be necessary or convenient for its use and lawful purposes;

   

labor performed for or services actually rendered to the corporation (NOTE: Future services are NOT acceptable!); previously incurred indebtedness by the corporation; amounts transferred from unrestricted retained earnings to stated capital; outstanding shares exchange for stocks in the event of reclassification or conversion

WHAT FORMS ARE UNACCEPTABLE?   

future services promissory notes value less than the stated par value

HOW IS THE ISSUED PRICE OF NO-PAR SHARES FIXED? It may be fixed as follows: (1)

In the AOI; or

(2)

By the BOD pursuant to authority conferred upon it by the AOI or the by-laws; or

(3)

In the absence of the foregoing, by the SHs representing at least a majority of the outstanding capital stock at a meeting duly called for the purpose (Sec. 62)

IF THE CONSIDERATION FOR SHARES IS OTHER THAN CASH, HOW IS THE VALUE THEREOF DETERMINED? It is initially determined by the incorporators or the Board of Directors, subject to approval by the SEC. (Sec. 62)

Watered Stocks WHAT IS WATERED STOCK? Stocks issued as fully paid up in consideration of property at an overvaluation. Oftentimes, the consideration received is less than the par value of the share. NOTE: No-par shares CAN be watered stock: when they are issued for less than their issued value as fixed by the corp. in accordance with law.

WHAT ARE THE WAYS BY WHICH WATERED STOCK CAN BE ISSUED? (1)

Gratuitously, under an agreement that nothing shall be paid to the corporation;

(2)

Upon payment of less than its par value in money or for cost at a discount;

(3)

Upon payment with property, labor or services, whose value is less than the par value of the shares; and

(4)

In the guise of stock dividends representing surplus profits or an increase in the value of property, when there are no sufficient profits or sufficient increases in value to justify it.

WHAT IS THE LIABILITY OF DIRECTORS FOR THE ISSUANCE OF WATERED STOCK?

Directors and officers who consented to the issuance of watered stocks are solidarily liable with the holder of such stocks to the corp. and its creditors for the difference between the fair value received at the time of the issuance and the par or issued value of the share. The liability will be to all creditors, whether they became such prior or subsequent to the issuance of the watered stock. Reliance by the creditors on the alleged valuation of corporate capital is immaterial and fraud is not made an element of liability. NOTE: In the Philippines, it is the statutory obligation theory that is controlling (cf. Sec. 65).

PRIVATE TRIPLEX SHOE V. RICE & HUTCHINSTC \L 1 "TRIPLEX SHOE V. RICE & HUTCHINS" (72 A.L.R. 932; 1930) In this case, the stocks issued to the Dillman faction were no par value shares, the consideration for which were never fixed as required by law. Hence, their issuance was void. Moreover, the stocks were issued to the Dillmans for services rendered and to be rendered. Future services are not lawful consideration for the issuance of stock.

PRIVATE MCCARTY V. LANGDEAUTC \L 1 "MCCARTY V. LANGDEAU" (337 S.W. 2d 407; 1960) McCarty agreed to purchase shares of a corp. with a downpayment of only $20, with the balance due to be evidenced by a note. McCarty failed to pay a big portion of the balance. The Court affirmed the judgement against McCarty for the balance due on the contract. McCarty contends that the contract is void. But the law only prohibits the issuance of stock. If it is understood that the stock will not be issued to the subscriber until the note is paid, the contract is valid and not illegal. If a security such as a note, which is not a valid consideration, is accepted, the law does not say that such note, or the stock issued for it, shall be void. What is void by express provision of law is the fictitious increase of stock or indebtedness. The law was designed for the protection of the corporation and its creditors. It emphasizes the stockholder‘s obligations to make full and lawful payment in accord with its mandate, rather than furnish him with a defense when he has failed in that obligation. Its purpose is to give integrity to the corporation‘s capital. None of these objects would be promoted by declaring a note given by a subscriber for stock uncollectible in the hands of a bona fide stockholder.

RHODE V. DOCK-HOP CO. (12 A.L.R. 437; 1920) This case involves an action to collect unpaid balances on par value of shares. It was held that innocent transferees of watered stock cannot be held to answer for the deficiency of the stocks even at the suit of the creditor of the company. The creditor‘s remedy is against the original owner of the watered stock.

PRIVATE BING CROSBY V. EATONTC \L 1 "BING CROSBY V. EATON" (297 P. 2d 5; 1956) A subscriber to shares who pays only part of what he agreed to pay is liable to creditors for the balance. Holders of watered stock are generally held liable to the corporation‘s creditors for the difference between the par value of the stock and the amount paid in. Under the misrepresentation theory, the creditors who rely on the misrepresentation of the corporation‘s capital stock are entitled to recover the ―water‖ from holders of the watered stock. Reliance of creditors on the misrepresentation is material. However, under the statutory obligation theory, reliance of creditors on the capital stock of the corporation is irrelevant. (It must be noted that here in the Philippines, it is the statutory obligation theory which is prevailing.)

Issuance of Certificate Certificate of stock

CONDITION FOR ISSUANCE:

payment of full amount of subscription price plus interest, if any is due (Sec. 64)

CERTIFICATION THAT: person named therein is a holder or owner of a stated number of shares in the corporation. INDICATES:

BEARS:

AMOUNT ISSUED:

1. kind of shares 2. date of issuance 3. par value, if par value shares Signatures of the proper officers, usually president or secretary, as well as the corporate seal For no more than the number of shares authorized in articles of incorporation; excess would be void

Nature and function of a certificate of stock A certificate of stock is not necessary to render one a stockholder in a corporation. Nevertheless, a certificate of stock is the paper representation or tangible evidence of the stock itself and of the various interests therein. The certificate is not stock in the corporation but is merely evidence of the holder's interest and status in the corporation, his ownership of the shares represented thereby, but is not in law the equivalent of such ownership. It expresses the contract between the corporation and the SH, but it is not essential to the existence of a share in stock or the creation of the relation of shareholder to the corporation. (Tan v. SEC, 206 SCRA 740) Requisites for valid issuance of formal certificate of stock (Sec. 63) (1)

The certificates must be signed by the President / Vice-President, countersigned by the secretary or assistant secretary, and sealed with the seal of the corporation.  A mere typewritten statement advising a SH of the extent of his ownership in a corporation without qualification and/or authentication cannot be considered as a formal certificate of stock. (Bitong v. CA, 292 SCRA 503)

(2)

Delivery of the certificate  There is no issuance of a stock certificate where it is never detached from the stock books although blanks therein are properly filled up if the person whose name is inserted therein has no control over the books of the company. (Bitong v. CA, 292 SCRA 503)

(3)

Par value of par value shares / Full subscription of no par value shares must be fully paid.

(4)

Surrender of the original certificate if the person requesting the issuance of a certificate is a transferee from a SH.

BITONG V. CA (292 SCRA 503) Stock issued without authority and in violation of law is void and confers no rights on the person to whom it is issued and subjects him to no liabilities. Where there is an inherent lack of power in the corporation to issue the stock, neither the corporation nor the person to whom the stock is issued is estopped to question its validity since an estoppel cannot operate to create stock which under the law cannot have existence.

Unpaid Subscriptions



Unpaid subscriptions are not due and payable until a call is made by the corporation for payment. (Sec. 67)



An obligation arising from non-payment of stock subscriptions to a corporation cannot be offset against a money claim of an employee against the employer. (Apodaca v. NLRC, 172 SCRA 442)



Interest on all unpaid subscriptions shall be at the rate of interest fixed in the by-laws. If there is none, it shall be the legal rate. (Sec. 66)

How Payment of Shares Enforced HOW ARE UNPAID SUBSCRIPTIONS COLLECTED? (1)

(2)

Call for payment as necessary, i.e. the BOD declares the unpaid subscriptions due and payable (Sec. 67); Delinquency sale (Sec. 68; to be discussed in the next section)

(3) Court action for collection (Sec. 70)

VELASCO VS POIZAT (37 Phil. 802; 1918) Poizat subscribed to 20 shares but only paid for 5. Board made a call for payment through a resolution. Poizat refused to pay. Corporation became insolvent. Assignee in insolvency sued Poizat whose defense was that the call was invalid for lack of publication. It was held that the Board call became immaterial in insolvency which automatically causes all unpaid subscriptions to become due and demandable.

LINGAYEN GULF ELECTRIC VS BALTAZAR (93 Phil. 404; 1953) Company‘s president subscribed to shares and paid partially. The Board made a call for payment through a resolution. However, the president refused to pay, prompting the corporation to sue. The defense was that the call was invalid for lack of publication. It was held that the call was void for lack of publication required by law. Such publication is a condition precedent for the filing of the action. The ruling in Poizat does not apply since the company here is solvent.

DA SILVA VS ABOITIZ (44 Phil. 755; 1923) Da Silva subscribed to 650 shares and paid for 200. The company notified him that his shares will be declared delinquent and sold in a public auction if he does not pay the balance. Da Silva did not pay. The company advertised a notice of delinquency sale. Da Silva sought an injunction because the by-laws allegedly provide that unpaid subscriptions will be paid from the dividends allotted to stockholders. The Court held that by-laws provide that unpaid subscriptions may be paid from such dividends. Company has other remedies provided for by law such as a delinquency sale or specific performance.

NATIONAL EXCHANGE VS DEXTER (51 Phil. 601; 1928)

Dexter subscribed to 300 shares. The subscription contract provided that the shares will be paid solely from the dividends. Company became insolvent. Assignee in insolvency sued Dexter for the balance. Dexter's defense was that under the contract, payment would come from the dividends. Without dividends, he cannot be obligated to pay. The Court held that the subscription contract was void since it works a fraud on creditors who rely on the theoretical capital of the company (subscribed shares). Under the contract, this theoretical value will never be realized since if there are no dividends, stockholders will not be compelled to pay the balance of their subscriptions. LUMANLAN VS CURA (59 Phil. 746; 1934) Lumanlan had unpaid subscriptions. Company‘s receiver sued him for the balance and won. While the case was on appeal, the company and Lumanlan entered into a compromise whereby Lumanlan would directly pay a creditor of the company. In exchange, the company would forego whatever balance remained on the unpaid subscription. Lumanlan agreed since he would be paying less than his unpaid subscription. Afterwards, the corporation still sued him for the balance because the company still had unpaid creditors. Lumanlan‘s defense was the compromise agreement. The Court held that the agreement cannot prejudice creditors. The subscriptions constitute a fund to which they have a right to look to for satisfaction of their claims. Therefore, the corporation has a right to collect all unpaid stock subscriptions and any other amounts which may be due it, notwithstanding the compromise agreement.

Rights and Obligations of Holders of Unpaid but Non-delinquent Stock WHAT ARE THE RIGHTS OF UNPAID SHARES? Holders of subscribed shares not fully paid which are not delinquent shall have all the rights of a stockholder. (Sec. 72) FUA CUN V. SUMMERS (44 Phil. 704; 1923) Chua Soco bought 500 shares of China Banking Corp. at par value of P100.00, paying the sum of P25,000.00, 50% of the subscription price. Chua mortgaged the said shares in favor of plaintiff Fua Cun to secure a promissory note for the sum of P25,000.00. In the meantime, Chua Soco's interest in the 500 shares were attached and levied upon to satisfy his debt with China Banking Corp. Fua Cun brought an action to have himself declared to hold priority over the claim of China Bank, to have the receipt for the shares delivered to him, and to be awarded damages for wrongful attachment, on the ground that he was owner of 250 shares by virtue of Chua Soco's payment of half of the subscription price. The Court held that payment of half the subscription price does not make the holder of stock the owner of half the subscribed shares. Plaintiff's rights consist in an equity in 500 shares and upon payment of the unpaid portion of the subscription price he becomes entitled to the issuance of certificate for the said 500 shares in his favor. BALTAZAR V. LINGAYEN GULF ELECTRIC POWER (14 SCRA 522; 1965) Baltazar, et al. subscribed to a certain number of shares of Lingayen Gulf Electric Power. They had made only partial payment of the subscription but the corporation issued them certificates corresponding to shares covered by the partial payments. Corporation wanted to deny voting rights to all subscribed shares until total subscription is paid. The Court held that shares of stock covered by fully paid capital stock shares certificates are entitled to vote. Corporation may choose to apply payments to subscription either as: (a) full payment for corresponding number of stock the par value of which is covered by such payment; or (b) as payment pro-rata to each subscribed share. The corporation chose the first option, and, having done so, it cannot unilaterally nullify the certificates issued. Note: The Camposes are of the opinion that § 64 of Corporation Code makes the Lingayen Gulf inapplicable at present. NAVA V. PEERS MARKETING (74 SCRA 65; 1976) Teofilo Co subscribed to 80 shares of Peers Marketing Corp. at P100.00 a share for a total of P8,000.00. He, however, paid only P2,000.00 corresponding to 20 shares or 25% of total subscription. Nava bought 20 shares from Co and sought its transfer in the books of the corporation. The corporation refused to transfer said shares in its books. It was held that the transfer is effective only between Co and Nava and does not affect the corporation. The Fua Cun ruling applies. Lingayen Gulf does not apply because, unlike in Lingayen Gulf, no certificate of stock was issued to Co.

