Chapter XI – Financing the Corporation; Capital Structure

Sources of financing Three main sources:

— —

Equity investments; Contributions of SHs o Investor making equity investments expects that his returns shall be tied up with the success or loss of the operations of the corporation  Return of equity investor is intricately woven into the business affairs of the corporation and participates in the income  Investor/SH is given a say in the management—he is entitled to participate in the election of the board and cast votes on corporate matters where SHs are required to give ratificatory action  Absence of carrying cost since corporation is not bound to pay any return on investment unless there are profits and subject to business judgment of the board in declaring dividends o Equity investment generally non-withdrawable for so long as the corporation has not been dissolved o Investors of equity can only receive a return of their investment only from the remaining assets after payment of creditors

Refers to the aggregate of the securities issued by the corporation Two classes of securities: o Shares of stock o Debt securities o Senior securities: those which have a prior but limited claim upon corporate earnings (such as debt and typical PS) o Equity securities: those which have the residual interest in corporate earnings (such as CS and participating PS) Important characteristics of securities as forms of investments: o Right to any early claim on the income before other security holders o Right to residual income o Right to vote Only 25% of authorized capital stock need be subscribed initially o Promoters are not bound to limit the starting capital needed by the business o Other sources of capital may be tapped, at the initial stages or when the corporation is already a going concern Two questions to consider: o What should be the relation between basic equity interests and senior securities? o What type of senior securities should be issued?

Capital and Capital Stock Distinguished — 137: total shares of stock issued to subscribers or SHs, whether or not fully or partially paid, provided there is a binding subscription agreement; composed of (2) items: o portion paid by the SHs (paid-up capital) o portion which is to be paid on the subscriptions (subscription receivables) Capital stock: the amount fixed by the AOI to be subscribed and paid in or secured to be paid in by the SHs, either in money, property, or services o Represents the legal and proportional standing of the SHs with respect to the corporation and corporate matters o Represents the financial and proprietary claim of the SHs to the net assets of the corporation upon dissolution o Totality of the portion of the corporation’s assets and receivables covered by the trust fund doctrine and are deemed protected for the benefit of corporate creditors o The corporation does not have to issue all shares at one time o Remains the same unless the AOI are amended to either increase or decrease

Debt contracts: Loans/advances by creditors o Person extending a loan or debt looks at the financial condition and operations of the corporations as a means of gauging capacity to pay  Creditor puts no stake on the operations of the business; his relationship to the corporation is based on contract  Contractual obligation of corporation to pay the stipulated return (in the form of interest) remains even when losses are incurred o Expected return: creditor can only demand the stipulated fixed return/interest o Legal preference in payment from corporate properties—once insolvent, the corporation shall devote and prefer all corporate assets towards the payment of creditors — Profits of the corporation Capital structure

1

o —

Cannot be used to declare dividends

Capital: actual property of the corporation, including cash, real and personal property o Includes all corporate assets—contributions of SHs, loans by creditors, earnings less losses o Fluctuates depending on current profits or losses of the business

stipulation in the subscription agreement (67) b) To impose interest on unpaid subscriptions (66) c) To refuse to issue certificates covering shares where subscription has not been fully paid (64) d) To refuse to recognize and register the sale or assignment of any share where subscription is not fully paid (63) e) To refuse to recognize a sale or assignment which has not been duly registered in the stock and transfer book (63) Corporation does NOT have the power to: a) demand for the repurchase of shares unless classified as redeemable in the AOI (Sec 8) b) refuse to pay dividends to SHs as declared and not been declared delinquent in order to apply to the unpaid subscription (Sec 71) c) bid delinquent shares and obtain greater profit for itself (68) Power to issue shares: — Power to issue shares or sell them inherent and express in the corporation, lodged with the board o SH meeting not required on the issuance of unissued authorized capital stock (first issuance from corporation to SH) — Limitations on power to issue shares: o 62: Cannot be issued for a consideration less than the par or issued value  Sec 9: except treasury shares so long as the price is reasonable o 62: Cannot be issued in exchange for PNs or future services o 59: if consideration not in cash: value shall be determined by the incorporators or the board subject to SEC approval Power to classify shares — Sec 6: shares may be divided into classes or series or both, any of which may have rights, privileges, or restrictions stated in the AOI o No share may be deprived of voting rights except those classified and issued as “preferred” and “redeemable” shares o Any or all shares or series of shares may have par or no par value — Code adopts presumption of equality of the rights and features of shares when nothing is expressly provided to the contrary in the AOI or when AOI is silent o In the absence of restrictions in the AOI, PS shall would be voting shares having the same rights as CS — Code provides for voting rights for all types of shares on matters of fundamental importance; Sec 6: non-voting shares shall be entitled to vote on: o Amendment to the AOI

Shares of Stock; Kinds Sec 6

Defn: Share of stock: a unit or several units of interest acquired when a person contributes capital to a corporation by way of equity o Units into which the capital stock is divided o Represents the interest of the holder:  to participate in the management of the corporation,  to share proportionally in the profits, and  upon liquidation, to obtain an aliquot part of the corporate assets after creditors are paid o GR: SH cannot get back his investment until dissolution or liquidation of the corporation o Ownership of shares do not make the SH the owner of any specific property of the corporation, but the shares owned are his own personal property which he may transfer, mortgage, pledge, or otherwise dispose of o Not to be confused with certificate of stock—evidence of the interest of the SH in the corporation

Nature of shares of stock — Constitute personal property of the SH which he can contract with as in any other form of property — Represent aliquot parts of the corporation’s capital or the right to share in the proceeds; holder is not the owner of any part of the capital of the corporation nor is he entitled to any definite portion of the property and cannot be treated as a co-owner or tenant-in-common (SHs of Guanzon v. RoD) — Holders do not own any part of the assets nor are they entitled to possession — Do not represent proprietary rights of SHs to the corporate assets or properties Rights of the corporation with respect to shares: a) To call for payment of unpaid subscriptions subject to contrary

2

Adoption and amendment of by-laws Sale, lease, exchange, mortgage, pledge or any disposition of all or substantially all corporate property o Incurring, creating or increasing bonded indebtedness o Increase or decrease of capital stock o Merger or consolidation o Investment in another corporation or another business o Dissolution of the corporation — All other corporate acts: non-voting shares not entitled to vote — Minimum restrictions on classification, provided that there be a class with complete voting rights — NOTE: rights of PS and bondholders are a matter of contract o o Trust relations on shares of stock — — — — — A trust relationship may be created involving shares of stock of a corporation Sec 10: each incorporator must own or be a subscriber to at least one (1) share Sec 23: every director must own at least one (1) share of stock, which shall stand in his name on the books of the corporation of which he is a director Nominal ownership in shares is all that is required under Sec 23 even when it is shown that the registered SH is only a nominee or trustee of another person Nominee and trustee arrangements do not violate public policy but such nominees and trustees must still comply with the applicable legal restrictions and formalities

