16.

CONSIDERATION FOR ISSUANCE OF SHARES

16.1. Form of Consideration
Section 62

Section 62. Consideration for stocks. – Stocks shall not be issued for a consideration less than the par or
issued price thereof. Consideration for the issuance of stock may be any or a combination of any two or
more of the following:

1. Actual cash paid to the corporation;

2. Property, tangible or intangible, actually received by the corporation and necessary or

convenient for its use and lawful purposes at a fair valuation equal to the par or issued value of
the stock issued;

3. Labor performed for or services actually rendered to the corporation;

4. Previously incurred indebtedness of the corporation;

5. Amounts transferred from unrestricted retained earnings to stated capital; and

6. Outstanding shares exchanged for stocks in the event of reclassification or conversion.

Where the consideration is other than actual cash, or consists of intangible property such as
patents of copyrights, the valuation thereof shall initially be determined by the incorporators or the
board of directors, subject to approval by the Securities and Exchange Commission.

Shares of stock shall not be issued in exchange for promissory notes or future service.

The same considerations provided for in this section, insofar as they may be applicable, may be
used for the issuance of bonds by the corporation.

The issued price of no-par value shares may be fixed in the articles of incorporation or by the
board of directors pursuant to authority conferred upon it by the articles of incorporation or the by-
laws, or in the absence thereof, by the stockholders representing at least a majority of the
outstanding capital stock at a meeting duly called for the purpose. (5 and 16)

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)

16.2. Liability on Watered Stocks

Section 65

Section 65. Liability of directors for watered stocks. – Any director or officer of a corporation
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 who, having
knowledge thereof, does not forthwith express his objection in writing and file the same with the
corporate secretary, shall be solidarily, liable with the stockholder concerned to the corporation
and its creditors for the difference between the fair value received at the time of issuance of the
stock and the par or issued value of the same.

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).

CASE:

Triplex Shoe Co. v. Rice & Hutchins, Inc. 152 A. 342 (1930)

Emergency Recit:

NO PAR VALUE STOCK CANNOT BE REGARDED AS VALID AND OUTSTANDING UNLESS THE
CONSIDERATION THEREFOR WAS FIXED AS REQUIRED BY LAW.

 The stocks issued to the Dillman faction were no-par value shares, the consideration for which
were never fixed as required by law. Hence, its issuance was void. The certificate of incorporation
did not confer upon the Board of Directors authority to fix the consideration for no par value stock,
and therefore, the consideration could be fixed only by the stockholders as provided by the
statute. The stockholders never fixed the consideration for any of the no par value stock issued
by the corporation after its organization, and there is no escape from the conclusion that all such
stock was invalid at the tine of the election I question and not entitled to be voted.

FUTURE SERVICES ARE NOT LAWFUL CONSIDERATION FOR THE ISSUANCE OF STOCK.

 Moreover, the stocks were issued to the Dillmans in consideration for services rendered in
organizing the company and in agreeing to serve the company at a much smaller compensation.
Clearly, the stocks were issued not for services rendered but for services yet to be rendered, and
are therefore, invalid for having no valid consideration.
 The Dillman faction, therefore, cannot vote the invalid stocks they hold and the directors they
elected into office cannot be held to be validly elected.
 The Hutchison faction, on the other hand, who holds preferred stock but the preference of which
was not stated , was held to be validly elected into office although the amended certificate of
incorporation provided that “ The sole voting power shall reside in the holders of the common
stock.”
 The court interpreted the provision to mean that if there is any common stock legally issued and
outstanding, that is entitled to vote, the preferred stock cannot vote, but if there is no such
common stock, the situation is the same as would be if no common stock had been issued at all.

FACTS:
 Triplex Shoes Company was incorporated in 1919. Its certificate of incorporation provided that its
total authorized capital stock should be 150,000 USD, divided into 750 preferred shares, of the par
value of $100 each. The remaining 75,000 in shares of common stock without any par value.
 During the first meeting, Albert Dillman was elected President, Elmer Solly as Vice President and
secretary, and Louis Dillman as Treasurer. In one set of minutes, these indviduals composed the
board of directors. In another set of minutes, Robinson and Emery had also been elected to the
board.
 In the same meeting, the directors adopted a resolution giving 376 shares of the common stock to
Mr. Dillman, 114 common stock shares to Louis Dillman and 50 common stock shares to Elmer
Solly.
 Thereafter, Solly transferred his fifty shares to the two Dillmans, so that Albert Dillman would have
401 shares and Louis would have 139 shares, both of the common stock.
 Before February 28, 1921, other common shares amounting to 121 were distributed to various
persons
 On February 28, 1921 during a special meeting of stockholders, a resolution authorizing an
amendment to the certificate of incorporation was adopted but not filed until a later. It stated that all
of the outstanding common and preferred shares voted for the said amendment. The amendment
would reflect that the total authorized capital stock of this corporation consists of 2375 preferred
stock with a par value of $100 each, amounting to $237,500 and 1075 shares of common stock,
which shall be without nominal or par value. It also indicated that the sole voting power shall reside in
the holders of the common stock.
 Rice and Hutchins, Inc. (petitioner of this case) purchased 249 shares of preferred stock and was
given 83 shares of common stock as a bonus on the basis of one share of common for three shares
of preferred.
 During the stockholders annual meeting in 1922 they voted to pay for services rendered by Albert
Dillman and Elmer Solly in the form of common stocks.
 In 1922, Rice Company purchased 250 preferred stock, with an additional 50 common shares.
 In May 1922, Rice again purchased 400 preferred stock, with an additional 80 shares of common.
 In 1925, Rice finally purchased 250 preferred stock, with an additional 50 common shared. Hence,
the total holdings of Rice Company was at 1149 preferred stock and 263 common shares.
 Due to the number of shares which Rice Company had, they were able to elect one director the
board until 1928.
 However, in 1929 there was an election contest over the directors for there were two tickets
presented, one of Rice Company and one of the Dillmans. The latter was declared to have been
elected.
 The question lies as to the validity of the election of the Dillman faction and the existence of the
common stock they claim to have.

ISSUE(S): Did the Dillman faction actually have any common stock in order to perform the vote?

HELD: No, they did not have any common stock allowing them to vote.

RATIO:

 The original certificate of incorporation created two classes of stock: a preferred with par value
and a common with no par value. The preferred, however, was such only on name, no preference
being stated, as required by law.
 The stocks issued to the Dillman faction were no-par value shares, the consideration for which
were never fixed as required by law. Hence, its issuance was void. The certificate of incorporation
did not confer upon the Board of Directors authority to fix the consideration for no par value stock,
and therefore, the consideration could be fixed only by the stockholders as provided by the
statute. The stockholders never fixed the consideration for any of the no par value stock issued
by the corporation after its organization, and there is no escape from the conclusion that all such
stock was invalid at the tine of the election I question and not entitled to be voted.
 Moreover, the stocks were issued to the Dillmans in consideration for services rendered in
organizing the company and in agreeing to serve the company at a much smaller compensation.
 Clearly, the stocks were issued not for services rendered but for services yet to be rendered, and
are therefore, invalid for having no valid consideration.
 The Dillman faction, therefore, cannot vote the invalid stocks they hold and the directors they
elected into office cannot be held to be validly elected.
 The Hutchison faction, on the other hand, who holds preferred stock but the preference of which
was not stated , was held to be validly elected into office although the amended certificate of
incorporation provided that “ The sole voting power shall reside in the holders of the common
stock.”
 The court interpreted the provision to mean that if there is any common stock legally issued and
outstanding, that is entitled to vote, the preferred stock cannot vote, but if there is no such
common stock, the situation is the same as would be if no common stock had been issued at all.

McCarty v. Langdeau 337 S.W. 2d 407 (1960)

FACTS:

 Langdeau, The Receiver of the Estate Life Insurance Company filed a suit against McCarty for a
sum of money, the based from a written agreement executed by McCarty wherein he agreed to
purchase 19370 shares of its no par stock at $20 which amounts to $387,380, which until the date
Estate life was placed under permanent receiver ship there was still a balance of $379,280.
 The contract stipulates the ff:
 Agreement to purchase 19,370 shares of no par stock of Estate Life at $20per share
 20$ down payment and the balance is to be paid in equal monthly installments
 That until said stock is paid in full, Estate Life shall have the right to retain the stock
certificates, and McCarty is granted power and authority to vote on such stock as has been
paid for.
 If there should be a default in the payment of any monthly installment as herein provided for
as long as 30 days then at the option of Estate Life this contact shall be null and void. And in
the event that it is cancelled, McCarty shall be entitled to receive a certificate for the number
of shares fully paid.
 That when the balance s paid in full then McCarty will be entitled to a certificate for the
number of shares purchased.
 McCarty’s assailed that the contract is void since it violates Art 12, Sec 6 of the Vernon St. Ann’s
Texas Constitution which states that “no corporation shall issue stock or bonds except for money
pad , labor done or property actually received, and all fictitious increase of stock or indebtedness
shall be void.
 The lower Court, by way of summary judgement decided in favor of Langdeau, and was awarded
judgement against McCarty for the sum of 379,280 with 6%interest.

ISSUE(S):

 WON The agreement between McCarty and Estate Life valid thus making McCarty Liable.

HELD: YES

RATIO:

 Is unnecessary that the court determine at this point between the constructs that this contract
may be construed either as a contract for the present issuance of shares of stock which are to be
held as security for the promissory note referred o t it might be construed as the issuance of
shares of stock periodically as the note is to be paid. Under either construction the contract is
enforceable.
 McCarty’s second contention is that judgement should have not been based on the contract since
the note referred to n it is the true evidence of the indebtedness, and that judgment on the contact
 would not preclude duplicatd liability on the note. The court held that the rights of a creditor of a
corporation against those owing the corporation for unpaid stock subscriptions are measured by
the original stock subscription contract and not by the terms of the subscription notes which are
as to the creditor but evidence of the liability of the subscriber. If McCarty had desired the
surrender of the notes, he should have established their existence. In any event the court holds
that his liability on the contract is not affected by the non production of the notes.
 Mccarty 3rd point is that the contract declared upon had never been accepted by the corporation
or a fact issue was presented as to its acceptance. The contact considered as an offer does not
show a signed acceptance upon its face. This may be shown by performance and acceptance of
benefits by the person to him the offer is made
 It was shown that McCarty paid Estate life on 6 different occasions. And Estate Life issued
corresponding shares for each payment McCarty Made the courts held that the transactions,
standing alone, require the conclusion that the contract was accepted by Estate Life.
 McCarty’s 4th contention that the contract had been terminated. Pleading to the effect that a
certain number of shares of stock had been fully paid for and issued to him, termination of the
contract was shown as a matter of law.
 The court stated that the course of dealings between the parties refutes the contention that
the contact was terminated by Estate Life. Clearly Estate life was given the option of
terminating its contract upon the conditions stated. Such termination would result in forfeiture
of McCarty’s future rights to purchase the stock as provided in the contract. Forfeitures are
not favored in law and may be waived by conduct inconsistent with an intent to insist upon it.
 It will be noted that all departures from the terms of the contract were for the benefit of
McCarty. Acceptance of payments less than contracted for and premature issuance of stock
certificates were acts of leniency on the part of Estate life. They cannot in reason be deemed
the acts of one bent on exercising the usually cruel act of forfeiture. To test the soundness of
McCarty’s position it is only necessary to reverse the situation and have Estate Life claiming
forfeiture, based on those acts alone, in a suit by appellant to enforce his rights under the
contract. We are confident that forfeiture would be denied in that case and that self imposed
forfeiture should be denied.

