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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) It is an artificial being;


(2) Created by operation of law;
(3) With right of succession;
(4) 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 Non-Stock

Definition Corporations which have capital All other private corporations (3)
stock divided into shares and
are authorized to distribute to the One where no part of its income is
holders of shares dividends or distributable as dividends to its
allotments of the surplus profits on members, trustees or officers. (87)
the basis of the shares (3)

Purpose Primarily to make profits for its May be formed or organized for
shareholders 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

Scope of right to vote Each stockholder votes according to Each member, regardless of class,
the proportion of his shares in the is entitled to one (1) vote UNLESS
corporation. No shares may be such right to vote has been limited,
deprived of voting rights except broadened, or denied in the AOI or
those classified and issued as by-laws. (Sec. 89)
"preferred" or "redeemable" shares,
and as otherwise provided by the
Code. (Sec. 6)

Voting by proxy May be denied by the AOI or the by- Cannot be denied. (Sec. 58)
laws. (Sec. 89)

Voting by mail May be authorized by the by-laws, Not possible.


with the approval of and under the
conditions prescribed by the SEC.
(Sec. 89)

Who exercises Corporate Board of Directors or Trustees Members of the corporation


Powers 23

Governing Board Board of Directors or Trustees, Board of Trustees, which may


consisting of 5-15 directors / consist of more than 15 trustees
trustees. unless otherwise provided by the
AOI or by-laws. (Sec, 92)

Term of directors or Directors / trustees shall hold office Board classified in such a way that
trustees for 1 year and until their successors the term of office of 1/3 of their
are elected and qualified (Sec. 23). 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 Officers may directly elected by the
Directors (Sec. 25), except in close members UNLESS the AOI or by-
corporations where the stockholders laws provide otherwise. (Sec. 92)
themselves may elect the officers.
(Sec. 97)

Place of meetings Any place within the Philippines, if Generally, the meetings must be
provided for by the by-laws (Sec. held at the principal office of the
93) 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 Transferable. Generally non-transferable since


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

Distribution of assets in See Sec. 94.


case of dissolution

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 compare with Corporators which


in the articles of incorporation as include all stockholders or
originally forming and composing members, whether incorporators
the corporation and who are or joining the corporation after its
signatories thereof stockholders incorporation.
or members mentioned in the
articles of incorporation as
originally forming and composing
the corporation and who are
signatories thereof

Characteristic natural persons excludes corporations and


partnerships

Number not less than 5; not more than 15 may be more than 15 for non-
stock 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

Age of legal age

Residence majority should be residents of residence a requirement;


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

Steps in the formation of a corporation

Mutual Agreement to perform certain acts required for organizing a corporation

1- Organize and establish a corporation


2- Comply with requirements of corporation code
3- Contribute capital/resources
4- Mode of use of capital/resource and control/management of capital/resource
5- distribution/disposition of capital/resource (embodied in constitutive documents)

STEPS COMMENTS

a. Promotional Stage (See SEC. 2. Promoter


Definitions) 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 chart below)


(See SEC. 14)

c. Filing of articles; payment of fees. AOI & the treasurers 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).

d. Examination of articles; approval or Process:


rejection by SEC. 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) Treasurers 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))

Decisions of the SEC disapproving or rejecting AOI


may be appealed to the CA by petition for review in
accordance w/ the ROC.

e. Issuance of certificate of Certificate of Incorporation will be issued if:


incorporation.
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 COMMENTS

Corporate Name 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.

Purpose Clause 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.

Capital Stock 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

Other matters 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 others 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 Cransons, 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
(Non-Stock)

Must be signed by stockholders or members voting for them

(b) Prior to incorporation


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

Where kept: (1) In the principal office of the corporation ; and


(2) Securities and Exchange Commission

When effective: Only upon the SECs 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 corporations 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) sue and be sued;


2) hold property in its own name;
3) enter into contracts with third persons; &
4) 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 latters 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. the parent corp. owns all or most of the capital stock of the subsidiary.
2. the parent and subsidiary have common directors and officers
3. the parent finances the subsidiary
4. the parent subscribes to all the capital stock of the subsidiary or otherwise
causes its incorporation
5. the subsidiary has grossly inadequate capital
6. the parent pays the salaries and other expenses or losses of the subsidiary
7. the subsidiary has substantially no business except with the parent corp. or no
assets except those conveyed to or by the parent corp.
8. 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 parents own
9. the parent uses the property of the subsidiary as its own
10. 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 latters
interest
11. the formal legal requirements of the subsidiary are not observed
(Garrett vs. Southern Railway)
(Note: Sir Jack said that we must not stop after weve 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 Workmens
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-Phils
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.