— — — —

Designed to induce persons to subscribe for shares of a corporation No more a debt than CS, and until a dividend is declared the holder of PS is not a creditor of the corporation Rights of PS holder are subordinate to the rights of creditors

Entitlement to preferences: o Cannot be deemed absolute and must be interpreted in accordance with the Code and jurisprudence o Under 43, stock dividends cannot be issued without approval of 2/3 OCS at a meeting called for the purpose — Underscores the principle that payment of dividends to SHs is not a matter of right but a matter of consensus o There is no guarantee that the PS will receive any dividends — Declaration of dividends is dependent upon the availability of surplus profit or unrestricted retained earnings — Preferences do not give PS holders a lien upon the corporate property Two limitations: o Can only be issued with a stated par value;

o

Preferences must be stated in both the AOI and the stock certificate; otherwise, each share shall be equal to every other share (1) Preference as to dividends — Dividends are payable only when there are profits earned — GR: even if there are existing profits, the board has the discretion to determine w/n to declare dividends — Gives the holder the right to receive dividends on said shares to the extent agreed upon before any dividends at all are paid to the holders of CS Types: i. Participating and non-participating—shares in which after getting their fixed dividend preference, they share with the CS the rest of the dividends; unless otherwise stipulated, PS are NON-participating shares ii. Cumulative and non-cumulative

Kinds of shares

1.

Common stocks—one which entitles the owner to an equal pro rata division of profits; one SH having no advantage, priority or preference over any other SH in the same class — — — — Most common classification Do not have special contract rights or preferences Represents the greatest proportion of the corporation’s capital structure and bears the greatest risk of loss in the event of failure Represents the residual ownership interest in the corporation

2.

Preferred Stocks—entitles holder to some preference either in the dividends or in distribution of assets upon liquidation, or both, or to other preferences not inconsistent with the code

— 3

Cumulative PS: entitle the holders to payment not only

— — —

of current dividends but also of back dividends not previously paid, when and if dividends are declared, to the extent agreed before CS are paid If PS dividends are not paid in full in a given year, whether or not earned, the deficiency must be made up before any dividend may be paid on the CS PS are deemed to be cumulative In any given year(s) where no dividends declared, the arrears for such year have to be made up in subsequent years before dividends are paid to CS Non-cumulative PS: entitle the holder to payment of current dividends that are paid, to the extent agreed, before CS holders are paid iii. Discretionary dividend type—right of SH to get dividends would depend on the discretion of the board, even if the corporation earns profits Mandatory dividend type—imposes a positive duty on directors to declare preferred dividends every year that profits are earned, and failure to declare would not deprive holders of his dividend rights for a particular year (Burk v Ottawa Gas) Earned cumulative or dividend credit type—gives a right to arrears in dividends where there were profits earned during the years when dividends were not declared 1. SH may not compel payment of dividends and must wait until the board decides to declare

to the exclusion of the CS holders, until the corporation declares and pays dividends for a full year on the PS. Thereafter the right to vote shall revert to the CS holders. Ellingwood contends that the clause “until the corporation pays for a one year period dividends on the PS” restricts the above provision in the AOI as to the duration of time when PS holders shall have the right to vote. TC ruled that PS were entitled to vote at the SH meeting. H: The AOI of the company evidences an intention to make provision for the protection of PS holders. When a dividend for a full year is paid on PS, the sole right to vote reverts to the CS holders, notwithstanding that dividends for 2 years are still due on PS. It clearly appears therefore that when the annual meeting of the corporation was held, dividends were accrued and unpaid on the PS, thus the company was in default, and therefore the PS holders were entitled to vote for the election of directors and all other purposes as stipulated in the AOI.

iv.

(3)
— — —

v.

Preferences upon liquidation (preferences as to assets) GR: PS holders participates pro rata with the CS holders, since each share is presumed to be equal Exception: PS holder may be given preference in the distribution of corporate assets Gives the holder preference in the distribution of assets of the corporation in case of liquidation

Hay v Hay. F: The Big Bend Co. is a real estate business concern. It

(2) Preference as to voting rights — GR: PS are denied by contract the right to vote — Exception: if the right is not clearly withheld in the certificate or AOI, since voting is incidental to ownership Ellingwood v. Wolf’s Head Oil Refining Co. F: Ellingwood is a preferred

SH of the Wolf’s Head Oil Co. At a SH meeting, the corporation was in default in the declaration and payment of dividends for 2 years on the PS. The AOI provides that PS holders are entitled to cumulative dividends, and gives exclusive voting power to holders of CS. PS holders have no voting rights, but is the corporation is in default in the payment of dividends, the majority PS holders shall have an election to exercise the sole right to vote for the election of directors and all other purposes,

amended its articles, stipulating that holders of PS are entitled to receive cumulative dividends, such that if in any year dividends shall not have been paid, the deficiency shall be paid before dividends are declared or paid upon the CS. It also provides: that out of any surplus profit remaining after payment of full dividends on PS for all dividend periods and after full dividends have been paid in full, then dividends may be paid to CS; and in the event of any liquidation of the corporation the holders of PS shall be entitled to be paid in the full the par value thereof, and all accrued unpaid dividends thereon before any sum shall be paid to any assets distributed among the holders of CS. No creditors are involved. No dividends on cumulative PS have been declared or paid. No surplus profits are available with which to pay dividends. A plan of liquidation, distribution, and dissolution of the corporation was adopted. It appears that the net assets were sufficient to redeem the PS at par, but if the PS holders received the promised dividends per the amended AOI, assets instead of surplus profits would be used. The result will be that the CS holders

4

will get no part of such assets. The liquidating trustees, being in doubt as to who was entitled to receive the assets upon liquidation after redemption of the PS, sought a declaratory judgment from the court. It is contended that the phrase “all accrued unpaid dividends” means that before there can be a dividend, there must be surplus profits, and that since none ever existed, the right to the dividends never accrued and therefore none are payable. A counterargument is raised that the provisions of the amended AOI relate to the payment of dividends to PS holders out of surplus profits while the corporation is a going concern, but that it authorizes payment of accumulated and unpaid dividends out of assets upon liquidation of the corporation, even though there is no surplus profits available. I: W/N holders of cumulative PS upon liquidation of the corporation are entitled to be paid accrued dividends from corporate assets before the common SHs become entitled to participate in the distribution thereof, the corporation having earned no surplus or net profits. H: The contract stating the rights of the PS has a double aspect. The provision on annual dividends payable out of the surplus profits was founded on the hope and prospect of a profitable business. Such dividends could be paid by a corporation financially successful. There can be no dividends declared by a corporation in financial distress. But if there were provision for the rights of PS holders even in the event of a business disaster resulting in voluntary winding up or dissolution of the corporation, they would be entitled to receive in full both the amount of their shares and the unpaid dividends accrued. In this case the words of preference were designed to be operative even under conditions of adversity. The advantages of holders of PS are not restricted to conditions of prosperity, but general in scope and intended to be operative in all the hazards of business. In the present case, the holders of PS are entitled to both the par value of their stock and to dividends which have not been declared or paid but which would have been so, had the company experience surplus profits. An investor places his money in cumulative PS because it has a guaranteed dividend and certain preferences, as set forth in the stock agreement. If this agreement gives preferences as to dividends in the liquidation proceedings, the stock would normally be considered as a better business risk. The clause “unpaid dividends accrued” would thus mean that it gives preference to holders regardless of any consideration of profits or surplus. Dissent: Differences of opinion usually arise when on liquidation, PS holders sought to have a preference in the distribution of assets to