Rhode v. Dock-Hop Co. 184 Cal. 367 (1920)

FACTS:

 This is an action by the judgment creditor of a corporation against certain of its stockholders, seeking
to collect from them what are claimed to be unpaid balances on the par value of their shares.
 The complaint alleged simply that the defendants were subscribers and stockholders of the
corporation in amounts specified, and that only twenty-five cents on the dollar had been paid in on
the par value of their shares. The shares which the defendants held, although issued as fully paid,
were in fact issued for property which the directors did not believe was equal in value to the par
value of the shares.
o AKA kulang pa raw yung bayad.
 The answers of the defendants, in addition to some other defenses, denied that they were either
subscribers or stockholders, or that the full par value of their stock had not been paid. Further, they
said that parties from whom they bought had represented to them that the stock was fully paid, and
that the corporation had itself so represented to them by issuing them certificates which contained no
notation that the shares evidenced by them were not fully paid.
o AKA they are innocent transferees.
 The court found in effect that only five-twelfths of the par value had been paid.
 The stock had a par value of a dollar a share, and the shares which it was claimed the defendants
owned, and which in fact they did own, were part of a lot of 599,995 shares issued as fully paid up,
but in consideration for the transfer to the company of certain unpatented mining claims with the
improvements upon them.
 These claims had been previously worked and abandoned by another company, and then relocated
by one Knapp, who had been interested in the former company and was one of the promoters of the
present debtor company.
 SUMMARY OF FINDINGS
o that the defendants were not subscribers
o that they did not directly or indirectly participate in the transaction whereby their
stock was issued for a consideration less than its par value
o that it does not appear that the defendants knew when they accepted their stock that
it had been so issued
o that the defendants acquired their stock merely as the transferees of one of the
parties to the original transaction by which it was issued.
 Judgment favored the plaintiff. The defendants appealed.

ISSUE(S): Whether or not the defendant stockholders are required to make up any difference/deficiency
which may exist between what was actually paid in on their stock and its par value.

HELD: No. Judgment reversed.

RATIO:

 When the capital of a corporation is paid in in something other than money, the thing accepted in
lieu of money must be reasonably near its equivalent, and while the hopes or prospects for a
property affect its immediate cash value, it is that cash value, and not the future value of the
property if the hopes or prospects are realized, which must be taken as the basis of capitalization.
 At most, the finding is one that Knapp, and through Knapp the defendants, purchased stock from
the company in consideration of the transfer of the claims. It is to be noted, however, that such a
finding would not make either Knapp or the defendants subscribers to the stock.
 The difference between subscribing for stock and then paying the subscription either in money or
property and a direct purchase of stock without any antecedent obligation, a purchase of treasury
stock in other words, is manifest. The case is not one where the defendants are liable as
subscribers, but one where, if they are liable at all, it is as stockholders.
 It is also to be noted that unless the defendants are to be held liable merely because they were
stockholders, and upon the theory that nothing more was necessary to establish their liability, the
finding under discussion is not supported by any allegation in the complaint. The complaint
alleges only that the defendants were subscribers and stockholders. That they were not
subscribers and liable as such is plain. As to their being liable as stockholders, there is no
allegation in the complaint other than that they were such.
 If the transferor genuinely believes that his property is fully worth the par value of the stock which
he is receiving in return for it, it is difficult to see any reason why the transaction should not stand
as it is as to him, no matter what the directors may believe, or why he should be compelled at the
suit of creditors of the corporation or otherwise to pay more on account of his stock than he
agreed to pay.
 It makes no difference whether any particular stockholder against whom a recovery is sought was
a party to the original transaction whereby the stock was issued or is only a transferee of some
such party. He is liable simply as the owner of the stock and because of the relationship with the
corporation which he voluntarily assumed when he accepted such ownership.
 Such, however, is not the situation of the stockholder owning shares ostensibly fully paid but not
so in fact. He owes the corporation no duty to make good the difference, and there is no
obligation on his part which is an asset of the corporation or which the corporation may enforce.
 He is liable only because of the original transaction whereby the stock was issued for a fictitious
consideration, and then only to those who were defrauded thereby. His liability, in other words, is
not based upon his relationship to the corporation as a stockholder but upon a fraudulent
transaction. Upon the plainest principles, therefore, he cannot be held liable unless he was either
a party to the transaction in the first instance or has in effect in some manner made himself a
party since. It is not sufficient to justify a recovery against him that it be pleaded, proven, and
found only that he be a stockholder owning watered stock.
 One who is only a transferee of watered stock, and did not participate in the transaction whereby
it was originally issued and who took his stock unaware of the character of that transaction,
 cannot be compelled to make good the false representation as to the capital of the company
which he had no part in making and the responsibility for which he has done nothing to assume.

CASE LAW/ DOCTRINE: Innocent transferees of watered stock cannot be held to answer for the
deficiency of the stocks even at the suit of the creditor of the company. The creditor’s remedy is against
the original owner of the watered stock.

Bing Crosby Minute Maid Corp. v. Eaton 46 Cal. 284 (1956)

FACTS:

 Wallazz B. Eaton, Sr. (Eaton) formed a corporation (name not disclosed in the case) to acquire his
going frozen food business.
 The Commissioner of Corporations issued a permit authorizing the corporation to sell and issue not
more than 4,500 shares of $10 par value stock to the Eaton and other individuals (not mentioned in
the case) in consideration of the transfer of the business.
 The corporation placed 1, 022 shares in escrow in Eaton’s name (this is allowed in the permit).
Although, the 1, 022 shares were listed on the corporate records as held by Eaton, they were never
released from escrow.
 The (unnamed) corporation had financial difficulties and executed an assignment of its assets for the
benefit of creditors to a credit association.
 Bing Crosby, a creditor, recovered a judgment against the corporation for $21,246.42.
 An action was filed by Bing Crosby against Eaton because he was a holder of watered-down stock in
the corporation.
 The amount to be recovered from Eaton was $15,000 since this remained unpaid from the
$21,246.42 judgment.
 Trial Court found that:
o Value to the corporation of the consideration from Eaton was $34,780.83
o The 4,500 shares of stock having a par value of $10 each was issued to Eaton and
he became the owner of the shares
o Subsequent to the issue of the shares, the corporation purchased merchandise from
Bing Crosby and has not paid for all of it.
 Judgment of the trial court was for Bing Crosby ($10,219.17). The trial court’s conclusion was that
Eaton was liable for the difference between the par value of the 4,500 shares and the value of the
consideration the defendant paid for them.
 An order for new trial was granted to Eaton. Hence, the case.

ISSUE(S): WON there could be a basis for the liability of Eaton, a holder of a watered-down stock, to the
creditor, Bing Cosby.

HELD: Yes. The Court granted the order for new trial to further consider Eaton’s appeal from
the judgment of the trial court.

RATIO: (the Court gave a discussion of the liability of a holder of watered stock)

 There a two theories on the liability of a holder of watered stock: misrepresentation theory and
statutory obligation theory.
 A subscriber to shares who pays only part of what he agreed to pay is liable to creditors for the
balance.
 Holders of watered stock are generally held liable to the corporation’s creditors for the difference
between the par value of the stock and the amount paid in. The courts view the issue of watered
stock as a misrepresentation of the corporation’s capital.
  Under the misrepresentation theory, the creditors who rely on the misrepresentation of
the corporation’s capital stock are entitled to recover the “water” from holders of the
watered stock. Reliance of creditors on the misrepresentation is material. However,
under the statutory obligation theory, reliance of creditors on the capital stock of the
corporation is irrelevant. (here in the Philippines, it is the statutory obligation theory
which is prevailing according to the reviewer)

CASE LAW/ DOCTRINE: Creditors who rely on the misrepresentation are entitled to recover
the “water” from the holders of the watered shares.

16.3. How Payment of Shares Enforced

Sections 13, 67, 68, 69 and 70

Section 13. Amount of capital stock to be subscribed and paid for the purposes of
incorporation. – At least twenty-five percent (25%) of the authorized capital stock as stated in
the articles of incorporation must be subscribed at the time of incorporation, and at least twenty-
five (25%) per cent of the total subscription must be paid upon subscription, the balance to be
payable on a date or dates fixed in the contract of subscription without need of call, or in the
absence of a fixed date or dates, upon call for payment by the board of directors: Provided,
however, That in no case shall the paid-up capital be less than five Thousand (P5,000.00)
pesos.

Section 67. Payment of balance of subscription. – Subject to the provisions of the contract of
subscription, the board of directors of any stock corporation may at any time declare due and payable to
the corporation unpaid subscriptions to the capital stock and may collect the same or such percentage
thereof, in either case with accrued interest, if any, as it may deem necessary.

Payment of any unpaid subscription or any percentage thereof, together with the interest accrued, if any,
shall be made on the date specified in the contract of subscription or on the date stated in the call made
by the board. Failure to pay on such date shall render the entire balance due and payable and shall make
the stockholder liable for interest at the legal rate on such balance, unless a different rate of interest is
provided in the by-laws, computed from such date until full payment. If within thirty (30) days from the said
date no payment is made, all stocks covered by said subscription shall thereupon become delinquent and
shall be subject to sale as hereinafter provided, unless the board of directors orders otherwise.

Section 68. Delinquency sale. – The board of directors may, by resolution, order the sale of delinquent
stock and shall specifically state the amount due on each subscription plus all accrued interest, and the
date, time and place of the sale which shall not be less than thirty (30) days nor more than sixty (60) days
from the date the stocks become delinquent.

Notice of said sale, with a copy of the resolution, shall be sent to every delinquent stockholder either
personally or by registered mail. The same shall furthermore be published once a week for two (2)
consecutive weeks in a newspaper of general circulation in the province or city where the principal office
of the corporation is located.

Unless the delinquent stockholder pays to the corporation, on or before the date specified for the sale of
the delinquent stock, the balance due on his subscription, plus accrued interest, costs of advertisement
and expenses of sale, or unless the board of directors otherwise orders, said delinquent stock shall be
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. The stock so purchased shall be transferred to such purchaser in
the books of the corporation and a certificate for such stock shall be issued in his favor. The remaining
shares, if any, shall be credited in favor of the delinquent stockholder who shall likewise be entitled to the
issuance of a certificate of stock covering such shares.
Should there be no bidder at the public auction who offers 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, the corporation may, subject to the provisions of this Code, bid
for the same, 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 provisions of this Code.