Effect of delinquency WHAT IS DELINQUENT STOCK? (Sec. 67) Stock that remains unpaid 30 days after the date specified in the subscription contract or the date stated in the call made by the Board. WHAT ARE THE EFFECTS OF DELINQUENCY? 1.

The holder thereof loses all his rights as a stockholder except only the rights to dividends;

2.

Dividends will not be paid to the stockholder but will be applied to the unpaid balance of his subscription plus costs and expenses. Also, stock dividends will be withheld until full payment is made.

3.

Such stockholder cannot vote at the election of directors or at any meeting on any matter proper for stockholder action.

4.

Stockholder cannot be counted as part of the required quorum.

5.

Stockholder cannot be voted for as director of the corporation.

WHAT IS THE PROCEDURE FOR THE CONDUCT OF A DELINQUENCY SALE? (Sec. 68) (1)

Issuance of Board resolution The BOD issues a resolution ordering the sale of delinquent stock, specifically stating the amount due on each subscription plus all accrued interest, and the date, time and place of the sale. Note: The sale shall not be less than 30 days nor more than 60 days from the date the stocks become delinquent.

(2)

Notice of sale and publication Notice of the date of delinquency sale and a copy of the resolution is sent to every delinquent stockholder either personally or by registered mail. The notice is likewise published once a week for 2 consecutive weeks in a newspaper of general circulation in the province or city where the principal office of the corporation is located.

(3)

Sale at public auction

If the delinquent stockholder fails to pay the corporation on or before the date specified for the delinquency sale, the delinquent stock is sold at public auction to such bidder who shall offer to pay the full amount of the balance on the subscription together with accrued interest, costs of advertisement and expenses of sale, for the smallest number of shares or fraction of a share. (4) Transfer and issuance of certificate of stock The stock so purchased is transferred to such purchaser in the books of the corporation and a certificate of stock covering such shares is issued. If there is no bidder at the public auction who offers to pay the full amount of the balance on the subscription and its attendant costs, the corporation may bid for the shares, and the total amount due shall be credited as paid in full in the books of the corporation. Title to all the shares of stock covered by the subscription shall be vested in the corporation as treasury shares and may be disposed of by said corporation in accordance with the Code.

Note that this is subject to the restrictions imposed by the Code on corporations as regards the acquisition of their own shares. (See the discussion under Dividends and Purchase by Corporation of its Own Shares.) CAN A DELINQUENCY SALE BE QUESTIONED? (Sec. 69) Yes. This is done by filing a complaint within 6 months from the date of sale, and paying or tendering to the party holding the stock the sum for which said stock was sold, with interest at the legal rate from the date of sale. No action to recover delinquent stock sold can be sustained upon the ground of irregularity or defect in the notice of sale, or in the sale itself of the delinquent stock unless these requirements are complied with.

Lost or Destroyed Certificate WHAT IS THE PROCEDURE FOR THE ISSUANCE OF NEW CERTIFICATES TO REPLACE THOSE STOLEN, LOST OR DESTROYED? (Sec. 73) (1) File an affidavit in triplicate with the corporation. The affidavit must state the following: (a) Circumstances as to how the certificates were SLD; (b) Number of shares represented; and (c) Serial number of the certificate (d) Name of issuing corporation (2) The corporation will publish notice after the affidavit and other information and evidence have been verified with the books of the corporation, (Note however that this is not mandatory. The corporation has the discretion to decide whether to publish or not.) The notice will contain the following information: (a) (b) (c) (d) (e)

Name of the corporation Name of the registered owner; Serial number of the certificate; Number of shares represented by the certificate; Effect of expiration of 1 year period from publication and failure to present contest within that period.

(3) SLD certificate is removed from the books if after one year from date of last publication, no contest is presented. NOTE: One-year period will not be required if the applicant files a bond good for 1 year. (4) The corporation will then issue new certificates. However, if a contest has been presented to the corporation, or if an action is pending court regarding the ownership of the SLD certificate, the issuance of the new certificate shall be suspended until the final decision by the court. NOTE: Should corporation issue new certificates without the conditions being fulfilled and a third party proves that he is the rightful owner of the shares, the corporation may be held liable to the latter EVEN IF it acted in good faith. NOTE: Even if the above procedure was followed, if there was fraud, bad faith, or negligence on the part of the corporation and its officers, the corporation may be held liable.

TRANSFER OF SHARES

HOW ARE SHARES OF STOCK TRANSFERRED?

By delivery of the certificate/s indorsed by the owner or his attorney-in-fact or other person legally authorized to make the transfer. (Sec. 63)

WHAT ARE THE REQUISITES FOR A VALID TRANSFER? (1) (2)

Delivery; Indorsement by the owner or his attorney-in-fact or other persons legally authorized to make the transfer  Indorsement of the certificate of stock is a mandatory requirement of law for an effective transfer of a certificate of stock. (Razon v. CA, 207 SCRA 234)

(3)

Recording of the transfer in the books of the corporation (so as to make the transfer valid as against third parties)  Until registration is accomplished, the transfer, though valid between the parties, cannot be effective as against the corporation. Thus, the unrecorded transferee cannot enjoy the status of a SH: he cannot vote nor be voted for, and he will not be entitled to dividends.

RURAL BANK OF SALINAS, INC. V. CA (210 SCRA 510) A corporation, either by its board, its by-laws or the act of its officers, cannot create restrictions in stock transfers.

TAN V. SEC (206 SCRA 740) A by-law which prohibits a transfer of stock without the consent or approval of all the SHs or of the President or Board of Directors is illegal as constituting undue limitation on the right of ownership and in restraint of trade (citing Fleisher v. Botica Nolasco Co., Inc., 47 Phil. 583) While Sec. 47 (9) of the Corporation Code grants to stock corporations the authority to determine in the by-laws the "manner of issuing certificates" of shares of stock, however, the power to regulate is not the power to prohibit, or to impose unreasonable restrictions of the right of SHs to transfer their shares. To uphold the cancellation of a stock certification as null and void for lack of delivery of the cancelled "mother" certificate whose endorsement was deliberately withheld by petitioner, is to prescribe certain restrictions on the transfer of stock in violation of the Corporation Code as the only law governing transfer of stocks.

USON V. DIOSOMITO (61 Phil. 535; 1935) Toribia Uson filed a civil action for debt against Vicente Dioisomito. Upon institution of said action, an attachment was duly issued and D's property was levied upon, including 75 shares of the North Electric Co., which stood in his name on the books of the company when the attachment was levied on 18 January 1932. The sheriff sold said shares at a public auction with Uson being the highest bidder. Jollye claims to be the owner of said certificate of sock issued to him by the co. on 13 February 1933. There is no dispute that Diosomito was the original owner of said shares, which he sold to Barcelon. However, Barcelon did not present these certificates to the corporation for registration until 19 months after the delivery thereof by Barcelon, and 9 months after the attachment and levy on said shares. The transfer to Jollye was made 5 months after the issuance of a certificate of stock in Barcelon's name. Is a bona fide transfer of the shares of corp., not registered or noted on the books of the corp., valid as against a subsequent lawful attachment of said shares, regardless of whether the attaching creditor had actual notice of said transfer or not. NO, it is not valid. The transfer of the 75 shares in the North Electric Co., Inc made by the defendant Diosomito as to the defendant Barcelon was not valid as to the plaintiff. Toribia Uson, on 18 Jan. 1932, the date on which she obtained her

attachment lien on said shares of stock which still stood in the name of Diosomito on the books of the corp. Sec. 35 says that No transfer, however, is valid, except as between the parties, until the transfer is entered and noted upon the books of the corporation so as to show the names of the parties to the transaction, the date of the transfer, the number of the certificate, and the number of shares transferred. All transfers of shares not so entered are invalid as to attaching or execution creditors of the assignors, as well as to the corporation and to subsequent purchasers in good faith, and indeed, as to all persons interested, except the parties to such transfers. No registration of transfer of unpaid shares No shares of stock against which the corporation holds any unpaid claim shall be transferable in the books of the corporation. (Sec. 63) Remedy if registration refused The proper remedy is a petition for a writ of mandamus to compel the corporation to record the transfer or issue a new certificate in favor of the transferee, as the case may be. The writ will be granted provided it is shown that he transferee has no other plain, speedy and adequate remedy and that there are no unpaid claims against the stocks whose transfer is sought to be recorded. It must be noted that unless the latter fact is alleged, mandamus will be denied due to failure to state a cause of action. (Campos & Campos)

RURAL BANK OF SALINAS, INC. V. CA (210 SCRA 510) The right of a transferee/assignee to have stocks transferred to his name is an inherent right flowing from his ownership of the stocks. Thus, whenever a corporation refuses to transfer and register stock, mandamus will lie to compel the officers of the corporation to transfer said stock in the books of the corporation. This is because the corporation's obligation to register is ministerial. (Note, however, that in such cases, the person requesting the registration must be the prima facie owner of the shares. Cf. Lim Tay v. CA, 293 SCRA 634)

TORRES V. CA (278 SCRA 793) It is the corporate secretary's duty and obligation to register valid transfers of stocks and if said corporate officer refuses to comply, the transferor SH may rightfully bring suit to compel performance. Note: In this case, Judge Torres had no right to enter the assignments (conveyances) of his shares himself in the corporation's stock and transfer book since he was not corporate secretary. RIVERA V. FLORENDO (144 SCRA 647; 1986) Isamu Akasako, a Japanese national who was allegedly the real owner of the shares of stock in the name of one Aquilino Rivera, a registered SH of Fujuyama Hotel and Restaurant, Inc., sold 2550 shares of the same to Milagros Tsuchiya along with the assurance that Tsuchiya would be made President of the corporation after the purchase. Rivera assured her that he would sign the stock certificates because Akasako was the real owner. However, after the sale was consummated and the consideration paid, Rivera refused to make the indorsement unless he is also paid. Tsuchiya, et al. attempted several times to have the shares registered but were refused compliance by the corp. They filed a special action for mandamus and damages. The Supreme Court held that mandamus was improper in this case since the shares of stock were not even indorsed by the registered owner who was specifically resisting the registration thereof in the books of the corporation. The rights of the parties would have to be threshed out in an ordinary action.

Restrictions on Transfer; Close Corporations General rule: Shares of stock are freely transferable, without restriction.

Exception:

In close corporations, restrictions may be placed on the transfer of shares. Such restrictions must appear in the AOI and in the by-laws, as well as in the certificate of stock. Otherwise, the restriction shall not be binding on any purchaser thereof in good faith. The restrictions imposed shall be no more onerous than granting the existing stockholders or the corporation the option to purchase the shares of the transferring stockholder with such reasonable terms, conditions or period stated therein. If this option is not exercised upon the expiration of the period, the transferring stockholder may sell his shares to any third person. (Sec. 98)

WHAT IS THE EFFECT OF ISSUANCE OR TRANSFER OF STOCK IN BREACH OF THE RESTRICTIONS? The corporation may, at its option, refuse to register the transfer of stock in the name of the transferee. (Sec. 99.4) However, this shall not be applicable if the transfer, though otherwise contrary to subsections (1), (2) and (3) of Sec. 99, has been consented to by all the stockholders of the close corporation, or if the close corporation has amended its AOI in accordance with Title XII of the Code. For his part, the transferee may rescind the transfer or recover from the transferor under any applicable warranty, whether express or implied.

UNAUTHORIZED TRANSFERS Certificates indorsed in blank; when quasi-negotiable A possessor, even without authority, may transfer good title to a bona fide purchaser if:  the real owner endorses the certificate in blank  the conveyance is for purposes other than transfer  that relying on the stock certificate, the purchaser believes the possessor to be the owner thereof or has authority to transfer the same. This proceeds from the theory of quasi-negotiability which provides that in endorsing a certificate in blank, the real owner clothes the possessor with apparent authority, thus, estopping him later from asserting his rights over the shares of stock against a bona fide purchaser. Quasi-negotiability does not apply in cases where the real owner: a. b.

did not entrust the certificate to anyone; and is not otherwise guilty of estoppel

For example, in case the transfer is made by a finder or a thief.