reimburse them, because the corporation may not have earned any net profits out of which dividends can be paid. Two schools of thought: (1) a dividend can come into being and exist only by affirmative declaration of the corporation, and only if there is surplus profits. No surplus profits, no right to the dividends accrues, and thus cannot be demanded in liquidation; (2) dividends, if not regularly paid out of available earnings, may be amassed, whether earned or not, at regular dividend rates, and may be paid out of assets when the corporation is liquidated if the AOI so provide.
(4) Preferred stockholder is not a creditor — PS holder is an equity holder and not a creditor — Investment is still subject to all risks of ownership Augusta Trust Co. v. Augusta, Hallowell & Gardiner Railroad Co et al. F: Augusta Railroad had outstanding bonds secured by mortgage.

These bonds gave the holders the right to convert into preferred stock of the company. The corporation contends that the certificates of PS issued in exchange for bonds were in fact certificates of indebtedness and not stock. I: W/N the rights of the holders of preferred shares to share in the proceeds on the sale of mortgaged property H: It is within the power of the legislature to prescribe that corporations may issue certificates in the form of certificates of PS, making the holders creditors of the corporation as well as SHs, and giving them a lien upon the corporate property with a priority over other creditors. This is not ordinary PS, nor technically PS at all. It is sui generis, not governed by the ordinary rules. The preferences given the holders of the PS in this case were not authorized by statute when made. The stock was not statutory PS of the kind described. PS may be issued in such a way as to make the certificates thereof merely evidence of indebtedness and the holders creditors and not SHs. Here all facts and circumstances characterize the PS issued by the corporation as PS, and not bonds. SHs voted increases in capital stock by the creation of PS. The certificates delivered to the holders of the bonds exchanged for it designated the stock as PS. The holders had the right to vote. The certificates contain every essential feature of a certificate of PS and none of a contract of indebtedness. By surrendering their bonds, and taking in lieu thereof PS, the bondholders ceased to become creditors and became mere SHs. Those who have no made the exchange are entitled to the security of the mortgages, excluding the illegal conversion agreements. The PS are not entitled to share in the assets of the corporation until all

5

creditors are paid in full.
3. Par and no-par shares

Par value: the minimum issue price of a share o Must be stated in stock certificate, which cannot be issued until paid in full by subscriber o Shares cannot be sold at less than par; otherwise they would be watered stock and SH would still be liable for the difference No par value: issued price is not stated in the stock certificate, but may be fixed in the AOI or by the board or in the by-laws, or by the SHs themselves o Sec 6: no par value shares shall be deemed fully paid and nonassessable and the holder thereof shall not be liable to the corporation or to its creditors o Subscriber must pay its full consideration o Such consideration shall be treated as capital and is not available for distribution as dividends o Delpher case: no par value share does not represent any stated proportionate interest in the capital stock, but only an aliquot part of the whole number of such shares issued  Capital stock of a corporation issuing no par shares is not set forth by a stated sum of money, but is expressed to be divided into a stated number of shares  By removing the par value, the attention of persons interested in the financial condition of the corporation is focused upon the value of the assets and debts o Limitations on the issuance of no-par value shares: a) Once issued, are deemed fully paid and therefore nonassessable b) Consideration cannot be less than P5.00 c) Entire consideration for the issuance constitutes capital d) Cannot be issued as PS e) Cannot be issued by banks, trust companies, etc f) AOI must state the fact that no-par shares were issued

corporation until and unless they are cancelled or retired Acquisition of treasury shares does not reduce the number of issued shares nor the amount of stated capital and their sale does not increase the number of issued shares or amount of stated capital

5. Redeemable shares


— —

— — — — —

Sec 8: may be issued by the corporation when expressly so provided in the AOI Redeeming shares: shares issued by a corporation which the corporation can purchase or take up from holders as expressly provided for in the AOI and stock certificates Redemption: repurchase, reacquisition of stock by a corporation which issued it in exchange for property, whether or not the stock is canceled, retired, or held in the treasury o Corporation gets back some of its stock, distributes cash or property as payment, and continues its business as before May be purchased or taken up by the corporation upon the expiration of a fixed period, regardless of unrestricted retained earnings May be redeemed regardless of whether or not there are unrestricted retained earnings, provided the corporation has sufficient assets in its books to cover debts and liabilities SEC Rules: in issuing redeemable shares, corporations must set up and maintain a sinking fund If the option to redeem is clearly vested in the corporation, the redemption is an “optional” one and the SH is without right to either compel or refuse the redemption Amount of unrestricted retained earnings equivalent to the cost of treasury shares held shall be restricted from being declared and issued as dividends

6. Founder’s shares — — Sec 7: founder’s shares classified as such in the AOI may be given certain rights and privileges not enjoyed by owners of other shares If it involves the exclusive right to vote and be vote for in the election of directors, it shall not exceed 5 years

4. Treasury shares Sec 9: shares issued and fully paid for, but subsequently reacquired by the issuing corporation by purchase, redemption, donation, or through other lawful means — No voting rights nor preemptive rights — Not entitled to dividends — May be sold for any amount the board may fix — SEC: treasury shares have no effect on the stated capital of the

Nature of Subscription Contract — Underpins the relationship between the SH and the corporation

6

72: holders of subscribed shares not fully paid which are not delinquent shall have ALL the rights of a SH o it is the subscription to shares, and not the payment, that create the legal relationship between the SH and the corporation (Fua Cun case infra) o full payment of the subscription value and/or issuance of the covering certificates are not important ingredients for transfer of ownership (72) o registration of the subscription is also not essential to constitute subscription and issuance of shares; it is merely meant to govern the binding effects of sale and dispositions of shares as to third persons (63) — two ways to become a SH: o by subscription to shares before or after incorporation o by acquisition of already issued shares from an existing SH —

fully paid for, belong in ownership to him with legal authority to sell or mortgage the same (Fua Cun) Is a valid subscription agreement enforceable even when it is not reduced in writing? o Villaneuva: yes! Corporation can adduce oral evidence on a verbal agreement