Section 69. When sale may be questioned. – 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 the party seeking to maintain such action first pays or tenders to the party holding the stock the
sum for which the same was sold, with interest from the date of sale at the legal rate; and no such action
shall be maintained unless it is commenced by the filing of a complaint within six (6) months from the date
of sale. (47a)

Section 70. Court action to recover unpaid subscription. – Nothing in this Code shall prevent the
corporation from collecting by action in a court of proper jurisdiction the amount due on any unpaid
subscription, with accrued interest, costs and expenses.

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)

16.3.1. Delinquency sale; requisites

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.)

16.3.2. Court action

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.

CASE:

Velasco v. Poizat 37 PHIL. 802 (1918)

FACTS:
  Plaintiff, as assignee in insolvency of "The Philippine Chemical Product Company" (Ltd.) is
seeking to recover of the defendant, Jean Poizat the sum of P1,500, upon a subscription made by
him to the corporate stock of said company. The corporation in question has a capital of P50,000,
divided into 500 shares. The defendant subscribed for 20 shares of the stock of the company,
and paid in upon his subscription P500.
 Defendant Poizat was a stockholder in the company, and for sometime acted as its treasurer and
manager. While serving in this capacity he collected all subscriptions to the capital stock of the
company, except the aforesaid 15 shares subscribed by himself and another 15 shares owned by
Jose Infante.
 On July 1914, a meeting of the board of directors was held and 2 resolutions, were adopted. The
first was that the directors, or shareholders, of the company should make good by new
subscriptions, 15 shares which had been surrendered by Infante. Accordingly, the directors
present at this meeting subscribed P1,200, leaving a deficiency of P300 to be recovered by
voluntary subscriptions from stockholders not present at the meeting.
 The other proposition was that Juan [Jean] Poizat, who was absent, should be required to pay the
amount of his subscription upon the 15 shares for which he was still indebted to the company and
in case he refuse to make payment, the management should file a case against him. When
notification of this resolution Poizat wrote a letter to Velasco, as treasurer and administrator.
Stating that as he understood he is relieved by the board of directors from his subscription upon
the terms agreed to Infante.
 When the company became insolvent, Velasco was named as assignee by the clerk in pursuance
of Act No. 1956.
 The principal contention of defendant Poizat is that the call made by the board of directors was
not made pursuant to the requirements of Corporation Law
 CFI judgment was rendered a judgment in favor of the defendant, and the complaint was
dismissed.

ISSUE(S): WON the assignee may sue in court for an action to recover the unpaid subscription of a
stockholder of insolvent corporation.

HELD: Yes.

RATIO:

 The provisions of the Corporation Law gave 2 remedies for the enforcement of stock
subscriptions. The first consists in permitting the corporation to put up the unpaid stock for sale
and dispose of it for the account of the delinquent subscriber. The other remedy is by action in
court which is embodied in Section 49 of the Corporation Law –

“Nothing in this Act shall prevent the directors from collecting, by action in any court of
proper jurisdiction, the amount due on any unpaid subscription, together with accrued
interest and costs and expenses incurred.”

 SC said that the Corporation Law does not prescribe conditions under which an action may be
maintained upon a stock subscription, and where a matured stock subscription is unpaid, none of
the provisions in Corporation Law can be permitted to obstruct the action to recover thereon. By
virtue of section 36 of the Insolvency Law the assignee of the insolvent corporation succeeds to
all the corporate rights of action vested in the corporation prior to its insolvency; and the assignee
therefore has the same freedom to sue upon the stock subscription as the directors themselves
would have.
 Also SC said that plaintiff must prevail in this action even if there is a failure of the directors to
comply with the requirements of sections 38 to 48 of the Corporation Law. Because when a
corporation becomes insolvent and the court assumes jurisdiction to wind up, all unpaid stock
subscriptions become payable on demand, and are at once recoverable in an action instituted by
the assignee or receiver appointed by the court.
  The judgment of the lower court is therefore reversed, and judgment will be rendered in
favor of the plaintiff and against the defendant for the sum of P1,500, with interest from
July 13, 1014, and costs of both instances. So ordered.

CASE LAW/ DOCTRINE: When a corporation becomes insolvent and the court assumes jurisdiction to
wind up, all unpaid stock subscriptions become payable on demand, and are at once recoverable in an
action instituted by the assignee or receiver appointed by the court.

Lingayen Gulf Electric Power Co., Inc. v. Baltazar 93 PHIL. 404 (1953)

FACTS:

 Lingayen Gulf Electric Power Company is a domestic corporation with an authorized capital stock
of P300,000 divided into 3,000 shares with a par value of P100 per share.
 Irineo Baltazar (defendant) appears to have subscribed for 600 shares. [Upon organization of the
corporation, he paid P15,000, and after the incorporation, he made further payments.]
 The corporation now seeks to collect from Baltazar the balance of the unpaid subscription in the
amount of P18,500.
 On July 23, 1946, a majority of the stockholders, among them was Baltazar, adopted Resolution
No. 17, which provided the following: a) it was agreed upon to call the balance of all unpaid
subscribed capital stock as of July 23, 1946, the first 50 per cent payable within 60 days
beginning August 1, 1946, and the remaining 50 per cent payable within 60 days beginning
October 1, 1946; b) all unpaid subscription after the due dates of both calls would be subject to
12 per cent interest per annum; c) after the expiration of 60 days' grace which would be on
December 1, 1946 for the first call, and on February 1, 1947 for the second call, all subscribed
stocks remaining unpaid would revert to the corporation.

 The corporation wrote to Baltazar reminding him that the first 50% of his unpaid subscription will
be due on Oct. 1, 1946.
 Baltazar wrote 2 letters: first, asking the corporation that he be allowed to pay his unpaid
subscription by February 1, 1947, and that if he could not pay by that time, his unpaid
subscription would be reverted to the corporation; second, offering to withdraw completely from
the corporation by selling out to the corporation all his shares of stock in the total amount of
P23,000. The offer of the defendant was left unacted upon by the corporation.
 On April 17, 1948, the Board of Directors held a meeting and adopted Resolution No. 17.
Contents of the resolution:
a) The Board set aside the stockholders’ resolution approved on July 23, on the ground that
said stockholders' resolution was null and void; and because the plaintiff corporation was not
in a financial position to absorb the unpaid balance of the subscribed capital stock.
b) The directors decided to call 50 per cent of the unpaid subscription within 30 days
from April 17, 1948, the call payable within 60 days from receipt of notice from the
Secretary-Treasurer. (Call for Unpaid subscriptions)
c) The resolution authorized the legal counsel of the company to take all the necessary
legal steps for the collection of the payment of the call.
 The call for the payment of unpaid subscriptions was not published in a newspaper of general
circulation as required by section 40 of the Corporation Law.
 On June 10, 1949, the stockholders of the corporation held another meeting in which all
stockholders were present and adopted Resolution No. 4, where it was agreed to revalue the
stocks and assets of the company so as to attract outside investors to put in money for the
rehabilitation of the company. The president was authorized to make all arrangement for such
appraisal and the Secretary to call a meeting upon completion of the reassessment.
 On September 28, 1949, the legal counsel of the corporation wrote to Baltazar, demanding the
payment of the unpaid balance of his subscription amounting to P18,500.
  Baltazar ignored the demand, hence this action.

Lower Court: the call for payment was null and void for lack of publication and the resolution was null and
void in so far as it tried to relieve the defendant from liability on his unpaid subscription, on the ground that
the resolution was not approved by all the stockholders of the corporation.

ISSUES:

1. Whether call of the Board of the Directors for payment was valid?
2. Is Baltazar released from the obligation of the unpaid balance of his subscription by virtue of
stockholders’ resolutions No. 17 and 4?
HELD:

1. No. The call for payment is void for lack of publication.

2. No. The release claimed by Baltazar does not fall under the exception to the rule that a
subscription may not be cancelled so as to release a subscriber from liability.

RATIO:

1st issue (Whether the call for payment was valid - No)

 The Court agrees with the lower court that the law requires that notice of any call for the
payment of unpaid subscription should be made not only personally but also by
publication. Section 40 of the Corporation Law, Act No. 1459, as amended, provides:
 "Notice of call for unpaid subscriptions must be either personally served upon each stockholder
or deposited in the post-office, postage prepaid, addressed to him at his place of residence, if
known, and if not known, addressed to the place where the principal office of the corporation is
situated. The notice must also be published once a week for four successive weeks hi some
newspaper of general circulation devoted to the publication of general news published at the
place where the principal office of the corporation is established or located, and posted in some
prominent place at the works of the corporation if any such there he if there be no newspaper
published at the place where the principal office of the corporation is established or located, then
such notice may be published in any newspaper of general news in the Philippines."
 Publication is mandatory not only to assure notice to all subscribers, but also to assure equality
and uniformity in the assessment on stock-holders.This rule is supported by the different
authorities on Corporation law.
 The case of Velasco v. Poizat does not apply. In the case of Velasco vs. Poizat, the corporation
involved was insolvent, in which case all unpaid stock subscriptions become payable on demand
and are immediately recoverable in an action instituted by the assignee. In this case, the
corporation was solvent.

2nd issue (Whether Baltazar was released from the obligation to pay for his unpaid subscription - No)

 In order to effect the release, there must be unanimous consent of the stockholders of the
corporation.
 General rule: A valid and binding subscription for stock of a corporation cannot be cancelled so
as to release the subscriber from liability without the consent of all the stockholders or
subscribers. Furthermore, a subscription cannot be cancelled by the company, even under a
secret or collateral agreement for cancellation made with the subscriber at the time of the
subscription, as against persons who subsequently subscribed or purchased without notice of
such agreement.
 Exception: Where it is given pursuant to a bona fide compromise, or to set off a debt due from
the corporation, a release, supported by consideration, will be effectual as against dissenting
 stockholders and subsequent and existing creditors. A release which might originally have been
held invalid may be sustained after a considerable lapse of time.
 In the present case, the release claimed by Baltazar does not fall under the exception because it
was not given pursuant to a bona fide compromise, or to set off a debt due from the corporation,
and there was no consideration for it.
 In addition, the release attempted in Resolution No. 17 of 1946 was not valid for lack of a
unanimous vote. It found that at least seven stockholders were absent from the meeting when the
resolution was approved.

CASE LAW/ DOCTRINE: Payment of an unpaid subscription may be enforced through a court action. As
a general rule, there must be unanimous consent of the stockholders of the corporation to release a
stockholder from his stock subscription. The exception is if the release was given pursuant to a bona fide
compromise, or to set off a debt due from the corporation.