PROMOTERS CONTRACTS PRIOR TO INCORPORATION

Liability of Corporation for Promoters 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) Adopts or ratifies the contract; or


(2) 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 Promoters 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) Specific performance; or


(2) 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: Promoters are personally liable on their contracts made on behalf
of a corporation to be formed.

EXCEPTION: 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)

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)

Implied Powers

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

Blacks 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 formers 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 companys 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.

GOVT 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 +1
N+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 Must be filled by the SHs in a regular or special meeting
or expiration of term: 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: May be filled by the vote of at least a majority of the
remaining directors or trustees, if still constituting a
quorum.

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

(f) 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)

(v) Disloyalty (Sec. 34)

(vi) Watered stocks (Sec. 65)

(i) 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) president (who shall be a director);


(2) secretary (who shall be a resident and Filipino citizen); and
(3) 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.

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

(c) 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. He was assured by the board that no board approval was necessary.


2. He delivered P 20,000, performed his work with the knowledge of the board.
3. 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) approval of any action for which shareholders' approval is also required;
(2) the filling of vacancies in the board (refer to Sec. 29);
(3) the amendment or repeal of by-laws or the adoption of new by-laws;
(4) 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) removed the Treasurer and appointed a new one


b) fixed the annual salary of the members of the Executive Committee
c) 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) Amendment of articles of incorporation;


(2) Increase and decrease of capital stock;
(3) Incurring, creating or increasing bonded indebtedness;
(4) Sale, lease, mortgage or other disposition of substantially all corporate assets;
(5) 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. LEOWS 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 stockholders 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 SHs 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 SHs, 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) A VTA is prepared in writing, notarized, and filed with the corporation and SEC.

(2) 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.

(3) 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

1. Straight voting: 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. Freys 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 & Carys 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 majoritys 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: share with right to vote

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

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

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; founders 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.

Founders 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 founders shares enjoy the right to vote, this privilege is limited to 5 years upon SECs
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 cant 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 Cant give minority control of
representation on the board corp. affairs

Classification of shares MINORITY: so long as they hold Preferred and redeemable stock
more common stock as opposed can still vote on certain matters
to the majority who holds more as provided in Sec. 6 or as may
preferred stock be provided by the corp.

Restriction on transfer of MAJORITY: they can choose See Sec. 98


shares whether to keep or release
*applicable only to close shares and they can prevent
opposition from acquiring shares
corporations

Prescribing qualifications MAJORITY: theyre the ones who Qualifications must be


for directors; founders can prescribe the qualifications in reasonable and do not deprive
shares the by-laws minority of representation on the
board

Management contracts MAJORITY: allows them to Cannot exceed five years


delegate certain functions and BOD must retain control
duties without losing control over over corp. policies
the corporation BOD must have power to
recall contract

Unusual voting and quorum MINORITY: gives them stronger Subject to the limitations in Sec.
requirements veto power in certain corp. affairs 103.

MEETINGS

Meetings of Directors / Trustees


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

REGULAR: Held monthly, unless otherwise provided in the by-laws.


(Sec. 53)

SPECIAL: At any time upon call of the president or as provided in the by-
laws.

NOTICE: 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) If the AOI or by-laws provide for a greater majority;


(2) If the meeting is for the election of officers, which
requires the vote of a majority of all the members of the
Board

WHO PRESIDES: 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) Self-dealing directors (Sec. 32)


(2) Contracts between interlocking directors (Sec. 33)
(3) Disloyalty to the corporation (Sec. 34)
(4) 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 was ultra 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 Presidents 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 directors 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
cashiers 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 NATURE OF CONTRACTS ENTERED INTO BY SELF-DEALING


DIRECTORS?