Forged Transfers A corporation does not incur any misrepresentation in the issuance of a certificate made pursuant to a forged transfer. It can always recall from the person the certificate issued, for cancellation. In case where the certificate so issued comes into the hands of a bona fide purchaser for value from the original purchaser, the corporation is estopped from denying its liability. It must recognize both the original and the new certificate. But if recognition results to an over-issuance of shares, only the original certificate may be recognized, without prejudice to the right of the bona fide purchaser to sue the corporation for damages.

SANTAMARIA VS. HONGKONG (89 Phil. 780; 1951) Santamaria secured her order for a number of shares with Campos Co. with her stock certificate representing her shares with Batangas Minerals. The said certificate was originally issued in the name of her broker and endorsed in blank by the latter. As Campos failed to make good on the order, Santamaria demanded the return of the certificate. However, she was informed that Hongkong Bank had acquired possession of it inasmuch as it was covered by the pledge made by Campos with the bank. Thereafter, she instituted an action against Hongkong Bank for the recovery of the certificate. Trial court decided in her favor. The bank appealed. Issues: 1) WON Santamaria was chargeable with negligence which gave rise to the case 2) WON the Bank was obligated to inquire into the ownership of the certificate (1) The facts of the case justify the conclusion that she was negligent. She delivered the certificate, which was endorsed in blank, to Campos without having taken any precaution. She did not ask the Batangas Minerals to cancel it and instead, issue another in her name. In failing to do so, she clothed Campos with apparent title to the shares represented by the certificate. By her misplaced confidence in Campos, she made possible the wrong done. She was therefore estopped from asserting title thereto for it is well-settled that ―where one of the innocent parties must suffer by reason of a wrongful or unauthorized act, the loss must fall on the one who first trusted the wrongdoer.‖ (2) The subject certificate is what is known as a street certificate. Upon its face, the holder is entitled to demand its transfer into his name from the issuing corporation. The bank is not obligated to look beyond the certificate to ascertain the ownership of the stock. A certificate of stock, endorsed in blank, is deemed quasi-negotiable, and as such, the transferee thereof is justified in believing that it belongs to the transferor.

DE LOS SANTOS VS. MCGRATH (96 Phil. 577; 1955) De los Santos filed a claim with the Alien Property Custodian for a number of shares of the Lepanto corporation. He contended that said shares were bought from one Campos and Hess, both of them dead. The Philippine Alien Property Administrator rejected the claim. He instituted the present action to establish title to the aforementioned shares of stock. The US Attorney General, the successor of the Alien Property Administrator, opposed the action on the ground that the said shares of stock were bought by one Madrigal, in trust for the true owner, Matsui, and then delivered to the latter indorsed in blank. Issue: Had de los Santos in fact purchased the shares of stock? De los Santos‘ sole evidence that he purchased the said shares was his own unverified testimony. The alleged vendors of the stocks who could have verified the allegation, were already dead. Further, the receipt that might have proven the sale, was said to have been lost in a fire. On the other hand, it was shown that the shares of stock were registered in the records of Lepanto in the name of Madrigal, the trustee of Matsui; that Matsui was subsequently given possession of the corresponding stock certificates, though endorsed in blank; and, that Matsui had neither sold, conveyed nor alienated these to anybody. It is the rule that if the owner of the certificate has endorsed it in blank, and is stolen, no title is acquired by an innocent purchaser of value. This is so because even though a stock certificate is regarded as quasi-negotiable, in the sense that it may be transferred by endorsement, coupled with delivery, the holder thereof takes it without prejudice to such rights or defenses as the registered owner or credit may have under the law, except in so far as such rights or defenses are subject to the limitations imposed by the principles governing estoppel.

Collateral Transfers Shares of stock are personal property. Thus, they can either be pledged or mortgaged. However, such pledge or mortgage cannot have any legal effect if it is registered only in the corporate books. Where a certificate is delivered to the creditor as a security, the contract is considered a pledge, and the Civil Code will apply.

If the certificate of stock is not delivered to the creditor, it must be registered in the registry of deeds of the province where the principal office of the corporation is located, and in case where the domicile of the stockholder is in a different province, then registration must also be made there. In a situation where, the chattel mortgage having been registered, the stock certificate was not delivered to the creditor but transferred to a bona fide purchaser for value, it is the rule that the bona fide purchaser for value is bound by the registration in the chattel mortgage registry. It is said that such a rule tends to impair the commercial value of stock certificates.

CHUA GUAN VS. SAMAHANG MAGSASAKA (62 Phil. 473; 1935) To guarantee payment of a debt, Co mortgaged his shares of Samahang Magsasaka stock to Chiu. The said mortgage was duly registered in the City of Manila. Chiu later assigned his rights in the mortgage to Guan who soon foreclosed the same after Co failed to pay. Guan won in the public bidding. He requested the corporation that new certificates be issued in his name. The corporation refused because apparently prior to Guan‘s demand, several attachments against the shares covered by the certificates had been recorded in its books. Did the chattel mortgage in the registry of deeds of Manila gave constructive notice to the attaching creditors? The Chattel Mortgage Law provides two ways of executing a valid chattel mortgage: 1) the possession of mortgaged property is delivered and retained by the mortgagee; and, 2) without delivery, the mortgage is recorded in the register of deeds. But if chattel mortgage of shares may be made validly, the next question then becomes: where should such mortgage be properly registered? It is the general rule that the situs of shares is the domicile of the owner. It is also generally held that for the purpose of execution, attachment, and garnishment, it is the domicile of the corporation that is decisive. Going by these principles, it is deemed reasonable that chattel mortgage of shares be registered both at the owner‘s domicile and in the province where the corporation has its principal office. It should be understood that the property mortgaged is not the certificate but the participation and share of the owner in the assets of the corporation. It is recognized that this method of hypothecating shares of stock in a chattel mortgage is rather tedious and cumbersome. But the remedy lies in the legislature. Note: The provision of the Chattel Mortgage Law (Act No. 1508) providing for delivery of mortgaged property to the mortgagee as a mode of constituting a chattel mortgage is no longer valid in view of the Civil Code provision defining such as a pledge.

NON-TRANSFERABILITY IN NON-STOCK CORPORATIONS

Although shares of stock are as a rule freely transferable, membership in a non-stock corporation is personal and non-transferable, unless the articles of incorporation or by-laws provide otherwise. The court may not strip him of his membership without cause. (Sec. 90)

DIVIDENDS AND PURCHASE BY CORPORATION OF ITS OWN SHARES

Form of Dividends IN WHAT FORMS CAN DIVIDENDS BE ISSUED? 1.

Cash

2.

Property 

scrip - certificate issued to SHs instead of cash dividends which entitles them to a certain amount in the future

3.

Stock dividends       

Stock dividends are distribution to the SHs of the company‟s own stock. Stock dividends cannot be declared without first increasing the capital stock unless unissued shares are available. New shares are issued to the SHs in proportion to their interest. No new income unless sold for cash. Civil fruits belong to the usufructuary and not to the naked owner. Can only be issued to SHs. Whenever fractional shares result, corp may pay in cash or issue fractional share warrants.

DIFFERENTIATE BETWEEN CASH DIVIDENDS AND STOCK DIVIDENDS. Cash Dividend

Stock Dividend

Voting requirements for issuance

Board of Directors

Board of Directors + 2/3 OCS

Effect on delinquent stock

Shall be applied to the unpaid balance on the subscription plus costs and expenses.

Shall be withheld from the delinquent stockholder until his unpaid subscription is fully paid.

Can this be issued by Executive Committee?

No. 35)

No, since this requires SH approval. (Sec. 35)

(Sec.

NIELSON v LEPANTO (26 SCRA 540; 1968) Stock dividends are issued only to SHs This is so because only stockholders are entitled to dividends. A stock dividend really adds nothing to the interest of each stockholder; the proportional interest of each stockholder remains the same. If a stockholder is deprived of his stock dividends - and this happens if the shares of stock forming part of the stock dividends are issued to a non-stockholder - then the proportion of the stockholder's interest changes radically. Stock dividends are civil fruits of the original investment, and to the owners of the shares belong the civil fruits. FROM WHERE CAN DIVIDENDS BE SOURCED? Dividends can be sourced only out of the unrestricted retained earnings of the corporation. Unrestricted retained earnings is defined as "the undistributed earnings of the corporation which have not been allocated for any managerial, contractual or legal purposes and which are free for distribution to the stockholders as dividends." (SEC Rules Governing Redeemable and Treasury Shares, 1982) Retained earnings has been defined as "net accumulated earnings of the corporation out of transactions with individuals or firms outside the corporation." (Simmons, Smith, Kimmel, Intermediate Accounting, 1977, ed. P. 635) The term implies the limitation that no corporation can declare dividends unless its legal or stated capital is maintained. It does not include: 

premium on par stock i.e. difference between par value and selling price of stock by corp since this is regarded as paid-in capital; but SEC allowed declaration of stock dividends out of such premiums



transactions involving treasury stocks which are considered expansions and contractions of paid-in capital;



donations as additional paid- in capital;



increase in value of existing assets, being merely unrealized capital element

If subscribed shares have not been fully paid, the unpaid portion of subscribed capital stock is an asset, and as long as the net capital asset (after payment of liabilities) including this unpaid portion is at least equal to the total par value of the subscribed shares, any excess would be surplus or earnings from which dividends may be declared. However, if a deficit exists, subsequent profits must first be applied to cover the deficit. Restrictions on dividend distribution include: 

BOD‟s appropriation of certain earnings for certain purposes;



Agreements with creditors, bondholders and preferred SHs requiring retention of certain percent of corporate earnings to protect their interest and to secure redemption of their securities upon maturity;



SEC-imposed restrictions pursuant to law, like those imposed on banks and insurance companies;



Restriction on the retained earnings equivalent to the cost of treasury shares held by the corporation, which is lifted only after such shares are reissued or retired (Sec. 195, PD 612)

BERKS BROADCASTING v CRAUMER (52 A.2d 571; 1947) Dividends can only be declared only from the surplus, i.e. the excess in the value of the assets over the liabilities and the issued capital stock. To do otherwise would be illegal The object of the prohibition is to protect the creditors in view of the limited liability of the SHs and also to protect the SHs by preserving the capital so that the purposes of the corp. may be performed. Surplus must be bona fide i.e. founded upon actual earnings or profits and not to be dependent for its existence upon a theoretical estimate of an appreciation in the value of the company‘s assets. The prohibition does not apply, however, to stock dividends because creditors and SHs will not be affected by their declaration since they do not decrease the company‘s assets.

LICH V UNITED STATES RUBBER (39 F. Supp. 675; 1941) Dividends on non-cumulative preferred stock are payable only out of net profits and for the years in which said net profits are actually earned. The right to dividends is conditional upon: (1) accrual of net profits, and (2) retention in the business. If the annual net earnings of a corp. are justifiably applied to legitimate corp. purposes, such as payment of debts, reduction of deficits and restoration of impaired capital, the right of non-cumulative preferred stockholders to the payments of dividends is lost. If they are applied against prior losses and thereby completely absorbed, there are no net profits from which dividends may be lawfully paid.

SOME RULES ON DIVIDEND DECLARATION: 1.

BOD has discretion whether or not to declare dividends and in what form.

Exception:

Stock dividends, in which case a 2/3 vote of OCS is necessary.

However, such discretion cannot be abused and the BOD cannot accumulate surplus profits unreasonably on the excuse that it is needed for expansion or reserves. 2.

BOD should declare dividends when surplus profits of the corporation exceed 100% of the corporation's paid-in capital stock. Exceptions: (a)

When justified by definite corporate expansion projects or programs approved by the Board;

(b) When creditors prohibit dividend declaration without their consent as a condition for the loan, and such consent has not yet been secured; (c) When retention is necessary under special circumstances obtaining in the corporation, e.g. when there is a need for special reserve for probable contingencies. (Sec. 43) 4.

The corporation may be subjected to additional tax when it fails to declare dividends, thereby unreasonably accumulating profits. (See Sec. 25, NIRC)

5.

The dividends received are based on stock held whether or not paid. However, if the stocks are delinquent, the amount will first be applied to the payment of the delinquency plus costs and expenses; stock dividends will not be given to a delinquent SH.

KEOGH v ST. PAUL MILK (285 N.W. 809; 1939) The mere fact that a large corporate surplus exists is not enough to warrant equitable intervention; the test is good faith and reasonableness of the policy of retaining the profits. However, where dividends are withheld for an unlawful purpose – to deprive a SH of his right to a just proportion of the corporation's profit, the court may compel the corporation to declare dividends.