Miranda v. Tarlac Rice Mill Co. G.R. No. 35961 (1932)

FACTS:

 On June 8, 1926 Alberto Miranda executed a written contract whereby he subscribed for 100 shares
of the capital stock of a corporation to be known as Tarlac Rice Mill Co. Inc. (Tarlac)

 The par value of each share was P100. Alberto Miranda obligated himself to pay the sum of P10,000
as follows:
On or before September 21, 1926 P1,000.00
On or before January 21, 1927 2,000.00
On or before January 21, 1928 2,000.00
On or before January 21, 1929 2,500.00
On or before January 21, 1930 2,500.00

 On July 10, 1926, Alberto Miranda assigned a parcel of land instead of cash for the benefit and to
the credit of Tarlac.
 He appointed the officers of Tarlac as his attorneys-in-fact and explicitly gave them the power to
transfer, mortgage, or convey the land for a sum not to exceed P10,000.
 Tarlac then borrowed P10,000 from Mariano Tablante evidenced by a promissory note. As a security
for the loan, the said land was mortgaged to Tablante.
 When the note became due, the land was sold pacto de retro to Vicente Panlilio for P10,000, and the
proceeds were used to pay Mariano Tablante.
 Tarlac ceased to do business from the year 1928. Alberto Miranda died in 1930.
 The Petitioner now contends that the officers of the corporation violated the terms of the power of
attorney in mortgaging the land on February 19, 1927 for P10,000, because the only sum then due
and payable by Alberto Miranda to the corporation was P3,000. And that when the remaining
instalments of the stock subscription became due, Alberto Miranda was under no obligation to pay
them, because the corporation had already ceased to do business; it had also taken no steps to
compel the other stockholders to pay for the shares for which they had subscribed.

HELD/RATIO:

1. No. The fact that Alberto Miranda agreed on June 8, 1926 to pay the amount of his subscription
installments on certain fixed dates did not prevent him from authorizing the officers of the
corporation as his attorneys-in-fact to pay his subscription prior to the dates fixed in the
subscription agreement. It must be noted that the power of attorney explicitly provided that the
 power to convey and mortgage the property was for the payment of the subscriptions or for the
purpose of raising the capital of the corporation.

Hence, the Court held that it was the intention of the parties that the property should be
mortgaged immediately for a sum not to exceed P10,000, not only for the purpose of paying the
subscription agreement of Alberto Miranda, but also for the purpose, as stated in the power of
attorney, of increasing the capital of the corporation.

2. No. There is no need for a demand from the directors or stockholders to demand for payment of
subscriptions. It is the duty of the subscribers to pay the subscription as soon as it becomes due.
3. Yes. The facts have clearly shown that Alberto Miranda did not cancel his subscription
agreement, or that the corporation attempted to release him. Thus Alberto Miranda was deemed
to have acquiesced to the actions of the corporation following their agreement with one another
as to the subscriptions.

Da Silva v. Aboitiz & Co., Inc. 44 PHIL. 755 (1923)

FACTS:

 Arnaldo Da Silva, plaintiff, subscribed for 650 shares (php500 each) of stock with Aboitiz, of which he
has only paid 200, for which he was indebted in the sum of php225,000.
 Thereafter, he was notified by the corporate secretary of a resolution by the board of directors
declaring that unpaid subscriptions to the capital stock to have become due on May 31st, will be
declared delinquent, advertised for public sale for auction, and sold on the following June 16th, for the
purpose of paying up the amount of the subscription.
 After failing to tender his payment, and upon advertisement of the stock, Da Silva filed a complaint in
the CFI of Cebu asking for a writ of injunction to the following acts of the corporation:
1. Corporation prescribing another method of payment different from that provided in article 46 of its
by-laws
 according to aforesaid article 46 of the by-law of the corporation, which was inserted in
the complaint, all the shares subscribed to by the incorporation that were not paid for at
the time of the incorporation, shall be paid out of the 70 per cent of the profit obtained, the
same to be distributed among the subscribers, who shall not receive any dividend until
said shares were paid in full

2. Declaring the aforesaid 450 shares delinquent

 defendant corporation has violated the aforesaid article, which prescribes an operative
method of paying for the shares continuously until their full amortization, thus violating
and disregarding a right of the plaintiff vested under the said by-laws;

3. In directing the sale thereof, as advertised, the corporation exceeded its executive authority
 acts of the defendant corporation were in excess of its powers and executive authority
and the plaintiff had no other plain, speedy and adequate remedy in the ordinary course
of law than that prayed for in the said complaint, to prevent the defendant from taking any
further action in connection with the sale and alienation of the said shares
 CFI: issued a preliminary injunction
 Defendant then files for a demurrer on evidence contending that the facts alleged did not constitute a
cause of action
 CFI: sustained the demurrer, plaintiff having failed to amend his complaint; ordered dissolution of the
injunction
 Da Silva asked for a new trial but was subsequently denied by the lower court. Hence, appeal

ISSUE(S): Whether or not, under the provision of article 46 of the by-laws of the defendant corporation,
the latter may declare the unpaid shares delinquent, or collect their value by another method different
from that prescribed in the aforecited article.
HELD: YES

RATIO:

 Sec 46 (summary): net profit resulting from the annual liquidation shall be distributed as follows:
10% BOD, 10% GM, 10% reserve fund, 70% shareholders in equal parts – from this 70%, BOD
may deduct such amount of unpaid subscription as payment to the capital stock. When all shares
have been paid in full, BOD may deduct such amount for the creation of an emergency special
fund, or extraordinary reserve fund when in its judgment the same may convenient for the
development of the business of the corporation. Whenever the distributable dividend is found,
after the foregoing deduction, it should not be less than ten per cent (10%) of the paid up capital
stock.
 It is discretionary on the part of the board of directors to do whatever is provided in the said article
relative to the application of a part of the 70 per cent of the profit distributable in equal parts on
the payment of the shares subscribed to and not fully paid, and to the creation of a special
emergency fund or extraordinary reserve fund.
 The fact that special fund may not be created when distributable dividend, after deducting from
70% the amount to be applied for payment or for emergency fund, is less than 10% of the capital
actually paid, shows that the discretion whether or not such value must be paid out of a part of
the 70% of the profit lies with the BOD.
 If the board of directors does not wish to make, or does not make, use of said authority it has two
other remedies for accomplishing the same purpose.

1. Special remedy of permitting the corporation to put the unpaid stock for sale and dispose of it for
the account of the delinquent subscriber.(Secs 38-40 of Corp. Law)

2. Court Action (Sec 49)

 In this case, Abotiz made use of the first remedy. Aboitiz’s BOD made use of the discretionary
power granted to it by that law. No rights are vested with the stockholders of the corporation. It is
upon the discretionary powers of the Board of Directors, as conferred to them by the Corporation
Law.

National Exchange Co. v. Dexter 51 PHIL. 601 (1928)

FACTS:

 Dexter subscribed to 300 shares. The subscription contract provided that the shares will be paid
solely from the dividends.
 Upon this subscription the sum of P15, 000 was paid in January, 1920, from a dividend declared
at about that time by the company, supplemented by money supplied personally by the
subscriber. Beyond this nothing has been paid on the shares and no further dividend has been
declared by the corporation. There is therefore a balance of P15, 000 still paid upon the
subscription.
 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.

ISSUE(S): WON the stipulation contained in the subscription to the effect that the subscription is payable
from the first dividends declared on the shares has the effect of relieving the subscriber from personal
liability in an action to recover the value of the shares.

HELD: No

RATIO:
  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.
 A corporation has no power to receive a subscription upon such terms as will operate as a
fraud upon the other subscribers or stockholders by subjecting the particular subscriber
to lighter burdens, or by giving him greater rights and privileges, or as a fraud upon
creditors of the corporation by withdrawing or decreasing the capital.
 Philippine Commission inserted in the Corporation Law, enacted March 1, 1906, the following
provision: ". . . no corporation shall issue stock or bonds except in exchange for actual cash paid
to the corporation or for property actually received by it at a fair valuation equal to the par value of
the stock or bonds so issued."

 The prohibition against the issuance of shares by corporations except for actual cash to the par
value of the stock to its full equivalent in property is thus enshrined in both the organic and
statutory law of the Philippine; Islands. Now, if it is unlawful to issue stock otherwise than as
stated it is self-evident that a stipulation such as that now under consideration, in a stock
subscription, is illegal, for this stipulation obligates the subscriber to pay nothing for the shares
except as dividends may accrue upon the stock. In the contingency that dividends are not paid,
there is no liability at all. This is a discrimination in favor of the particular subscriber, and hence
the stipulation is unlawful.

 The law in force in this jurisdiction makes no distinction, in respect to the liability of the
subscriber, between shares subscribed before incorporation is effected and shares
subscribed thereafter. All like are bound to pay full value in cash or its equivalent, and
any attempt to discriminate in favor of one subscriber by relieving him of this liability
wholly or in part is forbidden. This is in reference primarily to subscriptions to shares
that have not been previously issued. The power of the corporation to make terms with
the purchaser would be greater where the shares which are the subject of the
transaction have been acquired by the corporation in course of commerce, after they
have already been once issued. But the shares in this case are not of this sort.

Lumanlan v. Cura 59 {HIL. 746 (1934)

FACTS:

 This is an appeal from a decision of the Court of First Instance of Tarlac, The appellant is
corporation duly organized under the laws of the Philippine Islands with its central office in the
City of Manila. The plaintiff-appellee Bonifacio Lumanlan, subscribed for 300 shares of stock of
said corporation at a par value of P50 or a total of P15,000.
 Valenzuela, Pedro Santos and Francisco Escoto, creditors of this corporation, filed suit against
the corporation praying that a receiver be appointed, however at that time the corporation had no
assets except credits against those who had subscribed for shares of stock.
 Since Bonifacio Lumanlan had only paid P1,500 of the P15,000, par value of the stock for which
he subscribed, the receiver on August 30, 1930, filed a suit against him for the collection of
P15,109, P13,500 of which was the amount he owed for unpaid stock and P1,609 for loans and
advances by the corporation to Lumanlan.
 CFI Manila sentenced Lumanlan to pay the corporation.
 Lumanlan appealed from this decision. Pending this appeal, with the permission of the court, the
creditors, some of the directors and the majority of the stockholders held several meetings whey
they agreed that subscribers for the capital stock who were in default should pay the creditors.
 Lumanlan was designated to pay the debt of the corporation to Julio Valenzuela, P8000 which is
what it owed plus the interest (12% per annum). Lumanlan agreed to assume this obligation and
in turn the corporation agreed that if Lumanlan would dismiss his appeal and the corporation
 would collect only 50 per cent of the amount subscribed by him for stock, and if it was insufficient
to pay Valenzuela he should pay an additional amount which should not exceed the amount of
the judgment against him in that case.
 Lumanlan withdrew his appeal and paid Valenzuela the sum of P11,840 including interest and
thereby was subrogated in place of Valenzuela. The petitioning creditors having been paid the
amounts owed to them by the corporation asked that the receiver be dismissed and the court
granted this.
 Disregarding this agreement and notwithstanding the payment made by Lumanlan to Valenzuela,
the corporation on asked for the execution of the sentence in the first case and by virtue of an
order of execution the provincial sheriff levied upon two parcels of land belonging to Lumanlan.
 Lumanlan brought the present action against the corporation, Dizon & Co., to prevent the sheriff
from selling the two parcel of lands.

ISSUE: Whether or not the agreement entitles Lumanlan to credit from the judgment in the first
case for having paid the creditor of the company of its obligation?

HELD: Yes, the payment of Lumanlan of the obligation of the company to its creditor
Valenzuela is considered fulfillment of his payment of the unpaid shares and should be credited
from the judgment on the first case.