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 arms
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 wasnt 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: Directors as such are not entitled to compensation for


performing services ordinarily attached to their office.

EXCEPTIONS: (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? The stockholders only (majority of the OCS)

EXCEPTION: 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 stockholders 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 stockholders 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 creditors 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. Agrees to hold himself personally and solidarily liable with the corporation;

IV. 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) Record of all business transactions;


(2) Minutes of all meetings of stockholders or members;
(3) Minutes of all meetings of Board of Directors or Trustees;
(4) 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 directors 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. The exercise of this right is subject to reasonable limitations similar to a citizens exercise of the
right to information. Otherwise, the corp. might be impaired, its efficiency in operations hindered,
to the prejudice of SHs.

2. Such limitations to be valid must be reasonable and not inconsistent with law ( Sec. 36[5] and
46).

3. 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. Place of inspection: Principal office of the corp. SH cannot demand that such records be taken
out of the principal office.

7. As to purpose:

PRESUMPTION: that SHs 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: inquiry about failure to declare dividends


Not legitimate: 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 parents 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 petitioners purpose is
improper and inimical to the interests of the corporation.

Writ should be directed against the corporation. The secretary and


the president may be joined as party defendants.

(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 secretarys 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 SMCs 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 intra-corporate
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) Contributions (stockholders); also known as stockholder equity/equity


investment
2) Loans or advances (creditors)
3) Profits (corporation itself)

Capital Structure
WHAT IS MEANT BY CAPITAL STRUCTURE?

This refers to the aggregate of the securities -- instruments which represent relatively
long-term 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 actual property of the corporation,
corporate charter, to be subscribed including cash, real, and personal
and paid in or secured to be paid property. Includes all corporate
in by the SHS of a corporation, assets, less any loss which may
and upon which the corporation is have been incurred in the
to conduct its operation business.

CONSTANCY CONSTANT, unless amended by FLUCTUATING


the AOI

Shares of Stock: Kinds


COMMO PREFERRE PAR NO PAR* TREASURY REDEEMABL FOUNDER
N D E S

DEFINITION Stock Stock which Shares that Shares issued Special


which entitles the have been by the shares
entitles holder to issued and corporation whose
the owner some fully paid that may be exclusive
of such preference but taken up by rights and
stocks to either in the subsequentl the privileges
an equal dividends or y reacquired corporation are
pro rata distribution of by the upon determined
division of assets upon issuing expiration of a by the AOI.
profits liquidation, or corporation fixed period.
in both by lawful
means. regardless of
the existence
of unrestricted
retained
earnings

VALUE Depends Stated par Fixed in Value not


if its par value the AOI, fixed in
or no par and the AOI,
indicated and
in the therefore
stock not
certificate indicated
. May be in the
sold at a stock
value certificate
higher, . Price
but not may be
lower, set by
than that BOD,
fixed in SHs or
the AOI. fixed in
the AOI
eventually
.

VOTING Usually Can vote Depends Depends No voting Usually denied


RIGHTS vested only under if its if its rights for as voting rights.
with the certain common common long as
exclusive circumstance or or such stock
right to s preferred preferred. remains in
vote . the treasury
(Sec. 57)

PREFERENC No First crack at


E UPON advantag dividends /
LIQUIDATIO e, priority, profits /
N or distribution of
preferenc assets
e over
any other
SH in the
same
class

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 the other subscribers consent to the


revocation; or

(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 SHs
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) Initial Public Offerings (IPOs);

2) Issuance of shares in exchange for property needed for corporate purposes,


including cases wherein an absorbing corporation issues new stocks to the
SHs in pursuance to the merger agreement (Sec. 39)

Why? (a) Because it is beneficial for the corporation to save its


cash;
(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 productive
corporate activities.