DODGE v FORD MOTOR CO (170 N.W. 668; 1919) This case involves an action against the Ford Motor Company to compel declaration of dividends. At the time this complaint was made, Ford had concluded its most prosperous year of business, and the demand for its cars at the price of the previous year continued. While it had been the practice, under similar circumstances, to declare larger dividends, the corporation refused to declare any special dividends. The Board justified its refusal to declare larger dividends on the expansion plans of the company by erecting a smelting plant, but maintaining the selling price of its cars (instead of reducing it as had been the practice in previous years). The plaintiffs contend that such a proposal would be tantamount to the business being conducted as a semi-eleemosynary (or charitable) institution instead of a business institution. The court pointed out that a business corporation is organized and carried on primarily for the profit of SHs. The discretion of the directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself – reduction of profits or to devote profits to another purpose. While the Court noted the capable management of the affairs of the corporation and therefore was not convinced that the motives of the directors were prejudicial to the company's interests, it likewise noted that the annual dividends paid were very small in relation to the profits that the company had been making. It therefore affirmed the amount fixed by the lower court to be distributed to the stockholders. Note: Prof. Jacinto is of the opinion that what happened in this case is possible under the present Code, even without changing the AOI.

Preference as to Dividends

Review discussion under kinds of stock. WABASH RAILWAY CO. V. BARCLAY (67 A.L.R. 762; 1930) In the AOI and the certificate of stock of Stock A, it was stated that the holders of said stocks are entitled to receive to receive preferential dividends of 5% per fiscal year, non-cumulative, before dividends are paid to other stocks. From 1915 to 1926, no dividends were declared. The net earnings were instead used for the improvements and additions to property and equipment. Due to this, the corporation became prosperous and proposed to pay dividends to A & B common stock. Plaintiffs filed this case in order to collect the dividends for fiscal years 1915-1926 before the other classes of stock are paid. Were the Class A stockholders entitled to dividends for FY 1915 to 1926? No, they were not. By the plain meaning of the words in the AOI and the certificates of stock, the holders are not entitled to dividends unless directors declare so. It is likewise generally understood that in cases where the company's net earnings are applied for improvements and no dividend is declared, the claim for such year is gone in case of non-cumulative stock, and cannot be later asserted.

BURK V. OTTAWA GAS & ELECTRIC CO. (123 Pac. 875; 1912) An action was brought by the preferred SHs of Ottawa against the directors of Ottawa to (1) require the directors to account for all the property and assets of the corporation, (2) declare such dividends from the net profits of the business of such co. as should have been declared since 1 Jan. 1906, and (3) restrain the officers and directors during the pendency of the action from paying out any of the money or disposing of the assets of the company except such amounts as should be necessary to pay the actual necessary current expenses of conducting the business of the corporation. The BOD maintained that the corporation's funds were exhausted by expenditures for the extension of the co‘s plant, hence it was unable to declare dividends. Expenditures were said to be necessary and for the betterment of the plant. Were the corp funds were wrongfully diverted, and were preferred SHs entitled to dividends? The case was remanded to the trial court, with instructions to make further findings to protect the preferred SHs in their rights. The fair interpretation of the contract between Ottawa and its SHS is that if in any year net profits are earned, a dividend is to be declared. To hold otherwise, meaning if the BOD had absolute discretion when to declare dividends and when not to, when the corporation has funds for such dividends, would result in temptation to unfair dealing, giving one party the option to pay the other or not. In the case at bar, the accumulated profits would be lost forever since the dividends were non-cumulative. Preferred SHs, however, are not generally creditors until dividends are declared. In the case at bar, if dividends should have been declared to such SHs, they are considered creditors from that time.

When Right to Dividends Vests; Rights of Transferee WHEN DOES THE RIGHT TO DIVIDENDS VEST? As soon as the BoD has declared dividends. From this time, it becomes a debt owed by the corporation, and therefore can no longer be revoked (McLaran v. Crescent Planning). EXCEPTION: the stockholders.

If the declaration has not yet been announced or

communicated to

NOTE: When no dividends are declared for 3 consecutive years, preferred SHs are given the right to vote for directors until dividends are declared. NOTE: The extent of the SH’s share in the dividends will depend on the capital contribution; NOT the number of shares he has.

MCLARAN V. CRESCENT PLANNING MILL CO. (93 S.W. 819; 1906) CPM Corp., having a surplus of $29,000, declared a 6% cash dividend payable in four installments. The first installment was paid by the Board after which an error was discovered in the computation of the assets: from the initial recognized surplus of $29,000 to $6,000. Mainly for this reason, the Board adopted a resolution rescinding the dividends payable on the three other installments despite the solvency of the corp and the existence of ample funds to pay said dividends. The original P was Humber, a SH, and was substituted by McLaran, the administrator of his estate when he died. The defendant corp maintained that there was no valid declaration of dividends because the corporation failed to set aside funds to pay for the same. A cash dividend, properly declared, cannot be revoked by the subsequent action of the corp. for by its declaration, the corp had become the debtor of the SH and it goes without saying that the debtor cannot revoke, recall or rescind the debt or otherwise absolve itself from its payment by a unilateral action or without the consent of the creditor. Thus, the rescission by the BOD of the subsequent installments was of no force. Dividends are defined as portions of profits/surplus funds of the corp. which have been actually set apart by a valid board resolution or by the SH at a corp. mtg. for distribution among SH according to their respective interests. The mere declaration of the dividend, without more, by competent authority under proper circumstances, creates a debt against the corporation in favor of the stockholders the same as any other general creditor of the corporation. By the mere declaration, the dividend becomes immediately fixed and absolute in the stockholder and from henceforth the right of each individual stockholder is changed by the act of declaration from that of partner and part owner of the corporate property to a status absolutely, adverse to every other stockholder and to the corporation itself, insofar as his pro rata proportion of the dividend is concerned.

Liability for Illegal Dividends WHAT ARE ILLEGAL DIVIDENDS? Illegal dividends are dividends declared in violation of law. WHAT ARE THE EFFECTS OF THE ILLEGAL DECLARATION OF DIVIDENDS? (1)

If the directors acted wilfully, or with negligence or in bad faith, they will be liable to the corporation. If the corporation has become insolvent, they are liable to the corporation's creditors for the amount of dividends based out of capital. (Based on Sec. 31)

(2)

If the directors cannot be held liable because they acted with due diligence and in good faith, in the absence of an express provision of law, an innocent stockholder is not liable to return the dividends received by him out of capital, unless the corporation was insolvent at the time of payment. (Majority view; Campos)

Purchase by Corporation of its own shares WHAT ARE THE REQUISITES FOR ACQUISITION BY THE CORPORATION OF ITS OWN SHARES? (Sec. 41) 1. 2.

unrestricted retained earnings to cover the shares to be acquired; legitimate corporate purpose

FOR WHAT PURPOSES CAN A CORPORATION ACQUIRE ITS OWN SHARES? (Sec. 41) 1. 2.

To eliminate fractional shares arising out of stock dividends; To collect or compromise an indebtedness to the corporation, arising out of unpaid subscription, in a delinquency sale, and to purchase delinquent shares sold during said sale;

3.

To pay dissenting or withdrawing stockholders entitled to payment for their shares under the Corporation Code (Appraisal Right).

Appraisal Right (Sec. 81) WHAT IS THE APPRAISAL RIGHT? The appraisal right refers to the right of a stockholder who dissented and voted against a proposed fundamental corporate action to get out of the corporation by demanding payment of the fair value of his shares. IN WHAT INSTANCES CAN THE APPRAISAL RIGHT BE EXERCISED? The Corporation Code lists 4 instances: (1)

In case any amendment to the AOI has the effect of changing or restricting the rights of any SH or class of shares, or of authorizing preferences in any respect superior to those of outstanding shares of any class, or of extending or shortening the term of corporate existence (Sec. 81);

(2)

In case of sale, lease, exchange, transfer, mortgage, pledge or other disposition of all or substantially all of the corporate property and assets as provided in this Code (Sec. 81; Sec. 40);

(3) (4)

In case of merger or consolidation (Sec. 81); In case the corporation invests its funds in any other corporation or business or for any purpose other than the primary purpose for which it was organized (Sec. 42)

WHAT ARE THE REQUISITES FOR THE EXERCISE OF THE APPRAISAL RIGHT? (Sec. 82) (1) (2) (3)

SH must have voted against he proposed corporate action; Written demand on the corporation for payment of the fair value of his shares; Such demand must have been made within 30 days after the date on which the vote was taken; (4) Surrender of the stock certificate/s representing his shares; (5) Unrestricted retained earnings in the books of the corporation to cover such payment.

WHAT IS THE EFFECT OF DEMAND FOR PAYMENT IN ACCORDANCE WITH THE APPRAISAL RIGHT? (Sec. 83) All rights accruing to the shares, including voting and dividend rights, are suspended in accordance with the Corporation Code, except for the right of the SH to receive payment of the fair value thereof. Such suspension shall be from the time of demand until either: (1) (2)

abandonment of the corporate action involved; or the purchase of the said shares by the corporation.

However, if said dissenting SH is not paid the value of his shares within 30 days after the award, his voting and dividend rights shall immediately be restored.

WHAT ARE THE DUTIES OF THE DISSENTING STOCKHOLDER IN RELATION TO THE EXERCISE OF THE APPRAISAL RIGHT? The dissenting SH must submit the certificates of stock representing his shares to the corporation for notation thereon that such shares are dissenting shares within 10 days after

demanding payment for his shares. Failure to do so shall, at the option of the corporation, terminate his rights under Title X of the Corporation Code. (Sec. 86)

WHAT ARE THE EFFECTS OF TRANSFER OF THE CERTIFICATES BEARING THE NOTATION THAT THEY REPRESENT DISSENTING SHARES? If the certificates are consequently cancelled, the rights of the transferor as a dissenting SH cease and the transferee has all the rights of a regular stockholder. All dividend contributions which would have accrued on the shares will be paid to the transferee. (Sec. 86)

AMENDMENTS OF CHARTER

The charter of a private corporation consists of its articles of incorporation as well as the Corporation Code and such other law under which it is organized.

Amendment by Legislature Subject to the limitation that no accrued rights or liabilities be impaired, the legislature has the power to make changes in existing corporations through an amendment to the Corporation Code.

Amendment by Stockholders One of the powers expressly granted by law to all corporations is the power to amend its articles of incorporation. This, in effect, is a grant of power to owners of 2/3 of the outstanding stocks to change the basic agreement between the corporation and its stockholders, making such change binding on all the stockholders, subject only to the right of appraisal, if proper.

WHAT ARE THE LIMITATIONS ON THE POWER TO AMEND?

(1)

(2)

PURPOSE:

must be legitimate

VOTE:

2/3 of OCS / membership

The appraisal right must be recognized in case the amendment has the effect of changing rights of any stockholder or class of shares, or of authorizing preferences in any respect superior to those of outstanding shares of any class, or extending or shortening the term of corporate existence. Extension of corporate term cannot exceed 50 yrs. in any one instance

(3)

A copy of the amended articles should be filed with the SEC, and with the proper governmental agencies, as appropriate (e.g., in the case of banks, public utilities, etc.)

(4)

Original and amended articles should contain all matters required by law to be set out in said articles.

(5)

An amendment to increase/decrease capital stock as well as to extend/shorten corporate term cannot be made under Sec. 16, but must be made under Sec. 37-38, respectively, both of which require a meeting; and

(6)

Amendment must be in the form prescribed by the Code

ON WHAT GROUNDS CAN THE SEC DISAPPROVE THE PROPOSED AMENDMENTS? The same grounds as for the disapproval of the original articles (Sec. 17):  

Not substantially in accordance with the form prescribed by the Code; Purpose(s) patently unconstitutional, illegal, immoral, or contrary to government rules and regulations;

  

Treasurer‟s Affidavit concerning amount of capital stock subscribed/paid is false; Required percentage of ownership of capital stock to be owned by citizens of the Phils. has not been complied with as required by the Constitution or existing laws; Absence of a favorable recommendation from the appropriate government agency.