RATIO:

 It is established doctrine that subscriptions to the capital of a 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 the payment of its debts.
 Corporation Law clearly recognizes that a stock subscription is a subsisting liability from the time
the subscription is made, since it requires the subscriber to pay interest quarterly from that date
unless he is relieved from such liability by the by-laws of the corporation. The subscriber is as
much bound to pay the amount of the share subscribed by him as he would be to pay any other
debt, and the right of the company to demand payment is no less incontestable.
 By virtue of these facts Lumanlan is entitled to a credit against the judgment in case No. 37492
for P11,840 and an additional sum of P2,000, which is 25 per cent on the principal debt, as he
had to file this suit to collect, or receive credit for the sum which he had paid Valenzuela for and in
place of the corporation, or a total of P13,840. This leaves a balance due Dizon & co., Inc., of
P1,269 on that judgment with interest thereon at 6 per cent per annum from August 30, 1930.
Upon payment of such balance, Lumanlan should be issues 300 shares of its capital stock.

CASE LAW/DOCTRINE: The Corporation Law clearly recognizes that a stock subscription is a subsisting
liability from the time the subscription is made, since it requires the subscriber to pay interest quarterly
from that date unless he is relieved from such liability by the by-laws of the corporation. The subscriber is
as much bound to pay the amount of the share subscribed by him as he would be to pay any other debt,
and the right of the company to demand payment is no less incontestable.

16.3.3. Effect of Delinquency

Section 71

Section 71. Effect of delinquency. – No delinquent stock shall be voted for or be entitled to vote
or to representation at any stockholder’s meeting, nor shall the holder thereof be entitled to any
of the rights of a stockholder except the right to dividends in accordance with the provisions of
this Code, until and unless he pays the amount due on his subscription with accrued interest,
and the costs and expenses of advertisement, if any.

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.

16.3.4. Rights and Obligations of Holders of Unpaid but Non-delinquent Stock

Section 72, 66, 63 and 64

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)

CASE:

Fua Cun v. Summers 44 PHIL. 704 (1923)

FACTS:

 Chua Soco subscribed to 500 shares of stock in China Banking Corporation (CBC), at par value of
P100, and paying P25,000 which is equal to half of the subscription price.
 To secure a promissory note for the sum of P25,000, Chua Soco mortgaged the said shares in favor
of Petitioner Fua Cun
 For dishonored acceptances of commercial paper, Chua Soco also became indebted to the CBC
 Hence, Chua Soco's interest in the 500 shares were attached and levied upon to satisfy his debt with
CBC
 This prompted Petitioner Fua Cun to file an action on the ground that he was owner of 250 shares by
virtue of Chua Soco's payment of half of the subscription price:
o To have himself declared to hold priority over the claim of CBC,
o To have the receipt for the shares delivered to him, and
o To be awarded damages for wrongful attachment
 Lower court held that by virtue of the payment of half of the purchase price, Chua Soco
owned and subsequently transferred 250 shares to Petitioner Fua Cun.

ISSUE(S): Whether partial payment of the subscription price makes the stockholder owner of the
subscribed shares

HELD: No.

RATIO:

 The SC held that payment of half the subscription price does not make the holder of stock the
owner of half the subscribed shares.
 Petitioner Fua Cun’s rights consist in an equity in 500 shares and only 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.
CASE LAW/ DOCTRINE: Partial payment does not entitle the stockholder to the issuance of a certificate
for the number of shares to which the amount paid may correspond.

Baltazar v. Lingayen Gulf Electric Power Co., Inc. 14 SCRA 522 (1965)

FACTS:

 Irineo S. Baltazar filed the complaint against Lingayen Gulf Electric Power Co., Inc. (Corporation).
 The Corporation has an authorized capital stock of P300,00.00 divided into 3,000 shares of voting
stock at P100.00 par value, per share.
 Baltazar is among the incorporators taking it slow like it so typical and subscribed to 600 shares of
the capital stocks. He said that “we can be beautiful.”
 It is alleged that it has always been the practice and procedure of the Corporation to issue
certificates of stock to its individual subscribers for unpaid shares of stock (Tuntununun) (tanan
tanan) say you’ll never let me go.
 Of the 600 shares of capital stock subscribed by Baltazar, he had fully paid 535 shares of stock, and
the Corporation issued to him several fully paid-up and non-assessable certificates of stock,
corresponding to the 535 shares. After having made transfers to third persons and acquired new
ones, Baltazard had 341 shares fully paid and non-assessable.
 4 members of the Board of Directors were elected – 2 representing the Ungson Group (majority
stockholders) 2 representing the Baltazar group.
 The Ungson group in order to continue retaining such control, over the objection of three majority
members of the Board, passed 3 resolutions. On the authority of these resolutions, the Ungson
group was threatening and procuring to ‘expel and oust the plaintiffs and their companion
stockholders, for the ultimate purpose of depriving them of their right to vote in the annual
stockholders’ meeting.
 “Any and all shares of stock of the Corporation issued as fully paid-up to stockholders whose
subscription to a number of shares has been declared delinquent with the accrued interest
on the unpaid thereof per Resolution No. 42 S. 1954, of the Board of Directors…, are hereby
incapacitated to utilize or avail of the voting power until such delinquency with the accrued
interest is fully paid-up…”
 There are a lot of cases and motions for reconsideration filed by Baltazar. Ultimately, he filed a
petition for immediate execution and for preliminary injunction and/or mandamus, praying that a writ
be issued, ordering the defendants, as controlling majority of hold-over board of directors, to hold
immediately the long delayed stockholders’ meeting, and to allow the plaintiffs and all the
stockholders, with still unpaid subscriptions, to vote all their stocks and subscriptions at said
stockholders’ meeting, as directed in the decision.
 Court: Regarding the right to vote, agrees with the corporation that the facts considered during the
negotiations for settlement do not warrant repeal of the declaration of delinquency and complete
restoration of voting rights until full payment of the unpaid stock subscriptions and interest.

ISSUE(S):

 Are the plaintiffs and all the stockholders, with still unpaid subscriptions, allowed to vote
all their stocks and subscription at a stockholders’ meeting

HELD: No.

RATIO:

 The cases at bar do not come under the aegis of the principle enunciated in the Fua Cun v.
Summers case, because it was the practice and procedure, since the inception of the corporation,
to issue certificates of stock to its individual subscribers for unpaid shares of stocks and gave
voting power to shares of stock fully paid.
  Section 37 of the Corporation Law:
No certificate of stock shall be issued to a subscriber as fully paid up until the full par value
thereof, or the full subscription in the case of no par stock, has been paid by him to the
corporation. Subscribed shares not fully paid up may be voted provided no subscription is unpaid
and delinquent.
 The present law requires as a condition before a shareholder can vote his shares, that his full
subscription be paid in the case of no par value stock; and in the case of stock corporation with
par value, the stockholder can vote the shares fully paid by him only, irrespective of the unpaid
delinquent shares.
 In the present case, the defendant-corporation had applied the payments made by the
stockholders to the full par value of the shares of stock subscribed by them, instead of the
accrued interest, as shown by the capital stock shares certificate issued for the payments
made, and the stockholders had accepted such certificates issued for such payments. The
Corporation Law and the by-laws of the Corporation do not contain any provision, prohibiting the
applicant of stockholders’ payments to the full par value of a corporation’s capital stock, ahead of
the payment of accrued interest for unpaid subscription.
 A corporation may, upon request of an interested stockholder, as his option, apply
payments by them to the full par value of shares of capital stock subscribed, leaving its
collection later of the accrued interest on unpaid subscriptions, and that once such option
has been exercised and the corresponding stock certificates have been issued, the
corporation cannot, by a unilateral act, legally nullify and cancel the capital stock
certificates so issued.

Nava v. Peers Marketing Corp. 74 SCRA 65 (1976)

FACTS:

 Teofilo Po, as an incorporator, subscribed to 80 shares of Peers Marketing Corporation (Peers) at

P100 a share for a total par value of P8000. Po paid P2000 (25%) of the amount of his subscription.
No certificate of stock was issued to him.
 Po sold 20 of his eighty shares to Nava for P2000. In the deed of sale, Po stated that he was "the
absolute and registered owner of twenty shares" of Peers.
 Nava requested the officers of the corporation to register the sale in their books. This was denied
because Po has not paid fully the amount of his subscription.
 Nava was informed that Po was delinquent in the payment of the balance due on his subscription
and that the corporation had a claim on his entire subscription of 80 shares which included the 20
that had been sold to Nava.
 Nava then filed a petition for mandamus to compel the corporation to register the 20 shares he
bought from Po in their books.

ISSUE(S):

Can the officers of Peers be compelled by mandamus to register the 20 shares Nava bought from Po?

HELD/RATIO:

 No. The Court held that the transfer made by Po to Nava is not the "alienation, sale, or transfer of
stock" that is supposed to be recorded in the stock and transfer book, as contemplated in section
52 of the Corporation Law. As a rule, the shares which may be alienated are those which are
covered by certificates of stock, as shown in the Corporation Law and ruled on in previous cases.
 As prescribed in Section 35, shares of stock may be transferred by delivery to the transferee of
the certificate properly indorsed. There should be compliance with the mode of transfer
prescribed by law. The usual practice is for the stockholder to sign the form on the back of the
 stock certificate. The certificate may then be transferred from one person to another. Then he
delivers the certificate to the secretary of the corporation so that the transfer may be entered in
the corporation's books. The certificate is then surrendered and a new one issued to the
transferee.
 That procedure cannot be followed in this case because the 20 shares in question are not
covered by any certificate of stock in Po's name. Moreover, the corporation has a claim on these
shares for the unpaid balance of Po's subscription.
 In this case no stock certificate was issued to Po. Without stock certificate, which is the evidence
of ownership of corporate stock, the assignment of corporate shares is effective only between the
parties to the transaction.

CASE LAW/ DOCTRINE:

The delivery of the stock certificate, which represents the shares to be alienated, is essential for the
protection of both the corporation and its stockholders.

16.4. 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.

16.5. Lost or Destroyed Certificate

Section 73

Section 73. Lost or destroyed certificates. – The following procedure shall be followed for the issuance by
a corporation of new certificates of stock in lieu of those which have been lost, stolen or destroyed:

1. The registered owner of a certificate of stock in a corporation or his legal representative shall
file with the corporation an affidavit in triplicate setting forth, if possible, the circumstances as to
how the certificate was lost, stolen or destroyed, the number of shares represented by such
certificate, the serial number of the certificate and the name of the corporation which issued the
same. He shall also submit such other information and evidence which he may deem necessary;

2. After verifying the affidavit and other information and evidence with the books of the
corporation, said corporation shall publish a notice in a newspaper of general circulation
published in the place where the corporation has its principal office, once a week for three (3)
consecutive weeks at the expense of the registered owner of the certificate of stock which has
been lost, stolen or destroyed. The notice shall state the name of said corporation, the name of
the registered owner and the serial number of said certificate, and the number of shares
represented by such certificate, and that after the expiration of one (1) year from the date of the
last publication, if no contest has been presented to said corporation regarding said certificate of
stock, the right to make such contest shall be barred and said corporation shall cancel in its
books the certificate of stock which has been lost, stolen or destroyed and issue in lieu thereof
new certificate of stock, unless the registered owner files a bond or other security in lieu thereof
as may be required, effective for a period of one (1) year, for such amount and in such form and
with such sureties as may be satisfactory to the board of directors, in which case a new certificate
may be issued even before the expiration of the one (1) year period provided herein: Provided,
That if a contest has been presented to said corporation or if an action is pending in court
regarding the ownership of said certificate of stock which has been lost, stolen or destroyed, the
issuance of the new certificate of stock in lieu thereof shall be suspended until the final decision
by the court regarding the ownership of said certificate of stock which has been lost, stolen or
destroyed.