Characteristics of Subscription agreements — There can be a subscription only with reference to UNISSUED shares of stock o Original issuance from authorized stock at the time of incorporation o Opening of a portion of the original but unissued authorized capital stock to subscription o Increase of authorized capital stock through formal amendment — Def’n of subscription: a contract for the acquisition of unissued stock of of the AOI and approval of the SEC a corporation whether existing or still to be formed — On ISSUED shares: any transaction thereon is NOT a subscription o subscription price need not be paid in full at the time of the contract agreement, and is therefore governed by the Law on Sales o once perfected, SH becomes a debtor to the corporation and may be — 60: agreements for the acquisition of unissued shares shall be liable to pay any unpaid portion upon call by the board deemed a subscription agreement  no interest unless by-laws provide o affords protection to corporate creditors so that any and all  SH personally liable for the financial obligations of the transactions relating to the issuance of shares of stock is a corporation to the extent of his unpaid portion subscription agreement — When shares deemed subscribed o in case of insolvency, corporate creditors may enforce even o 60: any contract for the acquisition of unissued stock in an existing against one denominated as a purchaser corporation or one still to be formed shall be deemed a subscription — Stipulations in subscription agreements of unissued shares that the agreement subscriber’s right to be treated as a SH and enjoy the rights thereof  even if the parties refer to it as some other contract would commence upon full payment of the subscription would be o The entering into any contract for the acquisition of UNISSUED stock, VOID which shall be deemed as a subscription agreement, would itself o Affects the ability or liability of the subscription agreement constitute the tradition by which the subscriber becomes a SH of the o Agreement will not be treated as a sale of shares; falls under Sec corporation and through which he becomes the owner of the shares 60 and thus exercise acts of ownership pre-incorp contracts are valid & enforceable; are types of promoter’s contracts… GR: a that would deprive the not 60-60: o It is only when delinquency is declared promoter’s contract is  A subscription agreement constitutes the very mode by necessarily binding on the corporation; EXC: when the subscriber the benefits at SH time of its creation corp received rights of a the which shares are thereby issued and then owned  It exists upon the meeting of the minds of the corporation Sec 66 and the subscriber as to the number and value of the subscription of shares Garcia v. Lim Chu Sing. F: Lim Cuan Sy is the debtor of the  The covered shares would then be deemed issued by the Mercantile Bank of China, by virtue of a trust account with the bank, corporation at that point in time in the form of trust receipts guaranteed by CMs and by Defendant • The sale of unissued shares of stock may be treated Lim Chu Sing as the surety of Lim Cuan. Lim Chu is also a SH of the wholly as a sale of shares governed by the law on bank iao P10000. When the obligation became due, the bank sales (Bayla) foreclosed the CMs without the knowledge of the surety Lim Chu. The • The entire shareholdings of a SH, even when not bank also required Lim Chu as surety to execute a PN, where in the

7

event of Lim’s default in payment of any installment as they become due, the entire amount or unpaid balance becomes due and demandable. Lim leaves a balance of P9,105.17. The bank is under liquidation at the time of the action. I: W/N it is proper to compensate Lim’s indebtedness with the sum of P10000 in shares of stock with the Mercantile Bank of China. H: A share of stock or the certificate thereof is not an indebtedness to the owner nor evidence of indebtedness, and is thus not a credit. SHs are not creditors of the corporation. The capital stock of a corporation is a trust funds to be used for the security of the creditors of the corporation, who deal with it on the credit of the capital stock. SC ruled that Lim Chu not being a creditor of the Bank, although the latter is a creditor of the former, there is no sufficient ground to justify a compensation.
1. — Pre-incorporation subscription

o o o o

since the consent of all is necessary (Velasco v Poizat infra) Consistent with 25% minimum requirement After 6 month period, a pre-incorporation subscriber may revoke his subscription agreement without the consent of the other subscribers But if AOI have already been submitted to SEC, there can be no more revocation even if other subscribers consent and even after 6 month period Once perfected, each subscriber has to comply with his contract and pay his subscription; not even the corporation can release him

Sec 13 Sec 61 Wallace v. Eclipse Pocahontas Coal Co. F: Case involves a contract

Theories on the binding effect of pre-incorporation subscriptions: o Offer theory: such subscriptions are only continuing offers to the proposed corporation which do not ripen into contracts until accepted by the corporation when organized  Thus subscribers are allowed to withdraw their subscription at any time before the corporation comes into existence and accepts the offer o Contract theory: becomes a binding contract and is irrevocable from the time of subscription unless cancelled by all parties before acceptance by the corporation  Prevents subscribers from withdrawing unless consented to by all subscribers — Sec 61: Corpo Code adopts the view that 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 — 61: GR: a pre-incorporation subscription shall be IRREVOCABLE for a period of at least 6 months from date of subscription o Exceptions:  When all the other subscribers consent to the revocation  Incorporation fails to materialize within 6 months or longer as may be stipulated in the subscription agreement o Fusion of the best features of the offer and contract theories  Contract between subscriber and the to-be-formed corporation 60: any contract for the acquisition of unissued subscribers; thus it is  Contract between and among the stock in an existing or tobeyond the corp shall be deemed a release the subscribers be formed powers of the board to subscription, notwithstanding reference by the parties as a purchase or some other contract

entered into by Wallace and the promoters of the Eclipse Pocahontas Coal Co. Wallace was to transfer and assign an option for a lease to the promoters and from the promoters to the corporation, in exchange for money to pay for the purchase price for the lease, and once the corporation is up and running, Wallace was to have a 1/5 interest in the property fully-paid up, and a 1/5 interest in the corporation fully paid up. Wallace was also to be entitled to 50 shares of the corporation, but only 5 shares were issued to him. Wallace alleged that the corporation and its promoters failed to perform their part of the contract. TC ruled that Wallace was to recover a little over $1000 from each of the defendants, or a total of $4300, which the court found to be the value of 43 shares which he had been deprived, being 1/5 of the shares issued less 5 shares delivered to him. The corporation was not held liable. Wallace contends that he was erroneously limited to money decrees against the promoters and seeks a judgment against the entire property and plant of the corporation as a trust therein his 1/5 undivided interest or a judgment to order the issuance and delivery of 43 additional shares, or a judgment for the actual, not par value of the shares. H: Promoters are indeed solidarily liable to Wallace for the stock to which he is entitled, and so is the corporation. The corporation and the other subscribing SHs accepted and benefited from the contract with Wallace. Thus, not only did the corporation have notice of Wallace’s right but all the SHs of the corporation participating in the 1st SH meeting of the corporation had notice that Wallace had at least some interest or claims based on his contract. Wallace is definitely a subscriber to the stock of the corporation. His

8

contract was to sell or convey to the corporation the leasehold and accept payment in fully paid up stock to the value of the property leased when fully equipped for the business purposes of the corporation. Being entitled to this amount of stock easily ascertainable when the equipment was completed, he became entitled to the stock, and a court of equity can compel specific performance to deliver the shares to him. One who has paid for his subscription may sue in court to compel the issuance of proper certificates therefor. The TC was therefore wrong in limiting Wallace to a money decree severally against the promoters and not including the corporation.
2. — Post-incorporation subscription