Amendment changing stockholder’s rights The law expressly allows amendments which would change or restrict existing rights of stockholders or any class of shares. (Sec. 81)

MARCUS V. RH MACY (74 N.E. 2d 228; 1947) The Board of Directors gave notice to SH that among the matters to be acted upon in its annual meeting would be a proposal to amend certificate of incorporation to add to the rights of preferred stockholders, voting rights equal to those of common stockholders. Marcus, objected and demanded payment for the common stock owned by her. The Court held that Marcus may invoke her appraisal right. The aggregate number of shares having voting rights equal to those of common shares was substantially increased and thereby the voting power of each common share outstanding prior to the meeting was altered or limited by the resulting pro rata diminution of its potential worth as a factor in the management of the corporate affairs. Considering that she held diminished voting power; that she notified the corpo of her objection; that her shares were voted against the amendment—these were sufficient to qualify her to invoke her statutory appraisal right. Effectivity of amendment Amendments take effect only from the approval by the SEC. However, such approval or rejection must be made within six months of filing of amendment; otherwise it shall take effect even w/o such approval (as of the date of filing), unless cause of delay is attributable to the corporation. (Sec. 16)

Special amendments Increase of capital stock After the authorized capital stock has been fully subscribed and the corporation needs to increase its capital, it will have to amend its articles to increase its capital stock. A corporation does not have the implied power to increase capital stock; such a power can only be granted by law. The power to increase or decrease capital stock must be exercised in accordance with the provisions of Sec. 38 of the Code.

Reduction of capital stock Reduction of capital stock is not allowed if it will prejudice the rights of corporate creditors.

PHILIPPINE TRUST CO. V. RIVERA (44 Phil. 469; 1923) It is established doctrine that subscriptions to the capital of a corporation constitute a fund to which creditors have a right to look for satisfaction of their claims and that the assignee in insolvency can maintain an action upon any unpaid stock subscription in order to realize assets for the payment of its debts. A corporation has no power to release an original subscriber to its capital stock from the obligation of paying for his shares, without valuable consideration for such release; and as against creditors a reduction of the capital stock can take place only in the manner and under the conditions prescribed by the statute or charter or the articles of incorporation.

Change in corporate term The Code allows a corporation not only to extend but also to shorten its term of existence. As in the case of increase/decrease of capital stock, change must be approved at a members‘/stockholders‘ meeting by 2/3 of the members/outstanding capital stock.

Amendments in close corporations To recall, the provisions required to be contained in the AOI of a close corporation: (1) All issued stock of all classes should be held by not more than 20; (2) All issued stock shall be subject to one or more specified restrictions on transfer permitted by law; (3) Corporation should not be listed in the stock exchange or make any public offering of its stock. If any of these are deleted, then the corporation will cease to be a close corporation and will lose the special privileges of such corporations. Thereafter, it will be governed by the general provisions of the Code. Since such amendment involves a change in the nature of the corporation, even non-voting stocks are given a voice in the decision. A stockholders‟ meeting is required and a 2/3 vote must approve the amendment, unless otherwise provided by the articles of incorporation.

DISSOLUTION

Modes of Dissolution HOW MAY A CORPORATION BE DISSOLVED? (1) Failure to organize and commence business (Sec. 22); (2) Cessation of business for 5 years (Continuous inoperation; Sec. 22); (3) Expiration of original, extended, or shortened term;

(4) Voluntary dissolution (Sec. 118-119); (a)

Where no creditors are affected (Sec. 118) This is effected by majority vote of the BOD and a 2/3 vote of the OCS or members. (Note the special notice requirements.) The copy of the resolution authorizing the dissolution shall be certified by a majority of the BOD and countersigned by the secretary of the corporation. THE SEC shall thereupon issue the certificate of dissolution.

(b)

Where creditors are affected (Sec. 119) (1)

Filing of petition for dissolution with SEC A petition for dissolution must be filed with the SEC after having been signed by a majority of the BOD, verified by the president or secretary or one

of the directors, and resolved upon by the affirmative vote of 2/3 of the OCS or members. The petition must set forth all claims and demands against the corporation, and the fact that the dissolution was approved by the SHs with the requisite 2/3 vote. (2)

Fixing of date by SEC for filing of objections to petition If the petition is sufficient in form and substance, the SEC shall fix a date on or before which objections thereto may be filed by any person. Date: not less than 30 days nor more than 60 days after the entry of the order

(3)

Publication of order Before the date fixed by the SEC, the SEC order shall be published and posted accordingly.

(4)

Newspaper:

Once a week for 3 weeks in a newspaper of general circulation published in the municipality or city where the corporation's principal office is situated, or there be no such newspaper, in a newspaper of general circulation in the Philippines

Posting:

For 3 consecutive weeks in 3 public places in the city or municipality where the corporation's principal office is situated

Hearing of the petition for dissolution Upon 5 days notice, given after the date on which the right to file objections to the order has expired, the SEC shall proceed to hear the petition and try any issue made by the objections filed. If no objection is sufficient, and the material allegations are true, the SEC shall render judgment dissolving the corporation and directing such disposition of its assets as justice requires. Note: The SEC may appoint a receiver to collect such assets and pay the debts of the corporation.

(3) Involuntary dissolution (Sec. 121): (a) Revocation of Certificate of Registration by SEC (Sec. 121) A corporation may be dissolved by the SEC upon filing of a verified complaint and after proper notice and hearing on grounds provided by existing laws, rules and regulations. (b) Quo Warranto proceedings (See Sec. 5b, PD 902-A and Rule 66, Rules of Court. Previously, the SEC had exclusive jurisdiction over quo warranto proceedings involving corporation. Under the Securities Regulation Code or RA 8799, however, the jurisdiction of the SEC over all cases enumerated under Sec. 5 of PD 902-A have been transferred to the Regional Trial Courts. The grounds for involuntary warranto proceedings are:

dissolution

of

a

corporation

under quo

(1)

When the corporation has offended against a provision of an act for its creation or renewal;

(2)

When it has forfeited its privileges and franchises by nonuser;

(3)

When it has committed or omitted an act which amounts to a surrender of its corporate rights, privileges or franchises;

(4)

When it misused a right, privilege or franchise conferred upon it by law, or when it has exercised a right, privilege or franchise in contravention of law (PNB v. CFI, 209 SCRA 294; 1992)

(4) Shortening of corporate term (Sec. 120) NOTE: The simplest and most expedient way of effecting dissolution is by shortening the corporate term and waiting for such term to expire.

Dissolution of close corporations In close corporations, any stockholder may, by written petition to the SEC, compel the dissolution of such corporation when: (1)

Any of the acts of the directors, officers, or those in control of the corporation is:    

(2)

Illegal; Fraudulent; Dishonest; Oppressive or unfairly prejudicial to the corporation or any other SH;

Corporate assets are being misapplied or wasted. (Sec. 105)

Effects of Dissolution WHAT ARE THE EFFECTS OF DISSOLUTION?  

Corporation ceases to be a juridical person and consequently can no longer continue transacting its business. Corporate existence continues for 3 years following dissolution for the ff. purposes only: (a) winding up of affairs; and (b) liquidation of corporate assets.



Corporation can no longer continue its business, except for winding up.



Corporation CANNOT even be a de facto corporation.



Corporate existence may be subject to COLLATERAL attack.

NOTE that the subsequent dissolution of a corporation may not remove or impair any right or remedy in favor of or against, nor any liability incurred by, any corporation, its stockholders, members, directors, trustees or officers. (Sec. 145)

Loss of juridical personality NATIONAL ABACA V. PORE (2 SCRA 989; 1961) Plaintiff National Abaca Corporation filed a complaint against Pore for the recovery of a sum of money advanced to her for the purchase of hemp. She moved to dismiss the complaint by citing the fact that National Abaca had been abolished by EO 372 dated Nov. 24, 1950. Plaintiff objected to such by saying that it shall nevertheless be continued as a corporate body for a period of 3 years from the effective date of said order for the purpose of prosecuting and defending suits by or against it and to enable the Board of Liquidators to close its affairs. Can an action commenced within 3 years after the abolition of plaintiff corporation be continued by the same after the expiration of said period? The Corp. Law allows a corporation to continue as a body for 3 years after the time when it would have been dissolved for the purposes of prosecuting and defending suits by or against it. But at any time during the 3 years, the corporation should convey all its property to trustees so that the latter may be the ones to continue on with such prosecution, with no time limit on its hands. Since the case against Pore was strong, the corp.'s amended complaint was admitted and the case was remanded to the lower court.

CLEMENTE V. CA (242 SCRA 717) The termination of the life of a juridical entity does not by itself cause the extinction or diminution of the right and liabilities of such entity nor those of its owners and creditors. If the 3-year extended life has expired without a trustee or receiver having been expressly designated by the corporation itself within that period, the board of directors or trustees itself may be permitted to so continue as "trustees" by legal implication to complete the corporate liquidation. In the absence of a board of directors or trustees, those having any pecuniary interest in the assets, including not only the shareholders but likewise the creditors of the corporation, acting for and in its behalf, might make proper representations with the SEC, which has primary and sufficiently broad jurisdiction in matters of this nature, for working out a final settlement of the corporate concerns. Executory contracts The prevailing view is that executory contracts are not extinguished by dissolution. Sec. 145 of the Code states that "No right or remedy in favor of or against any corporation….nor any liability incurred……shall be removed or impaired either by the subsequent dissolution of said corp. or by any subsequent amendment or repeal of this Code or of any part thereof."

Liquidation WHAT IS LIQUIDATION? (Sec. 122) Liquidation, or winding up, refers to the collection of all assets of the corporation, payment of all its creditors, and the distribution of the remaining assets, if any, among the stockholders thereof in accordance with their contracts, or if there be no special contract, on the basis of their respective interests.

WHAT ARE THE METHODS OF LIQUIDATING A CORPORATION? AND WHO MAY UNDERTAKE THE LIQUIDATION OF A CORPORATION? 1.

Liquidation by the corporation itself through its board of directors

Although there is no express provision authorizing this method, neither is there any provision in the Code prohibiting it. 2.

Conveyance of all corporate assets to trustees who will take charge of liquidation. If this method is used, the 3-year limitation will not apply provided the designation of the trustees is made within said period. There is no time limit within which the trustee must finish liquidation, and he may sue and be sued as such even beyond the 3-year period unless the trusteeship is limited in its duration by the deed of trust. (See Nat'l Abaca Corp. v. Pore, supra)

3.

Liquidation is conducted by the receiver who may be appointed by the SEC upon its decreeing the dissolution of the corp. As with the previous method, the three-year rule shall not apply. However, the mere appointment of a receiver, without anything more, does not result in the dissolution of the corporation nor bar it from the exercise of its corporation rights.

FOR HOW LONG MAY THE LIQUIDATION OF A CORPORATION BE UNDERTAKEN? Generally, a corporation may be continued as a body corporate for the purpose of liquidation for 3 years after the time when it would have so dissolved. (Sec. 122) However, it was held in the case of Clemente v. CA (supra) that if the 3-year period has expired without a trustee or receiver having been expressly designated by the corporation itself within that period, the BOD itself may be permitted to so continue as "trustees" by legal implication to complete the corporate liquidation.

WHAT CAN AND SHOULD BE DONE DURING THE PERIOD OF LIQUIDATION? (Sec. 122) (1) (2)

Collection of corporate assets and property; Conveyance of all corporate property to trustees for the benefit of SHs, members, creditors, and other persons in interest;

(3)

Payment of corporation's debts and liabilities;

(4)

Distribution of assets and property

Distribution of assets after payment of debts GENERAL RULE:

No corporation shall distribute any of its assets or property except upon lawful dissolution and after payment of all its debts and liabilities. (Sec. 122)

EXCEPTION:

In cases of decrease of capital stock, and as otherwise allowed by the Corporation Code

WHAT HAPPENS IF AN ASSET CANNOT BE DISTRIBUTED TO THE PERSON ENTITLED TO IT? Any asset distributable to any creditor or stockholder or member who is unknown or cannot be found shall be escheated to the city or municipality where such assets are located. (Sec. 122)

CHINA BANKING V. MICHELIN & CIE. (58 Phil. 261; 1933)

The appointment of a receiver by the court to wind up the affairs of the corporation upon petition of voluntary dissolution does not empower the court to hear and pass on the claims of the creditors of the corporation at first hand. In such cases, the receiver does not act as a receiver of an insolvent corporation. Since "liquidation" as applied to the settlement of the affairs of a corporation consists of adjusting the debts and claims, that is, of collecting all that is due the corporation, the settlement and adjustment of claims against it and the payment of its just debts, all claims must be presented for allowance to the receiver or trustees or other proper persons during the winding-up proceedings within the 3 years provided by the Corporation Law as the term for the corporate existence of the corporation, and if a claim is disputed so that the receiver cannot safely allow the same, it should be transferred to the proper court for trial and allowance, and the amount so allowed then presented to the receiver or trustee for payment. The rulings of the receiver on the validity of claims submitted are subject to review by the court appointing such receiver though no appeal is taken to the latter ruling, and during the winding-up proceedings after dissolution, no creditor will be permitted by legal process or otherwise to acquire priority, or to enforce his claim against the property held for distribution as against the rights of other creditors. Note: Under the Corporation Code, it is the SEC which may appoint the receiver.