Except in case of fraud, bad faith, or negligence on the part of the corporation and its officers, no
action may be brought against any corporation which shall have issued certificate of stock in lieu
of those lost, stolen or destroyed pursuant to the procedure above-described.

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.

17. DIVIDENDS AND PURCHASE BY CORPORATION OF ITS OWN SHARES

17.1. Form of Dividends

IN WHAT FORMS CAN DIVIDENDS BE ISSUED?

1. Cash

2. Property

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

3. Stock dividends

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

DIFFERENTIATE BETWEEN CASH DIVIDENDS AND STOCK DIVIDENDS.

Cash Dividend Stock Dividend

Voting requirements 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?

CASE:

Nielson & Co. v. Lepanto Consolidated Mining Co. 26 SCRA 540 (1968)

FACTS:

 1.The suit involves an operating agreement executed before World War II between the Nielson and
the Lepanto Consolidated whereby the former operated and managed the mining properties owned
by the latter for a management fee of P2,500.00 a month and a 10% participation in the net profits
resulting from the operation of the mining properties. The contract in
question was made by the parties on January 30, 1937 for a period of 5 years. In the latter part of
1941, the parties agreed to renew the contract for another period of five (5) years, but in the
meantime, the Pacific War broke out in December, 1941.
 2.In January, 1942 operation of the mining properties was disrupted on account of the war. In
February of 1942, the mill, power plant, supplies on hand, equipment, concentrates on hand and
mines, were destroyed upon orders of the United States Army, to prevent their utilization by the
invading Japanese Army. The Japanese forces thereafter occupied the mining properties, operated
the mines during the continuance of the war, and who were ousted from the mining properties only in
August of 1945.

After the mining properties were liberated from the Japanese forces, Lepanto took possession and
embarked in rebuilding and reconstructing the mines and mill; setting up new organization; clearing
the mill site; repairing the mines; erecting staff quarters and bodegas and repairing existing
structures; installing new machinery and equipment; repairing roads and maintaining the same;
salvaging equipment and storing the same within the bodegas; doing police work necessary to take
care of the materials and equipment recovered; repairing and renewing the water system; and
remembering. On June 26, 1948 the mines resumed operation under the exclusive management of
Lepanto.
 3.Shortly after the mines were liberated from the Japanese invaders in 1945, a disagreement arose
between NIELSON and LEPANTO over the status of the operating contract in question which as
renewed expired in 1947. Under the terms thereof, the management contract shall remain in
suspense in case fortuitous event or force majeure, such as war or civil commotion, adversely affects
 the work of mining and milling.

Nielson held the view that, on account of the war, the contract was suspended during the war; hence
the life of the contract should be considered extended for such time of the period of suspension. On
the other hand, Lepanto contended that the contract should expire in 1947 as originally agreed upon
because the period of suspension accorded by virtue of the war did not operate to extend further the
life of the contract.No understanding appeared from the record to have been bad by the parties to
resolve the disagreement. In the meantime, Lepanto rebuilt and reconstructed the mines and was
able to bring the property into operation only in June of 1948,..
 When the SC ruled against Nielson in the December 17 case, he filed this MR citing 9 grounds: 1.
The court failed to apply the proper law to the contract; 2.the court erred in holding that the contract
was suspended; 3. that it erred when ruled that the management contract was only but not extended;
4. That Petiioner Nielson's action has prescribed; 5. it erred in holding that the period of suspension
of contract lasted from Feb 1942- June 26 1948 because of World War II; 6. it erred on amount of
awarded damages; 7. Assuming Nielson is entitled to any relief,the court erred in ordering
Lepanto to issue and deliver to Nielson shares of stock together with fruits thereof; 8. it erred
in awarding Nielson and undetermined amount of shares of stock; and 9.erred in rendering judgment
for attorney's fees.
 In its motion for reconsideration, Lepanto contends that the payment to Nielson of stock dividends as
compensation for its services under the management contract is a violation of the Corporation Law,
and that it was not, and it could not be, the intention of Lepanto and Nielson — as contracting parties
— that the services of Nielson should be paid in shares of stock taken out of stock dividends
declared by Lepanto.

ISSUE(S): WON Lepanto is under the obligation to issue and deliver shares of stock to Nielson as
the latters compensation.

HELD: SC sustained Lepanto's contention that Nielson enttiled to P300,000 in cash (not stocks) as
payment for its services, which is equivalent to 10% of the money value of the stock dividends worth
P3,000,000 which were declared on November 28,1949 and August 20,1950, with interest at the rate of
6% from Feb 6,1958.

RATIO:

 That under Section 16 of the Corporation Law stock dividends can not be issued to a person who
is not a stockholder in payment of services rendered. That Nielson can not be paid in shares of
stock which form part of the stock dividends of Lepanto for services it rendered under the
management contract.
 That the understanding between Lepanto and Nielson was simply to make the cash of the value
of the stock dividends declared as the basis for determining the amount of compensation that
should be paid to Nielson which amounted to 10% percent of the cash value of the stock
dividends declared.

 3.According to their contract as included in one of their sentence that,

"The Chairman stated that he believed that it
would be better to tie the computation of the 10% participation of
Nielson & Company, Inc., to the dividend, because Nielson will then be able to
definitely compute its net participation by the amount of the dividends declared"
The idea is conveyed that the intention of Lepanto, as expressed by its
Chairman C. A. DeWitt, was to make the value of the dividends declared — whether the
dividends were in cash or in stock — as the basis for determining the amount of
compensation that should be paid to Nielson, in the proportion of 10% of the cash value of the
dividends so declared.
 It does not mean, however, that the compensation of Nielson would be taken from the
amount actually declared as cash dividend to be distributed to the stockholder, nor from
 the shares of stocks to be issued to the stockholders as stock dividends, but from the
other assets or funds of the corporation which are not burdened by the dividends thus
declared.

CASE LAW/ DOCTRINE:

1. Section 16 of the Corporation Law, the consideration for which shares of stock may be issued are: (1)
cash; (2) property; and (3) undistributed profits. Shares of stock are given the special name "stock
dividends" only if they are issued in lieu of undistributed profits. If shares of stocks are issued in exchange
of cash or property then those shares do not fall under the category of "stock dividends". A corporation
may legally issue shares of stock in consideration of services rendered to it by a person not a stockholder,
or in payment of its indebtedness. A share of stock issued to pay for services rendered is equivalent to a
stock issued in exchange of property, because services is equivalent to property.
Likewise a share of stock issued in payment of indebtedness is equivalent to issuing a stock in
exchange for cash. But a share of stock thus issued should be part of the original capital stock of the
corporation upon its organization, or part of the stocks issued when the increase of the capitalization of a
corporation is properly authorized. Those shares of stock may be issued to a person who is not a
stockholder, or to a person already a stockholder in exchange for services rendered or for cash or
property. But a share of stock coming from stock dividends declared cannot be issued to one who
is not a stockholder of a corporation.

2. A "stock dividend" is any dividend payable in shares of stock of the corporation declaring or
authorizing such dividend. It is, what the term itself implies, a distribution of the shares of stock of the
corporation among the stockholders as dividends. A stock dividend of a corporation is a dividend
paid in shares of stock instead of cash, and is properly payable only out of surplus profits. So, a
(stock dividend is actually two things: 1) a dividend, and (2) the enforced use of the dividend money to
purchase additional shares of stock at par. When a corporation issues stock dividends, it shows that the
corporation's accumulated profits have been capitalized instead of distributed to the stockholders or
retained as surplus available for distribution, in money or kind, should opportunity offer.

3. Thus, it is apparent that stock dividends are issued only to stockholders. This is so because only
stockholders are entitled to dividends. They are the only ones who have a right to a proportional share in
that part of the surplus which is declared as dividends.

17.2. Source of Dividends

Section 43

Section 43. Power to declare dividends. - The board of directors of a stock corporation may declare
dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock
to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due
on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and
expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid
subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of
stockholders representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or
special meeting duly called for the purpose. (16a)

Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%) percent
of their paid-in capital stock, except: (1) when justified by definite corporate expansion projects or
programs approved by the board of directors; or (2) when the corporation is prohibited under any loan
agreement with any financial institution or creditor, whether local or foreign, from declaring dividends
without its/his consent, and such consent has not yet been secured; or (3) when it can be clearly shown
that such retention is necessary under special circumstances obtaining in the corporation, such as when
there is need for special reserve for probable contingencies.

FROM WHERE CAN DIVIDENDS BE SOURCED?

Dividends can be sourced only out of the unrestricted retained earnings of the
corporation.

Unrestricted retained earnings is defined as "the undistributed earnings of the

corporation which have not been allocated for any managerial, contractual or legal
purposes and which are free for distribution to the stockholders as dividends." (SEC
Rules Governing Redeemable and Treasury Shares, 1982)

Retained earnings has been defined as "net accumulated earnings of the corporation
out of transactions with individuals or firms outside the corporation." (Simmons, Smith,
Kimmel, Intermediate Accounting, 1977, ed. P. 635) The term implies the limitation that
no corporation can declare dividends unless its legal or stated capital is maintained. It
does not include:

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

 transactions involving treasury stocks which are considered

expansions and contractions of paid-in capital;

 donations as additional paid- in capital;

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

element

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

Restrictions on dividend distribution include:

 BOD’s appropriation of certain earnings for certain purposes;

 Agreements with creditors, bondholders and preferred SHs

requiring retention of certain percent of corporate earnings to
protect their interest and to secure redemption of their securities
upon maturity;

 SEC-imposed restrictions pursuant to law, like those imposed

on banks and insurance companies;

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

CASE:
Berks Broadcasting Co. v. Craumer 356 PA. 620 (1947)

FACTS:

 1931 – 3 defendants, together with one Landis, incorporated and organized plaintiff company, Berks
Broadcasting Company, under the Corporation Act of 1874, for the purpose of constructing and
operating a radio broadcasting station in Reading.
 The authorized capital stock was $100,000 consisting of 1,000 shares, each of a par value of $100,
and stock in that amount was issued to the 4 incorporators, who thereupon became the directors of
the company.
 According to the book entries of the corporation the stock was fully paid for by the receipt from each
of the shareholders $5,000 and by the fixing of a value of $80,000 upon an asset denominated
“Franchise and Promotion Expense.”
 A year later, this (Franchise and Promotion Expense) was written off the books and in its place were
substituted entries:
1. $50K as an amount “Due on Unpaid Stock Subscriptions” – (each shareholder paid $4.2K
reducing the item to $23,300, then it was cancelled altogether and was replaced with the entry
“Goodwill and Promo Expense”) and
2. Following “write-ups” or increases in the valuation of fixed assets of the company over and
above the cost of those assets less depreciation, totaling $30K
 As of December 31, 1943 the balance sheet of the company showed assets in excess of the
liabilities and the issued capital stock in the amount of $2,545.94. However, the existence of that
alleged surplus depended on the inclusion in the assets of the “write-ups” of $26K which still remain
on the balance sheet, for, if that amount were eliminated so far from being a surplus there would
then have been a deficiency to the extent of $23,545.06.
 Directors sold their stock, and declared a series of dividends totaling $13K based on the earnings of
the company of $12K+ plus the “surplus.”
 The corporation, now under the control of the new shareholders, sued the directors to recover the
$13K which was allegedly unlawfully declared and paid out as dividends

ISSUE(S): WON the declaration of dividends of the directors is unlawful.