Distinction between purchase and subscription of shares erased by Sec 60 — Since anyone who acquires unissued shares is a subscriber, then he enjoys all rights of a SH regardless of w/n he has fully paid for his subscription (unless he becomes delinquent) — Since he is a debtor to the corporation, the subscriber remains liable to pay the balance of his subscription price Bayla et al v Silang Traffic Co Inc. F: Bayla et al are SHs who file an

action to recover certain sums of money which they had paid to the corporation on account of shares of stock they individually agreed to take and pay for under certain specified conditions. The action is based on a resolution by the board of Silang Traffic Inc. The resolution revokes the rescission of the agreement. Silang argues that the resolution does not apply to Bayla because on the date thereof the subscribed shares had already automatically reverted to the corporation, and the installments paid had already been forfeited, without need for demand, and that the resolution itself had been revoked. TC ruled ifo Silang Traffic, invoking the ruling in Velasco v Poizat that a corporation has no legal capacity to release an original subscriber to its capital stock from the obligation to pay for its shares, and any agreement to this effect is invalid. CA affirms. The parties, TC and CA treated the agreement as a contract of subscription to the capital stock of Silang Traffic. It should be noted that the agreement is entitled, “Agreement for Installment Sale of Shares in the Silang Traffic Co. Inc, and that while the purchaser is designated as a “subscriber”, the corporation is described as “seller.” The agreement took effect long after incorporation of the company. I: W/N the contract in question is a subscription or a contract of sale. H: Whether a particular contract is a subscription or a sale of stock is a matter of construction and depends upon its terms and intention of the parties. A subscription to a stock in an existing corporation is, as

between the subscriber and the corporation, simply a contract of purchase and sale. Thus the terms of the contract indicate that they are contracts of sale and not of subscription. A subscription is the mutual agreement of the subscribers to take and pay for the stock of a corporation, while a purchase is an independent agreement between the individual and the corporation to buy shares at a stipulated price. Likewise, the rule that the corporation has no legal capacity to release an original subscriber to its capital stock from the obligation to pay for his shares, is inapplicable to a contract of purchase of shares. The contract being one of purchase and not subscription there is no legal impediment to its rescission by agreement of the parties. The rescission was made for the good of the corporation and in order to terminate the pending civil case. Since the civil case was eventually dismissed, and that the purchasers of stock would be able to benefit by the resolution. It would be an unjust discrimination to deny the same benefit to Bayla. There is also no intimation that the corporation is insolvent, or that the right of any creditor was prejudiced by the rescission. I: W/N under the contract, the failure of the purchaser to pay any of the installments automatically gave rise to the forfeiture of the paid installments. H: the contract did not expressly provide for automatic forfeiture and cancellation without necessity of demand. Under the CC persons obliged to deliver or do something are not in default until the amount the creditor judicially demands the same, unless the obligation or the law expressly provides that demand shall not be necessary or that by reason of the nature and circumstances of the obligation it shall appear that the designation of the time when the thing is to be delivered or service rendered was the principal inducement to the creation of the obligation.
— — The nature of a contract covering unissued shares after incorporation was either a subscription contract or a purchase of shares of stock, depending on the terms of the agreement and intent of the parties Subscription agreements are mutual agreements among subscribers to take and pay for the stock of a corporation, and it is not possible for SHs to withdraw from such an agreement without the consent of the other subscribers Purchase agreements are independent agreements between the individual and the corporation to buy shares at a stipulated price

Preemptive Right to Shares 1. Basis of right; common law rule

9

— — — — —

Preemptive right: option privilege of an existing SH to subscribe to a proportionate part of shares subsequently issued by the corporation before the same can be disposed in favor of others o Common-law right granted to SHs of a corporation to be granted the first option to subscribe to any opening of the unissued capital stock, or to any increase from the authorized capital stock Economic aspect: right to invest capital—the right becomes valuable when the enterprise has demonstrated that it will earn a higher rate of return on the capital than the SH could get were he to invest it in the open market Limited to shares issued in pursuance of an increase in the authorized capital stock; does not apply to additional issues of originally authorized shares forming part of the existing capital stock An original subscriber is deemed to have taken his shares knowing that they form a definite proportionate part of the whole number of authorized shares When unsubscribed shares are later reoffered, the SH cannot claim that his interest would be diluted Preemptive rights are not statutory rights, but common law rights Preemptive rights are personal rights of the SH o Need not be stipulated in the AOI or by-laws o May be removed, denied, or altered only through specific provisions in the AOI or amendment thereto o SEC: vote by majority of SHs to waive the right is NULL and VOID; such waiver must be given individually by the SHs concerned  But unanimous vote of all will bind them Extent and limitations of preemptive right under Code

— — —


All issues or disposition of shares of any class Includes issues from the existing unsubscribed portion of authorized capital stock Includes not only new shares but also previously unissued shares which form part of the existing authorized capital stock Includes reissuance and sale treasury shares SEC: does not include subscription deposits; these are payments received for the future issuance of stock which may or may not materialize

… except… — When shares are issued in exchange for property needed for corporate purposes, or for a debt previously contracted, the SH cannot demand his preemptive right — Where all shares are issued by a corporation in exchange for shares in another corporation (merger), the preemptive right does not exist, provided the issue is made with approval of 2/3 SHs (Thom case) — In widely held corporations, where future financing plans may be seriously hindered by the existence of the preemptive right — Code allows waiver or denial provided it is in the AOI, either as an original provision or as an amendment Effects of exercise and waiver of preemptive right — Exercising SHs still retain their relative and proportionate voting strength, which will not be affected thereby — Waiving SHs’ shares may be offered to non-SHs of record on a first-come-first-served basis o Not necessary that the shares will again be offered on a prorata basis to SHs who availed of the right 3. — — In close corporations Balance of power in close corporations may be disturbed by an indiscriminate issuance of new shares without regard to preemptive right of SHs In a close corp, exceptions in Sec 39 are not applicable

2.

Sec 39: all SHs of a stock corporation shall enjoy pre-emptive rights to subscribe to all issues and dispositions of shares of any class, in proportion to their respective shareholdings — Exceptions: o If denied by the AOI or an amendment thereto o On shares issued in compliance with laws requiring stock offerings or minimum stock ownership by the public o On shares to be issued in GF, approved by at least 2/3 OCS in exchange for property for corporate purposes o On shares to be issued in GF, approved by at least 2/3 OCS, in payment of a previously contracted debt Coverage of preemptive right…

Sec 102 4. — — Waiver of preemptive right GR: Any prior waiver or denial should appear in the AOI o Ordinary waiver agreement is not sufficient Exception: If all existing SHs unanimously agree to a waiver,