RP V. MARSMAN DEVELOPMENT COMPANY (44 SCRA 418; 1972) Defendant corp. was a timber license holder with concessions in Camarines Norte. Investigations led to the discovery that certain taxes were due on it. BIR assessed Marsman 3 times for unpaid taxes. Atty. Moya, in behalf of the corp., received the first 2 assessments. He requested for reinvestigations. As a result, corp. failed to pay within the prescribed period. Numerous BIR warnings were given. After 3 years of futile notifications, BIR sued the corp. Although Marsman was extrajudicially dissolved, with the 3-year rule, nothing however bars an action for recovery of corporate debts against the liquidators. In fact, the 1st assessment was given before dissolution, while the 2nd and 3rd assessments were given just 6 months after dissolution (within the 3-year rule). Such facts definitely established that the Government was a creditor of the corp. for whom the liquidator was supposed to hold assets of the corp.

TAN TIONG BIO V. CIR (G.R. No. L-15778; April 23, 1962) The creditor of a dissolved corp. may follow its assets, as in the nature of a trust fund, once they pass into the hands of the stockholders. The dissolution of a corp. does not extinguish the debts due or owing to it. An indebtedness of a corp. to the government for income and excess profit taxes is not extinguished by the dissolution of the corp. The hands of government cannot, of course, collect taxes from a defunct corporation, it loses thereby none of its rights to assess taxes which had been due from the corporation, and to collect them from persons, who by reason of transactions with the corporation hold property against which the tax can be enforced and that the legal death of the corporation no more prevents such action than would the physical death of an individual prevent the government from assessing taxes against him and collecting them from his administrator, who holds the property which the decedent had formerly possessed. Thus, petitioners can be held personally liable for the corporation's taxes, being successors-in-interest of the defunct corporation.

Distribution of assets of non-stock corporations WHAT ARE THE RULES FOR CORPORATIONS? (Sec. 94-95)

DISTRIBUTION

OF

ASSETS

OF

NON-STOCK

(1)

All liabilities and obligations of the corporation shall be paid, satisfied, and discharged, or adequate provision shall be made therefor.

(2)

Assets held by the corporation upon a condition requiring return, transfer or conveyance, and which condition occurs by reason of the dissolution, shall be returned, transferred or conveyed in accordance with such requirements.

(3)

Assets received and held by the corporation subject to limitations permitting their use only for charitable, religious, benevolent, education or similar purposes, but not subject to condition (2) above, shall be transferred or conveyed to one or more corporations, societies or organization engaged in activities in the Philippines

substantially similar to those of the dissolving corp. according to a plan of distribution adopted pursuant to Sec. 95 of the Code. (4)

Assets other than those mentioned in preceding paragraphs shall be distributed in accordance with the AOI or by-laws.

(5)

In any other case, assets may be distributed to such persons, societies, organizations or corporations, whether or not organized for profit, as may be specified in a plan of distribution adopted pursuant to Sec. 95.

* The plan of distribution of assets may be adopted by a majority vote of the Board of trustees and approval of 2/3 of the members having voting rights present or represented by proxy at the meeting during which said plan is adopted. It must be noted that the plan of distribution of assets must not be inconsistent with the provisions of Title XI of the Code.

CORPORATE COMBINATIONS

Techniques to achieve corporate combinations WHAT ARE THE TECHNIQUES TO ACHIEVE A CORPORATE COMBINATION? (1) Merger (A + B = A) (2) Consolidation (A + B = C) (3) Sale of substantially all corporate assets and purchase thereof by another corporation; (4) Acquisition of all / substantially all of the stock of one corporation from its SHs in exchange for the stock of the acquiring corporation

Merger or Consolidation WHAT IS THE PROCEDURE FOR MERGER OR CONSOLIDATION? (1)

(2) (3)

(4)

Board of Directors of the constituent corporations must prepare and approve a plan of merger or consolidation. 2/3 vote of OCS of the constituent corporations. Execution of the Articles of Merger/Consolidation, to be signed by the Pres/VP and certified by the secretary / assistant secretary. Submission to the SEC for approval.

WHAT ARE THE EFFECTS OF MERGER OR CONSOLIDATION? (Sec. 80) (1)

The constituent corporation shall become a single corporation: If merger:

the surviving corporation designated in the plan of merger

If consolidation: the consolidated corporation designated in the plan of Consolidation. (2)

The separate existence of the constituent corporations shall cease, except that of the surviving or consolidated corporation.

(3)

The surviving or consolidated corporation shall possess all rights, privileges, immunities and powers and shall be subject to all the duties and liabilities of a corporation organized under the Corporation Code.

(4)

The surviving or consolidated corporation shall thereupon and thereafter possess all the rights, privileges, immunities and franchises of each of the constituent corporations;

(5)

All property (real or personal) and all receivables due on whatever account (including subscriptions to shares and other choses in action), and all and every other interest of, or belong to, or due to each constituent corporation, shall be deemed transferred and vested in such surviving or consolidated corporation without further act or deed.

(6)

The surviving or consolidated corporation shall be responsible and liable for all the liabilities and obligations of each of the constituent corporations in the same manner as if such surviving or consolidated corporation had itself incurred such liabilities or obligations; and any pending claim, action or proceeding brought by or against any of such constituent corporations may be prosecuted by or against the surviving or consolidated corporation. (Note: The merger or consolidation does not impair the rights of creditors or liens upon the property of any such constituent corporations.)

LOZANO V. DE LOS SANTOS (274 SCRA 452) Consolidation becomes effective not upon mere agreement of the members but only upon issuance of the certificate of consolidation by the SEC. There can be no intra-corporate nor partnership relation between 2 jeepney drivers' and operators' associations whose plans to consolidate into a single common association is still a proposal.

WHAT ARE THE RULES GOVERNING MERGER OR CONSOLIDATION INVOLVING A FOREIGN CORPORATION LICENSED IN THE PHILIPPINES? (Sec. 132) 

A foreign corporation authorized to transact business in the Philippines may merge or consolidate with any domestic corporation if such is permitted under Philippine law and by the law of its incorporation.



The requirements on merger or consolidation as provided in the Corporation Code must be complied with.



Whenever a foreign corporation authorized to transact business in the Philippines is a party to a merger or consolidation in its home country or state, such foreign corporation shall file a copy of the articles or merger or consolidation with the SEC and the appropriate government agencies within 60 days after such merger or consolidation becomes effective. Such copy of the articles must be duly authenticated by the proper officials of the country or state under the laws of which merger or consolidation was effected. If the absorbed corporation in such a merger / consolidation happens to be the foreign corporation doing business in the Philippines, it shall file a petition for withdrawal of its license in accordance with Sec. 136.

Sale of substantially all corporate assets

WHEN IS A SALE OR OTHER DISPOSITION DEEMED TO COVER SUBSTANTIALLY ALL THE CORPORATE PROPERTY AND ASSETS? If by the sale the corporation would be rendered incapable of continuing the business or accomplishing the purpose for which it was incorporated. (Sec. 40)

WHAT ARE THE REQUIREMENTS? (Sec. 40) (1)

Majority vote of BOD + 2/3 vote of OCS or members at a meeting duly called for the purpose;

(2)

Compliance with the laws on illegal combinations and monopolies

Note, however, that after such approval by the SHs, the BOD may nevertheless, in its discretion, abandon such sale or other disposition without further action or approval by the SHs. This, of course, is subject to the rights of third parties under any contract relating thereto.

WHEN IS SH APPROVAL NOT NECESSARY FOR THE ABOVE DISPOSITION? (1) If the disposition is necessary in the usual and regular course of business; or (2) If the proceeds of the disposition be appropriated for the conduct of its remaining business (Sec. 40)

IS THE APPRAISAL RIGHT AVAILABLE TO DISSENTING STOCKHOLDERS? Yes. However, it must be stressed that this right is generally available only to dissenting stockholders of the selling corporation, not the purchasing corporation. (It can be argued, though, that in instances wherein the purchase constitutes an investment in a purpose other than its primary purpose, stockholders' approval of such investment is necessary, and anyone who objects thereto will have the appraisal right under Sec. 42.)

Exchange of stocks In this method, all or substantially all the stockholders of the "acquired" corporation are made stockholders of the acquiring corporation. With the exchange, the acquired corporation becomes a subsidiary of the acquiring corporation. Although this method does not combine the 2 businesses under a single corporation as in merger and sale of assets, from the point of view of the acquiring (parent) corporation, there is hardly any difference between owing the acquired corporation's business directly and operating it through a controlled subsidiary. In fact, the parent corporation would have the power to buy all the subsidiary's assets and dissolve it, achieving the same result as in the other methods of combination. (Campos & Campos)

FOREIGN CORPORATIONS

WHAT IS A FOREIGN CORPORATION? (Sec. 123) A corporation formed and organized under laws other than those of the Philippines, regardless of the citizenship of the incorporators and stockholders. Such corporation must have been organized and must operate in a country which allows Filipino citizens and corporations to do business there.

In times of war:

For purposes of security of the state, the citizenship of the controlling stockholders determines the corporation’s nationality.

IN WHAT WAYS CAN A FOREIGN CORPORATION DO BUSINESS IN THE PHILS.? (1)

Wholly-owned subsidiary; or

(2)

Branch office; or

(3)

Joint venture with a local partner.

Permitted areas of investment 100% EQUITY:

Mass media, except recording The practice of a profession (law, medicine, etc.) Operation of rural banks Cooperatives Private security agencies Small-scale mining Utilization of marine resources Ownership, operation, and management of cockpits; Manufacture, repair, stockpiling of nuclear, biological, chemical, and radiological weapons;

Note: Retail trade is no longer required to be 100% Filipino-owned on account of the Retail Trade Liberalization Act. 75%-25% EQUITY:

Inter-island shipping (R.A. 1937, Sec. 8) Private recruitment Contracts for construction and repair of locally-funded public works Except: Public works that would fall under the BuildOperate-Transfer Law, as well as those that are foreign-funded

70%-30% EQUITY:

Advertising

60%-40% EQUITY:

Other industries.

WHAT IS THE SO-CALLED "GRANDFATHER RULE"? Where a domestic corporation which has both Philippine and foreign stockholders is an investor in another domestic corporation which has also both Philippine and foreign stockholders, the so-called "grandfather rule" is used to determine whether or not the latter corporation is qualified to engage in a partially nationalized business, i.e. by determining the extent of Philippine equity therein. Under present SEC rules, if the percentage of Filipino ownership in the first corporation is at least 60%, then said corporation will be considered as a Philippine national and all of its investment in the second corporation would be treated as Filipino equity. On the other hand, if the Philippine equity in the first corporation is less than 60%, then only the number of shares corresponding to such percentage shall be counted as of

Philippine nationality. (See SEC Rule promulgated on 28 Feb. 1967, cited in Opinion # 18, Series of 1989, Department of Justice, dated 19 January 1989.) NOTE: The reader would be well-advised to cross-reference this definition of the "grandfather rule" with a trusted commentary.

Legal Requirements Prior to Transaction of Business Documentary Requirements (Sec. 125) (1) BOI certificate The BOI certificate is issued upon a finding of the Board of Investments that the business operations of the foreign corp. will contribute to the sound and balanced development of the national economy on a self-sustaining basis. (See Omnibus Investments Code, Sec. 48-49) NOTE: Applications, if not acted upon within 10 days from official acceptance thereof, shall be considered automatically approved! (Art. 53, Omnibus Investments Code) (2) SEC license to do business (Sec. 125) 

Application under oath setting forth the information specified in Sec. 125;



Additional information as may be necessary or appropriate to enable the SEC to determine whether the corporation is entitled to a license to transact business in the Philippines, and to determine and assess the fees payable;



Duly executed certificate under oath by authorized official/s of the jurisdiction of the company's incorporation, attesting to the fact that the laws of the country of the applicant allow Filipino citizens and corporations to do business therein, and that the applicant is an existing corporation in good standing;



Statement under oath of the president or any other person authorized by the corporation showing that the applicant is solvent and in good financial condition, and setting forth the assets and liabilities of the corporation within 1 year immediately prior to the application.