HELD: YES.

RATIO:

 One of the basic principles of corporation law is that the capital of a corporation must not be
impaired in any manner, except, of course, as such an impairment may involuntarily occur
through losses resulting from the operation of the company's business. It is illegal to declare and
pay dividends from other than a surplus consisting of an excess in the value of the assets over
the aggregate of the liabilities and the issued capital stock. The object of this prohibition is to
afford a margin of protection for creditors in view of the limited liability of the shareholders, and
also to protect the interest of the shareholders themselves by preserving the capital so that the
purposes for which the corporation was formed may be carried out.
 Surplus must be a bona fide and not an artificial or fictitious one; it must be founded
upon actual earnings or profits and not be dependent for its existence upon a theoretical estimate
of an appreciation in the value of the company's assets. The reason why a purely conjectural
increase in valuations cannot be considered for the purpose of dividends is because such re-
appraisals, however apparently justified and accurate for the time being, are subject to market
fluctuations, are merely anticipatory of future profit, and may never be actually realized as an
asset of the company.
 "If any dividend shall be paid, or if any withdrawal or distribution of the corporate assets shall be
made, except as provided in this act, the directors under whose administration the same were
made, . . . [with an exception not here relevant] shall be jointly and severally liable to the
corporation in an amount equal to the amount of the unlawful dividend or the unlawful withdrawal
or distribution of assets." It is clear, therefore, from these express provisions that since the "write-
 ups" of $26,000 represented an unrealized appreciation in value of the plaintiff company's fixed
assets, their inclusion in determining the existence of a surplus from which dividends might be
declared was unlawful, and since, when eliminated, there would be, not a surplus, but a revealed
deficiency in capital, it would follow that the corporation is now entitled to recover from these
defendants the amount improperly distributed by them as dividends.
 It is thus clear that since the “write-ups” of $26,000 represented an unrealized
appreciation in the value of the fixed assets, their inclusion in determining the existence
of a surplus from which dividends might be declared was unlawful, and since when
eliminated there would be not a surplus, but a deficiency in capital.

Lich v. United States Rubber 39 F. Supp 675 (1941)

 US Rubber Company is a New Jersey organized corporation, it was originally incorporated in

1892 under a particular act concerning corporations. Sophia Lich a holder of 300 shares of non-
cumulative preferred stock of the corporation.

YEAR ANNUAL NET EARNING DEFICIT

1935 $2, 231, 377.69 $25, 870, 402.67

1936 $10, 172, 484.46 $17, 204, 158.52

1937 $8, 607, 902.92 $10, 471, 626.89

 The deficit, representing the accrued losses of prior years, existed in 1934 and was carried over
into the succeeding years, varying in each year only as to amount.
 In each of the said years the annual net earnings were applied to the deficit, thereby effecting
substantial reductions.
 There were no dividends declared on either the preferred or the common stock during the said
fiscal years
 In 1938, US rubber Co. in accordance with existing statutes, reconstructed its capital structure.
 There was issued, in lieu of the outstanding common stock of no par value, common stock of the
par value of $10.
 This reconstruction reduced the capital liability and created a capital surplus, which was applied
to the then existing deficit, resulting in its cancelation.
 From 1938-1940, deficit having been cancelled, the annual net earnings for each of the said
years were productive of net profits and were available for the declaration and lawful payment of
 dividends; in each of the said years dividends on the non-cumulative preferred stock were
declared and paid in full. No dividends, however, were declared on the common stock.
 On March 5 1941, US Rubber declared a divided, which was payable on April 30 of the same
year on both the preferred and common stock.
 The controversial declaration specifically contemplates payment from the net profits of the current
and year and from no other source of funds.
 Plaintiff Sophia Lich sought to enjoin the dividends on the grounds that the established
preference as to dividends, to wit, priority of payment, extends not only to the current year, but to
the prior years of 1935, 1936, and 1937, to the extent of the annual net earnings of the said
years; and, that dividends may not be paid on the common stock at this time until the dividends
are paid on the preferred stock for the years in question, either in full or in proportion to the
annual net earnings of those years.

ISSUE(S): whether or not the right of the holders of non-cumulative preferred stock to share in the
undistributed net profits was lost on the passing of the fiscal year in which the net profits were earned.

HELD: Judgment in favor of the corporation, plaintiff’s motion to enjoin is dissolved.

RATIO:

 The doctrine of the Cast Iron Pipe cases must be viewed in the light of the particular facts of
those cases; when so viewed it is apparent that it is limited in its application. The doctrine, based
upon sound equitable principles, is a departure from the general rule that the holders of non-
cumulative preferred stock lose with the close of the fiscal year all right in the undistributed net
profits of that year.
 It preserves to the holders of the non-cumulative preferred stock their right in the undivided net
profits withheld from them and retained in the business, but otherwise available for the payment
of dividends. The right to earned dividends is not extinguished upon the mere passing of the fiscal
year. The doctrine, however, cannot be extended by implication beyond its clear intendment.
 It may be generally stated that as to the payment of dividends the holders of preferred stock are
in no better position than the holders of common stock except as to priority of payment.
 The payment of dividends on the preferred stock, both cumulative and non-cumulative, is subject
to the same statutory restrictions as the payment of dividends on the common stock. It is well
established that dividends on preferred stock are not payable absolutely and unconditionally, but
only out of the sources designated by the statute, to wit, "surplus" or "net profits."
 When the doctrine is considered in the light of the statute and the foregoing principles, it is
evident that the right of the non-cumulative preferred stockholders is conditional upon: First, the
accrual of net profits, and, second, their retention in the business. It presupposes a source, to wit,
net profits, from which the dividends on the non-cumulative preferred stock may be lawfully paid,
if the directors in their discretion elect so to do. The doctrine presupposes the accrual of net
profits, as distinguished from annual net earnings, to which the non-cumulative preferred
stockholders' inchoate right to earned dividends attaches; this inchoate right continues beyond
the fiscal year in which the net profits are actually earned, and, upon distribution of the accrued
net profits in a succeeding year, the inchoate right becomes consummate and must be
recognized.

CASE LAW/ DOCTRINE:

  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 conditioned upon
1.accrual of net profits
2. retention in the business.
 If the annual net earnings of a corporation are justifiably applied to legitimate corporation
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 lost.

 If they are applied against prior losses and thereby completely absorbed, there are no profits from
which dividends may be lawfully paid.

17.3. Dividend Declaration Discretionary with Board

Section 43

Section 43. Power to declare dividends. - The board of directors of a stock corporation may declare
dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock
to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due
on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and
expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid
subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of
stockholders representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or
special meeting duly called for the purpose. (16a)

Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%) percent
of their paid-in capital stock, except: (1) when justified by definite corporate expansion projects or
programs approved by the board of directors; or (2) when the corporation is prohibited under any loan
agreement with any financial institution or creditor, whether local or foreign, from declaring dividends
without its/his consent, and such consent has not yet been secured; or (3) when it can be clearly shown
that such retention is necessary under special circumstances obtaining in the corporation, such as when
there is need for special reserve for probable contingencies.

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.

CASE:

Keough v. St. Paul Milk Co. 205 Minn. 96, 285 NW 809

FACTS:

 The business, assets, and liabilities of the partnership were exchanged for 597 shares of the St.
Paul Milk Company of $100 par value.
 The 597 shares represent the only stock issued until the stock dividend in 1936.
 In November 1930, the outstanding capital stock was reduced to $41,200 when the corporation
purchased from PJ Keough 185 of his shares.
 The stockholders of St. Paul Milk Company instituted a suit against the corporation. The suit was
brought for the purpose of compelling the declaration of stock dividend.
 Petitioners argue that those in charge of corporate affairs are wrongfully and needlessly
withholding profits available and conspiring to retain them for their benefit and to the prejudice of
the majority.
 The surplus of the company for the year 1936 amounted to $ 435, 491.73.

ISSUE(S): WON the court may compel distribution of dividends

HELD: Generally NO (SEE DOCTRINE FOR QUALIFICATION)

RATIO:

 The determination whether or not dividends should be declared is essentially a matter of internal
management. It is primarily for the corporate directors in their sound discretion to decide. But their
powers are not unlimited and judicial review should be secured when abuses contravening
shareholder rights manifest themselves.
 Ordinarily, courts will not compel a dividend unless the directors act fraudulently, unjustly, or
unreasonably so as to impair the rights of complaining stockholders to their just proportion of
corporate profit. The mere fact that a large corporate surplus exist is not enough to warrant
equitable intervention. Ultimately, the test resolves itself into an examination of the good faith and
reasonableness of the policy of retaining that which otherwise is available for dividends.

CASE LAW/ DOCTRINE: 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 204 Mich. 459, 170 N.W. 668 (1919)

FACTS:
 Stockholders led by DODGE were seeking to compel the declaration of dividends by FORD MOTOR
COMPANY.
 It turns out that FORD MOTOR COMPANY has operated successfully and profitably. However, the
management of the company has shifted its focus from seeking profitability to one that has more
emphasis on charitable purposes. Specifically is sought to provide more cars for the public at the
lowest price possible. To effect this, it was argued by management that the corporate profits earned
must be set aside for the expansion of its production facilities so that it will have a more streamlined
and cost efficient system.
 In 1916, Ford’s president and majority shareholder, Henry Ford, announced that there would be no
more special dividends, and that all future profits would be invested in lowering the price of the
product and growing the company. The board quickly ratified his decision.
 The DODGE brothers, who owned their own motor company, were minority shareholders in Ford,
and sued to reinstate the special dividends and stop the building of Ford’s proposed smelting plant.
 The lower court ordered the payment of a special dividend and enjoined Ford from building the
smelting plant.
 Ford appealed.

ISSUE(S): Whether or not such a change in corporate policy is a valid reason for not declaring dividends.

HELD: The SC ruled that the stockholders must be issued such dividends. The change in corporate policy
is prejudicial to the interests of the stockholders.

RATIO:

 The company has accumulated a very large amount of profit and that the costs of expansions are
still feasible even if dividends will be declared. The financing of such are spread over a significant
span of time. Therefore, not all of the retained earnings will be restricted especially for the current
year. It is worth mentioning though that the change in policy by the company’s board of directors
was not prejudicial to the interests of the stockholders. Yet, equity still demands that because of
the large profits, dividends which are affordable must still be paid since the receipt of such is a
right of a stockholder in the first place.