10

although not in the AOI, they will be bound by such agreement Datu Tagoranao Benito v. SEC. F: Benito subscribed to 460 shares of

the Jamiatul Philippine-Al Islamis Inc. The corporation increase its capital stock, with an additional issuance of worth P110,980.00. Benito files a complaint with the SEC alleging that the issuance was made in violation of his pre-emptive right to the additional issue and that the SHs of record were not notified of the meeting. SEC ruled that the issuance was valid, and that his preemptive rights are inapplicable. H: Issuance is not invalid even without notice to the SHs. The power to issue shares of stocks is lodged in the board and no SH meeting is necessary to consider it because additional issuance of shares does not need SH approval. GR: preemptive right is recognized only with respect to new issue of shares, and not with respect to additional issues of originally authorized shares. The theory is that when a corporation at its inception offers it first shares, it is presumed to have offered all of those which it is authorized to issue. The original subscriber is deemed to have taken his shares knowing that they form a definite proportionate part of the whole number of authorized shares. When the shares left unsubscribed are later reoffered, he cannot therefore claim a dilution of interest.
5. — When the issue is in breach of trust SHs can still object even if preemptive right does not exist or comes within exceptions in Sec 39 if the directors acted in breach of trust or to “freeze out” the minority (Ross Transport case) Remedies when right violated Aggrieved SH can obtain an injunction or mandamus Derivate suit proper, not only in the violation of preemptive right but also where the violation resulted in waste and mismanagement of corporate assets

shares of the new stock at par, but was refused. As a result, he now has only ½ voting power that he had before, because the number of shares had been doubled while he still owns 221. After the sale to Blair, Stokes renewed his demand but was again refused. At this time the stock rose in value, from 450 to 550 to 750. Stokes sued. TC ruled that Stokes had the right to subscribe, and was entitled to recover the difference between the market value at the time of increase and its par value. CA reversed. I: W/n Stokes had the legal right to subscribe and take the same number of new stock he held of the old. H: A vote to increase the capital stock, if it was not the creation of new and disjointed capital, was in its nature an agreement among the SH to enlarge their shares in the amount or in the number of the extent required to effect that increase. If the right claimed by Stokes was a right of property belonging to him as SH, he could not be deprived of it by the joint action of the other SHs and of all directors and officers of the corporation. He has an inherent right to his proportional share of any dividend declared, or of any surplus arising upon dissolution, and he can prevent waste or misappropriation of the property of the corporation by those in control. Hence the power of the individual SH to vote in proportion to the number of his shares is vital and cannot be cut off or curtailed by the action of all other SHs even with the cooperation of the other directors and officers. The ownership of stock is in the nature of an inherent but indirect power to control the corporation. The stock, when issued ready for delivery, does not belong to the corporation, but is held by it with not power of alienation, and in trust for the SHs, who are the beneficial owners and become the legal owner upon paying therefor. The new stock issued by the corporation did not belong to it, but was held in trust for the SHs. In this case, the new stock came into existence through the exercise of a right belonging wholly to the SHs. As the right to increase belonged to them, the stock when increased belonged to them also, as it was issued for money and not for property or for some other purpose other than the sale for money. By the increase in stock the voting power of Stokes was reduced ½, and while he consented to the increase he did not consent to the disposition of new stock which belonged to them. In other words, it was a partial division of property of the old SHs. The corporation cannot dispose of the shares to strangers against the protest of any SH who insists that he has a right to his proportion.

6. — —

Stokes v. Continental Trust Co. F: Stokes is one of the original SHs of

Continental Trust Co, owning 221 shares at the time of the controversy. Blair & Co. proposed that if the company decides to increase the capital stock, they would purchase the new shares at a higher price, and acquire the right to nominate their people to the board of trustees. The SH were informed of the Blair offer, and Stokes made his demand to exercise his preemptive right. Stokes at the SH meeting for the purpose of increasing the capital stock, demanded the right to subscribe for 221

11

Otherwise the majority could deprive the minority of their proportionate power in the election of directors and of their proportionate right to share in the surplus, each of which is an inherent, preemptive, and vested right of property. It is inviolable and can neither be taken away nor lessened without consent or a waiver implying consent. A share of stock is a share in the power to increase stock, and belongs to the SHs the same as the stock itself. When that power is exercise, the new stock belongs to the old SHs in proportion to their holding of old stock, subject to compliance with the lawful terms upon which it is based. A SH has an inherent right to a proportionate share of a new stock issued for money only and not to purchase property for the purposes of the corporation or to effect a consolidation, and while he can waive that right, he cannot be deprived of it without his consent except when the stock is issued at a fixed price not less than par and he is given the right to take at that price in proportion to his holding, or in some other equitable way that will enable him to protect his interest by acting on his own judgment and using his own resources. After the price was fixed it was the duty of the corporation to offer him his proportion at that price, for it had notice that Stokes had not acquiesced in the proposed sale of his share, but wanted it for himself. The directors were under the legal obligation to give him an opportunity to purchase at the price fixed before they could sell his property to a third party, even with the approval of a large majority of the SHs. By selling to strangers without thus offering to sell him, the corporation wrongfully deprived him of his property and is liable for such damages.
Thom v Baltimore Trust Co. F: Thom, owner of 6416 of 70000 shares, is

H: The preemptive right of SHs are said to be inherent in their stock ownership. The SHs of a corporation have a preferential right to purchase new issues of its shares, to the proportional extent of their respective interests in the capital stock then outstanding. The right adheres in stock ownership as an essential means of enabling a SH to maintain the existing ration of his proprietary interest and voting power in the corporation. In transactions involving the acquisition of property by corporations in exchange for shares of stock, the determining consideration to the owners of the property may be the advantage of sharing as SHs in the profits of the corporation with which they are contracting. In this case, the preemptive rights of Thom et al are recognized and protect by the amendment to its AOI. In declaring the right as to sales of stock for cash, and in restricting it as to issues of stock for accomplishing merger or acquisition of property, the amendment is valid.
Ross Transport Inc v Crothers. F: Derivative suit by SH Crothers to

a SH of the Baltimore Trust Co who wants to exercise his preemptive right to purchase a due proportion of a supplemental issue of its capital stock. The Baltimore Trust Co wanted to merge with the National Union Bank of Maryland, and that the company would issue 150000 shares at $112 to acquire the 10000 shares of National Union Bank at $168/share, and would require delivery of 70% of the stock. A resolution was passed to increase the capital stock of Baltimore, which also stipulated that the SH shall have the pro rata preferential right to subscribe at such price and terms as the board may fix. In any additional issuance, the directors may issue without preferential subscription rights and on such terms as the board may deem proper. Thom protested and voted against the merger, alleging the corporation disregarded the proportional purchase right of SHs.

set aside the issuance of stock dividends to 4 SHs and ordering them to repay Ross Transport Inc the dividends received on stock declared to be illegally issued. The corporation’s business is to operate a fleet of buses to service the transport needs of employees of the Triumph Explosives Inc. The company was an immediate financial success. It was engaged in a special business, of which it had a monopoly. The company then issued new stock to the family of the directors and the president, and had the effect of increasing the outstanding stock. There was no meeting, no notice, and no offer to the other SHs. The company declared dividends 3 times, and authorized salary payments to the officers. The benefit of the dividends would not only increase the value of the stock, but the first two declared dividends would pay back all the subscribers had invested, leaving any future earnings and distributions pure profit. Under these circumstances, they took the opportunity they thought they had to increase their investment. Crothers et al contend that changed conditions make it unnecessary to use the remaining unsold stock to obtain capital. H: Existing SHs are the owners of the business, and are entitled to have the ownership continued in the same proportion. Therefore, when additional stock is issued, those already having shares, are held to have the first right to buy the new stock in proportion to their holdings. This is the preemptive right. An exception would be where the stock about the be issued is part of the original issue. This is based on the fact that the original subscribers took their stock on the implied understanding that the incorporators could complete the sale of the remaining stock to obtain the capital necessary to start the business. The exception to the exception would be where conditions