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 Only if there are profits


has profits or not

NATURE Expense Not an expense

TAXABILITY Can be deducted for tax CANNOT be deducted


purposes

MATURITY DATE? Yes No

RANK ON Ranked together with Superior to stockholders,


DISSOLUTION other corporate creditors 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 stockholders 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 corporations 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 creditors 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 corporations 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
corporations 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: 1. kind of shares


2. date of issuance
3. par value, if par value shares

BEARS: Signatures of the proper officers, usually president


or secretary, as well as the corporate seal

AMOUNT ISSUED: 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) Call for payment as necessary, i.e. the BOD declares the unpaid subscriptions due
and payable (Sec. 67);

(2) 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)

Companys 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. Companys 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. Lumanlans 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) Name of the corporation


(b) Name of the registered owner;
(c) Serial number of the certificate;
(d) Number of shares represented by the certificate;
(e) 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) Delivery;

(2) 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. did not entrust the certificate to anyone; and


b. 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 Guans 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 owners 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 companys 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 Board of Directors Board of Directors +


for issuance 2/3 OCS

Effect on delinquent Shall be applied to the Shall be withheld from the


stock unpaid balance on the delinquent stockholder
subscription plus costs and until his unpaid
expenses. subscription is fully paid.

Can this be issued by No. (Sec. 35) No, since this requires SH
Executive approval. (Sec. 35)
Committee?

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:

BODs 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
companys 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 companys 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 cos 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: If the declaration has not yet been announced or


communicated to the stockholders.

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 SHs 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. unrestricted retained earnings to cover the shares to be acquired;


2. legitimate corporate purpose

FOR WHAT PURPOSES CAN A CORPORATION ACQUIRE ITS OWN SHARES?


(Sec. 41)

1. To eliminate fractional shares arising out of stock dividends;

2. 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) In case of merger or consolidation (Sec. 81);

(4) 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) SH must have voted against he proposed corporate action;


(2) Written demand on the corporation for payment of the fair value of his shares;
(3) 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) abandonment of the corporate action involved; or


(2) 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?

PURPOSE: must be legitimate

VOTE: 2/3 of OCS / membership

(1) 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.

(2) 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;

Treasurers 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 stockholders 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 amendmentthese 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.

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

(4) 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 dissolution of a corporation under quo


warranto proceedings are:

(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
non-user;

(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:

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

(2) 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 incurredshall 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) Collection of corporate assets and property;

(2) 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 DISTRIBUTION OF ASSETS OF NON-STOCK
CORPORATIONS? (Sec. 94-95)
(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) Board of Directors of the constituent corporations must prepare and approve
a plan of merger or consolidation.

(2) 2/3 vote of OCS of the constituent corporations.

(3) Execution of the Articles of Merger/Consolidation, to be signed by the


Pres/VP and certified by the secretary / assistant secretary.

(4) 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 corporations
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 Build-


Operate-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 its
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.

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: A resident of the Philippines.

PURPOSE: 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
plaintiffs capacity to sue, must be affirmatively pleaded. In short, facts showing foreign
corporations 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 mens
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: Rustans 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 3rd 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 corporations 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


Firemens Fund Insurance (FFI) for the payment of 12 marine insurance policies. The
summons was served on Union which was then acting as FFIs 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 Managed by Board of


stockholders (Sec. 97) Directors

Meetings May be dispensed with (Sec. Actual meetings are


101) required.

Quorum and Voting Greater quorum and voting


requirements allowed. (Sec. 97)
Pre-emptive right Extends to all stock, including Does not extend to treasury
treasury shares (Sec. 102) shares.

Buy-back of shares Must be > par value (Sec. 105) May be < par value

Resolution of SEC has the power to arbitrate


deadlocks 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 Generally requires a 2/3 vote


stockholder whenever any of the of the stockholders and a
acts of the directors or officers or majority vote of the BOD.
those in control of the
corporation is illegal, fraudulent, (Note however that in case
dishonest, oppressive or unfairly of involuntary dissolution
prejudicial to the corporation or under Sec. 121, a
any stockholder, or whenever corporation may be
corporate assets are being dissolved by the SEC upon
misapplied or wasted. (Sec. filing of a verified complaint
105) and after proper notice and
hearing.)

WHAT IS A PROVISIONAL DIRECTOR? (Sec. 104)

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 duly-elected 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 Appraisal Right

Type of corporation Close corporation "Regular" corporation


involved

When availed of For any reason (Sec. 105) Only the grounds
enumerated in Sec. 81
and Sec. 42

Fair value of shares Must be > par or issued value May be < par or issued
(Sec. 105) value
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)