(3) Certificate from appropriate government agency NOTE: Certain sectors such as banking, insurance, etc. require prior approval from the government agencies concerned. (Sec. 17)

Deposit requirement (Sec. 126) Within 60 days after the issuance of the license, the licensee shall deposit with the SEC securities with an actual market value of at least P 100,000.00. These securities are for the benefit of present and future creditors, and shall consist of any of the following:    

Bonds or other evidence of indebtedness of the Government or instrumentalities, etc.; Shares of stock in "registered enterprises" as defined in R.A. 5186; Shares of stock in domestic corporations registered in the stock exchange; Shares of stock in domestic insurance companies and banks.

its

Once the licensee ceases to do business in the Philippines, these deposited securities shall be returned, upon the licensee's application and proof to the satisfaction of the SEC that the licensee has no liability to Philippine residents or the Philippine government. Note: Foreign banking and insurance corporations are the exceptions to this requirement.

Designation of a resident agent (Sec. 128) The designation of a resident agent is a condition precedent to the issuance of the license to transact business in the Philippines. WHO: PURPOSE:

A resident of the Philippines. To be served any summons and other legal processes which may be served in all actions or other legal proceedings against such corporation. Service upon such resident shall be admitted and held as valid as if served upon the duly authorized officers of the foreign corporation at its home office.

Laws applicable to foreign corporations Foreign corporations lawfully doing business in the Philippines are bound by all laws, rules and regulations applicable to domestic corporations of the same class. Exceptions: (1) As regards the creation, formation, organization or dissolution of the corporation; (2) As regards the fixing of relations, liabilities, responsibilities, or duties of stockholders, members, or officers or corporations to each other or to the corporation (Sec. 129)

Effects of Failure to Secure SEC License WHAT ARE THE EFFECTS OF FAILURE TO SECURE A LICENSE? (1) The corporation will not be permitted to maintain agency in the Philippines; (2) The corporation will be subject to penalties and fines; (3) The corporation will not be permitted to maintain or intervene in any action before Philippine courts or administrative agencies; it can be SUED.

Isolated transactions MARSHALL WELLS V. ELSER (46 Phil. 71; 1924) Marshall Wells, a corporation organized under the State of Oregon, sued a domestic corp. for the unpaid balance on a bill of goods. Defendant demurred to the complaint on the ground that it did not show that plaintiff had complied with the law regarding corp. desiring to do business in the Phil., nor that the plaintiff was authorized to do business in the Phil. The Supreme Court, in ruling for Marshall Wells, stated that the object of the statute was to subject the foreign corp. doing business in the Phil. to the jurisdiction of its courts. The object of the statute was not to prevent it from performing single acts but to prevent it from acquiring a domicile for the purpose without taking the steps necessary to render it amenable to suit in the local courts. The implication of the law is that it was never the purpose of the Legislature to exclude a foreign corp. which happens to obtain an isolated order for business from the Phil., from securing redress in Phil. Courts, and thus, in effect to permit persons to avoid their contract made with such foreign corporation.

ATLANTIC MUTUAL V. CEBU STEVEDORING (G.R. No. 18961; Aug. 31, 1966) A foreign corp. engaged in business in the Phil. can maintain suit in this jurisdiction if it is duly licensed. If a foreign corp. is not engaged in business in the Phil., it can maintain such suit if the transaction sued upon is singular and isolated, in which no license is required. In either case, the fact of compliance with the requirement of license, or the fact that the suing corp. is exempt therefrom, as the case may be, cannot be inferred from the mere fact that the party suing is a foreign corp. The qualifying circumstance, being an essential part of the element of the plaintiff‘s capacity to sue, must be affirmatively pleaded. In short, facts showing foreign corporation‘s capacity to sue should be pleaded.

Curing of defect HOME INSURANCE V. EASTERN SHIPPING (123 SCRA 424; 1983) A contract entered into by a foreign insurance corp. not licensed to do business in the Phil. is not necessarily void and the lack of capacity to sue at the time of execution of the contract is cured by its subsequent registration.

Protection of intellectual property rights GENERAL GARMENTS CORP. V. DIR. OF PATENTS (41 SCRA 50; 1971) Domestic corporation General Garments registered ―Puritan‖ trademark for its men‘s wear. US corporation Puritan Sportswear petitioned the Phil. Patent Office for cancellation of said trademark, alleging its ownership and prior use in the Phil. The Supreme Court held that a foreign corp. which does not do business in the Phil. and is unlicensed but is widely known in the Phil. through the use of its products here has legal right to maintain an action to protect its reputation, corporate name and goodwill. The right to use the corporate name is a property right which the corp. may assert and protect in any of the courts of the world.

LE CHEMISE LACOSTE V. FERNANDEZ (129 SCRA 377; 1984) A foreign corporation not doing business in the Phil. needs no license to sue in the Phil. for trademark violations. Where a violation of our unfair trade laws which provide a penal sanction is alleged, lack of capacity to sue of injured foreign corp. becomes immaterial (because a criminal offence is essentially an act against the State).

NOTE: Sec. 160 of R.A. 8293 (Intellectual Property Code) provides that any foreign national or juridical person who meets the requirements of Sec. 3 of the Act (i.e., is a national or is domiciled in a country party to any convention, treaty or agreement relating to intellectual property rights or the repression of unfair competition, to which the Philippines is also a party, or extends reciprocal rights to Philippine nationals by law) and does not engage in business in the Philippines may bring a civil or administrative action for opposition, cancellation, infringement, unfair competition, or false designation of origin and false description, whether or not it is licensed to do business in the Philippines under existing laws.

What Constitutes Transacting Business WHAT IS CONSIDERED AS NOT DOING BUSINESS, AND THEREFORE NOT SUBJECT TO THE LICENSING REQUIREMENT? 

Mere investment as a shareholder and the exercise of the rights as such investor;



Having a nominee director or officer represent the foreign investors‟ interests;



Appointing a representative or distributor in the Philippines who transacts business in his own name and for his own account Example:



Rustan’s exclusive distributorship of Lacoste t-shirts

Publication of a general advertisement; NOTE: Under the Code of Commerce, the publication of an ad is prima facie evidence (or at least creates a presumption) of doing business in the Philippines.



Maintaining stock of goods for processing by another entity in the Philippines;



Consignment of equipment to be used in processing products for export;



Collecting information in the Philippines;



Performing services incidental to an isolated contract of sale Example: Installing machinery sold by a foreign corporation to a Philippine buyer

WHAT IS THE TEST OF DOING BUSINESS IN THE PHILIPPINES? Whether or not there is continuity of transactions which are in pursuance of the normal business of the corporation. (Metholatum v. Mangaliman)

MENTHOLATUM V. MANGALIMAN (72 Phil. 525; 1941) The true test as to whether a foreign corporation is doing business in the Philippines seems to be whether the foreign corp. is continuing the body or substance of the business for which it was organized or whether it has substantially retired

from it and turned it over to another. The term implies a continuity of dealings and arrangements and contemplates performance of acts/works or the exercise of the functions normally incident to and in progressive prosecution of the purpose and object of its organization.

FACILITIES MANAGEMENT CORP. V. DE LA OSA (89 SCRA 131; 1979) The Court of Industrial Relations ordered Facilities Management Corporation (FMC) to pay Dela Osa his overtime compensation, swing shift and graveyard shift premiums. FMC filed a petition for review on certiorari on the issue of whether the CIR can validly affirm a judgment against persons domiciled outside and not doing business in the Phil. and over whom it did not acquire jurisdiction. The Supreme Court held that the petitioner may be considered as doing business in the Philippines within the scope of Sec. 14, Rule 14 of the Rules of Court: Sec. 14. Service upon private foreign corp. - If the defendant is a foreign corp., or a non-resident joint stock corporation or association, doing business in the Phil., service may be made on its resident agent, on the government official designated by law to the effect, or to an y of its officers or agents within the Philippines. FMC had appointed Jaime Catuira as its agent with authority to execute Employment Contracts and receive, on behalf of the corp., legal services from, and be bound by processes of the Phil. Courts, for as long as he remains an employee of FMS. If a foreign corp. not engaged in business in the Phil., through an Agent, is not barred from seeking redress from courts in the Phil., that same corp. cannot claim exemption done against a person or persons in the Phil.. NOTE:

Under Sec. 12, Rule 14 of the 1997 Rules of Civil Procedure, the term "doing business" has been replaced with the phrase "has transacted business," thereby allowing suits based on isolated transactions.

MERRILL LYNCH FUTURES INC. V. CA (211 SCRA 824) Merrill Lynch Futures, Inc. (MLF) filed a complaint against the spouses Lara for the recovery of a debt. MLF is a non-resident foreign corp. not doing business in the Phil., organized under the laws of Delaware, USA. It is a futures commission merchant duly licensed to act as such in the futures markets and exchanges in the US, essentially functioning as a broker executing orders to buy and sell futures contract received from its customers on US futures exchanges. (Futures contract is a contractual commitment to buy and sell a standardized quantity of a particular item at a specified future settlement date and at a price agreed upon with the purchase or sale being executed on a regulated futures exchange.) The spouses refused to pay and moved to dismiss the case alleging that plaintiff had no legal capacity to sue because (1) MLF is doing business in the country without a license; and (2) the transactions were made with Merrill Lynch Pierce, Fenner and Smith and not with plaintiff MLF. Issue: Can MLF sue in Philippine courts to establish and enforce its rights against spouses in light of the undeniable fact that it had transacted business without a license? Legal capacity to sue may be understood in two senses: (1) That the plaintiff is prohibited or otherwise incapacitated by law to institute suit in the Phil. Courts, or (2) although not otherwise incapacitated in the sense just stated, that it is not a real party in interest. The Court finds that the Laras were transacting with MLF fully aware of its lack of license to do business in the Phils., and in relation to those transactions had made payments and the spouses are estopped to impugn MLF's capacity to sue them. The rule is that a party is estopped to challenge the personality of a corp after having acknowledged the same by entering into a contract with it. The principle is applied to prevent a person contracting with a foreign corporation from later taking advantage of its noncompliance with the statutes, chiefly in cases where such person has received the benefits of the contract.

PACIFIC VEGETABLE OIL V. SINGSON (G.R. No. 7917; April 29, 1955) This is an action instituted by the plaintiff, a foreign corporation, against the defendant to recover a sum of money for damages suffered by the plaintiff as a consequence of the failure of the defendant to deliver copra which he sold and

bound himself to deliver to the plaintiff. Defendant filed a motion to dismiss on the ground that the plaintiff failed to obtain a license to transact business in the Phil and, consequently, it had no personality to file an action. Has appellant transacted business in the Philippines in contemplation of law? Contrary to the findings of the trial court, the copra in question was actually sold by the defendant to the plaintiff in the US, the agreed price to be covered by an irrevocable letter of credit to be opened at the Bank of California, and delivery to be made at the port of destination. It follows that the appellant corporation has not transacted business in the Phil in contemplation of Sec. 68 and 69 which require any foreign corporation to obtain a license before it could transact business, or before it could have personality to file a suit in the Phil.. It was never the purpose of the Legislature to exclude a foreign corporation which happens to obtain an isolated order of business from the Phil., from securing redress in the Phil. Courts, and thus, in effect, to permit persons to avoid their contracts made with such foreign corp.. The lower court erred in holding that the appellant corporation has no personality to maintain the present action.

AETNA CASUALTY & SURETY CO. VS. PACIFIC STAR LINE (80 SCRA 635; 1977) Aetna as subrogee of I. Shalom sued Pacific Star Line (PSL), the common carrier for the loss of Linen & Cotton piece goods due to pilferage and damage amounting to US$2,300.00. PSL contends that Aetna has no license to transact insurance business in the Philippines as gathered from the Insurance Commission and SEC . It also argues that since said company has filed 13 other civil suits, they should be considered as doing business here and not merely having entered into an isolated transaction. Based on rulings in Mentholatum and Eastboard Navigation, the Supreme Court held that Aetna is not transacting business in the Philippines for which it needs to have a license. The contract was entered into in New York and payment was made to the consignee in the New York branch. Moreover, Aetna was not engaged in the business of insurance in the Philippines but was merely collecting a claim assigned to it by consignee. Because it was not doing business in the Philippines, it was not subject to Sec. 68-69 of the Corporation Law and therefore was not barred from filing the instant case although it had not secured a license to transact insurance business in the Philippines.