12

have changed since the original issue. Trustees and directors of corporations cannot purchase, directly or indirectly, at their own sale. Such a transaction is entirely voidable at the option of the party interested. The transaction may not be ipso facto void, but it is necessary to establish that there had been actual fraud or imposition practiced by the party holding the confidential or fiduciary relation. In this case, the directors have not shown the company needed the money so badly and was such in a financial condition that the sale of additional stock to themselves was the only way the money could be obtained. On the contrary, the corporation appears to be in a very good financial condition. The sale must be set aside as a constructive fraud upon the other SHs. At the time of the supposed ratification, the principal must have been fully aware of every material aspect of the transaction, the real value of the subject of the contract, and his act of ratification must have been an independent and substantive act founded on complete information and of perfect freedom of volition.
Debt securities — — Debt contracts one of the two basic sources by which a corporation is able to finance its operations Debt securities (bonds): do not represent an ownership interest but creates a debtor-creditor relationship between the corporation and the bondholder o A person who extends a loan or debt looks at the financial condition and operations of the corporation as a means of gauging the ability to pay back the loan o Creditor (or bondholder) puts no stake on the operations of the corporate enterprise, and thus the contractual obligation of the corporation to pay the stipulated return remains even when operations are incurring losses or there are no unrestricted retained earnings o Returns in a loan placement in a corporation: bondholder would only be able to demand the stipulated fixed returns even if corporation is hugely profitable because of the loan o Creditors are legally preferred in payment from a corporation in a state of insolvency; such corporation must devote and prefer all corporate assets towards the payment of creditors o Interest paid on debt securities are deductible to the corporation for income tax purposes, but generally taxable to the holder thereof

1. 2. 3. —

Form of borrowings Bonds and debentures Convertible securities; stock options

Warrants: a type of security which entitles the holder the right to subscribe to the unissued capital stock of a corporation or to purchase issued shares in the future, evidenced by a warrant certificate which may be sold or offered for sale to the public o Who may issue? Two (2) types of issuers recognized by SEC  a domestic corporation duly registered  a person or group of persons who issues or proposes to issue warrants o Two types of warrants:  Subscription warrant-- entitles the holder the right to subscribe to the unissued capital stock of a corporation  Covered warrant-- entitles the holder the right to purchase issued shares in the future Stock options: a privilege granted to a party to subscribe to a certain portion of the unissued capital stock of the corporation within a specified period and under terms and conditions of the grant, exercisable by the grantee at any time within the period granted o No corporation shall grant any stock option unless approved by the SEC o Formal board resolution + detailed statement of the stock options plan o No exercise shall be valid unless accompanied by payment of not less than 40% of the total price of shares issued  25% for employees/officers not directors  initial payment not required for services already rendered o guidelines on stock options (SEC)  may be granted on the basis of proportionate interests of SHs in the capital stock  those granted to employees/officers not directors/board members allowed after review of the stock options scheme  those granted to non-SHs allowed upon showing that the board is duly authorized to grant the same by its AOI or resolution of SHs 2/3 OCS  granted to directors/mgt groups/corporate officers must be approved in a SH meeting, vote of at least 2/3 OCS  exercisable within a period of 3 years from SEC approval  no transfer without SEC approval

Merritt-Chapman & Scott Corp v. New York Trust Co. F: Stock

13

purchase (option) warrants were issued by Merritt-Chapman (MC) in bearer form. The bearer would be entitled to purchase fully-paid and non-assessable shares of CS, no par value, at $30/share. To insure that the stock to be purchased under the warrants would be available, the trust deed requires that stock certificates for an aggregate amount of 40,000 shares be delivered to the trustee and made the Trust co the agent of the corporation to receive the purchase price and deliver the stock certificates. The board of the corporation issued a resolution declaring a stock dividend iao 40%/shares of no par CS on each legally issued and outstanding share of CS. The resolution fixed the price at $20/share, and directed the warrant holders outstanding and to the trust company the 60-day notice required incase the corporation shall pay any stock dividend upon the outstanding CS. The corporation contends that the warrant holder must exercise his warrant before a certain date in order to share in the dividend. The trustee contends that the corporation must first deposit with the trustee, stock certificates in the amount equal to 40% of the certificates now on deposit with the trustee, and that the holder who wishes to exercise the warrant must pay the basic purchase price before he will be entitled to receive 1.4 share. H: The warrants gave the holders the privilege, unlimited in time, to purchase 40,000 authorized but unissued shares. Had the warrant holders exercise their option, they would have acquired a definite percentage of the CS. A stock dividend does not change the proportional interest of each SH in the corporate enterprise; it changes only the evidence which represents that interest. It is a mere “watering” of outstanding shares. If the corporation were at liberty to declare stock dividends without making provision for warrant holders, the percentage of interest in the CS capital of the corporate enterprise which the warrant holders would acquire could be reduced to practically the point of extinction. The privilege the warrant holders originally had of acquiring a definite proportional interest in the CS would be lost without recourse unless their contract with the corporation contained some provision to protect it. By this covenant the corporation recognized the possibility that a stock dividend might be declared and paid on outstanding shares before the warrants had been exercised, and promised in that event to deposit with the trustee stock certificates representing that proportion of dividend shares which the shares subject to the warrants bore to all the CS, and that the trustee would deliver such dividend shares without additional consideration.
4. Hybrid securities — Equity securities: represent an ownership interest in the corporation and includes both CS and PS

Jordan & Co. v. Allen. F: The Jordan Company issues “Debenture

Stock.” The company believes that the pay-outs made on the debentures were actually interest, and thus entitling them to deductions from their taxable income. The IRS claims the pay-outs were dividends to the holders. I: W/N payments made to the holders of Debenture stock of the Jordan Company were payments of interest on outstanding obligations or dividends paid on invested capital. H: The answer rests on what the payments actually are, and not what the payments are called. Although there is no precise formula, the usual factors considered are the ff: (1) treatment by the parties; (2) maturity date and right to enforce collection; (3) rank/preference during dissolution; (4) uniform rate of interest or income payable; (5) participation in the management and right to vote.

(1) voting rights: if security holders had such rights, this would

strongly indicate that the securities were stocks; the absence or extremely limited rights is of little probative value, because it is common both to bonds and preferred stock treated the debenture stocks as an obligation and the payments as interest. No evidence as to how the holders treated the same.