17.4. Preference as to Dividends

CASE:

Wabash Railway Co. v. Barclay 280 U.S. 197 (1930)

FACTS:

 The railway company was organized in 1915 under the laws of Indiana with three classes of
capital stock: Shares of the par value of $100, of 5% Profit Sharing Preferred Stock A; shares of
the same par value of 5% Convertible Preferred Stock B; and shares of the same par value of
Common Stock.
 At the date of the bill, there were 693,330.50 STOCK A, 24,211.42 STOCK B, and 666,977.75
COMMON STOCK. From 1915 to 1926 there were net earnings on most of the years, but for a
number of years no dividend, or 5% was paid on Class A, while $16,000,000 net earnings that
could have been used for the payment were spent upon improvements and additions to the
property and equipment of the road.
 The company does not deny that the latter expenditures were proper and were made in good
faith, or that the money could not have been applied to dividends consistently with the duties of
the road. The company now is more prosperous and proposes to pay dividends not only upon
STOCK A, but also on STOCK B and the COMMON STOCKS. However, the respondents say
that it is not entitled to do so until it has paid to them unpaid preferential dividends for prior fiscal
years in which it had net earnings that might have been applied to them but were not.
  The obligations assumed by the company appear in its instrument of incorporation and in the
certificates of Preferred Stock A, which states that
“The holders of the 5% Profit Sharing Preferred Stock A of the Company shall be entitled
to receive preferential dividends in each fiscal year up to the amount of 5%, before any
dividends shall be paid upon any other stock of the Company, but such preferential
dividends shall be non-cumulative. In the event of a liquidation, the holders shall be
entitled to be paid in full out of the assets of the Company, the par amount of their stock,
and all dividends thereon declared and unpaid before any amount shall be paid out of
said assets to the holders of any other stock of the Company.”
 By the plain meaning of the words, the holders are not entitled to dividends payable out of the net
profits accruing in any particular year, unless the directors of the Company formally declare, or
ought to declare, a dividend payable out of such profits. (In the first instance, it is at least a matter
for the directors to determine.)
 Respondents, as holders of the first preferred stock (called Class A) of the company, filed this bill
to have it declared that holders of such stock are entitled to receive preferential dividends up to
5% for each fiscal year from 1915 to 1926, inclusive to the extent that such dividends were
earned in such fiscal years but were unpaid, before any dividends are paid upon other stock. And
that the Company may be enjoined from paying dividends upon preferred stock B or common
stock, unless it shall first have paid such preferential dividends of 5% to the extent that the
Company has had net earnings available for the payment and that such dividends remain unpaid.
 DISTRICT COURT: DISMISSED (No Explanation)
 CIRCUIT COURT OF APPEALS: REVERSED (No Explanation)

ISSUE(S): WON the respondents are entitled to receive preferential dividends.

HELD: No, they are not.

RATIO:

 We believe that it has been the common understanding of lawyers and business men that in the
case of non-cumulative stock entitled only to a dividend if declared out of annual profits, if those
profits are justifiably applied by the directors to capital improvements and no dividend is declared
within the year, the claim for that year is gone and cannot be asserted at a later date.
 But recently, doubts have been raised that seem to have affected the minds of the majority below.
We suppose the ground for the doubts is the probability that the directors will be tempted to
abuse their power, in the usual case of a corporation controlled by the holders of the common
stock. Their interest would lead them to apply earnings to improvement of the capital rather than
to make avoidable payments of dividends, which they do not share. But whether the remedies
available in case of such a breach of duty are adequate or not, and apart from the fact that the
control of the Wabash seems to have been in Class A, the class to which the respondents
belong, the law 'has long advised them that their rights depend upon the judgment of men subject
to just that possible bias.'
 When a man buys stock instead of bonds, he takes a greater risk in the business. No one
suggests that he has a right to dividends if there are no net earnings. But the investment
presupposes that the business is to go on, and therefore, even if there are net earnings,
the holder of stock, preferred as well as common, is entitled to have a dividend declared
only out of such part of them as can be applied to dividends consistently with a wise
administration of a going concern.
 When, as was the case here, the dividends in each fiscal year were declared to be non-
cumulative and no net income could be so applied within the fiscal year referred to in the
certificate, the right for that year was gone. If the right is extended further upon some
conception of policy, it is enlarged beyond the meaning of the contract and the common
and reasonable understanding of men.

Burk v. Ottawa Gas & Electric Co. 87 Kan. 6, 123 Pac. 875 (1912)
FACTS:

 Ottawa Gas & Electric Co. was involved in a franchise to construct and maintain a natural gas plant in
the city of Ottawa for the term of 25 years.
 Burk is the holder of eight shares of 6% non-cumulative preferred shares of the said company. He
along with other preferred stockholders filed an action against the Board of Directors seeking:
1) an accounting of all assets;
2) a declaration of dividends; and
3) a restraining order against the officers of the company from paying out any of the money or
disposing of the assets except such amounts as would be necessary to conduct the business
of the corporation.
 Ottawa maintained that it was unable to declare a dividend because its funds were exhausted by
expenditures that it was obliged to make. The principal expenditure was for extensions of the
company’s plant.
 The lower court ruled for the defendant corporation and its officers on the ground that the extensions
of the company’s properties “were necessary and for the betterment of the plant and
accommodation of the patrons.” Hence, this appeal.

ISSUE(S): Whether or not the preferred stockholder has a right to a declaration and payment of
dividends under the circumstances of the case.

HELD: Yes. However, the case was remanded for more determinative proceedings because the manner
and nature of the expenditures for the extensions or expansions of the company’s plant was not clearly
illustrated

RATIO:

 If the word “necessary” is interpreted to mean that the extensions were such as the corporation
was REQUIRED to make by its obligation to the public, then the trial court was right in holding
that the plaintiff could not look for dividends to any part of the funds so expended.

 However, the trial court seemed to have used the term “necessary” as meaning merely that the
extensions were advisable as a matter of good judgment, for the BENEFIT of the business.
Under such an interpretation, the Supreme Court is of the opinion that the funds so
employed were wrongfully diverted from the payment of dividends to the plaintiffs. The
directors of the corporation owed a positive duty to pay a dividend to the preferred
stockholders whenever in any year there were net profits available. The funds that might be
used for that purpose could not rightfully be expended for extensions merely for the benefit of the
business, nor could they be withheld to meet the expenses of the next year.
 The fair interpretation of the contract between Ottawa and its stockholders is that if in any year
net profits are earned, a dividend is to be declared. To hold otherwise, meaning if the Board of
Directors 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 stockholders, however, are not generally creditors until dividends are declared. In the
case at bar, if dividends should have been declared to such stockholders, they are considered
creditors from that time.

CASE LAW/ DOCTRINE:

When Right to Dividends Vests

General Rule: The right of the stockholders to be paid dividends vests as soon as the same have been
lawfully declared by the Board of Directors. From that time, it becomes a debt owing by the corporation to
each stockholder and no revocation of the dividends can be made.

The reason for this rule is based on reasons of policy which is to prevent the misleading of investors and
the probable effect which a revocation may have on the stability of transactions involving shares of stock.

Exception: It does not apply where the declaration of dividends was:

(1) Not yet announced or communicated to the public, or,
(2) When stock dividends are declared since these are not distributions but merely represent changes in
the capital structure.

Rights of Transferee

Since the right to dividends vests upon its declaration, the RULE is: Whoever owns the stock at that
time also owns the dividends. A subsequent transfer of such stock would not carry with it the right to
the dividends which have been declared but not yet paid.

17.5. When Right to Dividends Vests; Right 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 SH’s share in the dividends will depend on
the capital contribution; NOT the number of shares he has.

CASE:

McClaran v. Crescent Planning Mill Co. 117 Mo. App. 40 (1906)

FACTS:

 Crescent Planning Mill, a manufacturing corporation in Missouri, through its board of directors,
declared a cash dividend. They declared such because they had an ample surplus of funds.
 The cash dividend was to be divided into 4 equal installments.
 No other board resolution followed. The funds for the dividends weren’t set aside.
 The corporation paid 1 of 4 installments.
 When April came which was the month where the 2nd installment should have been paid, the board
held a meeting and resolved that they had overestimated their surplus funds. Hence, they are
revoking and rescinding the 3 remaining installments indefinitely. In short, they took back what they
initially stated.
 The stockholder requested from the corporation to pay its 2nd installment. Obviously, this was refused
by the corporation.
 The stockholder filed an action for recovery of the alleged amount.
 Crescent Planning Mill sets up the following defenses: (1) no funds were set aside for the payment of
the dividends, and (2) their resolution superseded the dividend declaration.
 The lower court ruled in favor of the stockholder.
 Corporation then assailed the decision to the CA of Missouri.
 Stockholder died. McClaran, his counsel, was then appointed as administrator.
 Crescent Planning Mill’s counsel contends that: “the phrase set aside is included in the definition of
dividends”. Hence, the BOD needs to set aside funds for the dividends. He cited Ford v. East
Hampton which states that the BOD in that case validly rescinded its declaration of dividends. Why
shouldn’t they be allowed to do the same?

ISSUE(S):

 Whether the mere declaration of distribution of dividends by the corporation creates a debt in
favor of the stockholders despite the corporation not setting aside of funds for it?
 Whether or not the corporation can rescind its declaration that it will distribute dividends and thus
not pay the installments not yet paid?

HELD:

 YES.
 NO.

RATIO: The stockholder has the right to demand from the company its dividends. As soon as the BOD
declares the dividends, the corporation becomes indebted to the stockholder for what it declared as
dividends. Hence, the action of recovery instituted by a stockholder can prosper.

17.6. Liability for Illegal Dividends

- Directors

- Stockholders

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)

17.7. Purchase by Corporation of Its Own Shares

17.7.1. Limitations on power: proper purposes and existence of surplus
Section 41

Section 41. Power to acquire own shares. – A stock corporation shall have the power to purchase or
acquire its own shares for a legitimate corporate purpose or purposes, including but not limited to the
following cases: Provided, That the corporation has unrestricted retained earnings in its books to cover
the shares to be purchased or acquired:
 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; and

3. To pay dissenting or withdrawing stockholders entitled to payment for their shares under the
provisions of this Code.

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).

17.7.2. Remedies in case of improper purchase

Creditors who are prejudiced by the repurchase made by an insolvent corporation:

Remedy: May have a right of action against selling stockholders to recover the consideration paid.

If BoD are negligent/guilty of bad faith in approving the repurchase:

Remedy: BoD will be personally liable to the receiver of the corporate assets in accordance with section
31 “a director is solitarily liable to stockholders’ as well as to “others” who are prejudiced by their acts of
negligence or bad faith.

Effects of improper purchase:

1) May affect shareholders because it may reduce what is due to them as dividends.

2) Purchase may prove discriminatory to the other shareholders if the remaining assets are not sufficient
to cover debts as well as the par or issued value of their shares.

3) May result in shift of voting control.