TOPWELD MANUEL VS. ECED (138 SCRA 120; 1985) Topweld entered into 2 separate contracts with foreign entities: a license and technical assistance agreement with IRTI, and a distributor agreement with ECED, SA. When Topweld found out that the foreign corporations were looking into replacing Topweld as licensee and distributor, the latter went to court to ask for a writ of preliminary injunction to restrain the foreign corporations from negotiating with 3 rd parties as violative of RA 5445 (4). Although IRTI and ECED were doing business in the Philippines, since they had not secured a license from BOI, the foreign corporations were not bound by the requirement on termination and Topweld could not invoke the same against the former. Moreover, it was incumbent upon Topweld to know whether or not IRTI and ECED were properly authorized to engage in such agreements. The Supreme Court held that both parties were guilty of violating RA 5445. Being in pari delicto, Topweld was not entitled to the relief prayed for.

ANTAM CONSOLIDATED VS. CA (143 SCRA 289; 1986) Stokely Van Camp Inc. filed a complaint against Banahaw, Antam, Tambunting and Unicorn for the collection of a sum of money for failure to deliver 500 tons of crude coconut oil. Antam et al asked for dismissal of case on ground that Stokely was a foreign corporation not licensed to do business in the Philippines and therefore had no personality to maintain the suit. The SC held that the transactions entered into by Stokely with Antam et al (3 transactions, either as buyer or seller) were not a series of commercial dealings which signify an intent on the part of the respondent to do business in Philippines but constitute an isolated transaction. The records show that the 2nd and 3rd transactions were entered into because Antam wanted to recover the loss it sustained from the failure of the petitioners to deliver the crude oil under the first transaction and in order to give the latter a chance to make good on their obligation. There was only one agreement between the parties, and that was the delivery of the 500 tons of crude coconut oil.

How Courts Acquire Jurisdiction over Foreign Corporations

As a rule, jurisdiction over a foreign corporation is acquired by the courts through service of summons on its resident agent. If there is no assigned resident agent, the government official designated by law can receive the summons on their behalf and transmit the same to them by registered mail within 10 days. This will complete the service of the summons. Summons can also be served on any of the corporation's officers or agents within the Philippines. (See Sec. 128; Rule 14, Sec. 12, Rules of Court. Note that while Sec. 128 presupposes that the foreign corporation has a license, Rule 14 does not make such an assumption.) Note that if there is a designated agent, summons served upon the government official is not deemed a valid process. 

Johnlo Trading case holds that the service on the attorney of an FC who was also charged with the duty of settling claims against it is valid since no other agent was duly appointed.



Service on Officers or Agents of an foreign corporation‟s domestic subsidiary will only vest jurisdiction if there is sufficient ground to disregard the separate personalities.

GENERAL CORPORATION OF THE PHILIPPINES VS UNION INSURANCE (87 Phil. 313; 1950) General Corporation and Mayon investment sued Union Insurance and Firemen‘s Fund Insurance (FFI) for the payment of 12 marine insurance policies. The summons was served on Union which was then acting as FFI‘s settling agent in the country. At that time, it was not yet registered and authorized to transact business in the Philippines. Issue: Did the trial court acquire valid jurisdiction over FFI? Yes. The service of summons for FFI on its settling agent was legal and gave the court jurisdiction upon FFI. Section 14, Rule 7 of ROC embraces Union in the phrase, ―or agents within the Philippines‖. The law does not make distinctions as to corporations with or without authority to do business in the Philippines. The test is whether a foreign corporation was actually doing business here. Otherwise, a foreign corporation doing business illegally because of its refusal or neglect to obtain the corresponding authority to do business may successfully though unfairly plead such neglect or illegal act so as to avoid service and thereby impugn the jurisdiction of the courts.

Withdrawal of Foreign Corporation

(Sec. 136)

HOW: By filing a petition for withdrawal of license REQUISITES FOR ISSUANCE OF CERTIFICATE OF WITHDRAWAL: (1)

All claims which have accrued in the Philippines have been paid, compromised and settled;

(2)

All taxes, imposts, assessments, and penalties, if any, lawfully due to the Philippine Government or any of its agencies or political subdivisions have been paid; and

(3)

The petition for withdrawal of license has been published once a week for 3 consecutive weeks in a newspaper of general circulation in the Philippines.

Revocation and Suspension of License

(Sec. 134)

WHAT ARE THE GROUNDS FOR REVOCATION OR SUSPENSION OF A LICENSE OF A FOREIGN CORPORATION? (1)

Failure to file its annual report or pay any fees as required by the Corporation Code;

(2)

Failure to appoint and maintain a resident agent in the Philippines as required;

(3)

Failure, after change of resident agent or of his address, to submit to the SEC a statement of such change;

(4)

Failure to submit to the SEC an authenticated copy of any amendment to its AOI or by-laws or of any articles of merger or consolidation within the time prescribed by the Code;

(5)

A misrepresentation of any material matter in any application, report, affidavit or other document submitted by such corporation pursuant to Title XV;

(6)

Failure to pay any and all taxes, imposts, assessments or penalties, if any, lawfully due to the Philippine government or any of its agencies or political subdivisions;

(7)

Transacting business in the Philippines outside of the purpose/s for which such corporation is authorized under its license;

(8)

Transacting business in the Philippine as agent of or acting for and in behalf of any foreign corporation or entity not duly licensed to do business in the Philippines; or

(9)

Any other ground as would render it unfit to transact business in the Philippines.

SPECIAL AND MISCELLANEOUS PROVISIONS

Educational corporations (Sec. 106-108) 

Educational corporations other than government-run institutions are governed first by special laws, second, by the special provisions of the Corporation Code, and lastly, by the general provisions of the Corporation Code. (Sec. 106)



At least 60% of the authorized capital stock of educational corporations must be owned by Filipino citizens, and Congress may require increased Filipino equity participation therein. (With the exception of educational institutions established by religious groups and mission boards, which are not subject to this equity requirement.) However, control and administration of educational institutions must be vested exclusively in citizens of the Philippines. (Art. XIV, Sec. 4 (2), 1987 Constitution) This means that no alien may be elected as a member of the BOD nor appointed as Principal or officer thereof.



Once a school, college or university has been granted government recognition by the DECS, it must incorporate within 90 days from the date of such recognition, unless it is expressly exempt by DECS for special reasons. (Act 2706, Sec. 5) In addition, it must file a copy of its AOI and by-laws with the DECS. Without the favorable recommendation of the DECS Secretary, the SEC will not accept or approve such articles. (Sec. 107, Corporation Code)

Religious corporations

(Sec. 109-116)

Religious corporations are governed by Title XIII, Chapter II of the Corporation Code and by the general provisions of the Code on non-stock corporations insofar as they may be applicable. (Sec. 109) Corporation sole (Sec. 110-115) A corporation sole is an incorporated office, composed of a single individual who may be a bishop, priest, minister or presiding officer of a religious sect, denomination or church. Its purpose is to administer and manage as trustee the property and affairs of such religious sect, denomination or church, within the territorial jurisdiction of such office. (Sec. 110; Sec. 111 (3)) In case of death, resignation, transfer or removal of the person in office, his successor replaces him and continues the corporation sole. The property is not owned but is merely administered by the

corporation sole, and ownership pertains to the church or congregation he represents. On the other hand, he is the person authorized by law as the administrator thereof and the court may take judicial notice of such fact and of the fact that the parish priests have no control over such property. In determining whether the constitutional provision requiring 60% Filipino capital for corporation ownership of private agricultural lands, the Supreme Court has held that it is the nationality of the constituents of the diocese, and not the nationality of the actual incumbent of the office, which must be taken into consideration. Thus, where at least 60% of the constituents are Filipinos, land may be registered in the name of the corporation sole, although the holder of the office is an alien. This ruling is based on the fact that the corporation sole is not the owner but merely the administrator of the property, and that he holds it in trust for the faithful of the diocese concerned. (See Gana v. Roman Catholic Archbishop of Manila, 43 O.G. No. 8, 3225; 1947)

Religious societies (Sec. 116) In contrast to a corporation sole, religious societies are composed of more than one person. The requirements for incorporation of such societies are set forth in Sec. 116 of the Code.

Close Corporations

(Sec. 96-105)

WHAT ARE THE REQUISITES OF A CLOSE CORPORATION? (Sec. 96) A close corporation, within the meaning of the Corporation Code, is one whose articles of incorporation provide that: (1)

All the corporation's issued stock of all classes, exclusive of treasury shares, shall be held of record by not more than a specified number of persons not exceeding 20;

(2)

All the issued stock of all classes shall be subject to one or more specified restrictions on transfer permitted by Title XII of the Code; and

(3)

The corporation shall not list in any stock exchange or make any public offering of any of its stock of any class.

Notes: 

A narrow distribution of ownership does not, by itself, make a close corporation. (San Juan Structural and Steel Fabricators v. CA, 296 SCRA 631)



A corporation shall not be deemed a close corporation when at least 2/3 of its voting stock or voting rights is owned or controlled by another corporation which is not a close corporation.

CAN A CORPORATION THAT IS NOT A CLOSE CORPORATION BE A STOCKHOLDER IN A CLOSE CORPORATION? YES, provided that said corporation owns less than 2/3 of voting stock or voting rights.

WHAT ENTITIES MAY NOT BE ORGANIZED AS CLOSE CORPORATIONS? (Sec. 96)       

Mining Oil Stock Exchange Bank Insurance Public Utilities Educational Institutions



Corporations declared vested with public interest

DISTINGUISH CLOSE CORPORATIONS FROM REGULAR CORPORATIONS. Close Corporation

"Regular" Corporation

No. of stockholders

Not more than 20 (Sec. 96)

No limit

Management

Can be managed by the stockholders (Sec. 97)

Managed by Board of Directors

Meetings

May be dispensed with (Sec. 101)

Actual meetings are required.

Quorum and Voting

Greater quorum and voting requirements allowed. (Sec. 97)

Pre-emptive right

Extends to all stock, including treasury shares (Sec. 102)

Does not extend to treasury shares.

Buy-back of shares

Must be > par value (Sec. 105)

May be < par value

Resolution of deadlocks

SEC has the power to arbitrate disputes in case of deadlocks, upon written petition by any stockholder. (Sec. 104) This includes the power to appoint a provisional director, as well as to dissolve the corporation.

Dissolution

May be petitioned by any stockholder whenever any of the acts of the directors or officers or those in control of the corporation is illegal, fraudulent, dishonest, oppressive or unfairly prejudicial to the corporation or any stockholder, or whenever corporate assets are being misapplied or wasted. (Sec. 105)

WHAT IS A PROVISIONAL DIRECTOR? (Sec. 104)

Generally requires a 2/3 vote of the stockholders and a majority vote of the BOD. (Note however that in case of involuntary dissolution under Sec. 121, a corporation may be dissolved by the SEC upon filing of a verified complaint and after proper notice and hearing.)

A provisional director is an impartial person who is neither a stockholder nor a creditor of the corporation or of any subsidiary or affiliate of the corporation, and whose qualifications, if any, may be determined by the SEC. He is not a receiver of the corporation and does not have the title and powers of a custodian or receiver. However, he has all the rights and powers of a dulyelected director of the corporation, including the right to notice of and to vote at meetings of directors, until such time as he shall be removed by order of the SEC or by all the stockholders. (Sec. 104)

COMPARE APPRAISAL RIGHT AND WITHDRAWAL RIGHT IN CLOSE CORPORATIONS. (Sec. 105) Withdrawal Right Type corporation involved

of

Appraisal Right

Close corporation

"Regular" corporation

When availed of

For any reason (Sec. 105)

Only the grounds enumerated in Sec. 81 and Sec. 42

Fair value shares

Must be > par or issued value (Sec. 105)

May be < par or issued value

of

Miscellaneous Provisions (Sec. 137-149) 

The SEC has the power to issue rules and regulations reasonably necessary to enable it to perform its duties under the Code, particularly in the prevention of fraud and abuses on the part of the controlling stockholders, members, directors, trustees or officers. (Sec. 143)



Whenever the SEC conducts any examination of the operations, books and records of any corporation, the results thereof must be kept strictly confidential, unless the law requires them to be made public or where they are necessary evidence before any court. (Sec. 142)



All domestic and foreign corporations doing business in the Philippines must submit an annual report to the SEC of its operations, with a financial statement of its assets and liabilities and such other requirements as the SEC may impose. (Sec. 141)



No right or remedy in favor of or against, nor any liability incurred by, any corporation, its stockholders, members, directors, trustees or officers, may be removed or impaired by the subsequent dissolution of said corporation or by any subsequent amendment or repeal of the Code. (Sec. 145)



Violations of the Corporation Code not otherwise specifically penalized therein are punishable by a fine of not less than P 1,000.00 but not more than P 10,000.00 or by imprisonment for not less than 30 days but not more than 5 years, or both, in the discretion of the court. If the violation is committed by a corporation, the same may be dissolved in appropriate proceedings before the SEC. (Sec. 144)