(2) treatment by the parties: in this case the company itself

(3) Preference/rank in dissolution: GR holders of obligations are

secured or general creditors of the corporation and rank as such on dissolution. Here the holders ranked ahead of the other SHs but inferior to general creditors. One of the most important considerations is whether the right to share in the assets of the corporation in case of dissolution is subject to the rights of creditors. If subject to such rights, there is a strong presumption that the interest in question is that of a SH interest at a prescribed rate to paid out of the profits only. This fact loses significance when considered in conjunction with the provision that holders should rank inferior to general creditors significance. The existence of a fixed maturity date for the principal sum, together with the right to enforce payment as debt in case of default, is the most essential feature of a

(4) Payment out of profits: the debentures provide for payment of

(5) Maturity date and right to enforce payment. Of utmost

14

debtor and a creditor as opposed to a SH relationship. One of the most fundamental characteristics of a debt is a definite determinable date on which the principal falls due. The obligation in the debenture stock clearly had no maturity date. There was no time when the holders could demand their money; they were at the mercy of the company’s fortunes and payment was merely a way of distributing profit. Although the officers considered the debenture stock as matured after 20 years, mere opinion of corporate officers cannot override the provisions of the certificates themselves and the charter and by-laws. It is to be noted that when the issue was retired, after officers considered it matured, they retired it at a premium. Payment of premiums is certainly more consistent with the retirement of stock than with payment of past due obligations. The contention of the officers that the term of the debenture matures upon termination of corporate existence is also untenable. Termination of corporate existence cannot be considered the maturity of the debenture stock as it would not be a fixed or determinable date set in advance, but could be constantly moved forward simply by corporate action.
5. Trust indenture Alladin Hotel Co v Bloom. F: Bloom is a minority bondholder of bonds

of the trust deed, which did not provide for notice to the bondholders. The changes were approved by 2/3 of the bondholders. The rights of the 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 the provisions. There is no question that the provisions in the trust deed and the bonds were legal provisions which violated no principle of public policy or private right. No notice was required so far as the parties to the contract were concerned. Their rights must be determined by their contract and not by any equitable doctrine, and notice to the other bondholders could have served no possible purpose. There is no substantial evidence warranting BF, fraud, or corruption on the part of the Joneses. The changes made in the provisions of the trust deed were made before Bloom acquired her bonds, and were in fact past due when she purchased them. Bloom, with notice of the changes made, and with knowledge that she had no notice of the application for the changes, made no effort to repudiate it until she brought the suit, but accepted interest payable under the provisions of the contract.
Trust Fund doctrine — A corporate theory which seeks to protect the interest of corporate creditors o Capital stock of the corporation, especially its unpaid subscription, is a trust fund for the benefit of the general creditors of the corporation o When a corporation is solvent, the theory that its capital stock is a trust fund upon which there is any lien for the payment of its debts has in fact, very little foundation. o No general creditor has any lien upon the fund under such circumstances, and the right of the corporation to deal with its property is absolute so long as it does not violate its charter or the applicable law. Proper scope of the doctrine is that capital stock of a corporation (insolvent), as well as all its other property and assets are generally regarded in equity as a trust fund for the payment of corporate debts In RP jurisdiction trust fund doctrine applies in four cases: a) Where the corporation has distributed its capital among the SHs, without providing for the payment of creditors b) Where it had released the subscribers to the capital stock from their subscriptions c) Where it has transferred the corporate property in fraud of creditors d) Where the corporation is insolvent The doctrine as applied to a corporation not insolvent, would only be

issued by the Alladin Hotel Co. The bonds are secured by a deed of trust by which was mortgaged certain real estate, with the Mississippi Valley Trust Co as trustee. The deed of trust contained provisions empowering bondholders of not less than 2/3 to modify and extend the date of payment of the bonds. The Joneses are majority bondholders as well as the majority SHs of the company who entered into an agreement with the company to extend the maturity date of the bonds. The changes were certified by the trust company and has the consent of holders of 2/3 the principal amount of the bonds. Bloom objects to the change, contending that these were invalid for not being made in GF and that it was not for the benefit of the minority bondholders and deprived them of their rights and property. She added that the Joneses acted in a dual capacity as trustees for the other bondholders, being the majority, and therefore must not act detrimental to the rights of the other holders. She also added that the modifications are void for not giving notice to the other bondholders. TC held that the changes did not benefit the minority bondholders and that the bondholders were entitled to notice. But it held that the decree should be limited to a money judgment only. The hotel appeals. H: the modifications were made in strict compliance with the provisions

— —

15

up to the extent of the capital stock of the corporation o Retained earnings not covered since it does not constitute capital stock o Thus corporations are at liberty to declare and pay out its assets by way of dividends up to the extent of its unrestricted retained earnings Phil Trust v Rivera (infra): subscriptions to the capital of the corporation constitute a fund to which the 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 payment of its debts

Requirements under the Revised Securities Act 1. 2. 3. 4. 5. 6. Purpose and History of Revised Securities Act Registration of securities Exempt securities and exempt transactions Registration of brokers, dealers, and salesmen Registration of stock exchange Remedies of investor; SEC powers

Underwriting Securities Can never create preferences where SHs would have attributes of creditors over other SHs Debtor-creditor= SH-corp? yes as to unpaid subscription Preemptive right: benefits orig subscriber Pay up, or lose whole subscription (min 25%) Once paid, rights accrue If business is profitable, orig subscribers should have 1st crack at additional issuances Dilution: noone can exercise preemptive right Consequences: shift in control/management Usually denied in listed corporations Immediate opportunity to raise funds Otherwise deprive corporation of opportunity 89: contractual arrangements public offering opportunity to corporation for financing denial would also benefit SHs! Might enhance value of subscription Merger Bigger business, more clients Read dissent in Hay: more reasonable Merritt Chapman: consideration for warrant is separate and distinct from the shares Holders of stock options are not owners of the stock; no stock has been issued or purchased by them, thus not entitled to dividends paid

16

Whether equity or loans, these funds end up ultimately as assets of the corporation Investment and credit are two separate and distinct sources of funds Loans/debt: Creditors have a lien on corporate assets Revenues that ff will be earmarked for payment of obligations SHs do not have any definite right over the amount loaned or assets earmarked An indebted corporation is not barred from declaring dividends Creditor has fixed return based on interest due Lien on corporate assets w/n corporation is healthy, I still get paid I get paid 1st before everyone else Secured/unsecured= preference is undistinguished as to SHs Equity: Expectancy/inchoate: no guarantee to SHs Risk involved; be prepared to lose Recoverability of investment depends on viability of business But SHs can get dividends resulting from revenues SHs: not fixed return, so long as company is healthy Depends on profitability= unrestricted retained earnings Dividends, but more onerous risk Preferences: control (board seats, voting), or economic benefits (depends on extent of contribution and unrestricted retained earnings) Givens: No guarantee on investment Cannot be same stature among them Consideration Proprietary rights Money SH prerogative of paying in full or hope that the business will be good and pay dividends to take care of business Min paid up: 25% If I don’t pay and business is bad (i.e. no dividends), I am suspended, I cannot exercise my rights as SH Sec 7: founder’s shares: “mayayabang lahat” Market price may be higher than issued value For those who want control, economic benefits, and bragging rights Sec 6: classifications CS: control through common shares Voting for BOD and corporate acts Same or different par values Same voting rights regardless of value PS: Preference on dividends Coupon returns/year 10-redeemable